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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 September 30, 2005



| ̈ | 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 shell company (as defined by Rule 12b-2 of the Exchange Act.)    Yes ̈No  x



Transitional small business disclosure format:    Yes ̈No  x.



Accelerated Filer:    Yes ̈No  x.



At November 14, 2005,
4,076,993 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

September 30, 2005



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                        |  | 14                                        
|                              |  |                                                                    
|                              |  | Item 3.
Quantitative and Qualitative Disclosures about Market Risk  |  | 29                                        
|                              |  |                                                                    
|                              |  | Item 4.
Controls and Procedures                                     |  | 29                                        
|                              | 
|Part II.
OTHER INFORMATION    |  |                                                                    
|                              |  |                                                                    
|                              |  | Item 1.
Legal Proceedings                                           |  | 30                                        
|                              |  |                                                                    
|                              |  | Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds |  | 30                                        
|                              |  |                                                                    
|                              |  | Item 3.
Defaults Upon Senior Securities                             |  | 30                                        
|                              |  |                                                                    
|                              |  | Item 4.
Submission of Matters to a Vote of Security Holders         |  | 30                                        
|                              |  |                                                                    
|                              |  | Item 5.
Other Information                                           |  | 30                                        
|                              |  |                                                                    
|                              |  | Item 6.
Exhibits and Reports on Form 8-K                            |  | 31                                        
|                              | 
|SIGNATURES                    |  | 34                                                                 
|                              | 
|INDEX TO EXHIBITS             |  | 35                                                                 
|                              | 
|CERTIFICATIONS                |  | 38                                                                 



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##### Table of Contents

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.



3



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##### Table of Contents

PART 1  FINANCIAL INFORMATION

Item 1. Financial Statements.



VALLEY FINANCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)



|                                                                                                                                                      |  |                    |         |   |                   |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | ------- | - | ----------------- | - | ------- | -
|                                                                                                                                                      |  | (Unaudited)9/30/05 |         |   | (Audited)12/31/04 |  
|Assets                                                                                                                                                |  |                    |         |   |                   |   |         |  
|Cash and due from banks                                                                                                                               |  | $                  | 10,302  |   |                   | $ | 7,119   |  
|Money market investments:                                                                                                                             |  |                    |         |   |                   |   |         |  
|Federal funds sold                                                                                                                                    |  |                    |        |   |                   |   |        |  
|Interest-bearing deposits in other banks                                                                                                              |  |                    | 56      |   |                   |   | 62      |  
|                                                                                                                                                      |  |                    |         |   |                   |   |         |  
|Total money market investments                                                                                                                        |  |                    | 56      |   |                   |   | 62      |  
|Securities available for sale                                                                                                                         |  |                    | 34,198  |   |                   |   | 45,820  |  
|Securities held to maturity (approximate market values of $21,292 at September 30, 2005 and $22,084 at December 31,
2004)                             |  |                    | 21,437  |   |                   |   | 22,154  |  
|Restricted equity securities                                                                                                                          |  |                    | 3,987   |   |                   |   | 3,501   |  
|Loans:                                                                                                                                                |  |                    |         |   |                   |   |         |  
|Commercial and industrial loans                                                                                                                       |  |                    | 85,889  |   |                   |   | 71,580  |  
|Commercial real estate loans                                                                                                                          |  |                    | 139,373 |   |                   |   | 107,186 |  
|Real estate construction loans                                                                                                                        |  |                    | 52,101  |   |                   |   | 25,404  |  
|Residential real estate loans                                                                                                                         |  |                    | 73,382  |   |                   |   | 43,848  |  
|Loans to individuals                                                                                                                                  |  |                    | 28,495  |   |                   |   | 34,758  |  
|                                                                                                                                                      |  |                    |         |   |                   |   |         |  
|Total loans                                                                                                                                           |  |                    | 379,240 |   |                   |   | 282,776 |  
|Less unearned income                                                                                                                                  |  |                    |        |   |                   |   | (2      | )
|Less allowance for loan losses                                                                                                                        |  |                    | (4,003  | ) |                   |   | (2,989  | )
|                                                                                                                                                      |  |                    |         |   |                   |   |         |  
|Net loans                                                                                                                                             |  |                    | 375,237 |   |                   |   | 279,785 |  
|Foreclosed assets                                                                                                                                     |  |                    |        |   |                   |   |        |  
|Premises and equipment                                                                                                                                |  |                    | 6,505   |   |                   |   | 6,077   |  
|Bank owned life insurance                                                                                                                             |  |                    | 6,353   |   |                   |   | 6,125   |  
|Accrued interest receivable                                                                                                                           |  |                    | 1,779   |   |                   |   | 1,434   |  
|Other assets                                                                                                                                          |  |                    | 2,658   |   |                   |   | 1,902   |  
|                                                                                                                                                      |  |                    |         |   |                   |   |         |  
|Total assets                                                                                                                                          |  | $                  | 462,512 |   |                   | $ | 373,979 |  
|                                                                                                                                                      |  |                    |         |   |                   |   |         |  
|Liabilities and Shareholders Equity                                                                                                                  |  |                    |         |   |                   |   |         |  
|Deposits:                                                                                                                                             |  |                    |         |   |                   |   |         |  
|Non-interest bearing demand deposits                                                                                                                  |  | $                  | 19,896  |   |                   | $ | 47,108  |  
|Interest bearing demand deposits                                                                                                                      |  |                    | 4,475   |   |                   |   | 19,690  |  
|Money market deposits                                                                                                                                 |  |                    | 48,589  |   |                   |   | 36,759  |  
|Savings deposits                                                                                                                                      |  |                    | 52,156  |   |                   |   | 4,957   |  
|Certificates of deposits of $100,000 or more                                                                                                          |  |                    | 51,006  |   |                   |   | 38,059  |  
|Other time deposits                                                                                                                                   |  |                    | 173,893 |   |                   |   | 132,760 |  
|                                                                                                                                                      |  |                    |         |   |                   |   |         |  
|Total deposits                                                                                                                                        |  |                    | 350,016 |   |                   |   | 279,333 |  
|                                                                                                                                                      |  |                    |         |   |                   |   |         |  
|Federal funds purchased and securities sold under agreements to repurchase                                                                            |  |                    | 8,768   |   |                   |   | 8,004   |  
|Short-term borrowings                                                                                                                                 |  |                    | 23,000  |   |                   |   | 15,000  |  
|Long-term borrowings                                                                                                                                  |  |                    | 37,000  |   |                   |   | 37,000  |  
|Guaranteed preferred beneficial interests in the Companys junior subordinated debentures                                                             |  |                    | 11,000  |   |                   |   | 4,000   |  
|Accrued interest payable                                                                                                                              |  |                    | 1,500   |   |                   |   | 1,050   |  
|Other liabilities                                                                                                                                     |  |                    | 1,178   |   |                   |   | 1,276   |  
|                                                                                                                                                      |  |                    |         |   |                   |   |         |  
|Total liabilities                                                                                                                                     |  |                    | 432,245 |   |                   |   | 345,663 |  
|                                                                                                                                                      |  |                    |         |   |                   |   |         |  
|Commitments and other contingencies                                                                                                                   |  |                    |        |   |                   |   |        |  
|Preferred stock, no par value. Authorized 10,000,000 shares; none issued and outstanding.                                                             |  |                    |        |   |                   |   |        |  
|Common stock, no par value. Authorized 10,000,000 shares; issued and outstanding 4,076,993 at September 30, 2005, and 4,074,630 at
December 31, 2004. |  |                    | 16,998  |   |                   |   | 16,974  |  
|Retained earnings                                                                                                                                     |  |                    | 13,345  |   |                   |   | 11,321  |  
|Accumulated other comprehensive income / (loss)                                                                                                       |  |                    | (293    | ) |                   |   | 21      |  
|                                                                                                                                                      |  |                    |         |   |                   |   |         |  
|Total shareholders equity                                                                                                                            |  |                    | 30,050  |   |                   |   | 28,316  |  
|                                                                                                                                                      |  |                    |         |   |                   |   |         |  
|Total liabilities and shareholders equity                                                                                                            |  | $                  | 462,512 |   |                   | $ | 373,979 |  
|                                                                                                                                                      |  |                    |         |   |                   |   |         |  



See accompanying notes to consolidated
financial statements.



