Management's discussion and analysis of the financial condition and results of operations of the Company as of March 31, 2012 and December 31, 2011 and for the three month periods ended March 31, 2012 and 2011 is as follows. The discussion should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2011.

Written Agreement with the Federal Reserve

On September 30, 2010, the Company and the Bank entered into a written agreement ("Written Agreement") with the Federal Reserve Bank of Richmond (the "Reserve Bank"). Under the terms of the Written Agreement, the Bank has agreed to develop and submit to the Reserve Bank for approval written plans to, among other matters, strengthen credit risk management policies, maintain an adequate allowance for loan and lease losses, revise its contingency funding plan, and improve the Bank's earnings and overall condition. Such plans have been submitted and accepted by the Reserve Bank.

Both the Company and the Bank have also submitted capital plans to maintain sufficient capital and to refrain from declaring or paying dividends without prior regulatory approval. The Company has agreed that it will not take any other form of payment representing a reduction in Bank's capital or make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities without prior regulatory approval. The Company also has agreed not to incur, increase or guarantee any debt or to purchase or redeem any shares of its stock without prior regulatory approval.

The Company and the Bank have appointed a committee to monitor compliance with the Written Agreement. The directors of the Company and the Bank have recognized and unanimously agree with the common goal of financial soundness represented by the Written Agreement and have confirmed the intent of the directors and executive management to diligently seek to comply with all requirements of the Written Agreement.

The Reserve Bank has informed the Company that it is in full compliance with 15 of the 16 items included in the Written Agreement and in substantial compliance with the 16th item.

Critical Accounting Estimates

General
The Company's financial statements are prepared in accordance with Accounting Principles Generally Accepted in the United States ("GAAP") and with general practices within the banking industry. In connection with the application of those principles, we have made judgments and estimates, which in the case of the determination of our allowance for loan losses, deferred tax assets, and foreclosed assets have been critical to the determination of our financial position and results of operations.

Management considers accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on the Company's financial statements.

For a discussion on the Company's critical accounting estimates, see the Company's Annual Report on Form 10-K for the year ended December 31, 2011.

Non-GAAP Financial Measures

The Company measures the net interest margin as an indicator of profitability. The net interest margin is calculated by dividing tax-equivalent net interest income by total average earning assets. Because a portion of interest income earned by the Company is nontaxable, the tax-equivalent net interest income is considered in the calculation of this ratio. Tax-equivalent net interest income is calculated by adding the tax benefit realized from interest income that is nontaxable to total interest income then subtracting total interest expense. The tax rate utilized in calculating the tax benefit for 2012 and 2011 is 34%. The reconciliation of tax-equivalent net interest income, which is not a measurement under GAAP, to net interest income, is reflected in the table below.

                                              Three months     Three months
                                                 ended            ended
           In thousands                        3/31/2012        3/31/2011
           Net interest income, non
           tax-equivalent                     $      6,225     $      5,916
           Less: tax-exempt interest income           (133 )           (160 )
           Add: tax-equivalent of
           tax-exempt interest income                  203              242
           Net interest income,
           tax-equivalent                     $      6,295     $      5,998

Results of Operations

Net Income

2012 Compared to 2011
Net income for the three-month period ending March 31, 2012 was $1,659,000 as compared to net income of $1,101,000 for the same period last year, an increase of $558,000 or 51%. After the dividend on preferred stock and accretion of discounts on warrants, net income available to common shareholders was $1,415,000, or $0.30 per diluted common share, as compared to $859,000 or $0.18 per diluted common share for the first quarter of 2011, an increase of 65%. The Company's earnings for the first quarter of 2012 produced an annualized return on average total assets of 0.86% and an annualized return on average shareholders' equity of 11.01%, as compared to 0.58% and 7.97%, respectively for the same period last year.

