Forward-Looking Statements

Certain information contained in this discussion may include "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are generally identified by phrases such as "we expect," "we believe" or words of similar import. Such forward-looking statements involve known and unknown risks including, but not limited to, the following factors:

• interest rate fluctuations;
• risk inherent in making loans such as repayment risks and fluctuating collateral values;
• economic conditions in the Richmond metropolitan area;
• the ability to continue to attract low cost core deposits to fund asset growth;
• changes in general economic and business conditions;
• changes in laws and regulations applicable to us;
• competition within and from outside the banking industry;
• the ability to successfully manage the Company's growth or implement its growth strategies if it is unable to identify attractive markets, locations or opportunities to expand in the future;
• maintaining capital levels adequate to support the Company's growth;
• reliance on the Company's management team, including its ability to attract and retain key personnel;
• new products and services in the banking industry;
• problems with our technology;
• changing trends in customer profiles and behavior;
• Merger expenses have been incurred even if the Merger is not completed;
• the Merger may distract management from its other responsibilities;
• the Merger might be delayed or changed by regulatory agencies; and
• the Company may not be able to realize all of the anticipated benefits of the Merger.

Although we believe that our expectations with respect to the forward-looking statements are based upon reliable assumptions within the bounds of our knowledge of our business and operations, there can be no assurance that actual results, performance or achievements of the Company will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements.

General

The Company was organized under the laws of the Commonwealth of Virginia as a bank holding company whose activities consist of investment in its wholly-owned subsidiary, the Bank. The Bank is engaged in commercial and retail banking. We opened to the public on December 13, 1999. We place special emphasis on serving the financial needs of individuals, small and medium sized businesses, entrepreneurs, and professional concerns.

The Bank has three subsidiaries: Village Bank Mortgage Company, Village Insurance Agency, Inc., and Village Financial Services Company. Through our combined companies, we offer a wide range of banking and related financial services, including checking, savings, certificates of deposit and other depository services, and commercial, real estate and consumer loans. We are a community-oriented and locally owned and managed financial institution focusing on providing a high level of

Net interest income is our primary source of earnings and represents the difference between interest and fees earned on interest-earning assets and the interest paid on interest-bearing liabilities. The level of net interest income is affected primarily by variations in the volume and mix of those assets and liabilities, as well as changes in interest rates when compared to previous periods of operation. In addition, revenues are generated from fees charged on deposit accounts and gains from sale of mortgage loans to third-party investors.

Our total assets increased to $401,437,000 at June 30, 2008 from $393,264,000 at December 31, 2007, an increase of $8,173,000, or 2.1%. The increase in assets resulted primarily from increases in loans held for sale of $1,027,000, net loans of $16,026,000, premises and equipment of $5,617,000, and other assets of $3,556,000, offset by a decrease in liquid assets (cash and due from banks, federal funds sold and investment securities available for sale) of $18,065,000. In addition to the increase in net assets of $8,173,000, deposits decreased by $13,615,000. The net increase in assets and the decline in deposits was funded by a $21,675,000 increase in borrowings.

The following presents management's discussion and analysis of the financial condition of the Company at June 30, 2008 and December 31, 2007, and results of operations for the Company for the three and six month periods ended June 30, 2008 and 2007. This discussion should be read in conjunction with the Company's Annual Report on Form 10-KSB for the year ended December 31, 2007 as filed with the Securities and Exchange Commission as well as the second quarter 2008 financial statements and notes thereto appearing elsewhere in this report.

Results of operations

Net income totaled $179,000, or $0.07 per share on a fully diluted basis, in the second quarter of 2008 compared to net income of $178,000, or $0.07 per share on a fully diluted basis, in the second quarter of 2007. For the six months ended June 30, 2008, net income totaled $272,000 or $0.10 per share on a fully diluted basis, compared to net income of $537,000 or $.20 per share on a fully diluted basis, for the same period in 2007. This represents an increase in net income of $1,000, or .6% and a decrease of $265,000 or 49%, for the three and six month periods, respectively.

In the latter half of 2007, the financial markets experienced significant turmoil due to the collapse of the subprime mortgage asset market which has had a detrimental affect on banking in general. The collapse of the mortgage asset market has led to what many consider a recessionary economy and resulted in extraordinary write-offs of mortgage related assets by many banks. The detrimental affect of the collapse in the mortgage asset market has continued in 2008, depressing bank stock values. In reaction first to the mortgage market collapse and most recently to the real possibility of a recession, the Federal Open Market Committee ("FOMC") of the Federal Reserve reduced short-term interest rates significantly in the last three months of 2007 and continued to decrease rates in 2008. With this significant decline in short-term interest rates and how rapidly in which they were made, our earnings for the first six months of 2008 decreased significantly from the same period in 2007. This decline in our earnings is a result of a significant portion of our loan portfolio, the primary source of revenue to Village Bank, having interest rates that adjust according to the direction of short-term interest rates. Accordingly, as short-term rates are reduced by the FOMC, the income from our loan portfolio is reduced. While the reduction of short-term interest rates will also reduce the rates we pay on deposits, our largest expense, the reduction in interest rates paid on deposits will be slower than the reduction of interest rates on our loan portfolio as deposits generally do not reprice as quickly as loans. Consequently, our net interest income, the primary source of our