4



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##### Table of Contents

VALLEY FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(In thousands, except
per share data)



|                                                                                                      |  |                |       |                |       |         |        |         |       
|----------------------------------------------------------------------------------------------------- |  | -------------- | ----- | -------------- | ----- | ------- | ------ | ------- | ------
|                                                                                                      |  | 3 Months Ended |       | 9 Months Ended
|                                                                                                      |  | 9/30/05        |       | 9/30/04        |       | 9/30/05 |        | 9/30/04
|Interest Income:                                                                                      |  |                |       |                |       |         |        |         |       
|Interest and fees on loans                                                                            |  | $              | 5,783 |                | 3,822 |         | 15,064 |         | 10,667
|Interest on money market investments                                                                  |  |                | 11    |                | 15    |         | 70     |         | 41    
|Interest on securities  taxable                                                                      |  |                | 503   |                | 598   |         | 1,627  |         | 1,675 
|Interest on securities  nontaxable                                                                   |  |                | 138   |                | 160   |         | 447    |         | 485   
|                                                                                                      |  |                |       |                |       |         |        |         |       
|Total interest income                                                                                 |  |                | 6,435 |                | 4,595 |         | 17,208 |         | 12,868
|                                                                                                      |  |                |       |               
|Interest Expense:                                                                                     |  |                |       |                |       |         |        |         |       
|Interest on certificates of deposit > 100,000                                                         |  |                | 419   |                | 262   |         | 1,059  |         | 763   
|Interest on other deposits                                                                            |  |                | 1,793 |                | 1,045 |         | 4,491  |         | 2,716 
|Interest on long-term borrowings                                                                      |  |                | 398   |                | 397   |         | 1,179  |         | 1,183 
|Interest on federal funds purchased and securities sold under agreements to repurchase                |  |                | 80    |                | 19    |         | 182    |         | 52    
|Interest on guaranteed preferred beneficial interests in the Companys junior subordinated debentures |  |                | 71    |                | 48    |         | 191    |         | 134   
|Interest on short-term borrowings                                                                     |  |                | 151   |                | 63    |         | 376    |         | 155   
|                                                                                                      |  |                |       |                |       |         |        |         |       
|Total interest expense                                                                                |  |                | 2,912 |                | 1,834 |         | 7,478  |         | 5,003 
|                                                                                                      |  |                |       |                |       |         |        |         |       
|Net interest income                                                                                   |  |                | 3,523 |                | 2,761 |         | 9,730  |         | 7,865 
|                                                                                                      |  |                |       |               
|Provision for loan losses                                                                             |  |                | 455   |                | 331   |         | 1,180  |         | 578   
|                                                                                                      |  |                |       |                |       |         |        |         |       
|Net interest income after provision for loan losses                                                   |  |                | 3,068 |                | 2,430 |         | 8,550  |         | 7,287 
|                                                                                                      |  |                |       |                |       |         |        |         |       
|Noninterest Income:                                                                                   |  |                |       |                |       |         |        |         |       
|Service charges on deposit accounts                                                                   |  |                | 237   |                | 209   |         | 682    |         | 579   
|Income earned on bank owned life insurance                                                            |  |                | 75    |                | 77    |         | 227    |         | 226   
|Other income on real estate loans                                                                     |  |                | 23    |                | 19    |         | 69     |         | 74    
|Other fee income                                                                                      |  |                | 84    |                | 40    |         | 160    |         | 109   
|Gains on sale of foreclosed assets                                                                    |  |                | 129   |                |      |         | 129    |         |      
|Gains on sales of securities                                                                          |  |                |      |                |      |         | 53     |         | 17    
|                                                                                                      |  |                |       |                |       |         |        |         |       
|Total noninterest income                                                                              |  |                | 548   |                | 345   |         | 1,320  |         | 1,005 
|                                                                                                      |  |                |       |                |       |         |        |         |       
|Noninterest Expense:                                                                                  |  |                |       |                |       |         |        |         |       
|Compensation expense                                                                                  |  |                | 1,230 |                | 1,017 |         | 3,443  |         | 3,033 
|Occupancy expense                                                                                     |  |                | 157   |                | 135   |         | 453    |         | 363   
|Equipment expense                                                                                     |  |                | 119   |                | 107   |         | 343    |         | 319   
|Data processing expense                                                                               |  |                | 141   |                | 130   |         | 416    |         | 375   
|Advertising and marketing                                                                             |  |                | 75    |                | 26    |         | 199    |         | 99    
|Audit fees                                                                                            |  |                | 78    |                | 34    |         | 229    |         | 102   
|Franchised and purchased tax credit expense                                                           |  |                | 47    |                | 46    |         | 140    |         | 149   
|Business manager                                                                                      |  |                | 50    |                | 79    |         | 190    |         | 214   
|Deposit expenses                                                                                      |  |                | 90    |                | 44    |         | 192    |         | 139   
|Loan expenses                                                                                         |  |                | 52    |                | 29    |         | 159    |         | 105   
|Computer software                                                                                     |  |                | 75    |                | 52    |         | 212    |         | 153   
|Other expense                                                                                         |  |                | 272   |                | 180   |         | 772    |         | 582   
|                                                                                                      |  |                |       |                |       |         |        |         |       
|Total noninterest expense                                                                             |  |                | 2,386 |                | 1,879 |         | 6,748  |         | 5,633 
|                                                                                                      |  |                |       |                |       |         |        |         |       
|Net income before taxes                                                                               |  |                | 1,230 |                | 896   |         | 3,122  |         | 2,659 
|                                                                                                      |  |                |       |               
|Provision for income taxes                                                                            |  |                | 352   |                | 230   |         | 852    |         | 689   
|                                                                                                      |  |                |       |                |       |         |        |         |       
|Net income                                                                                            |  | $              | 878   |                | 666   |         | 2,270  |         | 1,970 
|                                                                                                      |  |                |       |                |       |         |        |         |       
|Basic earnings per share                                                                              |  | $              | 0.22  |                | 0.18  |         | 0.56   |         | 0.53  
|                                                                                                      |  |                |       |                |       |         |        |         |       
|Diluted earnings per share                                                                            |  | $              | 0.21  |                | 0.17  |         | 0.53   |         | 0.49  
|                                                                                                      |  |                |       |                |       |         |        |         |       



See accompanying notes to consolidated
financial statements.



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##### Table of Contents

VALLEY FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands, except
per share data)



|                                                                                                                    |  |                |         |   |         |   |         |  
|------------------------------------------------------------------------------------------------------------------- |  | -------------- | ------- | - | ------- | - | ------- | -
|                                                                                                                    |  | 9 Months Ended |        
|                                                                                                                    |  | 9/30/05        |         |   | 9/30/04 |  
|Cash Flows From Operating Activities:                                                                               |  |                |         |   |         |   |         |  
|Net income                                                                                                          |  | $              | 2,270   |   |         | $ | 1,970   |  
|Adjustments to reconcile net income to net cash provided by operating activities:                                   |  |                |         |   |         |   |         |  
|Provision for loan losses                                                                                           |  |                | 1,180   |   |         |   | 578     |  
|Depreciation and amortization                                                                                       |  |                | 515     |   |         |   | 474     |  
|Tax benefit from exercise of nonqualified stock options                                                             |  |                |        |   |         |   | 287     |  
|Net (gains)/losses on sale of securities                                                                            |  |                | (53     | ) |         |   | (17     | )
|Net (gains) losses on sales of foreclosed properties                                                                |  |                | (129    | ) |         |   | 8       |  
|Amortization (accretion) of premiums/discounts                                                                      |  |                | 152     |   |         |   | 225     |  
|Increase (decrease) in unearned fees                                                                                |  |                |        |   |         |   | (3      | )
|(Increase) decrease in interest receivable                                                                          |  |                | (345    | ) |         |   | (248    | )
|(Increase) decrease in other assets                                                                                 |  |                | (626    | ) |         |   | (207    | )
|(Increase) decrease in value of life insurance contracts                                                            |  |                | (228    | ) |         |   | (226    | )
|Increase (decrease) in accrued interest payable                                                                     |  |                | 450     |   |         |   | 303     |  
|Increase (decrease) in other liabilities                                                                            |  |                | (317    | ) |         |   | 162     |  
|                                                                                                                    |  |                |         |   |         |   |         |  
|Net cash provided by operating activities                                                                           |  |                | 2,869   |   |         |   | 3,306   |  
|                                                                                                                    |  |                |         |   |         |   |         |  
|Cash Flows From Investing Activities:                                                                               |  |                |         |   |         |   |         |  
|(Increase) decrease in money market investments                                                                     |  |                | 6       |   |         |   | (253    | )
|Purchases of premises and equipment                                                                                 |  |                | (856    | ) |         |   | (429    | )
|Purchases of securities available for sale                                                                          |  |                |        |   |         |   | (18,868 | )
|Purchases of securities held to maturity                                                                            |  |                | (215    | ) |         |   | (2,368  | )
|Purchases of restricted equity securities                                                                           |  |                | (801    | ) |         |   |        |  
|Principal repayments/sales/calls of securities available for sale                                                   |  |                | 11,283  |   |         |   | 10,613  |  
|Principal repayments of securities held to maturity                                                                 |  |                | 858     |   |         |   | 2,498   |  
|Principal repayments of restricted equity securities                                                                |  |                | 315     |   |         |   |        |  
|Proceeds from sale of fixed assets                                                                                  |  |                |        |   |         |   | 3       |  
|Proceeds from sale of foreclosed properties                                                                         |  |                | 1,350   |   |         |   | 276     |  
|Increase in loans, net                                                                                              |  |                | (97,853 | ) |         |   | (48,154 | )
|                                                                                                                    |  |                |         |   |         |   |         |  
|Net cash used in investing activities                                                                               |  |                | (85,913 | ) |         |   | (56,682 | )
|                                                                                                                    |  |                |         |   |         |   |         |  
|Cash Flows From Financing Activities:                                                                               |  |                |         |   |         |   |         |  
|Increase (decrease) in non-interest bearing deposits                                                                |  |                | (27,212 | ) |         |   | 6,785   |  
|Increase (decrease) in interest bearing deposits                                                                    |  |                | 97,895  |   |         |   | 47,359  |  
|Increase (decrease) in short-term borrowings                                                                        |  |                | 8,000   |   |         |   | (2,556  | )
|Increase (decrease) in Federal funds purchased and securities sold under agreements to repurchase                   |  |                | 764     |   |         |   | 1,049   |  
|Proceeds from Federal Home Loan Bank advances                                                                       |  |                |        |   |         |   |        |  
|Proceeds from issuance of guaranteed preferred beneficial interests in the Companys junior subordinated debentures |  |                | 7,000   |   |         |   |        |  
|Proceeds from issuance of common stock                                                                              |  |                | 24      |   |         |   | 467     |  
|Cash dividends paid                                                                                                 |  |                | (244    | ) |         |   | (227    | )
|                                                                                                                    |  |                |         |   |         |   |         |  
|Net cash provided by financing activities                                                                           |  |                | 86,227  |   |         |   | 52,877  |  
|                                                                                                                    |  |                |         |   |         |   |         |  
|Net Increase (Decrease) in Cash and Due from Banks                                                                  |  |                | 3,183   |   |         |   | (499    | )
|                                                                                                                    |  |                |         |   |         |   |         |  
|Cash and Due From Banks at Beginning of Period                                                                      |  |                | 7,119   |   |         |   | 7,511   |  
|                                                                                                                    |  |                |         |   |         |   |         |  
|Cash and Due From Banks at End of Period                                                                            |  | $              | 10,302  |   |         | $ | 7,012   |  
|                                                                                                                    |  |                |         |   |         |   |         |  
|Supplemental disclosure of cash flow information:                                                                   |  |                |         |   |         |   |         |  
|Cash paid during the period for interest                                                                            |  | $              | 7,028   |   |         | $ | 4,700   |  
|                                                                                                                    |  |                |         |   |         |   |         |  
|Cash paid during the period for taxes                                                                               |  | $              | 1,213   |   |         | $ | 523     |  
|                                                                                                                    |  |                |         |   |         |   |         |  
|Noncash financing and investing activities:                                                                         |  |                |         |   |         |   |         |  
|Transfer of loans to foreclosed property                                                                            |  | $              | 1,221   |   |         | $ | 283     |  
|                                                                                                                    |  |                |         |   |         |   |         |  



