##### Table of Contents

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-QSB



QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934



For
the Quarterly Period Ended September 30, 2003



Commission
File Number: 33-77568



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VALLEY FINANCIAL CORPORATION





|VIRGINIA                 |  | 54-1702380                             
|------------------------ |  | ---------------------------------------
|(State of Incorporation) |  | (I.R.S. Employer Identification Number)



36 Church Avenue,
S.W.

Roanoke, Virginia 24011

(Address of principal executive offices)



(540) 342-2265

(Issuers telephone number, including area code)



---



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



At October 31, 2003, 1,831,476 shares of the issuers common stock, no par value, were outstanding.



Transitional small business disclosure
format:    Yes ̈No  x.



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##### Table of Contents

VALLEY FINANCIAL CORPORATION

FORM 10-QSB

September 30, 2003



INDEX



|Part I. FINANCIAL INFORMATION                               |  |   
|----------------------------------------------------------- |  | --
|                                                            | 
|Item 1. Financial Statements                                |  |   
|                                                            | 
|Consolidated Balance Sheets                                 |  | 3 
|Consolidated Statements of Income                           |  | 4 
|Consolidated Statements of Cash Flows                       |  | 6 
|Notes to Consolidated Financial Statements                  |  | 7 
|                                                            | 
|Item 2.
Managements Discussion and Analysis                |  | 13
|                                                            | 
|Item 3.
Controls and Procedures                             |  | 28
|                                                            | 
|Part II. OTHER INFORMATION                                  |  |   
|                                                            | 
|Item 4.
Submission of Matters to a Vote of Security Holders |  | 29
|                                                            | 
|Item 5.
Other Information                                   |  | 29
|                                                            | 
|Item 6.
Exhibits and Reports on Form 8-K                    |  | 29
|                                                            | 
|SIGNATURES                                                  |  | 32
|                                                            | 
|EXHIBIT INDEX                                               |  | 33
|                                                            | 
|CERTIFICATIONS                                              |  | 44



2



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##### Table of Contents

PART 1  FINANCIAL INFORMATION



Item 1. Financial Statements.



VALLEY FINANCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)



|                                                                                                                                                     |  | (Unaudited) September 302003 |         |   | December 312002 |  
|---------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------- | ------- | - | --------------- | -
|Assets                                                                                                                                               |  |                              |         |   |                 |  
|Cash and due from banks                                                                                                                              |  | $                            | 13,166  |   |                 | $
|Money market investments:                                                                                                                            |  |                              |         |   |                 |  
|Federal funds sold                                                                                                                                   |  |                              |        |   |                 |  
|Interest-bearing deposits in other banks                                                                                                             |  |                              | 864     |   |                 |  
|                                                                                                                                                     |  |                              |         |   |                 |  
|Total money market investments                                                                                                                       |  |                              | 864     |   |                 |  
|Securities held to maturity (approximate market values of $21,923 at September 30, 2003 and $20,120 at December 31,
2002)                            |  |                              | 22,201  |   |                 |  
|Securities available for sale                                                                                                                        |  |                              | 40,777  |   |                 |  
|Restricted equity securities                                                                                                                         |  |                              | 3,143   |   |                 |  
|Loans:                                                                                                                                               |  |                              |         |   |                 |  
|Commercial and industrial loans                                                                                                                      |  |                              | 48,630  |   |                 |  
|Commercial real estate loans                                                                                                                         |  |                              | 83,906  |   |                 |  
|Real estate construction                                                                                                                             |  |                              | 21,177  |   |                 |  
|Residential real estate loans                                                                                                                        |  |                              | 30,523  |   |                 |  
|Loans to individuals                                                                                                                                 |  |                              | 28,381  |   |                 |  
|                                                                                                                                                     |  |                              |         |   |                 |  
|Total loans                                                                                                                                          |  |                              | 212,617 |   |                 |  
|Less unearned income                                                                                                                                 |  |                              | (8      | ) |                 |  
|Less allowance for loan losses                                                                                                                       |  |                              | (2,355  | ) |                 |  
|                                                                                                                                                     |  |                              |         |   |                 |  
|Net loans                                                                                                                                            |  |                              | 210,254 |   |                 |  
|Premises and equipment                                                                                                                               |  |                              | 5,634   |   |                 |  
|Bank owned life insurance                                                                                                                            |  |                              | 4,577   |   |                 |  
|Accrued interest receivable                                                                                                                          |  |                              | 1,149   |   |                 |  
|Other assets                                                                                                                                         |  |                              | 1,275   |   |                 |  
|                                                                                                                                                     |  |                              |         |   |                 |  
|Total assets                                                                                                                                         |  | $                            | 303,040 |   |                 | $
|                                                                                                                                                     |  |                              |         |   |                 |  
|Liabilities and Shareholders Equity                                                                                                                 |  |                              |         |   |                 |  
|Deposits:                                                                                                                                            |  |                              |         |   |                 |  
|Non-interest bearing demand deposits                                                                                                                 |  | $                            | 40,246  |   |                 | $
|Interest bearing demand deposits                                                                                                                     |  |                              | 14,805  |   |                 |  
|Money market deposits                                                                                                                                |  |                              | 27,784  |   |                 |  
|Savings deposits                                                                                                                                     |  |                              | 4,494   |   |                 |  
|Certificates of deposits > $100,000                                                                                                                  |  |                              | 41,977  |   |                 |  
|Other time deposits                                                                                                                                  |  |                              | 90,134  |   |                 |  
|                                                                                                                                                     |  |                              |         |   |                 |  
|Total deposits                                                                                                                                       |  |                              | 219,440 |   |                 |  
|                                                                                                                                                     |  |                              |         |   |                 |  
|Short-term borrowings                                                                                                                                |  |                              | 15,036  |   |                 |  
|Securities sold under agreements to repurchase                                                                                                       |  |                              | 5,279   |   |                 |  
|Accrued interest payable                                                                                                                             |  |                              | 782     |   |                 |  
|Other liabilities                                                                                                                                    |  |                              | 525     |   |                 |  
|Trust preferred securities                                                                                                                           |  |                              | 4,000   |   |                 |  
|Long-term borrowings                                                                                                                                 |  |                              | 37,000  |   |                 |  
|                                                                                                                                                     |  |                              |         |   |                 |  
|Total liabilities                                                                                                                                    |  |                              | 282,062 |   |                 |  
|                                                                                                                                                     |  |                              |         |   |                 |  
|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 1,831,476 at September 30, 2003 and 1,828,737 at
December 31, 2002. |  |                              | 12,382  |   |                 |  
|Retained earnings                                                                                                                                    |  |                              | 8,412   |   |                 |  
|Accumulated other comprehensive income                                                                                                               |  |                              | 184     |   |                 |  
|                                                                                                                                                     |  |                              |         |   |                 |  
|Total shareholders equity                                                                                                                           |  |                              | 20,978  |   |                 |  
|                                                                                                                                                     |  |                              |         |   |                 |  
|Total liabilities and shareholders equity                                                                                                           |  | $                            | 303,040 |   |                 | $
|                                                                                                                                                     |  |                              |         |   |                 |  



See accompanying notes to consolidated
financial statements.



3



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##### Table of Contents

VALLEY FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(In thousands, except
per share data)



