Caution about forward-looking statements

In addition to historical information, this report may contain forward-looking statements. For this purpose, any statement, that is not a statement of historical fact may be deemed to be a forward-looking statement. These forward-looking statements may include statements regarding profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk, growth strategy and financial and other goals. Forward-looking statements often use words such as "believes," "expects," "plans," "may," "will," "should," "projects," "contemplates," "anticipates," "forecasts," "intends" or other words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts. Forward-looking statements are subject to numerous assumptions, risks and uncertainties, and actual results could differ materially from historical results or those anticipated by such statements.

There are many factors that could have a material adverse effect on the operations and future prospects of the Company including, but not limited to:

· the inability of the Bank to comply with the requirements of agreements with its regulators;

· the inability to reduce nonperforming assets consisting of nonaccrual loans and foreclosed real estate;

· our inability to improve our regulatory capital position;

· the risks of changes in interest rates on levels, composition and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities, and interest sensitive assets and liabilities;

· changes in assumptions underlying the establishment of allowances for loan losses, and other estimates;

· changes in market conditions, specifically declines in the residential and commercial real estate market, volatility and disruption of the capital and credit markets, soundness of other financial institutions we do business with;

· risks inherent in making loans such as repayment risks and fluctuating collateral values;

· changes in operations of Village Bank Mortgage Corporation as a result of the activity in the residential real estate market;

· legislative and regulatory changes, including the Dodd-Frank Act Wall Street Reform and Consumer Protection Act and other changes in banking, securities, and tax laws and regulations and their application by our regulators, and changes in scope and cost of FDIC insurance and other coverages;

· exposure to repurchase loans sold to investors for which borrowers failed to provide full and accurate information on or related to their loan application or for which appraisals have not been acceptable or when the loan was not underwritten in accordance with the loan program specified by the loan investor;

· the effects of future economic, business and market conditions;

· governmental monetary and fiscal policies;

· changes in accounting policies, rules and practices;

· maintaining capital levels adequate to remain well capitalized;

· reliance on our management team, including our ability to attract and retain key personnel;

· competition with other banks and financial institutions, and companies outside of the banking industry, including those companies that have substantially greater access to capital and other resources;

· demand, development and acceptance of new products and services;

· problems with technology utilized by us;

· changing trends in customer profiles and behavior; and

· other factors described from time to time in our reports filed with the SEC.

These risks and uncertainties should be considered in evaluating the forward-looking statements contained herein, and readers are cautioned not to place undue reliance on such statements. Any forward-looking statement speaks only as of the date on which it is made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which it is made. In addition, past results of operations are not necessarily indicative of future results.

General

The Company's primary source of earnings is net interest income, and its principal market risk exposure is interest rate risk. The Company is not able to predict market interest rate fluctuations and its asset/liability management strategy may not prevent interest rate changes from having a material adverse effect on the Company's results of operations and financial condition.

Although we endeavor to minimize the credit risk inherent in the Company's loan portfolio, we must necessarily make various assumptions and judgments about the collectability of the loan portfolio based on our experience and evaluation of economic conditions. If such assumptions or judgments prove to be incorrect, the current allowance for loan losses may not be sufficient to cover loan losses and additions to the allowance may be necessary, which would have a negative impact on net income. Over the last three years, the Company has recorded record provisions for loan losses due primarily to loans collateralized by real estate located in its principal market area.

There is intense competition in all areas in which the Company conducts its business. The Company competes with banks and other financial institutions, including savings and loan associations, savings banks, finance companies, and credit unions. Many of these competitors have substantially greater resources and lending limits and provide a wider array of banking services. To a limited extent, the Company also competes with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies and insurance companies. Competition is based on a number of factors, including prices, interest rates, services, availability of products and geographic location.

Given current economic uncertainty as well as stress on our capital ratios resulting from operating losses, the Company has adopted a balance sheet reduction plan that focuses on the reduction of nonperforming assets and higher risk-weighted assets that will help increase capital ratios in three ways. First, the lower overall asset size affords the Company's capital reserves to support a smaller balance sheet. Second, the reduced risk profile of the Company's ensuing loan portfolio requires less capital support during times of economic stress. Third, a reduced infrastructure reduces general and administrative expenses, which in turn reduces the need for additional capital.

Given the asset growth restriction in the Consent Order, as well as the Company's current weakened financial position, the Company does not anticipate undertaking growth via acquisition or de novo branching during the foreseeable future.

