VIRGINIA FINANCIAL GROUP INC - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2002

OR

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from__________to__________

Commission File Number 000-22283

Virginia Financial Group, Inc.

(Exact name of registrant as specified in its charter)

Virginia		54-1829288

(State or other jurisdiction of Incorporation or organization)		(I.R.S. Employer Identification No.)

102 South Main Street, Culpeper, Virginia		22701

(Address of principal executive offices)		(Zip Code)

(Registrant’s telephone number, including area code) 540-829-1603

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such report(s), and (2) has been subject to such filing requirements for the past 90 days.

Yes

As of November 1, 2002, there were 7,253,588 shares of common stock, $5.00 par value, outstanding and the aggregate market value of common stock of Virginia Financial Group, Inc. held by nonaffiliates was approximately $220,799,219.

VIRGINIA FINANCIAL GROUP, INC.

INDEX

		Page No.

	PART I - FINANCIAL INFORMATION

ITEM 1	Consolidated Financial Statements (unaudited):

	Consolidated Balance Sheets	3

	Consolidated Statements of Income	4-5

	Consolidated Statements of Changes in Stockholders’ Equity	6

	Consolidated Statements of Cash Flows	7-8

	Notes to Financial Statements	9-12

ITEM 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13-19

ITEM 3	Quantitative and Qualitative Disclosures about Market Risk	20

ITEM 4	Controls and Procedures	20

	PART II - OTHER INFORMATION

ITEM 1	Legal Proceedings	20

ITEM 2	Change in Securities and Use of Proceeds	20

ITEM 3	Defaults upon Senior Securities	20

ITEM 4	Submission of Matters to a Vote of Security Holders	20

ITEM 5	Other Information	20

ITEM 6	Exhibits and Reports on Form 8-K	21

	SIGNATURES	22

- 2 -

VIRGINIA FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(000 OMITTED)

			SEPTEMBER 30, 2002		DECEMBER 31, 2001

			(unaudited)
ASSETS
Cash and due from depository institutions			$	42,066	$	42,573
Federal funds sold				16,077		20,908
Interest-bearing deposits in banks				409		556
Securities (market value: 2002, $321,049; 2001, $266,082)				320,230		265,773
Loans held for sale				7,606		17,384
Loans receivable, net				675,005		658,416
Bank premises and equipment				21,648		20,111
Interest receivable				5,688		5,656
Other real estate owned				643		547
Intangibles				1,747		1,866
Other assets				6,697		6,914

Total Assets			$	1,097,816	$	1,040,704

LIABILITIES
Deposits:
	Noninterest-bearing demand deposits		$	173,503	$	146,850
	Savings and interest-bearing demand deposits			369,400		337,030
	Time deposits			403,783		413,579

		Total deposits		946,686		897,459
Securities sold under agreements to repurchase				14,105		16,430
Federal funds purchased				—		500
Federal Home Loan Bank advances				12,240		12,300
Short-term borrowings				956		1,053
Interest payable				2,019		2,579
Other liabilities				5,774		3,677

	Total Liabilities			981,780		933,998

STOCKHOLDERS’ EQUITY
Preferred stock, no par value; (Authorized 5,000,000 shares, no shares outstanding)				—		—
Common stock, par value $5.00 per share; (Authorized 25,000,000 shares; issued and outstanding 7,256,588 shares in 2002 and 7,304,970 in 2001)				36,283		36,432
Capital surplus				10,344		11,332
Retained earnings				62,342		57,060
Accumulated other comprehensive income				7,067		1,882

	Total Stockholders’ Equity			116,036		106,706

Total Liabilities and Stockholders’ Equity			$	1,097,816	$	1,040,704

See accompanying notes to consolidated financial statements.

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VIRGINIA FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(000 OMITTED)

					THREE MONTHS ENDED SEPTEMBER 30,

					2002			2001

						(unaudited)			(unaudited)
Interest Income
		Interest and fees on loans			$	12,533		$	13,955
		Interest on deposits in other banks				—			22
		Interest on investment securities:
			Taxable			156			154
		Interest and dividends on securities available for sale:
			Taxable			2,275			2,073
			Nontaxable			900			798
			Dividends			57			53
		Interest income on federal funds sold				117			280

				Total Interest Income		16,038			17,335

Interest Expense
		Interest on deposits				5,388			7,669
		Interest on Federal Home Loan Bank advances				203			238
		Interest on federal funds purchased and securities sold under agreements to repurchase				60			136
		Interest on other short-term borrowings				2			6

				Total Interest Expense		5,653			8,049

		Net Interest Income				10,385			9,286
Less: Provision for loan losses						401			322