|                                                    |  | For the Period January 1, 2003 Through September 30, 2003 |        |   | For the Period January 1, 2002 Through September 30, 2002 |  
|--------------------------------------------------- |  | --------------------------------------------------------- | ------ | - | --------------------------------------------------------- | -
|Interest Income:                                    |  |                                                           |        |   |                                                           |  
|Interest and fees on loans                          |  | $                                                         | 9,681  |   |                                                           | $
|Interest on money market investments                |  |                                                           | 47     |   |                                                           |  
|Interest on securities - taxable                    |  |                                                           | 1,084  |   |                                                           |  
|Interest on securities - nontaxable                 |  |                                                           | 465    |   |                                                           |  
|                                                    |  |                                                           |        |   |                                                           |  
|Total interest income                               |  |                                                           | 11,277 |   |                                                           |  
|                                                    |  |                                                          
|Interest Expense:                                   |  |                                                           |        |   |                                                           |  
|Interest on certificates of deposit > 100,000       |  |                                                           | 727    |   |                                                           |  
|Interest on other deposits                          |  |                                                           | 2,201  |   |                                                           |  
|Interest on long-term borrowings                    |  |                                                           | 1,139  |   |                                                           |  
|Interest on repurchase agreements                   |  |                                                           | 39     |   |                                                           |  
|Interest on trust preferred securities              |  |                                                           | 45     |   |                                                           |  
|Interest on short-term borrowings                   |  |                                                           | 114    |   |                                                           |  
|                                                    |  |                                                           |        |   |                                                           |  
|Total interest expense                              |  |                                                           | 4,265  |   |                                                           |  
|                                                    |  |                                                           |        |   |                                                           |  
|Net interest income                                 |  |                                                           | 7,012  |   |                                                           |  
|                                                    |  |                                                          
|Provision for loan losses                           |  |                                                           | 471    |   |                                                           |  
|                                                    |  |                                                           |        |   |                                                           |  
|Net interest income after provision for loan losses |  |                                                           | 6,541  |   |                                                           |  
|                                                    |  |                                                           |        |   |                                                           |  
|Noninterest Income:                                 |  |                                                           |        |   |                                                           |  
|Service charges on deposit accounts                 |  |                                                           | 534    |   |                                                           |  
|Income earned on bank owned life insurance          |  |                                                           | 203    |   |                                                           |  
|Other income on real estate loans                   |  |                                                           | 157    |   |                                                           |  
|Other fee income                                    |  |                                                           | 118    |   |                                                           |  
|Securities gains                                    |  |                                                           | 7      |   |                                                           |  
|Losses on foreclosed properties                     |  |                                                           | (9     | ) |                                                           |  
|                                                    |  |                                                           |        |   |                                                           |  
|Total noninterest income                            |  |                                                           | 1,010  |   |                                                           |  
|                                                    |  |                                                           |        |   |                                                           |  
|Noninterest Expense:                                |  |                                                           |        |   |                                                           |  
|Compensation expense                                |  |                                                           | 2,684  |   |                                                           |  
|Occupancy                                           |  |                                                           | 283    |   |                                                           |  
|Data processing and equipment                       |  |                                                           | 541    |   |                                                           |  
|Franchise tax expense                               |  |                                                           |       |   |                                                           |  
|Purchased tax credit expense                        |  |                                                           | 248    |   |                                                           |  
|Deposit expenses                                    |  |                                                           | 115    |   |                                                           |  
|Loan expense                                        |  |                                                           | 254    |   |                                                           |  
|Other expense                                       |  |                                                           | 785    |   |                                                           |  
|                                                    |  |                                                           |        |   |                                                           |  
|Total noninterest expense                           |  |                                                           | 4,910  |   |                                                           |  
|                                                    |  |                                                           |        |   |                                                           |  
|Net income before taxes                             |  |                                                           | 2,641  |   |                                                           |  
|                                                    |  |                                                          
|Provision for income taxes                          |  |                                                           | 598    |   |                                                           |  
|                                                    |  |                                                           |        |   |                                                           |  
|Net income                                          |  | $                                                         | 2,043  |   |                                                           | $
|                                                    |  |                                                           |        |   |                                                           |  
|Basis earnings per share                            |  | $                                                         | 1.12   |   |                                                           | $
|                                                    |  |                                                           |        |   |                                                           |  
|Diluted earnings per share                          |  | $                                                         | 1.05   |   |                                                           | $
|                                                    |  |                                                           |        |   |                                                           |  



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)



|                                                    |  | For the Period July 1, 2003 Through September 30, 2003 |       |   | For the Period July 1, 2002 Through September 30, 2002 |  
|--------------------------------------------------- |  | ------------------------------------------------------ | ----- | - | ------------------------------------------------------ | -
|Interest Income:                                    |  |                                                        |       |   |                                                        |  
|Interest and fees on loans                          |  | $                                                      | 3,307 |   |                                                        | $
|Interest on money market investments                |  |                                                        | 7     |   |                                                        |  
|Interest on securities  taxable                    |  |                                                        | 434   |   |                                                        |  
|Interest on securities - nontaxable                 |  |                                                        | 160   |   |                                                        |  
|                                                    |  |                                                        |       |   |                                                        |  
|Total interest income                               |  |                                                        | 3,908 |   |                                                        |  
|                                                    |  |                                                       
|Interest Expense:                                   |  |                                                        |       |   |                                                        |  
|Interest on certificates of deposit > 100,000       |  |                                                        | 252   |   |                                                        |  
|Interest on other deposits                          |  |                                                        | 751   |   |                                                        |  
|Interest on long-term borrowings                    |  |                                                        | 397   |   |                                                        |  
|Interest on repurchase agreements                   |  |                                                        | 11    |   |                                                        |  
|Interest on trust preferred securities              |  |                                                        | 43    |   |                                                        |  
|Interest on short-term borrowings                   |  |                                                        | 37    |   |                                                        |  
|                                                    |  |                                                        |       |   |                                                        |  
|Total interest expense                              |  |                                                        | 1,491 |   |                                                        |  
|                                                    |  |                                                        |       |   |                                                        |  
|Net interest income                                 |  |                                                        | 2,417 |   |                                                        |  
|                                                    |  |                                                       
|Provision for loan losses                           |  |                                                        | 115   |   |                                                        |  
|                                                    |  |                                                        |       |   |                                                        |  
|Net interest income after provision for loan losses |  |                                                        | 2,302 |   |                                                        |  
|                                                    |  |                                                        |       |   |                                                        |  
|Noninterest Income:                                 |  |                                                        |       |   |                                                        |  
|Service charges on deposit accounts                 |  |                                                        | 202   |   |                                                        |  
|Income earned on bank owned life insurance          |  |                                                        | 71    |   |                                                        |  
|Other income on real estate loans                   |  |                                                        | 47    |   |                                                        |  
|Other fee income                                    |  |                                                        | 49    |   |                                                        |  
|Securities gains                                    |  |                                                        |      |   |                                                        |  
|Losses on foreclosed properties                     |  |                                                        | (3    | ) |                                                        |  
|                                                    |  |                                                        |       |   |                                                        |  
|Total noninterest income                            |  |                                                        | 366   |   |                                                        |  
|                                                    |  |                                                        |       |   |                                                        |  
|Noninterest Expense:                                |  |                                                        |       |   |                                                        |  
|Compensation expense                                |  |                                                        | 917   |   |                                                        |  
|Occupancy                                           |  |                                                        | 97    |   |                                                        |  
|Data processing and equipment                       |  |                                                        | 187   |   |                                                        |  
|Franchise tax expense                               |  |                                                        |      |   |                                                        |  
|Purchased tax credit expense                        |  |                                                        | 34    |   |                                                        |  
|Deposit expenses                                    |  |                                                        | 39    |   |                                                        |  
|Loan expense                                        |  |                                                        | 98    |   |                                                        |  
|Other expense                                       |  |                                                        | 284   |   |                                                        |  
|                                                    |  |                                                        |       |   |                                                        |  
|Total noninterest expense                           |  |                                                        | 1,656 |   |                                                        |  
|                                                    |  |                                                        |       |   |                                                        |  
|Net income before taxes                             |  |                                                        | 1,012 |   |                                                        |  
|                                                    |  |                                                       
|Provision for income taxes                          |  |                                                        | 283   |   |                                                        |  
|                                                    |  |                                                        |       |   |                                                        |  
|Net income                                          |  | $                                                      | 729   |   |                                                        | $
|                                                    |  |                                                        |       |   |                                                        |  
|Basis earnings per share                            |  | $                                                      | 0.40  |   |                                                        | $
|                                                    |  |                                                        |       |   |                                                        |  
|Diluted earnings per share                          |  | $                                                      | 0.37  |   |                                                        | $
|                                                    |  |                                                        |       |   |                                                        |  



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)