2011 Compared to 2010
Net income for the three-month period ending March 31, 2011 was $1,101,000 as compared to net income of $848,000 for the same period of 2010, an increase of $253,000 or 30.0%. After the dividend on preferred stock and accretion of discounts on warrants, net income available to common shareholders was $859,000, or $0.18 per diluted common share, as compared to $609,000 or $0.13 per diluted common share for the first quarter of 2010. The Company's earnings for the first quarter of 2011 produced an annualized return on average total assets of 0.58% and an annualized return on average shareholders' equity of 7.97%, as compared to 0.48% and 6.58%, respectively for the same period in 2010. Loan loss provisions decreased $644,000 in comparison to the prior year period, from $208,000 in 2010 to ($436,000) in the three-month period ended March 31, 2011.

The following table shows our key performance ratios for the periods ended March 31, 2012, December 31, 2011 and March 31, 2011:

                                Key Performance Ratios(1)
                                3 months ended       12 months ended       3 months ended
                                  3/31/2012            12/31/2011            3/31/2011
Return on average assets                   0.86 %                0.73 %               0.58 %
Return on average equity(2)               11.01 %                9.88 %               7.97 %
Net interest margin(3)                     3.51 %                3.39 %               3.36 %
Cost of funds                              0.98 %                1.17 %               1.32 %
Yield on earning assets                    4.48 %                4.54 %               4.66 %
Basic net earnings per
common share                   $           0.30     $            1.01     $           0.18
Diluted net earnings per
common share                   $           0.30     $            1.00     $           0.18

1. Ratios are annualized.

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

3. Calculated on a fully taxable equivalent basis ("FTE").

Net Interest Income
The primary source of the Company's banking revenue is net interest income, which represents the difference between interest income on earning assets and interest expense on liabilities used to fund those assets. Earning assets include loans, securities, and federal funds sold. Interest bearing liabilities include deposits and borrowings. To compare the tax-exempt yields to taxable yields, amounts are adjusted to pretax equivalents based on a 34% federal corporate income tax rate.

Net interest income is affected by changes in interest rates, volume of interest bearing assets and liabilities, and the composition of those assets and liabilities. The "interest rate spread" and "net interest margin" are two common statistics related to changes in net interest income. The interest rate spread represents the difference between the yields earned on interest earning assets and the rates paid for interest bearing liabilities. The net interest margin is defined as the percentage of net interest income to average earning assets. Earning assets obtained through noninterest bearing sources of funds such as regular demand deposits and shareholders' equity result in a net interest margin that is higher than the interest rate spread.

2012 Compared to 2011
Net interest income for the three-month period ended March 31, 2012 was $6,225,000, a $309,000 or 5% increase when compared to the $5,916,000 reported for the same period in 2011. The Company's net interest margin, at 3.51%, increased by 15 basis points over the 3.36% reported for the same quarter last year. In comparison to the linked quarter, the Company's net interest margin increased by 16 basis points over the 3.35% reported for the fourth quarter of 2011.

The increase in net interest income and corresponding increase in net interest margin is primarily attributable to the reduction in funding costs over the last 12 months. The Company's cost of funds was 0.98% during the three-month period ended March 31, 2012, compared to the 1.32% reported in the same period last year and the 1.07% in the linked quarter. Decreased rates on our primary non-maturity deposit products, including MyLifestyle checking, MyLifestyle savings and Prime Money Market accounts, and more aggressive pricing on time deposits have led to the decrease in funding costs. While the Company's yield on earning assets declined in comparison to the 4.66% from the same prior year period, the 4.48% yield earned during the three-month period ended March 31, 2012 was a 7 bps improvement over

the linked quarter. This improvement from the linked quarter was due to an 18 bps increase in our investment portfolio yield.

2011 Compared to 2010
Net interest income for the three-month period ended March 31, 2011 was $5,916,000, a $938,000 or 19% increase when compared to the $4,978,000 reported for the same period in 2010. The Company's net interest margin, at 3.36%, increased by 41 basis points over the 2.95% reported for the same quarter of 2010. In comparison to the linked quarter, the Company's net interest margin increased by 22 basis points over the 3.14% reported for the fourth quarter of 2010.