		Net Interest Income after Provision for Loan Losses				9,984			8,964
Other Income
		Service charges on deposit accounts				1,212			892
		Commissions and fees from fiduciary activities				735			831
		Investment fee income				67			82
		Gain on sale of mortgage loans				801			689
		(Loss) gain on sale of available for sale securities				(38	)		46
		Loss on sale of other real estate owned				(2	)		(8	)
		Other operating income				372			297

				Total Other Income		3,147			2,829

Other Expense
		Compensation and employee benefits				4,865			4,269
		Net occupancy and equipment expense				1,112			1,026
		Computer services				509			406
		Professional fees				25			117
		Other operating expenses				2,339			2,138

				Total Other Expense		8,850			7,956

	Income Before Income Tax Expense					4,281			3,837
Income tax expense						1,133			1,243

	Net Income				$	3,148		$	2,594

Earnings per Share, basic					$	.43		$	.36

Earnings per Share, diluted					$	.43		$	.35

Dividends per Share					$	.18		$	.17

See accompanying notes to consolidated financial statements.

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VIRGINIA FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(000 OMITTED)

						NINE MONTHS ENDED SEPTEMBER 30,

						2002		2001

						(unaudited)		(unaudited)
Interest Income
		Interest and fees on loans				$	37,610	$	42,150
		Interest on deposits in other banks					4		68
		Interest on investment securities:
			Taxable				506		478
		Interest and dividends on securities available for sale:
			Taxable				6,536		6,432
			Nontaxable				2,609		2,203
			Dividends				215		167
		Interest income on federal funds sold					381		865

					Total Interest Income		47,861		52,363

Interest Expense
		Interest on deposits					16,922		23,573
		Interest on Federal Home Loan Bank advances					606		754
		Interest on federal funds purchased and securities sold under agreements to repurchase					213		505
		Interest on other short-term borrowings					6		19

					Total Interest Expense		17,747		24,851

		Net Interest Income					30,114		27,512
Less: Provision for loan losses							1,202		1,138

		Net Interest Income after Provision for Loan Losses					28,912		26,374
Other Income
		Service charges on deposit accounts					3,025		2,614
		Commissions and fees from fiduciary activities					2,328		2,152
		Investment fee income					379		258
		Gain on sale of mortgage loans					2,047		1,792
		Gain on sale of available for sale securities					193		220
		Gain on sale of other real estate owned					54		12
		Other operating income					1,087		832

					Total Other Income		9,113		7,880

Other Expense
		Compensation and employee benefits					14,663		13,003
		Net occupancy and equipment expense					3,161		3,087
		Computer services					1,354		1,224
		Professional fees					435		419
	Other operating expenses						5,940		5,235

				Total Other Expense			25,553		22,968

	Income Before Income Tax Expense						12,472		11,286
Income tax expense							3,237		3,276

	Net Income					$	9,235	$	8,010

Earnings per Share, basic						$	1.27	$	1.10

Earnings per Share, diluted						$	1.26	$	1.09

Dividends per Share						$	.54	$	.51

See accompanying notes to consolidated financial statements.

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VIRGINIA FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(000 OMITTED)

		Common Stock			Capital Surplus			Accumulated Other Comprehensive Income		Retained Earnings			Comprehensive Income			Total

Balance, January 1, 2001		$	36,561		$	11,838		$	201	$	52,286		$	—		$	100,886
Net income			—			—			—		8,010			8,010			8,010
Other Comprehensive Income, net of tax:
	Unrealized gains on securities available for sale during the period, net of tax of $1,675		—			—			—		—			3,618			—
	Less: reclassification adjustment, net of tax of $75		—			—			—		—			(145	)		—

	Other comprehensive income		—			—			3,473		—			3,473			3,473

	Comprehensive income		—			—			—		—		$	11,483

Cash dividends			—			—			—		(3,834	)					(3,834	)
Stock options exercised			69			91			—		—						160
Repurchase of common stock			(105	)		(289	)		—		—						(394	)

Balance, September 30, 2001		$	36,525		$	11,640		$	3,674	$	56,462					$	108,301

Balance, January 1, 2002		$	36,432		$	11,332		$	1,882	$	57,060		$	—		$	106,706
Net income			—			—			—		9,235			9,235			9,235
Other Comprehensive Income, net of tax:
	Unrealized gains on securities available for sale during the period, net of tax of $2,660		—			—			—		—			5,312			—
	Less: reclassification adjustment, net of tax of $66		—			—			—		—			(127	)		—

	Other comprehensive income		—			—			5,185		—			5,185			5,185

	Comprehensive income		—			—			—		—		$	14,420

Cash dividends			—			—			—		(3,953	)					(3,953	)
Stock options exercised			91			226			—		—						317
Repurchase of common stock			(240	)		(1,192	)		—		—						(1,432	)
Fractional shares paid in cash			—			(22	)		—		—						(22	)

Balance, September 30, 2002		$	36,283		$	10,344		$	7,067	$	62,342					$	116,036

See accompanying notes to consolidated financial statements.