The Company's objective is to continue decreasing assets by loan and deposit attrition.

Results of Operations

The following represents management's discussion and analysis of the financial condition of the Company at March 31, 2012 and December 31, 2011 and the results of operations for the Company for the three months ended March 31, 2012 and 2011. This discussion should be read in conjunction with the Company's condensed consolidated financial statements and the notes thereto appearing elsewhere in this Quarterly Report.

Income Statement Analysis

Summary

For the three months ended March 31, 2012, the Company had a net loss totaling $(1,400,000) and a net loss available to common shareholders of $(1,621,000), or $(0.38) per fully diluted share, compared to net income of $83,000 and a net loss available to common shareholders of $(135,000) or $(0.03) per fully diluted basis, for the same period in 2011. The key factors in the decline in earnings were increases in the provision for loan losses of $732,000, from $1,003,000 for the first quarter of 2011 to $1,735,000 for the first quarter of 2012, and the expenses associated with foreclosed real estate of $657,000, from $462,000 for the first quarter of 2011 to $1,119,000 for the first quarter of 2012. These increases in 2012 reflect the continued stress on our borrowers and declining real estate values from the recessionary economy. Asset quality continues to be a concern as there continues to be uncertainty in the economy. The increase in the provision for loan losses is discussed further under Asset quality and provision for loan losses.

Our cost of deposits declined from 1.81% for the first quarter of 2011 to 1.34% for the first quarter of 2012. This decline in cost of deposits is a result of the repricing of higher cost certificates of deposit during the low interest rate environment that has existed for the last three years as well as an effort to change our deposit mix so that we are not so dependent on higher cost deposits. Our mortgage company's profit increased in the first quarter of 2012 compared to 2011 by $172,000 due to the mortgage company closing $64,121,000 in mortgage loans in the first quarter of 2012 compared to $42,899,000 in the first quarter of 2011.

Net interest income

Net interest income, which represents the difference between interest earned on interest-earning assets and interest incurred on interest-bearing liabilities, is the Company's primary source of earnings. Net interest income can be affected by changes in market interest rates as well as the level and composition of assets, liabilities and shareholders' equity. Net interest spread is the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities. The net yield on interest-earning assets ("net interest margin") is calculated by dividing tax equivalent net interest income by average interest-earning assets. Generally, the net interest margin will exceed the net interest spread because a portion of interest-earning assets are funded by various noninterest-bearing sources, principally noninterest-bearing deposits and shareholders' equity.

Net interest income for the first quarter of $4,421,000 represents a decrease of $617,000, or 12%, compared to the first quarter of 2011, and a decrease of $275,000, or 6%, compared to the fourth quarter of 2011.

Compared to the first quarter of 2011, average interest-earning assets for the first quarter of 2012 decreased by $35,414,000, or 7%. The decrease in interest-earning assets was due

primarily to decreases in portfolio loans of $29,308,000 and investment securities of $15,612,000, offset by increases in loans held for sale of $4,305,000 and federal funds sold of $5,201,000. In addition to the decline in interest-earning assets, the average yield on interest-earning assets decreased to 4.85% for the first quarter of 2012 compared to 5.54% for the first quarter of 2011. These declines resulted in a decline in interest income from the first quarter of 2011 to the first quarter of 2012 of $1,289,000, or 18%.

Average interest-bearing liabilities for the first quarter of 2012 decreased by $47,407,000, or 9%, compared to the first quarter of 2011. The decrease in interest-bearing liabilities was due primarily to declines in average deposits of $48,665,000. The average cost of interest-bearing liabilities decreased to 1.45% for the quarter of 2012 from 1.86% for the first quarter of 2011. The principal reason for the decrease in liability costs was the maintenance of short-term interest rates by the Federal Reserve. The continuing low interest rates have allowed us to reduce our cost of funds as certificates of deposit and borrowings mature. See our discussion of interest rate sensitivity below for more information.