|                                                                                  |  | For the Period January 1, 2003 Through September 30, 2003 |         |   | For the Period January 1, 2002 Through September 30, 2002 |  
|--------------------------------------------------------------------------------- |  | --------------------------------------------------------- | ------- | - | --------------------------------------------------------- | -
|Cash Flows From Operating Activities:                                             |  |                                                           |         |   |                                                           |  
|Net income                                                                        |  | $                                                         | 2,043   |   |                                                           | $
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                                                           |         |   |                                                           |  
|Provision for loan losses                                                         |  |                                                           | 471     |   |                                                           |  
|Depreciation and amortization                                                     |  |                                                           | 358     |   |                                                           |  
|Net gains on sale of securities                                                   |  |                                                           | (7      | ) |                                                           |  
|Net losses on foreclosed properties                                               |  |                                                           | 9       |   |                                                           |  
|Net losses on fixed asset disposals                                               |  |                                                           | 7       |   |                                                           |  
|Amortization (accretion) of premiums/discounts                                    |  |                                                           | 169     |   |                                                           |  
|Decrease in unearned fees                                                         |  |                                                           | (6      | ) |                                                           |  
|Increase in interest receivable                                                   |  |                                                           | (37     | ) |                                                           |  
|Increase in other assets                                                          |  |                                                           | (428    | ) |                                                           |  
|Increase in value of life insurance contracts                                     |  |                                                           | (199    | ) |                                                           |  
|Increase (decrease) in accrued interest payable                                   |  |                                                           | (262    | ) |                                                           |  
|Decrease in other liabilities                                                     |  |                                                           | (146    | ) |                                                           |  
|                                                                                  |  |                                                           |         |   |                                                           |  
|Net cash provided by operating activities                                         |  |                                                           | 1,972   |   |                                                           |  
|                                                                                  |  |                                                           |         |   |                                                           |  
|Cash Flows From Investing Activities:                                             |  |                                                           |         |   |                                                           |  
|(Increase) decrease in money market investments                                   |  |                                                           | 3,575   |   |                                                           |  
|Purchases of premises and equipment                                               |  |                                                           | (1,066  | ) |                                                           |  
|Purchases of securities available-for-sale                                        |  |                                                           | (28,502 | ) |                                                           |  
|Purchases of securities held to maturity                                          |  |                                                           | (12,352 | ) |                                                           |  
|Purchases of restricted equity securities                                         |  |                                                           | (716    | ) |                                                           |  
|Principal repays/sales/calls/maturities of securities available-for-sale          |  |                                                           | 7,291   |   |                                                           |  
|Principal repayments of securities held to maturity                               |  |                                                           | 10,223  |   |                                                           |  
|Investment in life insurance contracts                                            |  |                                                           | (1,200  | ) |                                                           |  
|Proceeds from sale of foreclosed properties                                       |  |                                                           | 480     |   |                                                           |  
|Capitalized foreclosed property expense                                           |  |                                                           | (29     | ) |                                                           |  
|Increase in loans                                                                 |  |                                                           | (27,350 | ) |                                                           |  
|                                                                                  |  |                                                           |         |   |                                                           |  
|Net cash used in investing activities                                             |  |                                                           | (49,646 | ) |                                                           |  
|                                                                                  |  |                                                           |         |   |                                                           |  
|Cash Flows From Financing Activities:                                             |  |                                                           |         |   |                                                           |  
|Increase in time deposits greater than $100,000                                   |  |                                                           | 7,997   |   |                                                           |  
|Increase in other time deposits                                                   |  |                                                           | 8,398   |   |                                                           |  
|Increase (decrease) in other deposits                                             |  |                                                           | 20,802  |   |                                                           |  
|Increase (decrease) in short-term borrowings                                      |  |                                                           | 5,036   |   |                                                           |  
|Increase (decrease) in securities sold under agreements to repurchase             |  |                                                           | (585    | ) |                                                           |  
|Proceeds from trust preferred securities                                          |  |                                                           | 4,000   |   |                                                           |  
|Proceeds from issuance of common stock                                            |  |                                                           | 29      |   |                                                           |  
|Cash in lieu of fractional shares                                                 |  |                                                           |        |   |                                                           |  
|Proceeds from long-term borrowings                                                |  |                                                           | 7,000   |   |                                                           |  
|                                                                                  |  |                                                           |         |   |                                                           |  
|Net cash provided by financing activities                                         |  |                                                           | 52,677  |   |                                                           |  
|                                                                                  |  |                                                           |         |   |                                                           |  
|Net Increase in Cash and Due from Banks                                           |  |                                                           | 5,003   |   |                                                           |  
|                                                                                  |  |                                                          
|Cash and Due From Banks at Beginning of Period                                    |  |                                                           | 8,163   |   |                                                           |  
|                                                                                  |  |                                                           |         |   |                                                           |  
|Cash and Due From Banks at End of Period                                          |  | $                                                         | 13,166  |   |                                                           | $
|                                                                                  |  |                                                           |         |   |                                                           |  
|Supplemental disclosure of cash flow information:                                 |  |                                                           |         |   |                                                           |  
|Cash paid during the period for interest                                          |  | $                                                         | 4,527   |   |                                                           | $
|                                                                                  |  |                                                           |         |   |                                                           |  
|Cash paid during the period for taxes                                             |  | $                                                         | 744     |   |                                                           | $
|                                                                                  |  |                                                           |         |   |                                                           |  
|Noncash financing and investing activities:                                       |  |                                                           |         |   |                                                           |  
|Transfer of loans to foreclosed property                                          |  | $                                                         | 264     |   |                                                           | $
|                                                                                  |  |                                                           |         |   |                                                           |  



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, 2003 (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 2002 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 will be required to maintain certain average reserve balances. The daily cash reserve requirement for the week including September 30, 2003 was $290. 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, 2003 was $4,800.



| | (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, 2003 are shown in the tables below. As of September 30, 2003, investments (including both available for sale and held to maturity) and restricted equity securities with amortized costs and fair values of $41,179 and
$41,172, respectively, were pledged as collateral for public deposits, a line of credit available from the Federal Home Loan Bank, customer sweep accounts, and for other purposes as required or permitted by law.



The following table sets forth the composition of securities
available for sale at September 30, 2003. Securities available for sale are carried at approximate market value.



7



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##### Table of Contents

Available for Sale Investment Portfolio  Category Distribution

(dollars in thousands)



|                                    |  | Amortized Costs |        | Unrealized Gains |   | Unrealized Losses |  |   | Approximate Fair Values
|----------------------------------- |  | --------------- | ------ | ---------------- | - | ----------------- |  | - | -----------------------
|U.S. Treasury                       |  | $               | 200    |                  | $ | 1                 |  | $ |                       
|U.S. Government agencies            |  |                 | 3,718  |                  |   | 48                |  |   |                       
|Mortgage-backed securities          |  |                 | 4,177  |                  |   | 89                |  |   | (14                    
|Collateralized mortgage obligations |  |                 | 22,145 |                  |   | 35                |  |   | (143                   
|States and political subdivisions   |  |                 | 10,058 |                  |   | 311               |  |   | (48                    
|Corporate debt securities           |  |                 | 200    |                  |   | 2                 |  |   | (2                     
|                                    |  |                 |        |                  |   |                   |  |   |                        
|Total securities available for sale |  | $               | 40,498 |                  | $ | 486               |  | $ | (207                   
|                                    |  |                 |        |                  |   |                   |  |   |                        



The
following table sets forth the composition of securities held to maturity at September 30, 2003. Securities held to maturity are carried at amortized cost.



Held to Maturity Investment Portfolio  Category Distribution

(dollars in thousands)



|                                    |  | Amortized Costs |        | Unrealized Gains |   | Unrealized Losses |  |   | Approximate Fair Values
|----------------------------------- |  | --------------- | ------ | ---------------- | - | ----------------- |  | - | -----------------------
|U.S. Government agencies            |  | $               | 5,991  |                  | $ |                  |  | $ | (98                    
|Mortgage-backed securities          |  |                 | 7,542  |                  |   | 31                |  |   | (7                     
|Collateralized mortgage obligations |  |                 | 1,729  |                  |   | 5                 |  |   | (22                    
|States and political subdivisions   |  |                 | 6,939  |                  |   | 9                 |  |   | (196                   
|                                    |  |                 |        |                  |   |                   |  |   |                        
|Total securities held to maturity   |  | $               | 22,201 |                  | $ | 45                |  | $ | (323                   
|                                    |  |                 |        |                  |   |                   |  |   |                        



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



The following table summarizes the loan loss experience for the nine-month periods ended September 30, 2003 and 2002.



Allowance for Loan Losses

(dollars in thousands)



|                                  |  | 2003 |       |   | 2002 |  
|--------------------------------- |  | ---- | ----- | - | ---- | -
|Balance at January 1              |  | $    | 2,014 |   |      | $
|Provision for loan losses         |  |      | 471   |   |      |  
|Recoveries  Loans to individuals |  |      | 1     |   |      |  
|Charged off loans                 |  |      |       |   |      |  
|Commercial                        |  |      | 0     |   |      |  
|Credit Cards                      |  |      | 0     |   |      |  
|Loans to individuals              |  |      | (131  | ) |      |  
|                                  |  |      |       |   |      |  
|Balance at September 30           |  | $    | 2,355 |   |      | $
|                                  |  |      |       |   |      |  



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##### Table of Contents

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



Basic earnings per share is based upon the weighted average number of common shares outstanding during the period. The weighted average
shares outstanding for the diluted earnings per share computations were adjusted to reflect the assumed conversion of shares available under stock options. The following table summarizes the shares utilized (adjusted for the three-for-two stock
split declared on April 24, 2002 to shareholders of record April 30, 2002 and payable on May 30, 2002) in the computations:



Weighted Average Shares Outstanding



|Three months ending September 30: |  | Basic     |  | Diluted  
|--------------------------------- |  | --------- |  | ---------
|2003                              |  | 1,831,476 |  | 1,958,891
|                                  |  |           |  |          
|2002                              |  | 1,819,637 |  | 1,895,789
|                                  |  |           |  |          
|                                  |  |          
|Nine months ending September 30:  |  | Basic     |  | Diluted  
|2003                              |  | 1,830,650 |  | 1,944,717
|                                  |  |           |  |          
|2002                              |  | 1,819,732 |  | 1,889,664
|                                  |  |           |  |          



| | (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 (losses) 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, 2003 and 2002, total comprehensive income was $1,925 and $2,165, respectively. For the three months ended September 30,
2003 and 2002, total comprehensive income was $378 and $911, respectively.



