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; and
• the Company may not be able to realize all of the anticipated benefits of the merger with River City Bank.

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. Additionally, the Company has investments in two trusts related to issuance of trust preferred securities. 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 responsive and personalized services to our customers, delivered in the context of a strong direct

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 $418,625,000 at September 30, 2008 from $393,264,000 at December 31, 2007, an increase of $25,361,000, or 6.4%. The increase in assets resulted primarily from increases in liquid assets (cash and due from banks, federal funds sold and investment securities available for sale) of $770,000, net loans of $14,222,000, premises and equipment of $6,910,000, and other assets of $3,500,000. In addition to the increase in net assets of $25,361,000, deposits decreased by $617,000. The net increase in assets and the decline in deposits were funded by increases in borrowings of $24,717,000 and stockholders' equity of $1,261,000.

The following presents management's discussion and analysis of the financial condition of the Company at September 30, 2008 and December 31, 2007, and results of operations for the Company for the three and nine month periods ended September 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 third quarter 2008 financial statements and notes thereto appearing elsewhere in this report.

Results of operations

Net income totaled $219,000, or $0.08 per share on a fully diluted basis, in the third quarter of 2008 compared to net income of $259,000, or $0.10 per share on a fully diluted basis, in the third quarter of 2007. For the nine months ended September 30, 2008, net income totaled $491,000 or $0.19 per share on a fully diluted basis, compared to net income of $796,000 or $.29 per share on a fully diluted basis, for the same period in 2007. This represents a decrease in net income of $40,000, or 15% and a decrease of $305,000 or 38%, for the three and nine 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 resulting in a total decrease in short-term interest rates of 325 basis points to 1.5% at September 30, 2008. With this significant decline in short-term interest rates and how rapidly in which they were made, our earnings for the first nine 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

Net interest income for the third quarter of $3,096,000 represents an increase of $29,000, or 1%, compared to the third quarter of 2007. 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 third 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). The decline in net interest income from the second quarter of 2008 to the third quarter of 2008 of $(92,000) resulted from a decline in our interest rate margin
(rate) in the third quarter. In contrast, the net interest income for the second quarter of 2008 increased by $402,000 over the first quarter of 2008 due to an improving interest rate margin (rate). The following table demonstrates this:

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

  Increase (decrease) in
  net
  interest income due to
  changes in
  Volume                               $ 201,000          $ 70,000        $ (48,000)
  Rate                                 (172,000)         (162,000)           450,000

                                        $ 29,000        $ (92,000)         $ 402,000

Our net interest margin (net interest margin is calculated by dividing net interest income by average earning assets) for the third quarter of 2007 was 3.71%. Our net interest margin declined significantly in the first quarter of 2008 to 3.09%. As discussed in prior reports, this decline was attributable to the significant and rapid decline in short-term interest rates by the FOMC in the latter part of 2007 and into 2008. Our interest rate margin improved to 3.53% in the second quarter of 2008 as short-term rates remained constant and our cost of funds declined as our interest-bearing liabilities began to reprice to the lower rates. In the third quarter of 2008, our interest rate margin declined to 3.31%. This decline was a result of a decision by management to raise rates on our certificates of deposit in July 2008 to increase our liquidity above normal amounts as we believed that depositors were demonstrating concern over the safety of their deposits.

However, overall, our net interest margin in 2008 has been lower than in 2007. For the nine months ended September 30, 2008, our net interest margin was 3.31% compared to 3.89% for the same period in 2007. This decline in net interest margin has decreased our net interest income by approximately $1.5 million. The decline in interest rates by the FOMC has had a detrimental affect on our profitability. Margin compression due to the lowering of short-term interest rates by the FOMC has been the most significant factor in our decline in profitability in 2008 compared to 2007.

Noninterest income increased significantly from $826,000 for the three months ended September 30, 2007 to $1,298,000 for the same period in 2008, an increase of $472,000, or 57%. This increase in noninterest income is a result of higher gain on loan sales and fees from increased loan production by our mortgage banking subsidiary as well as higher service charges and fees from our branch network. Additionally, there was a gain from sale of our previous headquarters building of $58,000.