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VIRGINIA FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(000 OMITTED)

						NINE MONTHS ENDED SEPTEMBER 30,

						2002			2001

						(unaudited)			(unaudited)
OPERATING ACTIVITIES
	Net income					$	9,235		$	8,010
	Adjustments to reconcile net income to net cash provided by operating activities:
		Provision for loan losses					1,202			1,138
		Deferred tax benefit					(371	)		(22	)
		Depreciation and amortization					1,757			1,660
		Pension expense					185			56
		Gain on sale of available for sale securities					(193	)		(220	)
		Gain on sale of other real estate owned					(54	)		(12	)
		Loss on sale of fixed assets					—			40
		Amortization of premiums and discounts on securities					338			117
		Gain on sale of mortgage loans					(2,047	)		(1,792	)
		Proceeds from sale of mortgage loans					121,692			108,069
		Origination of loans for sale					(109,867	)		(109,190	)
		Changes in assets and liabilities:
			(Increase) decrease in interest receivable				(32	)		886
			(Increase) decrease in other assets				(1,382	)		70
			Decrease in interest payable				(560	)		(506	)
			Increase (decrease) in other liabilities				1,094			(54	)

					Net cash provided by operating activities		20,997			8,250

INVESTING ACTIVITIES
	Proceeds from sale of securities available for sale						30,024			13,451
	Proceeds from maturities of investment securities						750			15,655
	Proceeds from maturities and principal payments of securities available for sale						47,596			72,147
	Purchase of securities available for sale						(125,000	)		(85,538	)
	Purchase of securities held to maturity						—			(2,619	)
	Purchase of premises and equipment						(3,210	)		(3,064	)
	Proceeds from sale of premises and equipment						35			28
	Additions to other real estate						(29	)		(54	)
	Proceeds from sale of other real estate						678			644
	Net increase in loans						(18,482	)		(39,801	)

				Net cash used by investing activities			(67,638	)		(29,151	)

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VIRGINIA FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(000 OMITTED)

			NINE MONTHS ENDED SEPTEMBER 30,

			2002			2001

			(unaudited)			(unaudited)
FINANCING ACTIVITIES
	Net increase in demand, money market and savings deposits			59,023			42,744
	Net (decrease) increase in time deposits			(9,795	)		10,022
	Payments of Federal Home Loan Bank advances			(60	)		(5,060	)
	Net (decrease) increase in repurchase agreements			(2,325	)		1,885
	Net decrease in federal funds purchased			(500	)		(6,000	)
	Net (decrease) increase in short-term borrowings			(97	)		270
	Fractional shares paid			(22	)		—
	Repurchase of common stock			(1,432	)		(394	)
	Stock options exercised			317			160
	Cash dividends paid on common stock			(3,953	)		(3,834	)

		Net cash provided by financing activities		41,156			39,793

		(Decrease) increase in cash and cash equivalents		(5,485	)		18,892

CASH AND CASH EQUIVALENTS
	Beginning of the period			64,037			43,710

	End of the period		$	58,552		$	62,602

Supplemental Schedule of Noncash Investing Activities
	Unrealized gain on securities available for sale		$	7,972		$	5,293

	Other real estate acquired in settlement of loans		$	691		$	101

	Transfer of securities from held to maturity to available for sale		$	—		$	22,040

See accompanying notes to consolidated financial statements.

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VIRGINIA FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002 AND DECEMBER 31, 2001

1.	In the opinion of management, the accompanying financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position as of September 30, 2002 and December 31, 2001, and the results of operations and cash flows for the nine months ended September 30, 2002 and 2001. The statements should be read in conjunction with the Notes to Financial Statements included in the Company’s Annual Report for the year ended December 31, 2001. Certain reclassifications have been made to prior amounts to conform to the current period presentation.

2.	The results of operations for the nine month period ended September 30, 2002 and 2001 are not necessarily indicative of the results to be expected for the full year.

3.	The Company’s securities portfolio is composed of the following (000 omitted):

		Amortized Cost		Fair Value

		September 30, 2002

		(unaudited)
Securities Held to Maturity:

	U.S. Treasury Securities	$	2,499	$	2,527
	Obligations of States and Political Subdivisions		7,047		7,838

		$	9,546	$	10,365


		December 31, 2001

	U.S. Treasury Securities	$	2,497	$	2,589
	Obligations of States and Political Subdivisions		7,789		8,006

		$	10,286	$	10,595


		September 30, 2002

		(unaudited)
Securities Available for Sale:

	U.S. Treasury Securities	$	10,104	$	10,842
	U.S. Government Securities		118,024		121,185
	Obligations of States and Political Subdivisions		88,146		93,321
	Corporate Bonds		15,547		16,153
	Mortgage-backed Securities		53,868		55,238
	Other Securities		14,155		13,945

		$	299,844	$	310,684

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VIRGINIA FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002 AND DECEMBER 31, 2001

	December 31, 2001

U.S. Treasury Securities	$	8,459	$	8,893
U.S. Government Securities		46,562		47,853
Obligations of States and Political Subdivisions		78,493		79,093
Corporate Bonds		12,964		13,139
Mortgage-backed securities		80,983		81,250
Other Securities		25,156		25,259

	$	252,617	$	255,487

4. The Company’s loan portfolio is composed of the following (000 omitted):

		September 30, 2002			December 31, 2001

		(unaudited)
Real estate loans:
	Construction	$	60,331		$	61,899
	Secured by farmland		2,883			2,698
	Secured by 1 – 4 family residential		241,093			248,877
	Other real estate loans		254,795			207,220
Loans to farmers (except secured by real estate)			1,621			2,615
Commercial and industrial loans (except those secured by real estate)			61,123			75,057
Loans to individuals for personal expenditures			55,239			60,180
All other loans			7,887			9,041

			684,972			667,587
Less:
	Deferred loan fees		(734	)		(905	)
	Allowance for loan losses		(9,233	)		(8,266	)

		$	675,005		$	658,416

5. Activity in the allowance for loan losses is as follows (000 omitted):

	September 30, 2002			December 31, 2001			September 30, 2001

	(unaudited)						(unaudited)
Balance at January 1	$	8,266		$	7,383		$	7,383

Recoveries added to the allowance		239			608			255
Loan losses charged to the allowance		(474	)		(1,103	)		(840	)
Provision recorded to expense		1,202			1,378			1,138

Balance at end of period	$	9,233		$	8,266		$	7,936

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VIRGINIA FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002 AND DECEMBER 31, 2001

6.	Short-term Borrowings:

	Outstanding short-term borrowings consisted of (000’s omitted):

	September 30, 2002		December 31, 2001

	(unaudited)
Federal Reserve borrowings	$	956	$	1,053

	Second Bank & Trust has an agreement with the Federal Reserve where it can borrow funds deposited by its customers. This agreement calls for variable interest and is payable on demand. U. S. Government securities and U. S. Treasury notes are pledged as collateral. The maximum amount available under this agreement is $1,000,000.

	Securities sold under agreements to repurchase, which are classified as secured borrowings, generally mature within one to four days from the transaction date. Securities sold under agreement to repurchase are reflected at the amount of cash received in connection with the transaction. The Company may be required to provide additional collateral based on the fair value of the underlying securities.

	The average balance of short-term borrowings outstanding did not exceed 30 percent of stockholders’ equity for the nine months ended September 30, 2002 or the year ended December 31, 2001.

7.	Federal Home Loan Bank Advances:

	The Corporation’s fixed-rate, long-term debt of $12,240,000 at September 30, 2002 matures through 2010. At September 30, 2002, the interest rates on fixed-rate, long-term debt ranged from 5.13% to 7.07%. One advance totaling $240 thousand at September 30, 2002 requires quarterly principal payments totaling $80 thousand annually plus interest. The remainder of the advances requires quarterly interest payments with principal due upon maturity. The average interest rate is 6.43% at September 30, 2002.

	The contractual maturities of long-term debt are as follows (000’s omitted):

2002	$	20
2003		3,080
2004		80
2005		4,060
2010		5,000

	$	12,240

The advances are collateralized by a blanket lien on first mortgage loans of Second Bank and Trust and Virginia Heartland Bank.

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VIRGINIA FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002 AND DECEMBER 31, 2001

8.	Earnings Per Share:

	The following shows the weighted average number of shares used in computing earnings per share and the effect on weighted average number of shares of diluted potential common stock for the three month periods ended September 30, 2002 and 2001.

		2002				2001

		Shares		Per Share Amount		Shares		Per Share Amount

Basic earnings per share			7,275,958	$	.43		7,304,403	$	.36

Effect of dilutive securities:
	Stock options		28,187				23,311

Diluted earnings per share			7,304,145	$	.43		7,327,714	$	.35

	The following shows the weighted average number of shares used in computing earnings per share and the effect on weighted average number of shares of diluted potential common stock for the nine month periods ended September 30, 2002 and 2001.

		2002				2001

		Shares		Per Share Amount		Shares		Per Share Amount

Basic earnings per share			7,284,835	$	1.27		7,305,747	$	1.10

Effect of dilutive securities:
	Stock options		25,213				19,373

Diluted earnings per share			7,310,148	$	1.26		7,325,120	$	1.09

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VIRGINIA FINANCIAL GROUP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion provides information about the major components of the results of operations, financial condition, liquidity and capital resources of Virginia Financial Group, Inc. (the Company). This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and supplemental financial data.