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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 and three month periods ended September 30, 2003 and 2002.



|                                                                   |  | For the Nine Months Ended September 30, 2003  |      |   | For the Nine Months Ended September 30, 2002 |  
|------------------------------------------------------------------ |  | --------------------------------------------- | ---- | - | -------------------------------------------- | -
|Net unrealized gains (losses) on securities available for sale:    |  |                                               |      |   |                                              |  
|Net unrealized holding gains (losses) during the year              |  | $                                             | (172 | ) |                                              | $
|Less reclassification adjustments for gains included in net income |  |                                               | (5   | ) |                                              |  
|Income tax benefit (expense)                                       |  |                                               | 59   |   |                                              |  
|                                                                   |  |                                               |      |   |                                              |  
|Other comprehensive income (loss), net of income taxes             |  | $                                             | (118 | ) |                                              | $
|                                                                   |  |                                               |      |   |                                              |  
|                                                                   |  |                                              
|                                                                   |  | For the Three Months Ended September 30, 2003 |      |   | For the Three Months EndedSeptember 30, 2002 |  
|Net unrealized gains (losses) on securities available for sale:    |  |                                               |      |   |                                              |  
|Net unrealized holding gains (losses) during the quarter           |  | $                                             | (532 | ) |                                              | $
|Less reclassification adjustments for gains included in net income |  |                                               |     |   |                                              |  
|Income tax benefit (expense)                                       |  |                                               | 181  |   |                                              |  
|                                                                   |  |                                               |      |   |                                              |  
|Other comprehensive income (loss), net of income taxes             |  | $                                             | (351 | ) |                                              | $
|                                                                   |  |                                               |      |   |                                              |  



| | (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, 2003, outstanding commitments to extend credit were $61,589 as compared to $62,076 at December 31, 2002.



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, 2003 aggregate loans to directors, executive officers, and principal shareholders total $8,535. An analysis of loan activity
to directors, executive officers and principal shareholders for the year ended December 31, 2002 is as follows:



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##### Table of Contents

Loans to Related Parties



|Balances as of January 1, 2002   |  | $ | 5,115  |  
|-------------------------------- |  | - | ------ | -
|Advances                         |  |   | 4,186  |  
|Repayments                       |  |   | (1,843 | )
|                                 |  |   |        |  
|Balances as of December 31, 2002 |  | $ | 7,458  |  
|                                 |  |   |        |  



| | (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, 2003. 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 any 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 LIBOR-based adjustable rate credit (ARC) at 3-month LIBOR flat. The $10.0 million convertible advance may be converted into a 3-month LIBOR-based floating rate advance (ARC) at 3-month LIBOR flat
only if 3-month LIBOR is greater than or equal to 7.0%. The following table provides more information on the outstanding advances as of September 30, 2003.



LONG-TERM FEDERAL HOME LOAN BANK ADVANCES



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



| | (10) | Trust Preferred Securities
| | ---- | --------------------------



Trust Preferred Securities are hybrid securities, which are considered equity (Tier I capital) for regulatory purposes and debt for
financial statement and tax purposes. Trust Preferred Securities offer the benefit of an attractive floating or fixed rate interest payment which is tax deductible, making the after-tax cost to the issuer less than traditional forms of capital. The
Company issued $4.0 million of trust preferred securities on June 26, 2003 through a special purpose subsidiary as part of a pooled transaction. As of September 30, 2003, the rate on the Trust I issuance was 4.24%, which is calculated as 3-Month
LIBOR plus 3.10%. The Companys trust preferred securities may be redeemed by the Company, in whole but not in part, prior to June 26, 2008, subject to the occurrence and continuation of a special event, at a redemption price of 107.5% of the
face value of the capital securities. On or after June 26, 2008, the trust preferred securities may be redeemed at face value. Debt issuance costs are being amortized over the term of the securities, with an unamortized balance of $114,000 as of
September 30, 2003.



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##### Table of Contents

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



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



Stock Option Plans



The Company has an Incentive Stock Plan (the Plan) pursuant to which the Human Resources Committee of the Companys Board of Directors may grant
stock options to officers and key employees. The Plan authorizes grants of options to purchase up to 155,925 shares (adjusted for stock splits) of the Companys authorized, but unissued common stock. Accordingly, 155,925 shares of authorized,
but unissued common stock are reserved for use in the Plan. There are options for 145,825 shares granted to officers and key employees currently outstanding as of September 30, 2003. All stock options have been granted with an exercise price equal
to the stocks fair market value at the date of the grant. Stock options under the Plan generally have 10-year terms, vest at the rate of 20 percent per year, and become fully exercisable five years from the date of the grant. In addition to
the Plan, certain other options for 91,098 shares (adjusted for stock splits) based on meeting certain performance criteria have been granted to executive officers. There are options for 81,998 shares granted to executive officers currently
outstanding as of September 30, 2003. Information related to pro forma net income and per share amounts for the periods presented is as follows:



|                                                                               |  | Nine Months Ended September 30,
|------------------------------------------------------------------------------ |  | -------------------------------
|                                                                               |  | 2003                           
|                                                                               |  |                                
|Compensation cost recognized in income for all stock-based compensation awards |  | $                              
|                                                                               |  |                                
|Pro forma net income, based on SFAS No. 123                                    |  | $                              
|                                                                               |  |                                
|Pro forma basic net income per share, based on SFAS No. 123                    |  | $                              
|                                                                               |  |                                
|Pro forma diluted net income per share, based on SFAS No. 123                  |  | $                              
|                                                                               | 
|                                                                               |  | Quarter Ended September 30,    
|                                                                               |  | 2003                           
|                                                                               |  |                                
|Compensation cost recognized in income for all stock-based compensation awards |  | $                              
|                                                                               |  |                                
|Pro forma net income, based on SFAS No. 123                                    |  | $                              
|                                                                               |  |                                
|Pro forma basic net income per share, based on SFAS No. 123                    |  | $                              
|                                                                               |  |                                
|Pro forma diluted net income per share, based on SFAS No. 123                  |  | $                              



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##### Table of Contents

Item 2. Managements Discussion and Analysis.



The following is managements discussion and analysis of the financial condition and results of operations of the Company as of and for the nine months ended September 30, 2003 and 2002. The discussion should be
read in conjunction with the Companys Consolidated Financial Statements and Notes thereto.



Forward-Looking Statements



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



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 six full-service branch locations, operating in various locations throughout the Cities of Roanoke and Salem and the County of Roanoke. The Bank plans to open its seventh full-service
branch in the Lewis-Gale Hospital area in the fall of 2003.



Total assets at September 30, 2003 were $303.0 million, up 21.8% from $248.8 million at December 31, 2002. The principal components of the Companys assets at the end of the period were $43.9 million in securities available-for-sale,
including restricted equity securities, $22.2 million in securities held to maturity, and $212.6 million in gross loans.



Total liabilities at September 30, 2003 were $282.1 million, up 22.8% from $229.8 million at December 31, 2002 with the increase represented by a $37.2
million growth in deposits, a $4.0 million trust preferred securities issue, and a $7.0 million and $5.0 million increase in long-term and overnight Federal Home Loan Bank advances, respectively, partially offset by a $600,000 decrease in securities
sold under agreements to repurchase.



Total shareholders
equity at September 30, 2003 was $21.0 million consisting of $9.1 million in net proceeds from the Companys initial public offering, $3.2 million in net proceeds from the Companys secondary offering, $97,000 in proceeds from the exercise
of stock options, increased by accumulated retained earnings of $8.4 million and $184,000 of net unrealized gains on securities available-for-sale, net of related deferred tax liability. Total shareholders equity was $21.0 million at September
30, 2003 compared with $19.0 million at December 31, 2002, an increase of $2.0 million or 10.5%. Exclusive of unrealized gains (losses) on investment securities, shareholders equity was $20.8 million at September 30, 2003 and $18.7 million at
December 31, 2002.



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##### Table of Contents

The Company had net income of $2.0 million for the nine months ended September 30, 2003, an increase of
$400,000 or 25.0% over the $1.6 million reported for the same period in 2002. Net income for the three months ended September 30, 2003 was $729,000, a 26.1% increase over the $578,000 recorded for the third quarter of 2002. An improved net interest
income combined with increased noninterest income, offset by increases in noninterest expense in virtually all categories, contributed to the 25.0% and 26.1% increase for the nine months ended September 30, 2003 as compared to the nine months ended
September 30, 2002 and the three months ended September 30, 2003 as compared to the three months ended September 30, 2002, respectively.



Profitability as measured by the Companys return on average assets (ROA) was 1.00% for the nine months ended September 30, 2003 compared
to .98% for the same period in 2002. ROA for the third quarter of 2003 was 0.99% versus 1.00% for the third quarter of 2002. Return on average equity (ROE) was 13.78% for the nine months ended September 30, 2003 compared to 12.16% for
the same period in 2002. ROE for the third quarter of 2003 was 14.08% as compared to 12.91% for the third quarter of 2002. The calculation of ROE excludes the effect of any unrealized gains or losses on investment securities.



Net Interest Income



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



Net interest income was $7.0 million for the nine months ended September 30, 2003 and is attributable to interest income
from loans and securities exceeding the cost of interest paid on deposits and borrowed funds. Net interest income for the first nine months of 2003 increased 14.8% from $6.1 million for the same period in 2002. The net interest margin on a fully
taxable equivalent (FTE ) basis was 3.80% for the first nine months of 2003, a decrease of 34 basis points from the 4.14% reported for the same period in 2002. Yields on earning assets are decreasing faster than funding costs may be
reduced. The Banks cost of funds ratio was 2.26% for the nine months ended September 30, 2003, down 49 basis points from the 2.75% reported for the first nine months of 2002. The Banks yield on earning assets was 6.04% for the nine
months ended September 30, 2003, down 78 basis points from the 6.82% reported for the nine months ended September 30, 2002. For the three months ended September 30, 2003 net interest income was $2.4 million, an increase of 14.3% from the $2.1
million reported for the three months ended September 30, 2002. The FTE net interest margin was 3.64% and 3.94% for the three month periods ended September 30, 2003 and 2002, respectively. Management is diligently working to maintain the net
interest margin by reducing the cost of funds ratio.