See accompanying notes to consolidated
financial statements.



6



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##### Table of Contents

VALLEY FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

September 30, 2005 (Unaudited)

(In
thousands, except share and per share data)



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



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



The consolidated financial statements of the Company conform
to generally accepted accounting principles and to general banking industry practices. The interim period consolidated financial statements are unaudited; however, in the opinion of management, all adjustments of a normal recurring nature which are
necessary for a fair presentation of the consolidated financial statements herein have been included. The consolidated financial statements herein should be read in conjunction with the Companys 2004 Annual Report on Form 10-KSB.



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



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



For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks. To comply with Federal Reserve
regulations, the Bank is required to maintain certain average reserve balances. The daily cash reserve requirement for the week including September 30, 2005 was $1,022, less cash on hand in the amount of $1,088, or a net of $0. We started a
deposit reclassification program in September 2005 that restructures interest and non-interest checking accounts so that a certain portion of the balance in each account is actually maintained in a linked Savings sub-account. The Savings portion of
the combined account balance is not subject to the 10% reserve that is required for checking balances, therefore the overall daily cash reserve requirement for the Federal Reserve has been reduced. We received approval from our Federal Reserve
district for this program. As such, for financial reporting purposes, our non-interest bearing demand deposits have been reduced and our savings deposits have been increased.



As a condition of our correspondent bank agreement, the Bank is also required to maintain a target balance.
The target balance as of September 30, 2005 was $250.



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



The carrying values, unrealized gains, unrealized losses and approximate fair values of available for sale and held to maturity investment
securities at September 30, 2005 are shown in the tables below. As of September 30, 2005 investments (including both available for sale and held to maturity) and restricted equity securities with amortized costs and fair values of $37,501
and $37,340, respectively, were pledged as collateral for public deposits, a line of



7



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##### Table of Contents

credit available from the Federal Home Loan Bank, customer sweep accounts, and for other purposes as
required or permitted by law. At September 30, 2005 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 September 30, 2005. Securities available for sale
are carried at approximate market value.



Available for Sale
Investment Portfolio  Category Distribution

(dollars in thousands)



|                                    |  |                |        |                 |   |                  |  |   |                        |   |  |   |       
|----------------------------------- |  | -------------- | ------ | --------------- | - | ---------------- |  | - | ---------------------- | - |  | - | ------
|                                    |  | AmortizedCosts |        | UnrealizedGains |   | UnrealizedLosses |  |   | ApproximateFair Values
|U.S. Government agencies            |  | $              | 6,598  |                 | $ | 3                |  | $ | (52                    | ) |  | $ | 6,549 
|Mortgage-backed securities          |  |                | 5,410  |                 |   | 1                |  |   | (145                   | ) |  |   | 5,266 
|Collateralized mortgage obligations |  |                | 15,412 |                 |   | 1                |  |   | (376                   | ) |  |   | 15,037
|States and political subdivisions   |  |                | 7,021  |                 |   | 149              |  |   | (20                    | ) |  |   | 7,150 
|Corporate debt securities           |  |                | 200    |                 |   |                 |  |   | (4                     | ) |  |   | 196   
|                                    |  |                |        |                 |   |                  |  |   |                        |   |  |   |       
|Total securities available for sale |  | $              | 34,641 |                 | $ | 154              |  | $ | (597                   | ) |  | $ | 34,198
|                                    |  |                |        |                 |   |                  |  |   |                        |   |  |   |       



The
following table sets forth the composition of securities held to maturity at September 30, 2005. 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. Treasury                       |  | $              | 200    |                 | $ |                 |  | $ |                       |   |  | $ | 200   
|U.S. Government agencies            |  |                | 9,936  |                 |   | 13               |  |   | (129                   | ) |  |   | 9,820 
|Mortgage-backed securities          |  |                | 3,297  |                 |   |                 |  |   | (50                    | ) |  |   | 3,247 
|Collateralized mortgage obligations |  |                | 626    |                 |   |                 |  |   | (18                    | ) |  |   | 608   
|States and political subdivisions   |  |                | 7,378  |                 |   | 76               |  |   | (37                    | ) |  |   | 7,417 
|                                    |  |                |        |                 |   |                  |  |   |                        |   |  |   |       
|Total securities held to maturity   |  | $              | 21,437 |                 | $ | 89               |  | $ | (235                   | ) |  | $ | 21,292
|                                    |  |                |        |                 |   |                  |  |   |                        |   |  |   |       



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



The following table summarizes the loan loss experience for the nine-month periods ended September 30, 2005 and 2004.



Allowance for Loan Losses

(dollars in thousands)



|                                  |  |      |       |   |      |   |       |  
|--------------------------------- |  | ---- | ----- | - | ---- | - | ----- | -
|                                  |  | 2005 |       |   | 2004 |  
|Balance at January 1              |  | $    | 2,989 |   |      | $ | 2,566 |  
|Provision for loan losses         |  |      | 1,180 |   |      |   | 578   |  
|Recoveries  Loans to individuals |  |      | 2     |   |      |   |      |  
|Charged off loans:                |  |      |       |   |      |   |       |  
|Commercial                        |  |      | (163  | ) |      |   | (104  | )
|Credit Cards                      |  |      | (5    | ) |      |   | (1    | )
|Loans to individuals              |  |      |      |   |      |   | (16   | )
|                                  |  |      |       |   |      |   |       |  
|Balance at September 30           |  | $    | 4,003 |   |      | $ | 3,023 |  
|                                  |  |      |       |   |      |   |       |  



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



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



Weighted Average Shares Outstanding



|        |  |                 |  |                 |  |           |  |          
|------- |  | --------------- |  | --------------- |  | --------- |  | ---------
|        |  | 9 Months Ending |  | 3 Months Ending
|        |  | 9/30/05         |  | 9/30/04         |  | 9/30/05   |  | 9/30/04  
|Basic   |  | 4,075,426       |  | 3,726,988       |  | 4,076,993 |  | 3,798,665
|Diluted |  | 4,233,365       |  | 3,981,501       |  | 4,233,816 |  | 4,006,616



| | (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 nine months ended September 30, 2005 and 2004, total comprehensive income was $1,956 and $1,376 respectively.



9



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##### Table of Contents

The information that follows discloses the reclassification adjustments and the income
taxes related to securities available for sale that are included in other comprehensive income (loss), net of income taxes for the nine month and three month periods ended September 30, 2005 and 2004.



|                                                                                        |  |                |      |   |                |   |       |         |  |   |         |   |  |   |     |  
|--------------------------------------------------------------------------------------- |  | -------------- | ---- | - | -------------- | - | ----- | ------- |  | - | ------- | - |  | - | --- | -
|                                                                                        |  | 9 Months Ended |      |   | 3 Months Ended |  
|                                                                                        |  | 9/30/05        |      |   | 9/30/04        |   |       | 9/30/05 |  |   | 9/30/04 |  
|Net unrealized gains (losses) on securities available for sale:                         |  |                |      |   |                |   |       |         |  |   |         |   |  |   |     |  
|Net unrealized holding gains (losses) during the year                                   |  | $              | (422 | ) |                | $ | 1,076 |         |  | $ | (400    | ) |  | $ | 70  |  
|Less reclassification adjustments for realized gains included in net income, net of tax |  |                | (35  | ) |                |   |      |         |  |   |        |   |  |   | (11 | )
|Income tax benefit (expense)                                                            |  |                | 143  |   |                |   | (366  | )       |  |   | 136     |   |  |   | (24 | )
|                                                                                        |  |                |      |   |                |   |       |         |  |   |         |   |  |   |     |  
|Other comprehensive income (loss), net of income taxes                                  |  | $              | (314 | ) |                | $ | 710   |         |  | $ | (264    | ) |  | $ | 35  |  
|                                                                                        |  |                |      |   |                |   |       |         |  |   |         |   |  |   |     |  



| | (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 September 30, 2005 outstanding commitments to extend credit were $136,847 as compared to $100,838 at December 31, 2004.