In addition to historical information, statements contained in this report that are not historical facts may be construed as forward-looking statements. The forward-looking statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from historical results, or those anticipated. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date thereof.

Critical Accounting Policies

General

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States (GAAP). The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss factors as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.

Allowance for Loan Losses

The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (i) SFAS 5, Accounting for Contingencies, which requires that losses be accrued when they are probable of occurring and estimatable and (ii) SFAS 114, Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.

The Company’s affiliate Banks conduct an analysis of the loan portfolio on a regular basis. This analysis is used in assessing the sufficiency of the allowance for loan losses and in the determination of the necessary provision for loan losses. The review process generally begins with lenders identifying problem loans to be reviewed on an individual basis for impairment. In addition to loans identified by lenders, all commercial loans also meet the Banks criteria for individual impairment testing. Impairment testing includes consideration of the current collateral value of the loan, as well as any known internal or external factors that may affect collectibility. When a loan has been identified as impaired, then a specific reserve may be established based on the Banks calculation of the loss embedded in the individual loan. In addition to impairment testing, the Banks have a seven point grading system for each loan in the portfolio. The loans meeting the criteria for special mention, substandard, doubtful and loss, as well as, impaired loans are segregated from performing loans within the portfolio. Loans are then grouped by loan type (i.e. commercial, installment) and by risk rating (i.e. substandard, doubtful). (Each loan type is assigned an allowance factor based on the associated risk, complexity and size of the individual loans within the particular loan category.) Classified loans are assigned a higher allowance factor than non-rated loans within a

- 13 -

VIRGINIA FINANCIAL GROUP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

particular loan type due to management’s concerns regarding collectibility or management’s knowledge of particular elements surrounding the borrower. Allowance factors grow with the degree of classification. Allowance factors used for unclassified loans are based on management’s analysis of charge-off history and management’s judgment based on the overall analysis of the lending environment including the general economic conditions. The total of specific reserves, the calculated reserve required for classified loans, by category, and the general reserves for each portfolio type is then compared to the recorded allowance for loan losses. This is the methodology used to determine the sufficiency of the allowance for loan losses and the amount of the provision for loan losses.

Results of Operations

Virginia Financial Group, Inc.’s consolidated net income for the quarter ended September 30, 2002 amounted to $3.15 million or $.43 per diluted share, compared to earnings of $2.59 million or $.35 per diluted share for the quarter ended September 30, 2001. Net income increased 21.4% and diluted earnings per share increased 22.9% compared to third quarter 2001 due to an increased net interest margin and average earnings assets, and continuing strength in non-interest income-producing business units. VFGI’s earnings for the third quarter produced an annualized return on average assets of 1.12% and an annualized return on average equity of 11.61%, compared to prior year ratios of 1.08% and 10.01%, respectively.

Excluding non-recurring net-of-tax charges consisting of integration costs associated with charter and system conversions of $197 thousand for 2002 and merger related expenses of $567 thousand in 2001, third quarter earnings amounted to $3.35 million or $.46 per diluted share, an increase of 6% compared to earnings of $3.16 million or $.43 per diluted share in 2001. Excluding the nonrecurring expenses, VFGI earned an annualized return on average assets of 1.23% and an annualized return on average equity of 11.79% for the quarter in 2002 compared to 2001 third quarter ratios of 1.27% and 11.96%, respectively.

For the nine months ended September 30, 2002, VFGI’s earnings were $9.24 million or $1.26 per diluted share, compared to $8.01 million or $1.09 per diluted share in 2001. This earnings growth represents an increase of 15.29% in net income and a 15.60% increase in diluted earnings per share. VFGI’s net income results yielded an annualized return on average assets of 1.17% and an annualized return on average shareholders’ equity of 11.20%, compared with prior year ratios of 1.10% and 10.28%, respectively. Earnings for the nine months ended September 30, excluding net-of-tax nonrecurring expenses noted above amounting to $275 thousand and $593 thousand, were $9.51 million, or $1.30 per diluted share, an increase of 10.5% compared to earnings of $8.60 million or $1.18 million per share in 2001. Utilizing recurring earnings, VFGI earned an annualized return on average assets of 1.20% and annualized return on average equity of 11.54% for the nine month period in 2002 and average assets of 1.18% and return on average equity of 11.04% for 2001.