The increase in net interest income and corresponding increase in net interest margin is primarily attributable to the reduction in funding costs. The Company's cost of funds was 1.32% during the three-month period ended March 31, 2011, compared to the 1.96% reported in the same period of 2010 and the 1.43% in the linked quarter. Decreased rates on our primary non-maturity deposit products, including MyLifestyle checking, MyLifestyle savings and Prime Money Market accounts, and more aggressive pricing on time deposits have led to the decrease in funding costs. In contrast to the decline in funding costs, we were able to maintain the earning rates in our loan portfolio. The Company's yield on loans was 5.33% during the three-month period ended March 31, 2011, compared to the 5.21% reported in the same period of 2010 and the 5.34% in the linked quarter. Due to declines in the yield on investments, however, the yield on earning assets declined to 4.66% during the three-month period ended March 31, 2011, compared to the 4.83% reported in the same period of 2010, but increased from 4.53% in the linked quarter. The declines in funding costs have been much more significant, leading to the overall increase in our net interest margin.

Noninterest Income

2012 Compared to 2011
Noninterest income for the three-month period ended March 31, 2012 was $1,031,000, an increase of $390,000 or 61% compared to the $641,000 for the same period last year. The Company earned a three-month record of fee income in both its brokerage and mortgage areas during the first quarter 2012. Brokerage fee income of $271,000 and mortgage fee income of $132,000 were earned during the period, an increase of $216,000 and $65,000, respectively, from the same prior year period and increases from the linked quarter of $160,000 and $6,000, respectively. Excluding the $40,000 of realized gains on the sale of securities earned during the three-month period ended March 31, 2012, annualized total noninterest income was 0.51% of average assets during the period compared to 0.32% in the same prior year period.

Growing our noninterest income has been a major focal point over the past twelve months and we are excited that our efforts are translating into real results in both the investment and mortgage lines of business. With the successful recruitment of Roanoke's top mortgage originator during the first quarter, we expect this line of business's income to continue to increase. The first quarter was significantly above expectations for Valley Wealth Management as we closed on several significant new relationships. While we would hope this level of activity could be sustained throughout 2012, a more realistic view anticipates revenues returning to more normal levels for the remainder of the year.

2011 Compared to 2010
Noninterest income for the three-month period ended March 31, 2011 was $641,000, an increase of $104,000 compared to the $537,000 for the same period in 2010. Increases in mortgage fee income and service charges on deposit accounts were the primary reasons for the increase.

Noninterest Expense

2012 Compared to 2011
Noninterest expense for the three-month period ended March 31, 2012 was $4,871,000, a decrease of $587,000, or 11%, compared to the $5,458,000 recorded in same period last year. As anticipated, the decreased expenses came largely from significant reductions in the Company's insurance and legal expenses of $985,000 in total. These reductions were offset by a $283,000 increase in compensation expense, which is the result of the Company's success in the recruitment of two new small business bankers and a new mortgage broker, with a combined 75 years of banking experience almost entirely

in the Roanoke Valley. Additionally, equity and merit increases for all employees as well as increased commissions paid for our mortgage banking division and Valley Wealth Management performance contributed to the increased compensation expense. Annualized noninterest expense for the three-month period ended March 31, 2012 totaled 2.52% of average assets during the period, an improvement from the 2.82% recorded in the same prior year period. The Company's efficiency ratio for the three-month period of 2012 was 65.78%, as compared to 81.30% for the same period last year.

2011 Compared to 2010
Noninterest expense for the three-month period ended March 31, 2011 was $5,458,000, an increase of $1,273,000, or 31%, compared to the same period of 2010. Specific items to note are as follows:

· Compensation expense increased $362,205 due primarily to profit sharing payments of $200,000 made as the result of the improvement in impaired loans during the quarter and increased retirement expenses of $87,000. The increase in retirement expenses is due to the reversal of $66,000 as the result of the retirement of one of our executives during the first quarter of 2010. The remaining increase is due to merit, equity, and promotional increases that went into effect January 1, 2011;

· Insurance expense increased $685,000 primarily due to FDIC adjustments totaling $433,482. The remaining increase is due to an increase in the assessment rate as well as the increase in deposits as compared to the quarter ended March 31, 2010;

· Legal fees increased $215,000 due to increased litigation costs; and

· Net foreclosed asset expense increased by $121,000 due to the $88,000 loss recognized on the sale of foreclosed assets in comparison to the $18,000 gain recognized in the first three months of 2010.