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



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



The Bank has entered into transactions with its directors, significant shareholders and their affiliates (related parties). Such
transactions were made in the ordinary course of business on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other customers, and did not, in
the opinion of management, involve more than normal credit risk or present other unfavorable features. As of September 30, 2005 aggregate loans to directors, executive officers, and principal shareholders totaled $16,536. An analysis of loan
activity to directors, executive officers and principal shareholders is as follows:



Loans to Related Parties

(dollars in thousands)



|                                  |  |   |        |  
|--------------------------------- |  | - | ------ | -
|Balances as of January 1, 2004    |  | $ | 6,324  |  
|Advances                          |  |   | 5,308  |  
|Repayments                        |  |   | (1,183 | )
|                                  |  |   |        |  
|Balances as of December 31, 2004  |  | $ | 10,449 |  
|                                  |  |   |        |  
|2004 Correction                   |  |   | (3     | )
|Addition of new director          |  |   | 3,209  |  
|Advances                          |  |   | 12,573 |  
|Repayments                        |  |   | (9,692 | )
|                                  |  |   |        |  
|Balances as of September 30, 2005 |  | $ | 16,536 |  
|                                  |  |   |        |  



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##### Table of Contents

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



The Company has outstanding long-term debt with the Federal Home Loan Bank of Atlanta in the amount of $37.0 million as of
September 30, 2005. There are four convertible advances in the amount of $5.0 million each, one convertible advance in the amount of $7.0 million, and one convertible advance in the amount of $10.0 million currently drawn. The Federal Home Loan
Bank of Atlanta has the option to convert the $37.0 million in convertible advances on the conversion dates below, and on any quarterly interest payment date thereafter, with at least two business days notice. If called, the four $5.0 million
convertible advances and the one $7.0 million convertible advance will be converted into a 3-month London Interbank Offered Rate (LIBOR) based adjustable rate credit (ARC) at 3-month LIBOR. The $10.0 million convertible advance may be
converted into a 3-month LIBOR-based floating rate advance (ARC) at 3-month LIBOR only if 3-month LIBOR is greater than or equal to 7.0%. The following table provides more information on the outstanding advances as of September 30, 2005:



LONG-TERM FEDERAL HOME LOAN BANK ADVANCES

(dollars in thousands)



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



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



Valley Financial (VA) Statutory Trust 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.



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##### Table of Contents

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



The debenture proceeds from Trust I and Trust II are included in the Companys Tier 1 capital for regulatory capital
adequacy purposes to the extent that they do not exceed 25% of the Companys total Tier I capital including the securities. This amount totaled $10,100 (of the $11,000 outstanding) at September 30, 2005. The remaining $900 is included in
the calculation of our total risk based capital ratio as Tier 2 capital. Our obligations with respect to the issuance of Trust I and Trust II preferred securities and common securities constitute a full and unconditional guarantee by
the Company of Trust I and Trust II obligations with respect to the preferred securities and common securities. Subject to certain exceptions and limitations, the Company may elect from time to time to defer interest payments on its junior
subordinated debentures, which would result in a deferral of distribution payments on Trust I and Trust IIs preferred trust securities and common securities.



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



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



12



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##### Table of Contents

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
non qualified 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 37,700 shares granted to officers and key employees currently outstanding as of September 30, 2005. Under the 1995 Plan, there are options for 239,283 shares granted to officers and key employees currently outstanding as of
September 30, 2005. 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. As of September 30, 2005, there are 6,958 shares available for grant under the 1995 Plan and 212,300 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 as of September 30, 2005, based on meeting certain past performance criteria have been granted.



Additionally under the 2005 Plan, there are 14,375
restricted stock grants (RSGs) that have been granted to officers and key employees currently outstanding as of September 30, 2005. These RSGs will vest 100% on January 31, 2008 (Vesting Date) based upon
successfully meeting certain performance criteria.



Information related to pro forma net income and per share amounts for the periods presented is as follows:



|                                                                               |  |                |       |                |   |         |  |         |      |  |   |     
|------------------------------------------------------------------------------ |  | -------------- | ----- | -------------- | - | ------- |  | ------- | ---- |  | - | ----
|                                                                               |  | 9 Months Ended |       | 3 Months Ended
|                                                                               |  | 9/30/05        |       | 9/30/04        |   | 9/30/05 |  | 9/30/04
|Compensation cost recognized in income for all stock-based compensation awards |  | $              |      |                | $ |        |  | $       |     |  | $ |    
|                                                                               |  |                |       |               
|Pro forma net income, based on SFAS No. 123                                    |  | $              | 2,233 |                | $ | 1,925   |  | $       | 860  |  | $ | 651 
|                                                                               |  |                |       |               
|Pro forma basic net income per share, based on SFAS No. 123                    |  | $              | 0.55  |                | $ | 0.52    |  | $       | 0.22 |  | $ | 0.17
|                                                                               |  |                |       |               
|Pro forma diluted net income per share, based on SFAS No. 123                  |  | $              | 0.52  |                | $ | 0.48    |  | $       | 0.21 |  | $ | 0.16



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##### Table of Contents

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



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



For the nine month period ending September 30, 2005, the net effect of
the implementation of SFAS No. 91 was an increase in pretax net income of $5, no change in basic earnings per share or diluted earnings per share.



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 nine months ended September 30, 2005 and 2004 is as follows. The discussion should
be read in conjunction with the Companys Consolidated Financial Statements and Notes on the December 31, 2004 Form 10-KSB.



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



14



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



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



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



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



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



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



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



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



Overview



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



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



15



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##### Table of Contents

Performance Summary



The following table shows our key performance ratios for the period ended September 30, 2005 and December 31, 2004 and September 30, 2004:



Key Performance Ratios



|                               |  |                       |       |   |                         |   |       |                       |  |   |       |  
|------------------------------ |  | --------------------- | ----- | - | ----------------------- | - | ----- | --------------------- |  | - | ----- | -
|                               |  | 9 monthsEnded 9/30/05 |       |   | 12 monthsEnded 12/31/04 |   |       | 9 monthsEnded 9/30/04 | 
|                               |  |                      
|Return on average assets       |  |                       | 0.74  | % |                         |   | 0.82  | %                     |  |   | 0.78  | %
|Return on average equity (1)   |  |                       | 10.31 | % |                         |   | 12.00 | %                     |  |   | 11.61 | %
|Net interest margin (2)        |  |                       | 3.39  | % |                         |   | 3.45  | %                     |  |   | 3.40  | %
|Cost of funds                  |  |                       | 2.62  | % |                         |   | 2.17  | %                     |  |   | 2.13  | %
|Yield on earning assets        |  |                       | 5.93  | % |                         |   | 5.57  | %                     |  |   | 5.50  | %
|Basic net earnings per share   |  | $                     | 0.56  |   |                         | $ | 0.75  |                       |  | $ | 0.53  |  
|Diluted net earnings per share |  | $                     | 0.53  |   |                         | $ | 0.70  |                       |  | $ | 0.49  |  

---

All percentage calculations are on an annualized
basis.



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

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



As shown above, the net interest margin has decreased slightly as compared to December 31, 2004 due to our relative reliance on higher-cost
certificates of deposit to fund rapid growth in earning assets and due to the flattening of the yield curve which has resulted in our deposit costs increasing faster than our asset yields. Net interest income for the nine-month period ended
September 30, 2005 was $9,730,000, a 24% increase when compared to the prior year. Net interest income for the quarter ended September 30, 2005 was $3,523,000, a 28% increase over the same period last year.



Growth



The following table shows our key growth indicators:



Key Growth Indicators

(dollars in thousands)



|                      |  |                       |         |                         |   |                         |  |   |        
|--------------------- |  | --------------------- | ------- | ----------------------- | - | ----------------------- |  | - | -------
|                      |  | 9 monthsEnded 9/30/05 |         | 12 monthsEnded 12/31/04 |   | 12 monthsEnded 12/30/03
|                      |  |                      
|Investment securities |  | $                     | 59,622  |                         | $ | 71,475                  |  | $ | 66,195 
|Loans, net            |  |                       | 375,237 |                         |   | 279,785                 |  |   | 220,032
|Deposits              |  |                       | 350,016 |                         |   | 279,333                 |  |   | 223,022
|Total assets          |  | $                     | 462,512 |                         | $ | 373,979                 |  | $ | 309,133



Total assets at
September 30, 2005 were $462.5 million, up 24% from $374.0 million at December 31, 2004. The asset growth is due to the 34% growth in our loan portfolio, offset by the 17% decrease in our investment portfolio. Due to the addition of five
new production employees during the last quarter of 2004, our loan growth in the first half of the year temporarily outstripped our immediate ability to grow deposits. Therefore, we liquidated a portion of our investment portfolio during the first
half of the year to help fund this growth.



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##### Table of Contents

Total liabilities at September 30, 2005 were $432.5 million, up 25% from $345.7 million at
December 31, 2004 with the increase primarily represented by a $70.7 million growth in deposits, a $7 million increase in guaranteed preferred beneficial interests in the Companys junior subordinated debentures, an $8 million increase in
short-term borrowings and a $2.2 million increase in securities sold under agreements to purchase. These increases were offset by the reduction in federal funds purchased of $1.5 million. During the first nine months of the year, we raised deposits
through local CD campaigns and also marketed CDs nationally to institutional depositors, primarily banks, thrift institutions and credit unions through an Internet-based rate posting service to raise funds to support the rapid loan growth.