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##### Table of Contents

Noninterest Income



Noninterest income for the nine months ended September 30, 2003 was $1.0 million, an increase of $446,000 or 80.5% over the $554,000 reported for the same
period one year earlier. The largest components of the increase are service charges on deposit accounts in the amount of $171,000, tax-exempt income earned on bank owned life insurance in the amount of $77,000, other income on real estate loans in
the amount of $95,000, and other fee income in the amount of $85,000. Securities gains totaled $7,000 during the first nine months of 2003 as compared to $0 for the first nine months of 2002. Losses on foreclosed properties totaled $9,000 for the
nine months of 2003 as compared to $30,000 for the nine months ended September 30, 2002. For the three months ended September 30, 2003 noninterest income was $366,000, an increase of $175,000 or 91.6% over the $191,000 reported for the third quarter
of 2002. The largest components of the increase are service charges on deposit accounts in the amount of $68,000, tax-exempt income earned on bank owned life insurance in the amount of $26,000, other income on real estate loans in the amount of
$15,000, and other fee income in the amount of $39,000. There were no securities gains during the quarters ended September 30, 2003 and 2002. Losses on foreclosed properties totaled $3,000 and $30,000 for the quarters ended September 30, 2003 and
2002, respectively. Future levels of noninterest income are expected to increase as a direct result of business growth and expansion.



Noninterest Expense



Noninterest expense for the first nine months of 2003 was $4.9 million, an increase of $1.0 million or 25.6% over the $3.9 million reported for the same
period in 2002. Compensation expense was the largest contributor to the increase in the amount of $583,000. The other major contributor to the increase was purchased tax credit expense in the amount of $248,000, which is offset by a reduction in
franchise tax expense in the amount of $113,000. Expenses associated with the opening of the Banks sixth full-service branch on May 20, 2002 are included in the nine months ended September 30, 2002. Expenses associated with the introduction of
online banking in May 2002 are also included in the nine months ended September 30, 2002. Substantially all major categories of noninterest expense increased due to growth and expansion. Noninterest expense for the quarter ended September 30, 2003
was $1.7 million, an increase of $300,000 or 21.4% over the $1.4 million reported for the third quarter of 2002. Substantially all major categories of noninterest expense increased due to growth and expansion. Noninterest expenses are expected to
increase in future years as a direct result of business growth and expansion.



Income Taxes



To reflect the Companys
anticipated federal income tax liability, an expense of $598,000 and $631,000 at an effective tax rate of 22.6% and 28.7% was recognized for the nine months ended September 30, 2003 and 2002, 2002, respectively. The provision for income taxes for
the third quarter of 2003 and 2002 was $283,000 and $231,000 at an effective tax rate of 28.0% and 28.6%, respectively. During the first quarter of 2003, the Bank purchased federal and state tax credits in the amounts of $174,000 and $217,000,
respectively. The federal and state tax credits were purchased at a total cost of $156,000 and $151,000, respectively. The credits were expensed in the amount of $248,000 during the first nine months of 2003, comprised of $156,000 federal and
$92,000 state, as purchased tax credit expense (a noninterest expense). The federal tax credits will offset income tax expense in 2003 while the state tax credits will offset franchise tax expense in 2003 and a partial amount in 2004. Other factors
contributing to the difference between the effective tax rate and the statutory rate of 34 percent include tax-exempt interest income on municipal securities, net of disallowance and tax-exempt income earned on bank owned life insurance.



15



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##### Table of Contents

Investment Securities



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



Investment
securities (available for sale and held to maturity), including restricted equity securities, at September 30, 2003 were $66.1 million, an increase of $23.7 million or 55.9% from their level of $42.4 million on December 31, 2002. The increase of
$23.7 million is primarily due to purchases in the amount of $41.6 million, offset by principal repayments, sale proceeds, call proceeds, and maturity proceeds in the amounts of $14.6 million, $564,000, $2.3 million, and $100,000, respectively. See
Note 3 to the Consolidated Financial Statements.



Loan Portfolio



The Companys total loans were $212.6 million at
September 30, 2003, an increase of $26.9 million or 14.5% from the $185.7 million reported at December 31, 2002. The Companys ratio of total loans to total funding sources (customer deposits, securities sold under agreements to repurchase,
federal funds purchased, Federal Home Loan Bank advances, and trust preferred securities) stood at 75.7% at September 30, 2003 and 81.4% at December 31, 2002. Management seeks to maintain the ratio of loans to funding sources at a maximum of 85%.



The loan portfolio primarily consists of commercial, real
estate (including real estate term loans, construction loans and other loans secured by real estate) and loans to individuals for household, family and other consumer purposes. The Company adjusts its mix of lending and the terms of its loan
programs according to economic and market conditions, asset/liability management considerations and other factors. Loans typically (in excess of 90%) are made to businesses and individuals located within the Companys primary market area, most
of whom maintain deposit accounts with the Bank. There is no concentration of loans exceeding 10% of total loans, which is not disclosed in the Consolidated Financial Statements and the Notes thereto or discussed below. The Company has not made any
loans to any foreign entities, including governments, banks, businesses or individuals. Commercial and construction loans and home equity lines of credit in the loan portfolio are primarily variable rate loans and have little interest rate risk.



The following table summarizes the loan portfolio by category
as of the nine-month periods ended September 30, 2003 and 2002 and the year ended December 31, 2002.



16



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##### Table of Contents

Loan Portfolio Summary

(dollars in thousands)



|                          |  | September 30,2003 |         | December 31,2002 |   | September 30,2002
|------------------------- |  | ----------------- | ------- | ---------------- | - | -----------------
|Commercial and industrial |  | $                 | 48,630  |                  | $ | 44,668           
|Commercial real estate    |  |                   | 83,906  |                  |   | 75,378           
|Real estate construction  |  |                   | 21,177  |                  |   | 15,727           
|Residential real estate   |  |                   | 30,523  |                  |   | 23,966           
|Loans to individuals      |  |                   | 28,381  |                  |   | 25,922           
|                          |  |                   |         |                  |   |                  
|Total loans               |  | $                 | 212,617 |                  | $ | 185,661          
|                          |  |                   |         |                  |   |                  



Loan Category Analysis



Commercial Loans. Commercial and industrial loans
accounted for 22.9% of the loan portfolio as of September 30, 2003 and stood at $48.6 million versus $44.7 million nine months earlier. Such loans generally are made to provide operating lines of credit, to finance the purchase of inventory or
equipment, and for other business purposes. The credit worthiness of the borrower is analyzed and re-evaluated on a periodic basis. Most commercial loans are collateralized with business assets such as accounts receivable, inventory and equipment.
Even with substantial collateral such as all the assets of the business and personal guarantees, commercial lending involves considerable risk of loss in the event of a business downturn or failure of the business.



Commercial Real Estate Loans.Commercial real estate construction and
commercial real estate mortgages represent interim and permanent financing of commercial properties that are secured by real estate, and were 39.5% of total loans at September 30, 2003. Outstanding loans in this category equaled $83.9 million and
$75.4 million at September 30, 2003 and December 31, 2002, respectively. The Company prefers to make commercial real estate loans secured by owner-occupied properties. These borrowers are engaged in business activities other than real estate, and
the primary source of repayment is not solely dependent on conditions in the real estate market.



Real Estate Construction Loans. Real estate construction loans represent interim financing on residential and commercial properties under
construction, and are secured by real estate. Once construction is completed and the loan becomes permanent, the loans are reclassified as commercial real estate loans, which are secured by commercial property or residential real estate loans, which
are secured by first deeds of trust. Outstanding loans in this category totaled $21.2 million (10.0% of total loans) at September 30, 2003 as compared to $15.7 million at December 31, 2002.



Residential Real Estate Loans. Residential real estate loans are
secured by first deeds of trust on 1-4 family residential properties. This category had $30.5 million in loans (14.3% of total loans) at September 30, 2003 and $24.0 million in such loans at December 31, 2002. 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 and offers a bi-weekly payment option to encourage faster repayment. Residential real estate lending involves risk elements when
there is lack of timely payment and/or a decline in the value of the collateral.



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Loans to Individuals.Loans to individuals include installment loans and home equity lines of
credit/loans secured by junior liens on residential real estate. The loan proceeds typically are used to purchase vehicles, finance home remodeling or higher education, or for other consumer purposes. Loans to individuals totaled $28.4 million
(13.3% of total loans) at September 30, 2003 compared to $25.9 million at December 31, 2002.