The Company's net interest margin is not a measurement under accounting principles generally accepted in the United States, but it is a common measure used by the financial services industry to determine how profitably earning assets are funded. Our net interest margin over the last several quarters is provided in the following table:

                             Quarter Ended

                           March 31, 2011         3.79 %
                           June 30, 2011          3.65 %
                           September 30, 2011     3.63 %
                           December 31, 2011      3.38 %
                           March 31, 2012         3.53 %

The net interest margin declined during 2011, primarily as a result of increasing nonaccrual loans. Additionally our margin was compressed as our deposits generally do not reprice as quickly as our loans. The improvement in net interest margin for the first quarter of 2012 compared to the fourth quarter of 2011 is a result of utilizing lower interest-earning assets, primarily federal funds sold, to fund a decrease in interest-bearing liabilities of $22,284,000. As a result higher yielding loans represented 86% of total interest-bearing assets as compared to 80% for the fourth quarter of 2011. However, given the continued depressed economy and the potential impact on interest income from new nonaccrual loans, no assurance can be provided that increases in the net interest margin will continue to occur.

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, shareholders' 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)

                                          Three Months Ended March 31, 2012                    Three Months Ended March 31, 2011
                                                         Interest       Annualized                            Interest       Annualized
                                      Average             Income/          Yield           Average             Income/          Yield
                                      Balance             Expense          Rate            Balance             Expense          Rate


Loans                              $      420,220       $     5,768            5.52 %   $      449,528       $     6,919            6.24 %
Investment securities                      31,307               150            1.93 %           46,919               300            2.59 %
Loans held for sale                        13,111               131            4.02 %            8,806               122            5.62 %
Federal funds and other                    38,657                21            0.22 %           33,456                18            0.22 %
Total interest earning assets             503,295             6,070            4.85 %          538,709             7,359            5.54 %

Allowance for loan losses and
deferred fees                             (11,845 )                                             (7,308 )
Cash and due from banks                    15,305                                                8,500
Premises and equipment, net                26,710                                               27,455
Other assets                               33,255                                               32,483
Total assets                       $      566,720                                       $      599,839

Interest bearing deposits
Interest checking                  $       42,168       $        40            0.38 %   $       33,402       $        63            0.76 %
Money market                               73,422                76            0.42 %           92,997               203            0.89 %
Savings                                    16,186                21            0.52 %           11,239                20            0.72 %
Certificates                              277,023             1,221            1.77 %          319,826             1,753            2.22 %
Total                                     408,799             1,358            1.34 %          457,464             2,039            1.81 %
Borrowings                                 49,805               291            2.35 %           48,547               283            2.36 %
Total interest bearing
liabilities                               458,604             1,649            1.45 %          506,011             2,322            1.86 %
Noninterest bearing deposits               63,206                                               44,234
Other liabilities                           3,676                                                1,730
Total liabilities                         525,486                                              551,975
Equity capital                             41,234                                               47,864

Total liabilities and capital      $      566,720                                       $      599,839

Net interest income before
provision for L/L                                       $     4,421                                          $     5,037

Interest spread - average yield
on interest
earning assets, less average
rate on
interest bearing liabilities                                                   3.40 %                                               3.68 %

Annualized net interest margin
(net
interest income expressed as
percentage of average earning
assets)                                                                        3.53 %                                               3.79 %

Provision for loan losses

Provisions for loan losses amounted to $1,735,000 for the three months ended March 31, 2012 compared to $1,003,000 for the first quarter of 2011. The increase in the provision for loan losses in 2012 reflects the continued stress on our borrowers from the recessionary economy as well as declining real estate values which collateralize many of our loans. Asset quality continues to be a concern as there continues to be uncertainty in the economy.

Noninterest income

Noninterest income increased from $2,055,000 for the three months ended March 31, 2011 to $2,689,000 for the same period in 2012, an increase of $634,000, or 31%. This increase in noninterest income is primarily a result of increases in service charges and fees of $135,000, gain on the sale of loans of $378,000, and gain on sale of securities of $101,000. The increase in service charges and fees and gains on sale of loans are attributable primarily to increased operations of our mortgage company. The mortgage company originated $64,121,000 in

mortgage loans for the first quarter of 2012 compared to $42,899,000 for the same period in 2011.

Noninterest expense

Noninterest expense for the three months ended March 31, 2012 was $6,775,000 compared to $5,898,000 for the three months ended March 31, 2011, an increase of $877,000 or 15%. The most significant increases in noninterest expense occurred in expenses related to foreclosed real estate of $656,000 and loan underwriting of $188,000.