Net interest income

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 nine months ended September 30, 2008 and 2007 was $9,070,000 and $8,744,000, respectively. This increase in net interest income of $326,000, or 4%, occurred despite a 58 basis point decline in our net interest margin. Our net interest margin for the nine months ended September 30, 2008 was 3.31% compared to 3.89% for the first nine months of 2007. The increase in net interest income resulted from growth in our loan portfolio. Loans net of deferred fees increased by $40,387,000, or 13%, from $301,562,000 at September 30, 2007 to $341,949,000 at September 30, 2008. Loans net of deferred fees averaged $342,902,000 in the first nine months of 2008 as compared to $273,095,000 in the first nine months of 2007, an increase of $69,807,000, or 26%. 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. Recently, the FOMC decreased short-term interest rates by another 50 basis points to 1% reflecting their concern about the economy. As a result, our net interest income for the last quarter of 2008 will decline from previous periods.

Average interest-earning assets for the first nine months of 2008 increased by $65,202,000, or 22%, compared to the first nine 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 7.44% for the first nine months of 2008 from 8.30% for the first nine 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 $75,250,000, or 27%, for the first nine months of 2008 compared to the first nine months of 2007. The growth in interest-bearing liabilities was due to growth in deposits as well as borrowings. The average cost of interest-bearing liabilities decreased to 4.31% for the first nine months of 2008 from 4.83% for the first nine 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)

                                Nine Months Ended September 30, 2008       Nine Months Ended September 30, 2007
                                               Interest     Annualized                    Interest     Annualized
                                Average        Income/        Yield        Average        Income/        Yield
                                Balance        Expense         Rate        Balance        Expense         Rate

Loans net of deferred fees       $ 342,902      $ 19,671         7.66%      $ 273,095      $ 17,508         8.57%
Investment securities                7,572           315         5.55%         14,521           633         5.83%
Loans held for sale                  3,689           172         6.24%          2,387           117         6.55%
Federal funds and other             11,304           196         2.32%         10,262           387         5.04%
Total interest earning
assets                             365,467        20,354         7.44%        300,265        18,645         8.30%
Allowance for loan losses          (3,577)                                    (2,837)
Cash and due from banks              7,513                                      5,025
Premises and equipment, net         22,557                                     13,373
Other assets                        12,652                                      9,014
Total assets                     $ 404,612                                  $ 324,840

Interest bearing deposits
Interest checking                 $ 11,269         $ 102         1.21%       $ 10,342          $ 72         0.93%
Money market                        26,885           411         2.04%         21,390           535         3.34%
Savings                              3,771            33         1.17%          3,693            32         1.12%
Certificates                       270,648         9,716         4.80%        225,935         8,732         5.17%
Total deposits                     312,573        10,262         4.39%        261,360         9,371         4.79%
Borrowings                          36,994         1,022         3.69%         12,958           530         5.47%
Total interest bearing
liabilities                        349,567        11,284         4.31%        274,318         9,901         4.83%
Noninterest bearing
deposits                            25,505                                     22,516
Other liabilities                    1,852                                      1,595
Total liabilities                  376,924                                    298,429
Equity capital                      27,688                                     26,411
Total liabilities and
capital                          $ 404,612                                  $ 324,840

Net interest income before
provision for loan losses                        $ 9,070                                    $ 8,744

Interest spread - average
yield on interest
earning assets, less
average rate on
interest bearing
liabilities                                                      3.13%                                      3.48%

Annualized net interest
margin (net
interest income expressed
as
percentage of average
earning assets)                                                  3.31%                                      3.89%