Shareholders Equity



Total shareholders equity at September 30, 2005 was $30 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,
$880,000 in proceeds from the exercise of stock options, $18,000 from the issuance of restricted stock grants, increased by accumulated retained earnings of $13.3 million and decreased by $293,000 of net unrealized losses on securities available for
sale, net of related deferred tax liability. Total shareholders equity (exclusive of unrealized gains (losses) on investment securities) was $30.3 million at September 30, 2005 compared with $28.3 million at December 31, 2004, an
increase of $2 million or 7.1%.



Net Income



We earned net income of $2,270,000 for the nine months ended
September 30, 2005, an increase of $300,000 or 15% over the $1,970,000 reported for the same period in 2004. Net income for the three months ended September 30, 2005 was $878,000, an increase of $212,000 or 32% over the $666,000 reported
for the third quarter of 2004. The biggest factor contributing to the increase in net income for both periods is the increase in our interest and fees on loans which is the result of the overall growth in our loan portfolio, as well as the result of
measures we took in 2003 and 2004 to position our portfolio to take advantage of the rising rate environment. Additionally, we earned gains of $129,000 on the sale of real estate acquired by foreclosure during the third quarter of 2005.



Net Interest Income



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



Net interest
income was $9.7 million for the nine months ended September 30, 2005, an increase of 22.8% from the $7.9 million reported for the same period in 2004. For the three months ended September 30, 2005, net interest income was $3.5 million, an
increase of 25% from the $2.8 million reported for the three months ended September 30, 2004.



17



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##### Table of Contents

Interest Rate Risk



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



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



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



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



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



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



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



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



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



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



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



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



The model also incorporates managements forecasts for balance sheet growth, noninterest income and noninterest expense. The interest rate scenarios
are used for analytical purposes and do not necessarily represent managements view of future market movements. Rather, these are intended to provide a measure of the degree of volatility interest rate movements may apply to our earnings.
Modeling the sensitivity of earnings to interest rate risk is highly dependent on numerous assumptions embedded in the simulation model. While the earnings sensitivity analysis incorporates managements best estimate of interest rate and
balance sheet dynamics under various market rate movements, the actual behavior and resulting earnings impact likely will differ from that projected. Our cumulative repricing gap for the 90-day time period has shifted from a liability sensitive
position at December 31, 2004 to an asset-sensitive position as of June 30, 2005 (the most recent date for which information is currently available).



We also estimate interest sensitivity by calculating the net present value of the balance sheets cash flows or the residual value of future cash
flows ultimately due to shareholders. This calculation is known as Economic Value of Equity or EVE and is generally considered a better measure of long-term interest sensitivity than is IRS. Our objective is for the result to change 25%
or less in an immediate 300 basis point interest rate shock scenario.



18



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##### Table of Contents

Noninterest Income



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



Noninterest Income

(dollars in thousands)



|                                    |  |                       |     |                       |   |                        |  |   |      |  
|----------------------------------- |  | --------------------- | --- | --------------------- | - | ---------------------- |  | - | ---- | -
|                                    |  | 3 monthsEnded 9/30/05 |     | 3 monthsEnded 9/30/04 |   | % Increase/ (Decrease) | 
|                                    |  |                      
|Service charges on deposits         |  | $                     | 237 |                       | $ | 209                    |  |   | 13.4 | %
|Gain/(Loss) on sale of other assets |  |                       | 129 |                       |   |                       |  |   | N/M  |  
|Other fee income                    |  |                       | 182 |                       |   | 136                    |  |   | 33.8 | %
|Realized securities gains/losses    |  |                       |    |                       |   |                       |  |   | 0.00 | %
|                                    |  |                       |     |                       |   |                        |  |   |      |  
|Total noninterest income            |  | $                     | 548 |                       | $ | 345                    |  | $ | 58.8 | %
|                                    |  |                       |     |                       |   |                        |  |   |      |  



Noninterest Income

(dollars in thousands)



|                                    |  |                      |       |                      |   |                       |  |   |       |  
|----------------------------------- |  | -------------------- | ----- | -------------------- | - | --------------------- |  | - | ----- | -
|                                    |  | 9 monthsEnded9/30/05 |       | 9 monthsEnded9/30/04 |   | % Increase/(Decrease) | 
|Service charges on deposits         |  | $                    | 682   |                      | $ | 579                   |  |   | 17.8  | %
|Gain/(Loss) on sale of other assets |  |                      | 129   |                      |   |                      |  |   | N/M   |  
|Other fee income                    |  |                      | 456   |                      |   | 409                   |  |   | 11.5  | %
|Realized securities gains/losses    |  |                      | 53    |                      |   | 17                    |  |   | 211.8 | %
|                                    |  |                      |       |                      |   |                       |  |   |       |  
|Total noninterest income            |  | $                    | 1,320 |                      | $ | 1,005                 |  | $ | 31.3  | %
|                                    |  |                      |       |                      |   |                       |  |   |       |  



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



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



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



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



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



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



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



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



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



Other fee income consists of several categories, primarily the following:



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



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



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



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



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



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



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



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##### Table of Contents

Levels of income derived from these categories vary. For example, general market conditions and new
insurance premiums purchased affect the income earned on bank owned life insurance. Fees for the issuance of official checks and customer check sales tend to grow as new branches are added. Fee schedules,

while subject to change, generally do not alone yield a significant or discernable increase in income when they change. Additionally, with rising interest rates, mortgage
originations and re-financings have slowed down, which decreases the fee income earned on real estate loans.



Realized gains on securities sold were $53,627 for the nine months ending September 30, 2005. The Bank sold securities during the second quarter of
2005 to provide additional liquidity for the rapid growth in the loan portfolio.



Noninterest Expense



Noninterest Expense

(dollars in thousands)



|                                           |  |                      |       |                      |   |                       |  |   |       |   
|------------------------------------------ |  | -------------------- | ----- | -------------------- | - | --------------------- |  | - | ----- | --
|                                           |  | 3 monthsEnded9/30/05 |       | 3 monthsEnded9/30/04 |   | % Increase/(Decrease) | 
|Salaries and employee benefits             |  | $                    | 1,230 |                      | $ | 1,017                 |  |   | 20.9  | % 
|Occupancy                                  |  |                      | 157   |                      |   | 135                   |  |   | 16.3  | % 
|Equipment                                  |  |                      | 119   |                      |   | 107                   |  |   | 11.2  | % 
|Data processing                            |  |                      | 141   |                      |   | 130                   |  |   | 8.5   | % 
|Advertising and marketing                  |  |                      | 75    |                      |   | 26                    |  |   | 188.5 | % 
|Audit fees                                 |  |                      | 78    |                      |   | 34                    |  |   | 129.4 | % 
|Franchise and purchased tax credit expense |  |                      | 47    |                      |   | 46                    |  |   | 2.2   | % 
|Business manager                           |  |                      | 50    |                      |   | 79                    |  |   | (36.7 | %)
|Deposit expense                            |  |                      | 90    |                      |   | 44                    |  |   | 104.5 | % 
|Loan expense                               |  |                      | 52    |                      |   | 29                    |  |   | 79.3  | % 
|Computer software                          |  |                      | 75    |                      |   | 52                    |  |   | 44.2  | % 
|Other expense                              |  |                      | 272   |                      |   | 180                   |  |   | 51.1  | % 
|                                           |  |                      |       |                      |   |                       |  |   |       |   
|Total noninterest expense                  |  | $                    | 2,386 |                      | $ | 1,879                 |  | $ | 27.0  | % 
|                                           |  |                      |       |                      |   |                       |  |   |       |   



Noninterest Expense

(dollars in thousands)



|                                           |  |                      |       |                      |   |                       |  |   |       |   
|------------------------------------------ |  | -------------------- | ----- | -------------------- | - | --------------------- |  | - | ----- | --
|                                           |  | 9 monthsEnded9/30/05 |       | 9 monthsEnded9/30/04 |   | % Increase/(Decrease) | 
|Salaries and employee benefits             |  | $                    | 3,443 |                      | $ | 3,033                 |  |   | 13.5  | % 
|Occupancy                                  |  |                      | 453   |                      |   | 363                   |  |   | 24.8  | % 
|Equipment                                  |  |                      | 343   |                      |   | 319                   |  |   | 7.5   | % 
|Data processing                            |  |                      | 416   |                      |   | 375                   |  |   | 10.9  | % 
|Advertising and marketing                  |  |                      | 199   |                      |   | 99                    |  |   | 101.0 | % 
|Audit fees                                 |  |                      | 229   |                      |   | 102                   |  |   | 124.5 | % 
|Franchise and purchased tax credit expense |  |                      | 140   |                      |   | 149                   |  |   | (6.0  | %)
|Business manager                           |  |                      | 190   |                      |   | 214                   |  |   | (11.2 | %)
|Deposit expense                            |  |                      | 192   |                      |   | 139                   |  |   | 38.1  | % 
|Loan expense                               |  |                      | 159   |                      |   | 105                   |  |   | 51.4  | % 
|Computer software                          |  |                      | 212   |                      |   | 153                   |  |   | 38.6  | % 
|Other expense                              |  |                      | 772   |                      |   | 582                   |  |   | 32.6  | % 
|                                           |  |                      |       |                      |   |                       |  |   |       |   
|Total noninterest expense                  |  | $                    | 6,748 |                      | $ | 5,633                 |  | $ | 19.8  | % 
|                                           |  |                      |       |                      |   |                       |  |   |       |   



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##### Table of Contents

As seen in the tables above, audit fees is the largest percentage increase in noninterest expense due
primarily to fees associated with the Sarbanes-Oxley Act of 2002 (SOX). Additionally, occupancy expense has increased due to the expansion of our commercial and business banking departments and loan expense has increased due to the rapid
growth in our loan portfolio. Compensation expense has increased over the prior year due to the addition of new employees in the 4thquarter of 2004 and due to merit increases throughout the year. The increase in advertising and marketing is primarily due to the costs associated with promoting the new branch opening, deposit generating promotions, and our new
investment subsidiary, Valley Wealth Management Services, Inc. Noninterest expenses are expected to continue to increase as a direct result of business growth and expansion as well as the implementation of SOX.