Income taxes

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 net deferred tax asset is included in other assets on the balance sheet. Accounting Standards Codification Topic 740, Income Taxes, requires that companies assess whether a valuation allowance should be established against their deferred tax assets based on the consideration of all available evidence using a "more likely than not" standard. Management considers both positive and negative evidence and analyzes changes in near-term market conditions as well as other factors which may impact future operating results. In making such judgments, significant weight is given to evidence that can be objectively verified. The deferred tax assets are analyzed quarterly for changes affecting realization. Management determined that as of December 31, 2011, the objective negative evidence represented by the Company's recent losses outweighed the more subjective positive evidence and, as a result, recognized a valuation allowance on its net deferred tax asset of approximately $3,900,000. At March 31, 2012, management continues to believe that the objective negative evidence represented by the Company's continued losses in the first quarter outweighed the more subjective positive evidence and, as a result, recognized an addition to the valuation allowance on its net deferred tax asset of approximately $476,000. The net operating losses available to offset future taxable income amounted to $6,800,000 at March 31, 2012 and expire through 2030.

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 $42,000 and $85,000 for the three months ended March 31, 2012 and 2011, respectively.

Balance Sheet Analysis

Our total assets decreased to $555,367,000 at March 31, 2012 from $581,704,000 at December 31, 2011, a decrease of $26,337,000, or 4.5%. During the first quarter of 2012 liquid assets (cash and due from banks, federal funds sold and investment securities available for sale) decreased by $14,993,000, loans held for sale increased by $1,023,000, net portfolio loans decreased by $14,196,000, and other real estate owned increased by $5,413,000.

Loans

A management objective is to maintain the quality of the loan portfolio. The Company seeks to achieve this objective by maintaining rigorous underwriting standards coupled with regular evaluation of the creditworthiness of and the designation of lending limits for each borrower. The

portfolio strategies include seeking industry and loan size diversification in order to minimize credit exposure and originating loans in markets with which the Company is familiar.

The Company's real estate loan portfolios, which represent approximately 90% of all loans, are secured by mortgages on real property located principally in the Commonwealth of Virginia. Sources of repayment are from the borrower's operating profits, cash flows and liquidation of pledged collateral. The Company's commercial loan portfolio represents approximately 9% of all loans. Loans in this category are typically made to individuals, small and medium-sized businesses and range between $250,000 and $2.5 million. Based on underwriting standards, commercial and industrial loans may be secured in whole or in part by collateral such as liquid assets, accounts receivable, equipment, inventory, and real property. The collateral securing any loan may depend on the type of loan and may vary in value based on market conditions. The remainder of our loan portfolio is in consumer loans which represent 1% of the total.

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)

                                               March 31, 2012           December 31, 2011
                                             Amount          %          Amount          %

Commercial                                  $  37,959         9.2 %   $   37,734         8.8 %
Real estate - Construction, land
development & other loans                      73,238        17.8 %       80,527        18.8 %
Real estate - Commercial                      166,832        40.5 %      168,796        39.5 %
Real estate - 1-4 Residential                 129,634        31.5 %      135,948        31.8 %
Consumer                                        4,265         1.0 %        4,865         1.1 %

Total loans                                   411,928       100.0 %      427,870       100.0 %
Deferred loan cost (unearned income), net         805                        768
Less: Allowance for loan losses               (14,362 )                  (16,071 )

                                            $ 398,371                 $  412,567

The decline in our total loan portfolio is part of management's strategy to decrease our level of assets to improve our regulatory capital ratios as well as reduce our overhead expenses.

The Company assigns risk rating classifications to its loans. These risk ratings are divided into the following groups:

· Risk rated 1 to 4 loans are considered of sufficient quality to preclude an adverse rating. 1-4 assets generally are well protected by the current net worth and paying capacity of the obligor or by the value of the asset or underlying collateral;

· Risk rated 5 loans are defined as having potential weaknesses that deserve management's close attention;

· Risk rated 6 loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any, and;

· Risk rated 7 loans have all the weaknesses inherent in substandard loans, with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

Loans are considered impaired when, based on current information and events it is probably the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan's existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

Allowance for loan losses

We monitor and maintain an allowance for loan losses to absorb an estimate of probable losses inherent in the loan portfolio. We maintain policies and procedures that address the systems of controls over the following areas of maintenance of the allowance: the systematic methodology used to determine the appropriate level of the allowance to provide assurance they are maintained in accordance with accounting principles generally accepted in the United States of America; the accounting policies for loan charge-offs and recoveries; the assessment and measurement of impairment in the loan portfolio; and the loan . . .