The following table provides a reconciliation of GAAP earnings to recurring earnings for the periods presented (000 omitted):

		Quarter Ending September 30,				Nine Months Ending September 30,

		2002		2001		2002		2001

GAAP earnings		$	3,148	$	2,594	$	9,235	$	8,010
Nonrecurring expenses:
	Charter and system conversions		197		—		275		—
	Merger expenses		—		567		—		593

Recurring earnings		$	3,345	$	3,161	$	9,510	$	8,603

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VIRGINIA FINANCIAL GROUP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Net Interest Income

Net interest income increased $1.1 million or 11.8% to $10.39 million for the three months ended September 30, 2002. This improvement can be attributed to an increase in average earning assets generated through loan and investment growth as well as an improved net interest margin. The net interest margin for the three months ended September 30, 2002 was 4.33%, compared to 4.23% for the third quarter 2001. Average earning assets for the quarter ended September 30, 2002 increased $81.8 million to $1.01 billion, an increase of 8.8% over $925.64 million for the same quarter in 2001. The increase in average earning assets can be attributed to growth in retail deposits, which were used to fund increases in loans receivable and investments. Last year’s falling rate environment continued to have some impact on net interest margin during the quarter, with interest-bearing retail deposits repricing at current lower interest rates.

The following table provides information on average earning assets and interest-bearing liabilities for the three months ended September 30, 2002 and 2001 as well as amounts and rates of tax equivalent interest earned and interest paid. The tax equivalent adjustment, utilizing a federal statutory rate of 34%, amounted to $510 and $483 thousand in 2002 and 2001, respectively.

						Quarter ended September 30,

						2002							2001

						Average Balance		Income/ Expense		Annual Yield/Rate			Average Balance		Income/ Expense		Annual Yield/Rate

						(in thousands)							(in thousands)
Securities
	Taxable					$	228,061	$	2,471		4.33	%	$	155,464	$	2,290		5.89	%
	Tax-exempt (1)						77,968		1,365		7.00	%		70,162		1,209		6.89	%

		Total securities					306,029		3,836		5.01	%		225,626		3,499		6.20	%
Loans, net							673,149		12,595		7.48	%		664,868		14,017		8.43	%
Interest earning bank deposits							505		2		1.58	%		2,345		22		3.75	%
Federal funds sold							27,762		115		1.66	%		32,804		280		3.41	%

		Total earning assets				$	1,007,445	$	16,548		6.57	%	$	925,643	$	17,818		7.70	%

Interest-bearing deposits:
	Checking					$	119,242	$	292		0.97	%	$	99,499	$	440		1.75	%
	Money market						142,870		599		1.66	%		109,591		848		3.07	%
	Savings						103,868		394		1.50	%		90,924		608		2.65	%
	Certificates of deposit:
			Less than $100,000				322,286		3,217		3.96	%		332,139		4,541		5.42	%
				$100,000 and more			84,788		886		4.15	%		87,486		1,232		5.59	%

	Total interest-bearing deposits						773,054		5,388		2.77	%		719,639		7,669		4.23	%

Federal funds and repurchase agreements							16,481		60		1.44	%		17,782		136		3.03	%
Other short term borrowings							818		2		0.97	%		675		6		3.53	%
FHLB of Atlanta borrowings							12,260		203		6.57	%		14,098		238		6.70	%

					Total interest-bearing liabilities	$	802,613	$	5,653		2.79	%	$	752,194	$	8,049		4.25	%

Net interest income								$	10,895						$	9,769
Interest rate spread											3.78	%						3.45	%
Interest expense as a percent of average earning assets											2.24	%						3.47	%
Net interest margin											4.33	%						4.23	%

(1) income and yields are reported on a taxable-equivalent basis

- 15 -

VIRGINIA FINANCIAL GROUP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Noninterest Income

Noninterest income increased $318 thousand to $3.15 million for the three months ended September 30, 2002, an increase of 11.2% over the comparative period in 2001. Income from service charges on deposit accounts totaled $1.21 million for the third quarter, an increase of 35.9% over 2001. Growth in deposit accounts, improved fee structure and higher transaction volume resulted in the increase for the three month period in 2002 over 2001. VFGI’s trust and investment advisory operations reported a 12.3% decrease in fee income for the quarter, with gross fees of $802 thousand compared to $913 thousand in 2001. This decrease was a result of lower fee based assets primarily due to declining market valuations, as well as a decrease in income from retail brokerage fees. Mortgage operations continued to show growth in fee income and profitability. Fee income from gains on sale of secondary market mortgages amounted to $801 thousand for the third quarter, an increase of $113 thousand or 16.3% compared to $689 thousand in 2001.

Noninterest Expense

Operating expenses increased $894 thousand, or 11.2% to $8.9 million for the three months ended September 30, 2002, compared to $8.0 million for the same period in 2001. Of this increase, approximately $596 thousand represents increases in compensation and benefits associated with increased incentive plan expense, pension costs, higher health insurance costs and a larger compensation base. Included in other expense are nonrecurring expenses amounted to $267 thousand for the quarter, consisting of computer system conversion costs and integration expenses associated with the conversion of Caroline Savings Bank into Virginia Heartland Bank.