Income Taxes



To reflect our anticipated federal income tax liability, an expense of $852,000 at an effective tax rate of 27.3% was
recognized for the nine months ended September 30, 2005, compared to an expense of $689,000 at an effective tax rate of 25.9% recognized for the nine months ended September 30, 2004. The provision for income taxes for the third quarter of
2005 was $352,000 at an effective tax rate of 28.6% as compared to $230,000 at an effective tax rate of 25.7% for the third quarter of 2004. Factors contributing to the difference between the effective tax rate and the statutory rate of 34% include
tax-exempt interest income on municipal securities (net of disallowance) and tax-exempt income earned on bank-owned life insurance.



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



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##### Table of Contents

Investment securities (available for sale and held to maturity), including restricted equity securities,
at September 30, 2005 were $59.6 million, a decrease of $11.9 million or 16.6% from their level of $71.5 million on December 31, 2004. The decrease is attributable to the principal prepayments on mortgage-backed securities and the sale of
a portion of our investment portfolio to help fund our rapid loan growth. See Note 3 to the Consolidated Financial Statements.



Loan Portfolio



Our total loans were $379.2 million at September 30, 2005, an increase of $96.5 million or 34.1% from the $282.8 million reported at
December 31, 2004. 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 88.2% at September 30, 2005 and 82.4% at December 31, 2004. We seek to maintain the ratio of loans to funding sources at a maximum of 85%.



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



The following table summarizes the loan portfolio by category as of the
nine-month periods ended September 30, 2005 and 2004 and the year ended December 31, 2004:



Loan Portfolio Summary

(dollars in thousands)



|                         |  |         |  |          |  |         |  |        |  |         |  |       
|------------------------ |  | ------- |  | -------- |  | ------- |  | ------ |  | ------- |  | ------
|                         |  | 9/30/05 |  | 12/31/04 |  | 9/30/04
|                         |  | $       |  | %        |  | $       |  | %      |  | $       |  | %     
|Commercial               |  | 85,889  |  | 22.65    |  | 71,580  |  | 25.31  |  | 68,239  |  | 25.24 
|Commercial real estate   |  | 139,373 |  | 36.75    |  | 107,186 |  | 37.91  |  | 104,162 |  | 38.53 
|Real estate construction |  | 52,101  |  | 13.74    |  | 25,404  |  | 8.98   |  | 23,291  |  | 8.62  
|Residential real estate  |  | 73,382  |  | 19.35    |  | 43,848  |  | 15.51  |  | 40,290  |  | 14.90 
|Loans to individuals     |  | 28,495  |  | 7.51     |  | 34,758  |  | 12.29  |  | 34,371  |  | 12.71 
|                         |  |         |  |          |  |         |  |        |  |         |  |       
|Total loans              |  | 379,240 |  | 100.00   |  | 282,776 |  | 100.00 |  | 270,353 |  | 100.00
|                         |  |         |  |          |  |         |  |        |  |         |  |       



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.



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##### Table of Contents

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



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



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



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



Asset Quality



Summary of Allowance for Loan Losses



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



A provision for loan
losses of $1,180,000 was provided during the nine months ended September 30, 2005, an increase of $602,000 or 104% over the same period in 2004, in recognition of our estimate of inherent risks associated with lending activities. The increase
is a result of the rapid loan growth in our portfolio.



The
ratio of the allowance for loan losses to net loans outstanding was approximately 1.1% at September 30, 2005, which compares to approximately 1.1% of net loans at December 31, 2004 (see Note 4 to the Consolidated Financial Statements).
These estimates are primarily based on our historical loss experience, portfolio concentrations, evaluation of individual loans and economic conditions. A total of $0 in special reserves was included in the balance of the allowance for loan losses
as of September 30, 2005 for impaired loans, which compares to a total of $108,000 as of September 30, 2004. For the three months ended September 30, 2005 a provision for loan losses of $455,000 was made versus $331,000 during the
same period in 2004, a 37.5% increase of $124,000.



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



23



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##### Table of Contents

increased provisions in the future. Additionally, regulatory examiners may require us to recognize additions to the
allowance based upon their judgment about the loan portfolio and other information available to them at the time of their examinations. (See Allowance for Loan Losses under Critical Accounting Policies.)



Nonperforming Assets and Impaired Loans



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



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



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



Nonperforming assets at September 30,
2005, December 31, 2004 and September 30, 2004 are presented in the following table:



Nonperforming Assets

(dollars in thousands)



|                                             |  |         |     |          |   |         |  |   |    
|-------------------------------------------- |  | ------- | --- | -------- | - | ------- |  | - | ---
|                                             |  | 9/30/05 |     | 12/31/04 |   | 9/30/04
|Nonaccrual loans                             |  | $       | 86  |          | $ | 150     |  | $ | 236
|Loans past due 90 days or more               |  |         | 596 |          |   | 240     |  |   |   
|Restructured loans                           |  |         |    |          |   |        |  |   |   
|                                             |  |         |     |          |   |         |  |   |    
|Total nonperforming loans                    |  | $       | 682 |          | $ | 390     |  | $ | 236
|                                             |  |         |     |          |   |         |  |   |    
|Foreclosed, repossessed and idled properties |  |         | 7   |          |   | 1       |  |   | 12 
|                                             |  |         |     |          |   |         |  |   |    
|Total nonperforming assets                   |  | $       | 689 |          | $ | 391     |  | $ | 248
|                                             |  |         |     |          |   |         |  |   |    



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



If nonaccrual loans had performed in
accordance with their original terms, additional interest income in the amount of $2,000 for the nine-month period ended September 30, 2005; $6,000 for the year ended December 31, 2004; and $7,000 for the nine-month period ended
September 30, 2004 would have been recorded.



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##### Table of Contents

Other Assets



We have purchased life insurance contracts on key employees, the tax-exempt income from which is the funding vehicle for the Companys Supplemental
Executive Retirement Plan (SERP). Bank owned life insurance was $6.4 million at September 30, 2005, an increase of $300,000 over the $6.1 million reported as of December 31, 2004. The increase is entirely due to the increase in
the cash surrender value of the life insurance contracts. During the second quarter of 2005, the board of directors approved the purchase of additional life insurance contracts for key employees. The Company plans to make this additional purchase
during the last quarter of 2005.



Other assets were $2.7
million at September 30, 2005, an increase of $800,000 from the $1.9 million level reported as of December 31, 2004.



Deposits



The levels and mix of deposits are influenced by such factors as customer service, interest rates paid, service charges and the convenience of banking
locations. Competition for deposits is intense from other depository institutions and money market funds, some of which offer interest rates higher than 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 nine months ended September 30, 2005 and for the year ended December 31, 2004:



Deposit Summary

(dollars in thousands)



|                                       |  |         |  |          |  |                     |  |        |  |         |   |  |        |  
|-------------------------------------- |  | ------- |  | -------- |  | ------------------- |  | ------ |  | ------- | - |  | ------ | -
|                                       |  | 9/30/05 |  | 12/31/04 |  | Increase/(Decrease) | 
|                                       |  | $       |  | %        |  | $                   |  | %      |  | $       |   |  | %      |  
|CDs                                   |  | 224,900 |  | 64.26    |  | 170,819             |  | 61.15  |  | 54,081  |   |  | 31.66  |  
|Interest bearing demand & money market |  | 53,064  |  | 15.16    |  | 56,449              |  | 20.21  |  | (3,385  | ) |  | (6.00  | )
|Savings                                |  | 52,156  |  | 14.90    |  | 4,957               |  | 1.78   |  | 47,199  |   |  | 952.17 |  
|                                       |  |         |  |          |  |                     |  |        |  |         |   |  |        |  
|Total interest bearing deposits        |  | 330,120 |  | 94.32    |  | 232,225             |  | 83.14  |  | 97,895  |   |  | 42.16  |  
|                                       |  |         |  |          |  |                    
|Noninterest demand & official checks   |  | 19,896  |  | 5.68     |  | 47,108              |  | 16.86  |  | (27,212 | ) |  | (57.77 | )
|                                       |  |         |  |          |  |                     |  |        |  |         |   |  |        |  
|Total deposits                         |  | 350,016 |  | 100.00   |  | 279,333             |  | 100.00 |  | 70,683  |   |  | 25.30  |  
|                                       |  |         |  |          |  |                     |  |        |  |         |   |  |        |  



In September 2005, we
implemented a deposit reclassification program that restructures interest and non-interest checking accounts so that a certain portion of the balance in each account is actually maintained in a linked Savings sub-account. The Savings portion of the
combined account balance is not subject to the 10% reserve that is required for checking balances, therefore the overall daily cash reserve requirement for the Federal Reserve has been reduced. We received approval from our Federal Reserve district
for this program. As such, for financial reporting purposes, our interest and non-interest bearing demand deposits have been reduced and our savings deposits have been increased.



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We would prefer to have transaction accounts comprise a larger percentage of total deposits, but in order
to fund our substantial loan growth, we often have to rely on higher-cost certificates of deposit. Within the certificate of deposit category, we have marketed CDs nationally to institutional depositors, primarily banks, thrift institutions and
credit unions through an Internet-based rate posting service. National market CDs at September 30, 2005 were $17.4 million, a decrease of $500,000 from the $17.9 million reported at December 31, 2004 and represent 7.74% of total CDs and
4.97% of total deposits at September 30, 2005.