Net interest income for the second quarter of $3,188,000 represents an increase of $238,000, or 8%, compared to the second quarter of 2007, and an increase of $403,000, or 14%, compared to the first quarter of 2008. Changes in net interest income are attributable to changes in the volume of interest-sensitive assets and liabilities and changes in interest rates. The increase in net interest income in the second quarter of 2008 when compared to the same period in 2007 is a result of an increase in the size of our loan portfolio (volume) while the second quarter 2008 increase over the first quarter of 2008 is due to an improving interest rate margin (rate). The following table demonstrates this:

                                        Second Qtr 2008   Second Qtr 2008
                                              vs                vs
                                        Second Qtr 2007   First Qtr 2008

Increase (decrease) in net
interest income due to changes in

           Volume                        $      460,000   $      (47,000)
           Rate                               (222,000)           450,000

                                         $      238,000    $      403,000

Our net interest margin (net interest margin is calculated by dividing net interest income by average earning assets) for the second quarter of 2008 was 3.56%, compared to 3.09% for the first quarter of 2008 and 3.95% for the second quarter of 2007. As discussed previously, the significant and rapid change in short-term interest rates in the latter half of 2007 and into the first quarter of 2008 resulted in the significant decline in our net interest margin in the first quarter. Margin compression was the single largest factor in our decline in profitability in the first quarter of 2008 compared to 2007, however as we have been able to reprice our liabilities to the lower interest rates in the second quarter of 2008, our interest rate margin has increased.

Noninterest income of $982,000 for the second quarter of 2008 is $270,000 higher than noninterest income of $712,000 for the second quarter of 2007. This increase in noninterest income is primarily a result of higher gain on loan sales and fees from increased loan production by our mortgage banking subsidiary, although service charges and fees also increased as a result of our expanded branch network.

Noninterest expense increased by $368,000 from the second quarter of 2007 to the second quarter of 2008. The largest increases in noninterest expense occurred in salaries and benefits of $152,000, occupancy costs of $47,000, data processing costs of $61,000, loan underwriting costs of $58,000 and the FDIC insurance assessment of $76,000. The increases in salaries and benefits, occupancy costs and data processing costs are a result of the growth of Village Bank; the increase in loan underwriting costs is directly related to the increase in loan origination by our mortgage company; and the increase in the FDIC insurance assessment is related to our capital ratios and overall growth.

Net interest income is our primary source of earnings and represents the difference between interest and fees earned on interest-earning assets and the interest paid on interest-bearing liabilities. The level of net interest income is affected primarily by variations in the volume and mix of those assets and liabilities, as well as changes in interest rates when compared to previous periods of operation.

Net interest income for the six months ended June 30, 2008 and 2007 was $5,973,000 and $5,677,000, respectively. This increase in net interest income of $296,000, or 5%, occurred despite a 68 basis point decline in our net interest margin. Our net interest margin for the six months ended June 30, 2008 was 3.32% compared to 4.00% for the first six months of 2007. The increase in net interest income resulted from growth in our loan portfolio. Loans net of deferred fees increased by $54,595,000, or 19%, from $288,805,000 at June 30, 2007 to $343,400,000 at June 30, 2008. Loans net of deferred fees averaged $340,721,000 in the first six months of 2008 as compared to $262,562,000 in the first six months of 2007, an increase of $78,159,000, or 30%. Whether this trend of increasing net interest income continues is dependent upon our ability to grow our loan portfolio as well as any changes in short-term interest rates by the FOMC. For the remainder of 2008, we do not expect our loan portfolio to increase significantly. Accordingly, if the FOMC were to decrease short-term interest rates further in 2008, our net interest income could decline from previous periods.

Average interest-earning assets for the first six months of 2008 increased by $75,840,000, or 27%, compared to the first six months of 2007. The increase in interest-earning assets was due primarily to the growth of our loan portfolio. The average yield on interest-earning assets decreased to 7.57% for the first six months of 2008 compared to 8.35% for the first six months of 2007. This decline in the average yield from 2007 to 2008 was due to the reduction in short-term interest rates by the FOMC during the last quarter of 2007 and the first quarter of 2008.