The provision for loan losses for the three months ended September 30, 2008 was $515,000, compared to $244,000 for the three months ended September 30, 2007. The provision for loan losses for the nine months ended September 30, 2008 was $1,262,000 compared to $812,000 for the nine months ended September 30, 2007. The 111% and 55% increases when comparing the three and nine month periods, respectively, was due to loan charge-offs for the first nine months of 2008 of $906,000. The largest loan charge-off in 2008 was for $500,000 related to one relationship and 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 September 30, 2008. The volume of our charge-offs in 2008 is higher than for all the previous years the Company has been in existence and reflects the significant downturn in the economy in 2008. If the economy continues to be depressed in the coming months, we could continue to see loan charge-offs at higher levels than we have experienced prior to 2008, which would have a detrimental effect on future profitability. 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 $826,000 for the three months ended September 30, 2007 to $1,298,000 for the three months ended September 30, 2008, an increase of $472,000, or 57%. Noninterest income also increased from $1,970,000 for the first nine months of 2007 to $2,945,000 for the first nine months of 2008, an increase of $975,000, or 50%. These increases were attributable to an increase in loan originations from the mortgage company and increased service charges and fees resulting from a larger deposit base. Gains on loan sales increased from $1,160,000 for the first nine months of 2007 to $1,753,000 for the first nine months of 2008, an increase of $593,000, or 51%. Service charges and fees increased by $254,000, or 47%, from $545,000 for the first nine months of 2007 to $799,000 for the first nine months of 2008.

Noninterest expense

Noninterest expense for the three months ended September 30, 2008 was $3,547,000 compared to $3,258,000 for the three months ended September 30, 2007, an increase of $289,000, or 9%. Non interest expense for the nine months ended September 30, 2008 totaled $10,008,000 an increase of $1,311,000, or 15%, from $8,697,000 for the nine months ended September 30, 2007. Salaries and benefits increased in both periods, increasing by $69,000, or 4%, from $1,798,000 for the three months ended September 30, 2007 to $1,867,000 for the same period in 2008, and increasing by $503,000, or 10%, from $5,080,000 for the first nine months of 2007 to $5,583,000 for the first nine months of 2008. Occupancy costs increased by $169,000 in comparing the three month periods and $177,000 comparing the nine month periods related to the new headquarters building. Loan underwriting expenses also had significant increases in both periods, increasing by $108,000, or 152%, from $71,000 for the three months ended September 30, 2007 to $179,000 for the same period in 2008, and increasing by $191,000 or 96% from $198,000 for the first nine months of 2007 to $389,000 for the first nine months of 2008. These increases in loan underwriting expenses relate to the increase loan volume by our mortgage company. Additionally, the FDIC insurance assessment increased by $30,000 in comparing the three month periods and by $191,000 in comparing the nine month periods.

The provision for income taxes of $253,000 for the nine months ended September 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.

The Company must also evaluate the likelihood that deferred tax assets will be recovered from future taxable income. If any such assets are not likely to be recovered, a valuation allowance must be recognized. We determined that a valuation allowance was not required for deferred tax assets as of September 30, 2008. The assessment of the carrying value of deferred tax assets is based on certain assumptions, changes in which could have a material impact on the Company's financial statements.

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 $130,000 and $158,000 for the nine months ended September 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)

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

      Commercial                           $ 24,481     7.2%     $ 23,152     7.1%
      Real estate - residential              59,972    17.5%       51,281    15.6%
      Real estate - commercial              151,362    44.2%      140,176    42.8%
      Real estate - construction             99,391    29.1%      106,556    32.5%
      Consumer                                6,972     2.0%        6,611     2.0%

      Total loans                           342,178   100.0%      327,776   100.0%
      Less: unearned income, net              (229)                 (433)
      Less: Allowance for loan losses       (3,853)               (3,469)

      Total loans, net                    $ 338,096             $ 323,874

Allowance for loan losses

The allowance for loan losses at September 30, 2008 was $3,853,000, 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 September 30, 2008 and December 31, 2007 was 1.13% 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,

The following table presents an analysis of the changes in the allowance for loan losses for the periods indicated.

                       Analysis of Allowance for Loan Losses
                                   (In thousands)

                                                         Nine Months Ended
                                                           September 30,
                                                         2008        2007

        Beginning balance                                $ 3,469     $ 2,553
        Provision for loan losses                          1,262         812
        Charge-offs
        Commercial                                         (104)        (29)
        Construction                                       (705)           -
        Consumer                                             (1)        (53)
        Mortgage                                            (96)        (43)
                                                           (906)       (125)
        Recoveries
        Commercial                                             9           -
. . .