Short-Term Borrowings



Total short-term borrowings (including federal funds
purchased and securities sold under agreements to repurchase) increased by $8.8 million from their level of $23 million at December 31, 2004 to a total of $31.8 million as of September 30, 2005. Short-term borrowings at September 30,
2005 include federal funds purchased of $708,000, Federal Home Loan Bank of Atlanta (FHLB) borrowings in the amount of $23.0 million, and a commercial sweep account program in the amount of $8 million.



The FHLB borrowings include a $10 million adjustable rate credit which
matures on December 16, 2005 and reprices quarterly on the date of each quarterly interest payment (rate of 3.95% on September 30, 2005). The second FHLB credit matures on January 30, 2006 and reprices monthly at 1-month LIBOR flat
(rate of 3.86% on September 30, 2005). The third FHLB borrowing is an $8 million daily rate credit which matures on September 27, 2006 (rate of 4.16% on September 30, 2005). See the liquidity section for further information on the
preceding borrowings.



The commercial sweep program involves
balances subject to repurchase agreements which are reported as short term borrowings rather than deposits since they are not FDIC insured. The balance in the program increased by $2.2 million from its $5.8 million level at December 31, 2004.
The program consists of a demand deposit account from which we invest available balances daily in securities on an overnight basis subject to repurchase. On the following business day, we repurchase from the customer the securities for an amount
equal to the amount of available balances invested in the securities. Interest is calculated daily at the rate applicable for each overnight period; however, it is posted to the customer accounts only once per month.



Long-Term Borrowings



Federal Home Loan Bank advances are relatively cost-effective funding sources and provide us with the flexibility to
structure borrowings in a manner that aids in the management of interest rate risk and liquidity. Long-term convertible Federal Home Loan Bank advances totaled $37.0 million at September 30, 2005 and December 31, 2004. (See Footnote 9 of
the Companys Consolidated Financial Statements for more information on the long-term advances.)



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



Valley Financial (VA) Statutory Trust 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.



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##### Table of Contents

Valley Financial (VA) Statutory Trust I, a statutory business trust (Trust I), was
created on June 26, 2003, at which time Trust I 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 and Trust II are included in our Tier 1 capital for regulatory capital adequacy purposes to the extent that
they do not exceed 25% of our total Tier I capital including the securities. This amount totaled $10.1 million (of the $11 million outstanding) at September 30, 2005. The remaining $900,000 is included in the calculation of our total risk-based
capital ratio as Tier 2 capital. Our obligations with respect to the issuance of Trust I and Trust IIs preferred securities and common securities constitute a full and unconditional guarantee of Trust I and Trust IIs obligations with
respect to the preferred securities and common securities. Subject to certain exceptions and limitations, we may elect from time to time to defer interest payments on its junior subordinated debentures, which would result in a deferral of
distribution payments on Trust I and Trust IIs preferred trust securities and common securities.



Capital Adequacy



Our
financial position at September 30, 2005 reflects liquidity and capital levels currently adequate to fund anticipated near-term business expansion. Capital ratios are in line with required regulatory minimums for a well-capitalized institution.
We review the adequacy of our capital on an ongoing basis. We seek to maintain a capital structure adequate to support anticipated asset growth and serve as a cushion to absorb potential losses.



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



Capital Ratios



|         |  |         |   |  |          |   |  |         |   |  |                                            |  
|-------- |  | ------- | - |  | -------- | - |  | ------- | - |  | ------------------------------------------ | -
|Ratio    |  | 9/30/05 |   |  | 12/31/04 |   |  | 9/30/04 |   |  | MinimumRequiredfor CapitalAdequacyPurposes |  
|Tier 1   |  | 10.3    | % |  | 10.5     | % |  | 9.3     | % |  | 4                                          | %
|Total    |  | 11.5    | % |  | 11.5     | % |  | 10.4    | % |  | 8                                          | %
|Leverage |  | 8.7     | % |  | 8.8      | % |  | 7.8     | % |  | 4                                          | %



Total
shareholders equity grew by $1.8 million from December 31, 2004 to September 30, 2005. Earnings and the changes in unrealized gains and losses for securities available for sale accounted for the net increase. The Company paid its
third consecutive semi-annual cash dividend on the Companys common stock, in the amount of $.06 per share on July 1, 2005 to shareholders of record June 1, 2005.



27



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##### Table of Contents

Liquidity



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



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



Liquid
assets, which include cash and due from banks, interest-bearing deposits at other banks and non-pledged securities available-for-sale, at September 30, 2005 totaled $26.5 million. Our funding sources consist of an established federal funds
lines with a regional correspondent bank totaling $12 million that had a $708,000 balance as of September 30, 2005, three established federal funds lines with third party banks totaling $16 million that had no outstanding
balances as of September 30, 2005, and an established line with the FHLB that had $60 million outstanding under a total line of $90.2 million as of September 30, 2005. We believe these arrangements will be renewed at maturity.



We sell excess funds as overnight federal funds sold to
provide an immediate source of liquidity. We had federal funds sold of $0 at September 30, 2005 and December 31, 2004.



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



Impact of Inflation



The Consolidated Financial Statements and Notes 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 December 2004, the FASB issued SFAS No. 123 (revised 2004)
(SFAS 123(R)), Share-Based Payments. SFAS 123(R) requires all entities to recognize compensation expense in an amount equal to the fair value of share-based payments, such as stock options granted to employees. We will apply SFAS 123(R)
on a modified prospective method. Under this method, we are required to record compensation expense (as previous awards continue to vest) for the unvested portion of previously granted stock option awards that remain outstanding at the date of
adoption. In addition, we may elect to adopt SFAS 123(R) by restating previously issued financial statements, basing the amounts on the expense previously calculated and reported in the pro forma disclosures that had been required by SFAS 123,
Accounting for Stock-Based Compensation. SFAS 123(R) is effective for us beginning January 1, 2006.



28



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##### Table of Contents

Item 3. Quantitative and Qualitative Disclosures about Market Risk



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



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



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



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



Item 4. Controls and Procedures.



As of the end of the period covered by the report, an evaluation was performed under the supervision and with the participation of the Companys management, including the Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the design and operation of
these disclosure controls and procedures were effective. This evaluation takes into account the discovery after the end of the quarter of computational errors in connection with the Companys initial earnings release on October 21, 2005, which
was corrected by the Companys 8-K filing on November 1, 2005. We have reviewed this carefully and concluded that it does not require a material change in the Companys disclosure control and procedures. 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.



29



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



PART II. OTHER INFORMATION



Item 1. Legal Proceedings.



There were no pending legal proceedings during the quarter.



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



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



Item 3. Defaults Upon Senior Securities.



There were no defaults upon Senior Securities in the quarter.



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



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



Item 5. Other Information.



None.



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##### Table of Contents

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



|(a) | We filed the following exhibits for the quarter ended September 30, 2005:
|--- | -------------------------------------------------------------------------



Exhibits:



|       |  |                                                                                                                                                                                                                                   
|------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1    |  | Articles of Incorporation (incorporated herein by reference to Exhibit No. 3.1 of Registration Statement No. 33-77568, on form S-1, as amended).                                                                                  
|       | 
|3.2    |  | Bylaws (incorporated herein by reference to Exhibit No. 3.2 of Registration Statement No. 33-77568, on form S-1, as amended).                                                                                                     
|       | 
|3.3    |  | Bylaws as amended July 19, 2003 (incorporated herein by reference to Exhibit 3.3 of Form 10-KSB filed March 30, 2005, File No. 000-28342).                                                                                        
|       | 
|*10.2  |  | Employment Agreement dated April 8, 1994, by and between the Company and A.Wayne Lewis (incorporated herein by reference to Exhibit No. 10.2 of Registration Statement No. 33-77568, on Form S-1,
as amended).                    
|       | 
|*10.3  |  | Severance Agreement dated December 19, 1996, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.3 of Form 10-KSB filed March 27, 1997, File No.
33-77568).                      
|       | 
|*10.4  |  | Stock Option Agreement dated December 19, 1996, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.4 of Form 10-KSB filed March 27, 1997, File
No. 33-77568).                   
|       | 
|*10.6  |  | Severance agreement dated February 9, 1998, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit No. 10.6 of Form 10-KSB filed March 30, 2000, File No.
33-77568).                      
|       | 
|*10.7  |  | Employment agreement dated September 21, 2000, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit 10.2 of Form SB-2, filed September 27, 2000, and Form
SB-2/A filed October 25, 2000).
|       | 
|*10.14 |  | Valley Bank Supplemental Retirement Plan effective January 1, 2002 (incorporated herein by reference to Exhibit 10.14 of Form 10-QSB filed May 15, 2002, File No. 33-77568).                                                      
|       | 
|*10.15 |  | Employment agreement dated August 26, 2002, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit 10.15 of Form 10-QSB filed November 14, 2002, File No.
33-77568).                      
|       | 
|*10.16 |  | Split-Dollar Insurance Agreement dated August 20, 2003, by and between Valley Bank and Ellis L. Gutshall (incorporated herein by reference to Exhibit 10.16 of Form 10-QSB filed November 14,
2003, File No. 33-77568).           