Asset Quality

Non-performing assets, including loans past due 90 days and still accruing interest, amounted to $1.2 million or .17% of loans and other property owned at September 30, 2002, compared to $3.8 million or .56% of loans and other property owned at September 30, 2001. The Company had a $1.4 million commercial loan that was brought current during the quarter and accounts for the decrease in nonperforming assets. This loan continues to be monitored and is a watch list credit. The Company recorded a provision for loan losses of $401 thousand for the three month period ended September 30, 2002, compared to a provision of $322 thousand for the three month period ended September 30, 2001.

- 16 -

VIRGINIA FINANCIAL GROUP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following table provides information on asset quality statistics for the periods presented:

		September 30, 2002			December 31, 2001			September 30, 2001

Non accrual loans		$	527		$	2,751		$	1,893
Other real estate owned			643			547			532

	Total nonperforming assets	$	1,170		$	3,298		$	2,425

	Loans past due as to principal or interest for 90 days or more accruing interest	$	2		$	213		$	1,390

Nonperforming assets to total assets			.11	%		.34	%		.38	%

Nonperforming assets to loans and other property			.17	%		.53	%		.56	%

Allowance for loan losses as a percentage of loans receivable			1.35	%		1.24	%		1.16	%

Allowance for loan losses as a percentage of nonperforming assets			787.8	%		235.43	%		208.02	%

Net charge-offs as a percentage of average loans receivable			.04	%		.08	%		.09	%

The allowance for loan losses was $9.2 million or 1.35% of loans at September 30, 2002, compared to $8.3 million or 1.24% of loans at December 31, 2001. The increase in the allowance as a percentage of loans reflects higher provisions for loan losses in view of the economic slowdown and a change in the risk profile of the loan portfolio. Non-residential real estate loans increased $47.6 million or 23.0% from December 31, 2001, and now represent 37.2% of the loan portfolio compared to 31.0% at the end of 2001. In addition, VFGI has provided additional allowance for acquired entities to align their collection, credit evaluation and charge-off policies and procedures with those of the Company.

Liquidity and Capital Resources

The Company’s capital base provides the resource and ability to support the assets of the Company and provide capital for future expansion. Stockholders’ equity as of September 30, 2002 of $116.0 million increased $9.3 million or approximately 8.74% from $106.7 million at December 31, 2001. This increase is primarily attributable to net income earned for the nine months ended September 30, 2002. The Company’s Tier I capital consists primarily of common stockholder’s equity. Risk weighted assets are determined by assigning various risk levels to each asset type. The Company’s Tier 1 risk based capital ratio was 14.02% at September 30, 2002, compared to 13.98% at December 31, 2001, placing the Company in a well-capitalized position as defined by regulators.

- 17 -

VIRGINIA FINANCIAL GROUP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following table includes information with respect to the Company’s risk-based capital as of September 30, 2002 (000 omitted):

Tier 1 capital		$	107,222
Tier 2 capital			9,233
Total risk-based capital			116,455
Total risk-weighted assets			764,873
Average adjusted total assets			1,075,804

Capital ratios:
	Tier 1 risk-based capital ratio		14.02	%
	Total risk-based capital ratio		15.23	%
	Leverage ratio (Tier 1 capital to average adjusted total assets)		9.97	%
	Equity to assets ratio		10.57	%

Liquidity is identified as the ability to generate or acquire sufficient amounts of cash when needed and at reasonable cost to accommodate withdrawals, payments of debt, and increased loan demand. These events may occur daily or at other short-term intervals in the normal operation of the business. Experience helps management predict time cycles in the amount of cash required. In assessing liquidity, management gives consideration to relevant factors including stability of deposits, quality of assets, economy of markets served, concentrations of business and industry, competition, and the Company’s overall financial condition.

The Company’s primary sources of liquidity are cash, due from banks, fed funds sold and securities in our available for sale portfolio. In addition, the affiliate banks have substantial lines of credit from their correspondent banks and access to the Federal Reserve discount window and Federal Home Loan Bank to support liquidity. The Corporation does not solicit brokered deposits, and is of the belief that predominantly all deposits are from established core depositors.

In the judgment of management, the Company maintains the ability to generate sufficient amounts of cash to cover normal requirements and any additional funds as needs may arise.

Effects of Inflation

The effect of changing prices on financial institutions is typically different from other industries as the Company’s assets and liabilities are monetary in nature. Interest rates and thus the Company’s asset liability management is impacted by changes in inflation, but there is not a direct correlation between the two measures. Management monitors the impact of inflation on the financial markets.