Summary of Allowance for Loan Losses



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



The allowance for loan losses is maintained at a level estimated to be adequate to absorb probable losses. Some of the
factors which management considers in determining the appropriate level of the allowance for loan losses are an evaluation of the current loan portfolio, identified loan problems, loan volume outstanding, past loss experience, present and expected
industry and economic conditions and, in particular, how such conditions relate to our market area. Bank regulators also periodically review the loan portfolio and other assets to assess their quality. The provision for loan losses is charged to
income in an amount believed to be necessary to maintain an allowance for loan losses adequate to provide for expected losses in the loan portfolio. Loans deemed uncollectible are charged to the allowance for loan losses and recoveries on loans
previously charged off are added to the allowance for loan losses. The Company believes the allowance for loan losses is adequate to provide for expected losses in the loan portfolio.



No assurance can be given that unforeseen adverse economic conditions or other circumstances will not result in increased
provisions in the future. Additionally, regulatory examiners may require the Company to recognize additions to the allowance based upon their judgment about the loan portfolio and other information available to them at the time of their
examinations.



A provision for loan losses of $471,000
was provided during the nine months ended September 30, 2003, a decrease of $45,000 or 8.7% over the same period in 2002, in recognition of managements estimate of inherent risks associated with lending activities. The allowance for loan
losses was $2.4 million as of September 30, 2003 and represented approximately 1.1% of net loans outstanding versus 1.1% of net loans at December 31, 2002 (see Note 4 to the Consolidated Financial Statements). The increase in the allowance for loan
losses as a percentage of net loans outstanding has gradually increased due to managements concern about perceived continuing economic weakness. A total of $24,000 in specific reserves is included in the balance of the allowance for loan
losses as of September 30, 2003. A total of $40,000 in specific reserves is included in the balance of the allowance for loan losses as of September 30, 2002. Of the $40,000 specific reserve, $40,000 was accrued during the second quarter of 2002. A
decline in the growth rate in average loans outstanding also contributed to the decrease in provision expense.



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Nonperforming Assets and Impaired Loans



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



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



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



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



The total recorded investment in impaired loans was $88,000, $390,000 and $6,000, respectively for the nine month period ended September 30, 2003, the
year ended December 31, 2002 and the nine-month period ended September 30, 2002. The loan loss allowance related to impaired loans was $24,000, $0 and $0, respectively for the above-referenced time periods. A total of $40,000 was included in the
loan loss allowance at September 30, 2002 to cover any declines in the value of foreclosed property. Management believes that the above allocated reserves are adequate for the impaired loans in the Companys portfolio based upon a detailed
review of the quality and pledged collateral of each individual loans considered impaired at each of the above-referenced periods.



Nonperforming assets at September 30, 2003, December 31, 2002 and September 30, 2002 are presented in the following table.



Nonperforming Assets

(dollars in thousands)



|                                             |  | September 30 ,2003 |    | December 31,2002 |   | Sepember 30,2002
|-------------------------------------------- |  | ------------------ | -- | ---------------- | - | ----------------
|Nonaccrual loans                             |  | $                  | 88 |                  | $ |                
|Loans past due 90 days or more               |  |                    |   |                  |   | 390             
|Restructured loans                           |  |                    |   |                  |   |                
|                                             |  |                    |    |                  |   |                 
|Total nonperforming loans                    |  |                    | 88 |                  |   | 390             
|                                             |  |                    |    |                  |   |                 
|Foreclosed, repossessed and idled properties |  |                    |   |                  |   | 196             
|                                             |  |                    |    |                  |   |                 
|Total nonperforming assets                   |  | $                  | 88 |                  | $ | 586             
|                                             |  |                    |    |                  |   |                 



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If nonaccrual loans had performed in accordance with their original terms, additional interest income in
the amount of $10,000, $15,000, and $15,000, respectively would have been recorded for the nine month period ended September 30, 2003, the year ended December 31, 2002 and the nine month period ended September 30, 2002.



Other Assets



The Company has purchased life insurance contracts on key employees, the tax-exempt income from which is the funding
vehicle for the Companys SERP plan. Bank owned life insurance was $4.6 million at September 30, 2003, an increase of $1.4 million over the $3.2 million reported as of December 31, 2002. An additional purchase of split dollar life insurance
contracts on key employees in the first quarter contributed to $1.2 million of the total increase during the first nine months of 2003.



Other assets were $1.3 million at September 30, 2003, an increase of $300,000 over the $1.0 million reported as of December 31, 2002.



Deposits



As of September 30, 2003 total deposits were $219.4 million, an increase of $37.2 million or 20.4% from their level of
$182.2 million at December 31, 2002. Certificates of deposit increased by $16.4 million to a total of $132.1 million (60.2% of total deposits) at September 30, 2003, up from $115.7 million (63.5% of total deposits) at December 31, 2002. Non-interest
bearing demand deposits, savings, interest bearing demand deposits, and money market accounts increased by $9.5 million, $1.2 million, $2.8 million, and $7.3 million, respectively.



At September 30, 2003 noninterest-bearing demand deposits were $40.2 million or 18.3% of total deposits. On December 31,
2002 noninterest-bearing demand deposits were $30.7 million or 16.8% of total deposits. Nonmaturity deposits (noninterest bearing demand deposits, interest bearing demand deposits, money market accounts and savings accounts) were $87.3 million or
39.8% of total deposits at September 30, 2003, compared with $66.5 million or 36.5% of total deposits at December 31, 2002. Total interest bearing deposits stood at $179.2 million at September 30, 2003, an increase of $27.7 million or 18.3% over
their level of $151.5 million at December 31, 2002.



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



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Short-Term Borrowings



The Companys short-term borrowings increased by $5.0 million from its level of $10.0 million at December 31, 2002 to a total of $15.0 million as of
September 30, 2003. Short-term borrowings at September 30, 2003 consist of federal funds purchased in the amount of $36,000, a Federal Home Loan Bank of Atlanta daily rate credit in the amount of $5.0 million, and a Federal Home Loan Bank of Atlanta
adjustable rate credit in the amount of $10.0 million. The increase of $5.0 million is attributable to the Federal Home Loan Bank of Atlanta daily rate credit advance finalized in September of 2003.



Federal funds purchased increased by $36,000 from its level of $0 at December
31, 2002.



The proceeds of the $5.0 million Federal Home Loan
Bank of Atlanta daily rate credit were received in September of 2003. The borrowing matures daily and is rolled over on a daily basis at the stated Federal Home Loan Bank of Atlanta daily rate. There is no stated maturity date. Interest is paid
monthly on the daily rate credit.



The Federal Home Loan Bank
of Atlanta adjustable rate credit in the amount of $10.0 million matures on December 16, 2003. The advance reprices quarterly on the date of each quarterly interest payment. The current rate is 1.17%. See the liquidity section for further
information on the preceding borrowings.



The Company placed in
service a commercial sweep account program in third quarter 1999. The balance in the program decreased by $600,000 from its level of $5.9 million at December 31, 2002 to a total of $5.3 million as of September 30, 2003. The program consists of
establishing a demand deposit account in which the Bank invests available balances daily in securities on an overnight basis subject to repurchase. On the following business day, the Bank will repurchase from the customer the securities for an
amount equal to the amount of available balances invested in the securities. Interest is calculated daily at the rate applicable for each overnight period; however, it is posted to the customer accounts only once per month. The contractual agreement
states that a repurchase agreement is not a deposit and therefore is not insured by the Federal Deposit Insurance Corporation. Therefore, these repurchase balances are not reported as deposits but as short-term borrowings.



Long-Term Borrowings



Federal Home Loan Bank advances are relatively cost-effective funding sources and provide the Company with the flexibility
to structure borrowings in a manner that aids in the management of interest rate risk and liquidity. Long-term convertible Federal Home Loan Bank advances totaled $37.0 million, an increase of $7.0 million over the $30.0 million as of December 31,
2002. The increase in advances during the year reflects the funding to support investment growth. See Footnote 9 for more information on the long-term advances.



Trust Preferred Securities are hybrid securities, which are considered equity (Tier I Capital) for regulatory purposes and debt for financial statement
and tax purposes. Trust Preferred Securities offer the benefit of an attractive floating or fixed rate interest payment which is tax deductible, making the after-tax cost to the issuer less than traditional forms of capital. The Company issued $4.0
million of trust preferred securities on June 26, 2003 through a special purpose subsidiary as part of a pooled transaction. As of September 30, 2003, the rate on the Trust I issuance was 4.24%, which is calculated as 3-Month LIBOR plus 3.10%. The



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Companys trust preferred securities may be redeemed by the Company, in whole but not in part, prior to June 26, 2008, subject to the occurrence and
continuation of a special event, at a redemption price of 107.5% of the face value of the capital securities. On or after June 26, 2008, the trust preferred securities may be redeemed at face value. Debt issuance costs are being amortized over the
term of the securities, with an unamortized balance of $114,000 as of September 30, 2003.