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##### Table of Contents

|       |  |                                                                                                                                                                                                                                                
|------ |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|*10.17 |  | Split-Dollar Insurance Agreement dated August 20, 2003, by and between Valley Bank and A. Wayne Lewis (incorporated herein by reference to Exhibit 10.17 of Form 10-QSB filed
November 14, 2003, File No. 33-77568).                           
|       | 
|*10.18 |  | Split-Dollar Insurance Agreement dated August 20, 2003, by and between Valley Bank and J. Randy Woodson (incorporated herein by reference to Exhibit 10.18 of Form 10-QSB filed November 14, 2003,
File No. 33-77568).                         
|       | 
|*10.19 |  | Insurance Loan Agreement dated December 31, 2003 by and among Valley Financial Corporation , Valley Bank, and A. Wayne Lewis (incorporated herein by reference to Exhibit 10.19 of Form 10-KSB
filed March 30, 2004, File No. 000-28342).      
|       | 
|*10.20 |  | Insurance Transfer Agreement dated December 31, 2003 by and among Valley Financial Corporation, Valley Bank, and Ellis L. Gutshall (incorporated herein by Reference to Exhibit 10.20 of Form
10-KSB filed March 30, 2004, File No. 000-28342).
|       | 
|*10.21 |  | Letter agreement regarding retirement of A. Wayne Lewis dated July 22, 2005 by and among Valley Financial Corporation and A. Wayne Lewis (filed herewith).                                                                                     
|       | 
|11     |  | Statement re Computation of Earnings per Share (filed herewith as Note 5).                                                                                                                                                                     
|       | 
|31.1   |  | Chief Executive Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).                                                                                                                              
|       | 
|31.2   |  | Chief Financial Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).                                                                                                                              



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##### Table of Contents

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

---

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



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



The Company filed four reports on Form 8-K during the quarter ended September 30, 2005:



| |  |  | The first report, dated July 7, 2005, reported that the Company granted a total of 35,650 incentive stock options and 14,040 restricted stock grants to employees of the Company
and Valley Bank.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The second report, dated July 22, 2005, reported the Companys consolidated financial results for the quarter ended June 30, 2005.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------



| |  |  | The third report, dated July 27, 2005, reported the retirement of the Companys Executive Vice President, Chief Operating Officer and Chief Financial Officer, A. Wayne
Lewis effective July 31, 2005, and the appointment of Kimberly B. Snyder as the Companys Senior Vice President and Chief Financial Officer effective August 1, 2005.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The fourth report, dated September 29, 2005, reported the issuance of $7,000,000 of trust preferred securities through the Companys newly formed and wholly-owned special
purpose finance subsidiary, Valley Financial (VA) Statutory Trust II.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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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                                         
|                  | 
|November 14, 2005 |  | /s/ Ellis L. Gutshall                                                
|Date              |  | Ellis L. Gutshall, President and Chief Executive
Officer             
|                  | 
|November 14, 2005 |  | /s/ Kimberly B. Snyder                                               
|Date              |  | Kimberly B. Snyder, Senior Vice President and Chief
Financial Officer



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INDEX TO EXHIBITS



|               |  |                                                                                                                                                                                                                                                                                     |  |           
|-------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------
|Exhibit Number |  | Description                                                                                                                                                                                                                                                                         |  | PageNumber
|3.1            |  | Articles of Incorporation (incorporated herein by reference to Exhibit No. 3.1 of Registration Statement No. 33-77568, on Form S-1, as amended).                                                                                                                                    |  |           
|               |  |                                                                                                                                                                                                                                                                                    
|3.2            |  | Bylaws (incorporated herein by reference to Exhibit No. 3.2 of Registration Statement No. 33-77568, on Form S-1, as amended).                                                                                                                                                       |  |           
|               |  |                                                                                                                                                                                                                                                                                    
|3.3            |  | Bylaws as amended July 19, 2003 (incorporated herein by reference to Exhibit 3.3 of Form 10-KSB filed March 30, 2005, File No. 000-28342).                                                                                                                                          |  |           
|               |  |                                                                                                                                                                                                                                                                                    
|10.2           |  | Employment Agreement dated April 8, 1994, by and between the Company and A. Wayne Lewis (incorporated herein by reference to Exhibit No. 10.2 of Registration Statement No. 33-77568, on Form
S-1, as amended).                                                                     |  |           
|               |  |                                                                                                                                                                                                                                                                                    
|10.3           |  | Severance Agreement dated December 19, 1996, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.3 of Form 10-KSB filed March 27, 1997, File No.
33-77568).                                                                        |  |           
|               |  |                                                                                                                                                                                                                                                                                    
|10.4           |  | Stock Option Agreement dated December 19, 1996, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.4 of Form 10-KSB filed March 27, 1997, File
No. 33-77568).                                                                     |  |           
|               |  |                                                                                                                                                                                                                                                                                    
|10.5           |  | Office Lease dated February 28, 1994, by and between First Federal Building, L.C. and Valley Financial Enterprises, L.C. (incorporated herein by reference to Exhibit No. 10.5 of Registration
Statement No. 33-77568, on Form S-1, as amended).                                    |  |           
|               |  |                                                                                                                                                                                                                                                                                    
|10.10          |  | First amendment dated August 5, 1994, to the Office Lease dated February 28, 1994, by and between First Federal Building, L.C. and Valley Financial Enterprises, L.C. (incorporated herein by
reference to Exhibit No. 10.10 of Form 10-K filed March 30, 1995, File No. 33-77568). |  |           



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##### Table of Contents

|      |  |                                                                                                                                                                                                                                                                                         |  | 
|----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | 
|10.12 |  | Second amendment dated December 14, 1994, to the Office Lease dated February 28, 1994, by and between First Federal Building, L.C. and Valley Financial Enterprises, L.C.
(incorporated herein by reference to Exhibit No. 10.12 of Form 10-K filed March 30, 1995, File No. 33-77568). |  | 
|      |  |                                                                                                                                                                                                                                                                                        
|10.13 |  | Lease agreement for office space dated September 20, 1996, by and between Valley Bank, N.A. and Betty J. Burrows (incorporated herin by reference to Exhibit No. 10.13 of Form 10-KSB filed March
27, 1997, File No. 33-77568).                                                         |  | 
|      |  |                                                                                                                                                                                                                                                                                        
|10.6  |  | Severance agreement dated February 9, 1998, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit 10.6 of Form 10-KSB filed March 30, 2000, File No.
33-77568).                                                                                |  | 
|      |  |                                                                                                                                                                                                                                                                                        
|10.7  |  | Employment agreement dated September 21, 2000, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit 10.2 of Form SB-2, filed September 27, 2000, and Form
SB-2/A filed October 25, 2000).                                                      |  | 
|      |  |                                                                                                                                                                                                                                                                                        
|10.14 |  | Valley Bank Supplemental Retirement Plan effective January 1, 2002 (incorporated herein by reference to Exhibit 10.14 of Form 10-QSB filed May 15, 2002, File No. 33-77568).                                                                                                            |  | 
|      |  |                                                                                                                                                                                                                                                                                        
|10.15 |  | Employment agreement dated August 26, 2002, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit 10.15 of Form 10-QSB filed November 14, 2002, File No.
33-77568).                                                                            |  | 
|      |  |                                                                                                                                                                                                                                                                                        
|10.16 |  | Split-Dollar Insurance Agreement dated August 20, 2003, by and between Valley Bank and Ellis L. Gutshall (incorporated herein by reference to Exhibit 10.16 of Form 10-QSB filed November 14,
2003, File No. 33-77568).                                                                 |  | 
|      |  |                                                                                                                                                                                                                                                                                        
|10.17 |  | Split-Dollar Insurance Agreement dated August 20, 2003, by and between Valley Bank and A. Wayne Lewis (incorporated herein by reference to Exhibit 10.17 of Form 10-QSB filed November 14, 2003,
File No. 33-77568).                                                                    |  | 
|      |  |                                                                                                                                                                                                                                                                                        
|10.18 |  | Split-Dollar Insurance Agreement dated August 20, 2003, by and between Valley Bank and J. Randy Woodson (incorporated herein by reference to Exhibit 10.18 of Form 10-QSB filed November 14, 2003,
File No. 33-77568).                                                                  |  | 



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|      |  |                                                                                                                                                                                                                                                 |  |   
|----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --
|10.19 |  | Insurance Loan Agreement dated December 31, 2003 by and among Valley Financial Corporation, Valley Bank, and A. Wayne Lewis (incorporated herein by reference to Exhibit 10.19 of Form
10-KSB filed March 30, 2004, File No. 000-28342).        |  |   
|      |  |                                                                                                                                                                                                                                                
|10.20 |  | Insurance Transfer Agreement dated December 31, 2003 by and among Valley Financial Corporation, Valley Bank, and Ellis L. Gutshall (incorporated herein by reference to Exhibit 10.20 of Form
10-KSB filed March 30, 2004, File No. 000-28342). |  |   
|      |  |                                                                                                                                                                                                                                                
|10.21 |  | Letter agreement regarding retirement of A. Wayne Lewis dated July 22, 2005 by and among Valley Financial Corporation and A. Wayne Lewis (incorporated herein by reference to Exhibit 10.21 of
Form 10-Q filed August 15, 2005).                |  |   
|      |  |                                                                                                                                                                                                                                                
|11    |  | Statement re Computation of Earnings per Share (filed herewith as Note 5).                                                                                                                                                                      |  |   
|      |  |                                                                                                                                                                                                                                                
|31.1  |  | Chief Executive Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).                                                                                                                               |  | 38
|      |  |                                                                                                                                                                                                                                                
|31.2  |  | Chief Financial Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).                                                                                                                               |  | 39
|      |  |                                                                                                                                                                                                                                                
|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).                                                                                |  | 40
|      |  |                                                                                                                                                                                                                                                
|32.2  |  | Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).                                                                                |  | 41



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