Asset Quality

Summary of Allowance for Loan Losses

2012 Compared to 2011
The allowance for loan losses ("ALLL") was $9,287,000 as of March 31, 2012, compared to $9,650,000 as of December 31, 2011 and $10,500,000 reported a year earlier. The ratio of the allowance for loan losses to total loans outstanding was approximately 1.80% at March 31, 2012, which compares to approximately 1.90% of total loans at December 31, 2011 and 1.96% of total loans at March 31, 2011. These estimates are primarily based on our historical loss experience, portfolio concentrations, evaluation of individual loans and economic conditions. A total of $2,119,000 in specific reserves was included in the balance of the allowance for loan losses as of March 31, 2012 for impaired loans, which compares to a total of $2,099,000 as of December 31, 2011 and $1,469,000 at March 31, 2011.

The Company recorded no provision for loan losses during the first quarter of 2012 compared to a net reduction in provision expense of $436,000 in the same period last year. During the first quarter of 2012 the Company charged off $355,000 related to one construction/development relationship. This charge-off is the primary reason for the reduction in the ALLL balance at March 31, 2012. We believe the allowance for loan losses is adequate to provide for expected losses in the loan portfolio, but there are no assurances that it will be.

Our ALLL percentage of total loans has been on a steady decline since December 31, 2009 as we have successfully reduced our level of classified assets by 53% or $48.9 million during this time period. Our nonperforming assets to total assets ratio has declined from 4.36% at December 31, 2009 to 3.76% at March 31, 2012. Additionally, our loan charge-offs during this period have declined from $8.1 million for the year ended December 31, 2009, to $4.8 million for the year ended December 31, 2010, to $1.8 million for the year ended December 31, 2011.

2011 Compared to 2010
The allowance for loan losses was $10,500,000 as of March 31, 2011, compared to $11,003,000 as of December 31, 2010 and $14,263,000 reported a year earlier. The ratio of the allowance for loan losses to total loans outstanding was approximately 1.96% at March 31, 2011, which compares to approximately 2.02% of total loans at December 31, 2010

and 2.51% of total loans at March 31, 2010. A total of $1,469,000 in specific reserves was included in the balance of the allowance for loan losses as of March 31, 2011 for impaired loans, which compares to a total of $1,280,000 as of December 31, 2010 and $4,037,000 at March 31, 2010.

The Company recorded a net reduction of provisions for potential loan losses of $436,000 for the first quarter of 2011, a decrease of $644,000 as compared to the same period of 2010. During the first quarter of 2011:

· The Company successfully collected full payment on a relationship that included a $463,000 specific reserve at December 31, 2010, and as a result reversed the entire reserve;

· The Company set aside additional specific reserves on one residential real estate development totaling $460,000;

· The Company established new specific reserves of $200,000 on an operating company that closed its doors and filed Chapter 7 Bankruptcy during the first quarter; and

· The Company recorded a reduction to general reserves of $624,000 as a result of the reduction in impaired loans, the reduction in charge-offs, the continued decline in loan balances, as well as a reduction in the environmental risk assessment associated with the Company's real estate portfolios.

Non-Performing Assets
Non-performing 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 be placed on nonaccrual status automatically 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.

Based on generally accepted accounting standards for receivables, a loan is impaired when, based on current information and events, it is likely that a creditor will be unable to collect all amounts, including both principal and interest, due according to the contractual terms of the loan agreement.

The Company's ratio of non-performing assets as a percentage of total assets increased 14 basis points to 3.76% as of March 31, 2012 as compared to 3.62% as of December 31, 2011 and remained flat compared to 3.76% as of March 31, 2011. Non-performing assets increased from $27,987,000 at December 31, 2011 to $29,365,000 at March 31, 2012. Non-performing assets consisted of non-accrual loans of $6,163,000, foreclosed assets of $20,672,000, troubled debt restructurings of $2,301,000 and loans totaling $229,000 that were past due greater than 90 days. The Company anticipates full payment of all past due amounts.