Interest Rate Risk



Interest rate risk is the risk to earnings or capital generated by the effects of changes in interest rates on the Companys on- and off-balance sheet positions, and can take one or more of several forms. Repricing risk comes from
timing mismatches in the ability to alter contractual rates earned on financial assets held or paid on interest-bearing liabilities. Basis risk refers to changes in the underlying relationships between market rates or indices, which result in a
narrowing of the spread earned on a loan or investment relative to its cost of funds. Option risk arises from embedded options in many financial instruments such as interest rate options, loan prepayment options, deposit early withdrawal
options, callable Federal Home Loan Bank advances and potential prepayment of the underlying collateral of asset-backed securities. Embedded options are complex risk positions that are difficult to predict and offset, and are a large component of
the overall interest rate risk to the Company.



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



At least quarterly, the Company measures the ALM position using earnings simulation modeling to estimate what assets and
liabilities would reprice, and to what extent, within a one-year period in response to an immediate 200 basis point change in the Prime Rate, as well as in response to more gradual interest rate change. The Companys objective is to keep the
change in net interest income over twelve months at or below 5%, and the change in net income at or below 10%, under an immediate 200 basis point interest rate shock scenario. The model also incorporates managements forecasts for balance sheet
growth, noninterest income and noninterest expense. The interest rate scenarios are used for analytical purposes and do not necessarily represent managements view of future market movements. Rather, these are intended to provide a measure of
the degree of volatility interest rate movements may apply to the earnings of the Company. Modeling the sensitivity of earnings to interest rate risk is highly dependent on numerous assumptions embedded in the simulation model. While the earnings
sensitivity analysis incorporates Managements best estimate of interest rate and balance sheet dynamics under various market rate movements, the actual behavior and resulting earnings impact likely will differ from that projected.



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Capital Adequacy



The Companys financial position at September 30, 2003 reflects liquidity and capital levels currently adequate to fund anticipated near-term
business expansion. Capital ratios are in excess of required regulatory minimums for a well-capitalized institution. The adequacy of the Companys capital is reviewed by management on an ongoing basis. Management seeks to maintain a capital
structure adequate to support anticipated asset growth and serve as a cushion to absorb potential losses.



Major capital expenditures planned during 2003 include the construction of the Banks seventh full-service branch in the Lewis-Gale Hospital area.
The branch is currently under construction and is planned to open in the fall of 2003, which will be funded by current operations. Extensive leasehold improvements to the Banks headquarters facility were completed during the quarter ended
September 30, 2003.



Total shareholders equity increased
by $2.0 million during the first nine months of 2003. The increase is attributable to net income for the first nine months of $2.0 million, offset by a $118,000 decrease in accumulated other comprehensive income, resulting from unrealized gains on
investment securities and $29,000 in proceeds from the exercise of stock options in March of 2003. Exclusive of unrealized gains (losses) on investment securities, shareholders equity was $20.8 million at September 30, 2003 and $18.7 million
at December 31, 2002.



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



Capital Ratios



|Ratio    |  | 9/30/03 |   |  | 12/31/02 |   |  | 9/30/02 |   |  | Minimum |  
|-------- |  | ------- | - |  | -------- | - |  | ------- | - |  | ------- | -
|Tier 1   |  | 10.5    | % |  | 9.3      | % |  | 9.5     | % |  | 4       | %
|Total    |  | 11.5    | % |  | 10.3     | % |  | 10.5    | % |  | 8       | %
|Leverage |  | 8.5     | % |  | 7.7      | % |  | 7.8     | % |  | 4       | %



Liquidity



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



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



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Cash and due from banks, money market investments, investments available for sale including restricted
equity securities, and through management of investment maturities/prepayments and loan repayments, provide the Companys asset liquidity. The Companys ratio of liquid assets to deposits and short-term borrowings was 24.2% at September
30, 2003 and 17.6% at December 31, 2002. The Company sells excess funds as overnight federal funds sold to provide an immediate source of liquidity. The Company had federal funds sold of $0 and $4.1 million at September 30, 2003 and December 31,
2002, respectively. The $4.1 million decrease in federal funds sold primarily contributed to the $5.0 million increase in cash and due from banks. During the first nine months of 2003, deposit growth in the amount of $37.2 million surpassed loan
growth in the amount of $26.9 million, or $10.3 excess funds. Federal Home Loan Bank advances in the amount of $12.0 million ($7 million in long-term borrowings and $5 million in overnight borrowings), $4.0 million in trust preferred securities, and
the $10.3 million excess deposit over loan growth, offset by a $600,000 decrease in securities sold under agreements to repurchase was used to fund total investment growth in the amount of $23.7 million and split dollar life insurance policies on
key employees in the amount of $1.2 million.



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



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



Impact of Inflation



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



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Recent and Future Accounting Considerations



In May 2003 the Financial Accounting Standards Board (FASB) issued Statement No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. This Statement dictates
certain instruments be classified as liabilities such as 1) a financial instrument issued in the form of shares that is mandatorily redeemable  that embodies an unconditional obligation requiring the issuer to redeem it by transferring its
assets at a specified or determinable date or upon an event that is certain to occur, 2) a financial instrument, other than an outstanding share, that, at inception, embodies an obligation to repurchase the issuers equity shares, or is indexed
to such an obligation, and that requires or may require the issuer to settle the obligation by transferring assets, and 3) a financial instrument that embodies an unconditional obligation, or a financial instrument other than an outstanding share
that embodies a conditional obligation, that the issuer must or may settle by issuing a variable number of its equity shares. This Statement does not apply to features that are embedded in a financial instrument that is not a derivative in its
entirety. It also does not affect the classification or measurement of convertible bonds, puttable stock, or other outstanding shares that are conditionally redeemable. This Statement is effective for financial instruments entered into or modified
after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatorily redeemable financial instruments of nonpublic entities. It is to be implemented by reporting the
cumulative effect of a change in an accounting principle for financial instruments created before the issuance date of the Statement and still existing at the beginning of the interim period of adoption. Restatement is not permitted.



In April 2003 the Financial Accounting Standards Board (FASB) issued
Statement No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, which amends FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities to amend and clarify financial
accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts. This Statement improves financial reporting by requiring that contracts with comparable characteristics be accounted for in a
similar manner. This Statement more clearly defines under what circumstances a contract meets the characteristic of a derivative and clarifies when a derivative contains a financing component. The changes in this Statement will result in more
consistent reporting of contracts as either derivatives or hybrid instruments. The provisions of this Statement are effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003.
The provisions of this Statement that relate to Statement 133 Implementation issues that have been effective for fiscal quarters that began prior to June 15, 2003, should continue to be applied in accordance with their respective effective dates.



In December 2002 the Financial Accounting Standards Board
(FASB) issued Statement No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment of FASB Statement No. 123, which amends FASB Statement No. 123, Accounting for Stock-Based Compensation to
provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of Statement 123 to require prominent
disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The provisions of this Statement are effective for interim
periods beginning after December 15, 2002 and for fiscal years ending after December 15, 2002.



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In October 2002, the Financial Accounting Standards Board (FASB) issued Statement No. 147,
Acquisitions of Certain Financial Institutions-an amendment of FASB Statements No. 72 and 144 and FASB Interpretation No. 9, which removes acquisitions of financial institutions from the scope of both Statement 72 and Interpretation 9.
The Statement requires that acquisitions of financial institutions be accounted for under the purchase method of accounting in accordance with Statement 141, Business Combinations and Statement 142, Goodwill and Other Intangible
Assets. Thus, the requirement in paragraph 5 of Statement 72 to recognize (and subsequently amortize) any excess of the fair market value of liabilities assumed over the fair value of tangible and identifiable intangible assets acquired as an
unidentifiable intangible asset no longer applies to acquisitions within the scope of this Statement. The provisions of this Statement relating to the application of the purchase method of accounting are effective for acquisitions initiated on or
after October 1, 2002. The provisions of this Statement relating to accounting for intangible assets are effective on October 1, 2002.



In June 2002, the Financial Accounting Standards Board (FASB) issued Statement No. 146, Accounting for Costs Associated with Exit or Disposal
Activities, which nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring). The Statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, not at the date of an entitys commitment to an exit plan. This Statement also
establishes that fair value is the objective for initial measurement of the liability. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002.



In October 2001, the Financial Accounting Standards Board (FASB) issued
Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which supercedes Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of. Statement
144 also supercedes the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events
and Transactions, for the disposal of a segment of a business. However, it retains the requirement in Opinion No. 30 to report separately discontinued operations and extends that reporting to a component of an entity that either has been
disposed of either by sale, abandonment, or distribution to owners or is classified as held for sale. Statement 144 carries over many of the fundamental provisions of Statement No. 121. Statement No. 144 is effective for fiscal years beginning after
December 15, 2001. The Company adopted the provisions of this Statement effective January 1, 2002, as required. The adoption of the Statement did not have any effect on the Companys financial position, results of operations, or liquidity.