Our average interest-bearing liabilities increased by $84,743,000, or 33%, for the first six months of 2008 compared to the first six months of 2007. The growth in interest-bearing liabilities was primarily due to growth in deposits. The average cost of interest-bearing liabilities decreased to 4.47% for the first six months of 2008 from 4.79% for the first six months of 2007. The principal reason for the decrease in liability costs was decreasing interest rates as liabilities reprice. The decreasing interest rates were a result of decreases in short term interest rates by the FOMC. See our discussion under interest rate sensitivity for more information.

The following table illustrates average balances of total interest-earning assets and total interest-bearing liabilities for the periods indicated, showing the average distribution of assets, liabilities, stockholders' equity and related income, expense and corresponding weighted-average yields and rates. The average balances used in these tables and other statistical data were calculated using daily average balances. We had no tax exempt assets for the periods presented.

--------------------------------------------------------------------------------
                                           Average Balance Sheets
                                               (In thousands)

                                  Six Months Ended June 30, 2008           Six Months Ended June 30, 2007
                                              Interest    Annualized                  Interest     Annualized
                                Average       Income/       Yield        Average       Income/       Yield
                                Balance       Expense        Rate        Balance       Expense        Rate

Loans net of deferred fees    $    340,721   $   13,151        7.76%   $   262,562   $    11,181        8.59%
Investment securities                8,777          234        5.36%        14,180           408        5.80%
Loans held for sale                  3,276           97        5.95%         2,212            71        6.47%
Federal funds and other              9,202          146        3.19%         7,182           187        5.25%
Total interest earning
assets                             361,976       13,628        7.57%       286,136        11,847        8.35%
Allowance for loan losses          (3,533)                                 (2,720)
Cash and due from banks              6,777                                   4,869
Premises and equipment, net         21,186                                  12,872
Other assets                        11,748                                   8,433
Total assets                  $    398,154                             $   309,590

Interest bearing deposits
Interest checking              $    11,215    $      61        1.09%   $    10,140    $       46        0.91%
Money market                        26,723          293        2.20%        20,665           336        3.28%
Savings                              3,657           21        1.15%         3,826            22        1.12%
Certificates                       270,486        6,641        4.94%       214,857         5,486        5.15%
Total deposits                     312,081        7,016        4.52%       249,488         5,890        4.76%
Borrowings                          32,291          638        3.97%        10,141           280        5.57%
Total interest bearing
liabilities                        344,372        7,654        4.47%       259,629         6,170        4.79%
Noninterest bearing
deposits                            24,461                                  22,159
Other liabilities                    1,867                                   1,576
Total liabilities                  370,700                                 283,364
Equity capital                      27,454                                  26,226
Total liabilities and
capital                       $    398,154                             $   309,590

Net interest income before
provision for loan losses                    $    5,974                              $     5,677

Interest spread - average yield on
interest
earning assets, less average
rate on
interest bearing
liabilities                                                    3.10%                                    3.56%

Annualized net interest
margin (net
interest income expressed
as
percentage of average earning assets)                          3.32%                                    4.00%

The provision for loan losses for the three months ended June 30, 2008 was $498,000, compared to $360,000 for the three months ended June 30, 2007. The provision for loan losses for the six months ended June 30, 2008 was $747,000 compared to $568,000 for the six months ended June 30, 2007. The 38% and 32% increases when comparing the three and six month periods, respectively, were primarily due to a write-off in the second quarter of 2008 related to one loan relationship. This loss is believed to be the result of fraudulent activity by the borrower which may be recoverable through insurance coverage, although we have not recognized any such recovery as of June 30, 2008. Without this write-off, the provision for loan losses for the six months ended June 30, 2008 would have been $293,000 and would have decreased from the $568,000 provision for the six months ended June 30, 2007. This decline would have been attributable to a decline in loan volume in 2008 compared to 2007. Loans net of deferred fees increased by $16,057,000 during the first six months of 2008 compared to an increase of $47,754,000 during the first six months of 2007. The amount of the loan loss provision is determined by an evaluation of the level of loans outstanding, the level of non-performing loans, historical loan loss experience, delinquency trends, the amount of actual losses charged to the reserve in a given period and assessment of present and anticipated economic conditions. See our discussion of the allowance for loan losses under Allowance for loan losses and Critical accounting policies below.

Noninterest income

Noninterest income increased from $712,000 for the three months ended June 30, 2007 to $982,000 for the three months ended June 30, 2008, an increase of $270,000, or 38%. Noninterest income also increased from $1,377,000 for the first six months of 2007 to $1,741,000 for the first six months of 2008, an increase of $364,000, or 26%. These increases were attributable to an increase in loan originations in the mortgage company and increased service charges and fees resulting from a larger deposit base. Gains on loan sales increased from $773,000 for the first six months of 2007 to $1,035,000 for the first six months of 2008, an increase of $262,000, or 34%. Service charges and fees increased by $122,000, or 34%, from $357,000 for the first six months of 2007 to $479,000 for the first six months of 2008.