Net charge-offs as a percentage of average loans receivable amounted to 0.07% for the first quarter of 2012, compared to 0.03% for the fourth quarter of 2011 and 0.01% for the same quarter in the prior year. Net charge-offs for the quarter ended March 31, 2012 were $363,000, in comparison to $162,000 for the fourth quarter of 2011 and $68,000 for the same period last year.

Nonperforming assets at March 31, 2012, December 31, 2011 and March 31, 2011 are presented in the following table:

                                  Nonperforming Assets

      In thousands                    3/31/2012        12/31/2011       3/31/2011
      Nonaccrual loans               $      6,163     $      8,638     $     11,811
      Loans past due 90 days or
      more                                    229                4            2,140
      Restructured loans                    2,301            2,305              224
      Total nonperforming loans      $      8,693     $     10,947     $     14,175

      Foreclosed, repossessed and
      idled properties                     20,672           17,040           15,887
      Total nonperforming assets     $     29,365     $     27,987     $     30,062

As can be seen from the table above, nonaccrual loans decreased by $2,475,000 and foreclosed properties increased by $3,632,000 during the first quarter of 2012 leading to an overall increase in our nonperforming assets. We added one note to nonaccrual status during the quarter totaling $696,000 and foreclosed on properties which were previously carried as nonaccrual totaling $3,387,000. If nonaccrual loans had performed in accordance with their original terms, additional interest income would have been recorded in the amount of $127,000 for the three months ended March 31, 2012; $550,000 for the year ended December 31, 2011; and $152,000 for the three months ended March 31, 2011.

Higher Risk Loans
Certain types of loans, such as option ARM products, interest-only loans, subprime loans, and loans with initial teaser rates, can have a greater risk of non-collection than other loans. We do not offer option ARM, interest-only, or subprime mortgage loans.

Junior-lien mortgages can also be considered higher risk loans and our junior lien portfolio currently consists of balances totaling $22,286,000 (4.3% of total portfolio) at March 31, 2012. Loans included in this category that were initially made with high loan-to-value ratios of 100% or greater have current balances totaling $1,402,000 at March 31, 2012. Since 2003, we have experienced net charge-offs totaling $830,000 in junior lien mortgages.

Financial Condition

Total assets at March 31, 2012 were $781,354,000, up $7,850,000 or 1% from $773,504,000 at December 31, 2011. The principal components of the Company's assets at the end of the period were $21,880,000 in cash and cash equivalents, $168,176,000 in securities available-for-sale, $28,130,000 in securities held-to-maturity and $514,653,000 in gross loans. Total assets at December 31, 2011 were $773,504,000 with the principal components consisting of $30,724,000 in cash and cash equivalents, $160,465,000 in securities available-for-sale, $28,770,000 in securities held-to-maturity and $508,586,000 in gross loans.

Total liabilities at March 31, 2012 were $719,377,000, up from $713,391,000 at December 31, 2011, an increase of $5,986,000 or 1%. Deposits increased $8,677,000 or 1% to $639,385,000 from the $630,708,000 level at December 31, 2011. Total shareholders' equity at March 31, 2012 was $61,977,000, up from $60,113,000 at December 31, 2011, an increase of $1,864,000 or 3%.

Capital Adequacy
The management of capital in a regulated financial services industry must properly balance return on equity to shareholders while maintaining sufficient capital levels and related risk-based capital ratios to satisfy regulatory requirements. The Company's capital management strategies have been developed to provide attractive rates of returns to shareholders, while maintaining its "well-capitalized" position at the banking subsidiary.

The primary source of additional capital to the Company is earnings retention, which represents net income less dividends declared. Following the Company's entrance into a Written Agreement with the Reserve Bank on September 30, 2010, any decision by the Board of Directors to pay dividends on the Series A Preferred Stock, interest on the Preferred Stock, or dividends on common stock will require the approval of the Reserve Bank. The Company is current on all payments for the Series A Preferred Stock and Trust Preferred Securities. In the future, the Company plans, subject to Board approval, to seek approval from the Federal Reserve to pay dividends on the Company's Series A Preferred Stock and Trust Preferred Securities to keep them current.
The Company and its banking subsidiary also are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company and the subsidiary bank's financial . . .