In June 2001, the Financial Accounting Standards Board (FASB)
issued Statement No. 142, Goodwill and Other Intangible Assets, which supercedes APB Opinion No. 17, Intangible Assets. Statement No. 142 addresses how intangible assets that are acquired individually or with a group of other
assets, excluding those acquired in a business combination, should be accounted for in financial statements upon their acquisition as well as after they have been initially recognized in the financial statements. The Statement eliminates the
requirement to amortize goodwill and other intangible assets that have indefinite useful lives, instead requiring the assets be tested at least annually for impairment based on the specific guidance in the Statement. The Company adopted the
provisions of the Statement effective January 1, 2002 as required. The Statement requires a transition impairment test of goodwill and other intangible assets in connection with the initial application of the Statement, with any resultant impairment
losses being recognized as a cumulative effect of a change in accounting principle. The adoption of the Statement did not have any effect on the Companys financial position, results of operations, or liquidity.



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In June 2001, the Financial Accounting Standards Board (FASB) issued Statement No. 141, Business
Combinations, which supersedes Accounting Principles Board (APB) Opinion No. 16, Business Combinations, and FASB Statement No. 38, Accounting for Preacquisition Contingencies of Purchased Enterprises. Statement 141
requires that all business combinations be accounted for by the purchase method of accounting. The purchase method of accounting requires the accounts of an acquired institution to be included with the acquirers accounts as of the date of
acquisition, recognizing any excess of purchase price over the fair value of the net assets acquired as goodwill. The Statement also requires that the assets of an acquired institution be recognized as assets apart from goodwill if they meet
specific criteria presented in the Statement. The provisions of the Statement apply to all business combinations initiated after June 30, 2001.



In September 2000, the Financial Accounting Standards Board (FASB) issued Statement No. 140, Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities, as a replacement for FASB Statement No. 125, which has the same title. Statement No. 140 revises the standards for accounting for securitizations and other transfers of financial assets and
collateral, but it carries over most of the provisions of Statement No. 125 without change. The statement provides accounting and reporting standards for such transactions based upon consistent application of a financial components approach, which
focuses on control. Under this approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, de-recognizes financial assets when control has been surrendered,
and de-recognizes liabilities when extinguished.



Statement No.
140 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. The Statement is effective for recognition and reclassification of collateral for fiscal years ending after December
15, 2000. The adoption of Statement No. 140 on January 1, 2001 did not have any effect on the Companys consolidated financial position, results of operation or liquidity.



In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 133,
Accounting for Derivative Instruments and Hedging Activities. Statement 133 established standards for accounting and reporting for derivative instruments, including certain instruments embedded in other contracts and for hedging
activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The Statement requires that changes in a derivatives fair
value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivatives gains and losses to offset related results on the hedged item in the income statement,
and requires that a company must formally document, designate and assess the effectiveness of transactions that receive hedge accounting.



Statement 133 shall be effective for all fiscal quarters of all fiscal years beginning after June 15, 2000. Initial application of this Statement shall be
as of the beginning of an entitys fiscal quarter. Earlier application of all of the provisions of this Statement is encouraged but is permitted only as of the beginning of any fiscal quarter that begins after issuance of this Statement.
Earlier application of selected provisions of this Statement is not permitted. This Statement shall not be applied retroactively to financial statements of prior periods. Adoption of Statement 133 on January 1, 2000 did not have any effect on the
Banks consolidated financial position, results of operation or liquidity.



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Item 3. Controls and Procedures.



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



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.



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PART II. OTHER INFORMATION



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



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



Item 5. Other Information.



None.



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



|(a) | The Company filed the following exhibits for the quarter ended September 30, 2003:
|--- | ----------------------------------------------------------------------------------



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).*10.2

Employment Agreement dated April 8, 1994, by and between the Company and A. Wayne Lewis (incorporated herein by reference to Exhibit No. 10.2 of Registration Statement No.
33-77568, on Form S-1, as amended).*10.3

Severance Agreement dated December 19, 1996, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.3 of Form 10-KSB filed March 27,
1997, File No. 33-77568).*10.4

Stock Option Agreement dated December 19, 1996, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.4 of Form 10-KSB filed March
27, 1997, File No. 33-77568).10.5

Office Lease dated February 28, 1994, by and between First Federal Building, L.C. and Valley Financial Enterprises, L.C. (incorporated herein by reference to Exhibit No. 10.5 of
Registration Statement No. 33-77568, on Form S-1, as amended).10.10

First amendment dated August 5, 1994, to the Office Lease dated February 28, 1994, by and between First Federal Building, L.C. and Valley Financial Enterprises, L.C. (incorporated
herein by reference to Exhibit No. 10.10 of Form 10-K filed March 30, 1995, File No. 33-77568).10.12

Second amendment dated December 14, 1994, to the Office Lease dated February 28, 1994, by and between First Federal Building, L.C. and Valley Financial Enterprises, L.C.
(incorporated herein by reference to Exhibit No. 10.12 of Form 10-K filed March 30, 1995, File No. 33-77568).




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##### Table of Contents

10.13

Lease agreement for office space dated September 20, 1996, by and between Valley Bank, N.A. and Betty J. Burrows (incorporated herein by reference to Exhibit No. 10.13 of Form
10-KSB filed March 27, 1997, File No. 33-77568).*10.6

Severance agreement dated February 9, 1998, by and between the Company and J. Randall Woodson (incorporated herein by reference to Exhibit 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 (filed herewith).*10.17

Split-Dollar Insurance Agreement dated August 20, 2003, by and between Valley Bank and A. Wayne Lewis (filed herewith).*10.18

Split-Dollar Insurance Agreement dated August 20, 2003, by and between Valley Bank and J. Randy Woodson (filed herewith).11

Statement re Computation of Earnings per Share (filed herewith as Note 5).




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##### Table of Contents

31.1

Chief Executive Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).31.2

Chief Financial Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).32.1

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

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


---

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



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



The Company filed one report on Form 8-K during the quarter ended September 30, 2003. The report, dated July 22, 2003,
reported the Companys consolidated financial results for the quarter ended June 30, 2003.



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##### Table of Contents

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, 2003 Date |  |                             
|                       |  |                             
|                       |  |                             
|November 14, 2003 Date |  |                             
|                       |  |                             



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##### Table of Contents

INDEX TO EXHIBITS



|Exhibit Number |  | Description                                                                                                                                                                                                                                                                             |  | Page Number
|-------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -----------
|               |  |                                                                                                                                                                                                                                                                                        
|3.1            |  | Articles of Incorporation (incorporated herein by reference to Exhibit No. 3.1 of Registration Statement No. 33-77568, on Form S-1, as amended).                                                                                                                                        |  |            
|               |  |                                                                                                                                                                                                                                                                                        
|3.2            |  | Bylaws (incorporated herein by reference to Exhibit No. 3.2 of Registration Statement No. 33-77568, on Form S-1, as amended).                                                                                                                                                           |  |            
|               |  |                                                                                                                                                                                                                                                                                        
|10.2           |  | Employment Agreement dated April 8, 1994, by and between the Company and A. Wayne Lewis (incorporated herein by reference to Exhibit No. 10.2 of Registration Statement No.
33-77568, on Form S-1, as amended).                                                                         |  |            
|               |  |                                                                                                                                                                                                                                                                                        
|10.3           |  | Severance Agreement dated December 19, 1996, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.3 of Form 10-KSB filed March 27,
1997, File No. 33-77568).                                                                            |  |            
|               |  |                                                                                                                                                                                                                                                                                        
|10.4           |  | Stock Option Agreement dated December 19, 1996, by and between the Company and Ellis L. Gutshall (incorporated herein by reference to Exhibit No. 10.4 of Form 10-KSB filed March
27, 1997, File No. 33-77568).                                                                         |  |            
|               |  |                                                                                                                                                                                                                                                                                        
|10.5           |  | Office Lease dated February 28, 1994, by and between First Federal Building, L.C. and Valley Financial Enterprises, L.C. (incorporated herein by reference to Exhibit No. 10.5 of
Registration Statement No. 33-77568, on Form S-1, as amended).                                        |  |            
|               |  |                                                                                                                                                                                                                                                                                        
|10.10          |  | First amendment dated August 5, 1994, to the Office Lease dated February 28, 1994, by and between First Federal Building, L.C. and Valley Financial Enterprises, L.C. (incorporated
herein by reference to Exhibit No. 10.10 of Form 10-K filed March 30, 1995, File No. 33-77568).     |  |            
|               |  |                                                                                                                                                                                                                                                                                        
|10.12          |  | Second amendment dated December 14, 1994, to the Office Lease dated February 28, 1994, by and between First Federal Building, L.C. and Valley Financial Enterprises, L.C.
(incorporated herein by reference to Exhibit No. 10.12 of Form 10-K filed March 30, 1995, File No. 33-77568). |  |            



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##### Table of Contents

|      |  |                                                                                                                                                                                                                                   
|----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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 (filed herewith).                                                                                                        
|      |  |                                                                                                                                                                                                                                   
|10.17 |  | Split-Dollar Insurance Agreement dated August 20, 2003, by and between Valley Bank and A. Wayne Lewis (filed herewith).                                                                                                           
|      |  |                                                                                                                                                                                                                                   
|10.18 |  | Split-Dollar Insurance Agreement dated August 20, 2003, by and between Valley Bank and J. Randy Woodson (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).                                                                                                                 
|      |  |                                                                                                                                                                                                                                   
|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).                                                                  



34