Noninterest expense

Noninterest expense for the three months ended June 30, 2008 was $3,401,000 compared to $3,033,000 for the three months ended June 30, 2007, an increase of $368,000, or 12%. Non interest expense for the six months ended June 30, 2008 totaled $6,554,000 an increase of $882,000, or 16%, from $5,672,000 for the six months ended June 30, 2007. Salaries and benefits represented the largest increase in both periods, increasing by $152,000, or 9%, from $1,717,000 for the three months ended June 30, 2007 to $1,869,000 for the same period in 2007, and increasing by $433,000, or 13%, from $3,283,000 for the first six months of 2007 to $3,716,000 for the first six months of 2008. Additionally, the FDIC insurance assessment increased significantly by $76,000 in comparing the three month periods and by $174,000 in comparing the six month periods.

Income taxes

The provision for income taxes of $140,000 for the six months ended June 30, 2008 is based upon the results of operations. Certain items of income and expense are reported in different periods for financial reporting and tax return purposes. The tax effects of these temporary differences are recognized currently in the deferred income tax provision or benefit. Deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using the applicable enacted marginal tax rate.

Commercial banking organizations conducting business in Virginia are not subject to Virginia income taxes. Instead, they are subject to a franchise tax based on bank capital. The Company recorded a franchise tax expense of $106,000 and $105,000 for the six months ended June 30, 2008 and 2007, respectively.

Loan portfolio

The following table presents the composition of our loan portfolio (excluding mortgage loans held for sale) at the dates indicated.

                                  Loan Portfolio, Net
                                     (In thousands)

                                          June 30, 2008         December 31, 2007
                                         Amount        %         Amount        %

     Commercial                       $     27,058     7.9%   $     23,152     7.1%
     Real estate - residential              56,226    16.3%         51,281    15.6%
     Real estate - commercial              152,645    44.4%        140,176    42.8%
     Real estate - construction            101,245    29.5%        106,556    32.5%
     Consumer                                6,533     1.9%          6,611     2.0%

     Total loans                           343,707   100.0%        327,776   100.0%
     Less: unearned income, net              (307)                   (433)
     Less: Allowance for loan losses       (3,500)                 (3,469)

     Total loans, net                 $    339,900            $    323,874

Allowance for loan losses

The allowance for loan losses at June 30, 2008 was $3,500,000, compared to $3,469,000 at December 31, 2007. The ratio of the allowance for loan losses to gross portfolio loans (net of unearned income and excluding mortgage loans held for sale) at June 30, 2008 and December 31, 2007 was 1.02% and 1.06%, respectively. The amount of the loan loss provision is determined by an evaluation of the level of loans outstanding, the level of non-performing loans, historical loan loss experience, delinquency trends, the amount of actual losses charged to the reserve in a given period and assessment of present and anticipated economic conditions. See our discussion of the allowance for loan losses under Critical accounting policies below.

                       Analysis of Allowance for Loan Losses
                                  (In thousands)

                                                         Six Months Ended
                                                             June 30,
                                                      2008             2007

   Beginning balance                              $       3,469    $       2,553
   Provision for loan losses                                747              568
   Charge-offs
   Commercial                                              (89)             (29)
   Construction                                           (557)                -
   Consumer                                                   -             (32)
   Mortgage                                                (96)             (30)
                                                          (742)             (91)
   Recoveries
   Commercial                                                 9                -
   Consumer                                                  17                -
                                                             26                -

   Ending balance                                  $      3,500    $       3,030

   Loans outstanding at end of period (1)          $    343,400   $      288,805
   Ratio of allowance for loan losses as
   a percent of loans outstanding at
   end of period                                          1.02%            1.05%

   Average loans outstanding for the period (1)    $    340,721    $     262,562
   Ratio of net charge-offs to average loans
   outstanding for the period                             0.22%            0.03%

(1) Loans are net of unearned income.

At June 30, 2008 and December 31, 2007, all of our securities were classified as available-for-sale. The following table presents the composition of our investment portfolio at the dates indicated.

                        Investment Securities Available-for-Sale
                                     ( in thousands)

                                                        Unrealized    Estimated
                                 Par        Amortized     Gain         Fair       Average
                                Value        Cost        (Loss)        Value       Yield
June 30, 2008
US Government Agencies
Within one year                $     360   $     360     $      3    $      363     4.65%
More than five years               3,000       2,965           22         2,987     5.70%
Total                              3,360       3,325           25         3,350     5.59%

Mortgage-backed securities
More than five years                  34          34            -            34     3.65%

Other investments
More than five years               2,000       1,969        (110)         1,859     5.65%

Total investment securities    $   5,394   $   5,328    $    (85)    $    5,243     5.60%


December 31, 2007
US Government Agencies
Within one year               $    1,600   $   1,579   $      (2)   $     1,576     4.22%
. . .