- 18 -

VIRGINIA FINANCIAL GROUP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Recent Accounting Pronoucements

The Financial Accounting Standards Board issued Statement No. 147, Acquisitions of Certain Financial Institutions, an Amendment of FASB Statements No. 72 and 144 and FASB Interpretation No. 9 in October 2002. FASB Statement No. 72, Accounting for Certain Acquisitions of Banking or Thrift Institutions, and FASB Interpretation No. 9, Applying APB Opinions No. 16 and 17 When a Savings and Loan Association or a Similar Institution Is Acquired in a Business Combination Accounted for by the Purchase Method, provided interpretive guidance on the application of the purchase method to acquisitions of financial institutions. Except for transactions between two or more mutual enterprises, this Statement removes acquisitions of financial institutions from the scope of both Statement 72 and Interpretation 9 and requires that those transactions be accounted for in accordance with FASB Statements No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets. Thus, the requirement in paragraph 5 of Statement 72 to recognize (and subsequently amortize) any excess of the fair value of liabilities assumed over the fair value of tangible and identifiable intangible assets acquired as an unidentifiable intangible asset no longer applies to acquisitions with the scope of this Statement. In addition, this Statement amends FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, to include in its scope long-term customer-relationship intangible assets of financial institutions such as depositor- and borrower-relationship assets and credit cardholder intangible assets. Consequently, those intangible assets are subject to the same undiscounted cash flow recoverability test and impairment loss recognition and measurement provisions that Statement 144 requires for other long-lived assets that are held and used.

Paragraph 5 of this Statement, which relates to the application of the purchase method of accounting, is effective for acquisitions for which the date of acquisition is on or after October 1, 2002. The provisions in paragraph 6 related to accounting for the impairment or disposal of certain long-term customer-relationship intangible assets are effective on October 1, 2002. Transition provisions for previously recognized unidentifiable intangible assets in paragraphs 8-14 are effective on October 1, 2002, with earlier application permitted.

This Statement clarifies that a branch acquisition that meets the definition of a business should be accounted for as a business combination, otherwise the transaction should be accounted for as an acquisition of net assets that does not result in the recognition of goodwill.

The transition provisions state that if the transaction that gave rise to the unidentifiable intangible asset was a business combination, the carrying amount of that asset shall be reclassified to goodwill as of the later of the date of acquisition or the date Statement 142 was first applied (fiscal years beginning after December 15, 2001). Any previously issued interim statements that reflect amortization of the unidentifiable intangible asset subsequent to the Statement 142 application date shall be restated to remove that amortization expense. The carrying amounts of any recognized intangible assets that meet the recognition criteria of Statement 141 that have been included in the amount reported as an unidentifiable intangible asset and for which separate accounting records have been maintained shall be reclassified and accounted for as assets apart from the unidentifiable intangible asset and shall not be reclassified to goodwill.

The Corporation is currently in the process of evaluating the impact, if any, arising from the adoption of Statement 147.

- 19 -

PART I – FINANCIAL INFORMATION

ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no significant changes to the quantitative and qualitative market risk disclosures in the Company’s Form 10K for the year ended December 31, 2001.

ITEM 4 – CONTROLS AND PROCEDURES

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures within 90 days of the filing date of this quarterly report. Based on that evaluation, our principal executive officer and principal financial officer have concluded that these controls and procedures are effective. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.

Disclosure controls and procedures are our controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

PART II - OTHER INFORMATION

ITEM 1.	LEGAL PROCEEDINGS .

	There are no material legal proceedings to which the Registrant or any of its subsidiaries, directors, or officers is a party or by which they, or any of them, are threatened. Any legal proceeding presently pending or threatened against Virginia Financial Group, Inc. and its subsidiaries are either not material in respect to the amount in controversy or fully covered by insurance.

ITEM 2.	CHANGES IN SECURITIES AND USE OF PROCEEDS.

	None.

ITEM 3.	DEFAULTS UPON SENIOR SECURITIES.

	None.

ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS.

	None.

ITEM 5.	OTHER INFORMATION.

	Not applicable.

- 20 -

PART II - OTHER INFORMATION

ITEM 6.	EXHIBITS AND REPORTS ON FORM 8-K.

	(a.) The following exhibits either are filed as part of this Report or are incorporated herein by reference:

	Exhibit No. 2	Agreement and Plan of Reorganization incorporated by reference to Agreement and Plan of Reorganization filed as Exhibit A to Form S-4 Amendment No. 2 filed on November 20, 2001 (File No. 333-69216).

	Exhibit No. 3.1	Articles of Incorporation incorporated by reference to Exhibit A to Form S-4 Amendment No. 2 filed on November 20, 2001 (File No. 333-69216).

	Exhibit No. 3.2	Bylaws incorporated by reference to Exhibit A to Form S-4 Amendment No. 2 filed on November 20, 2001 (File No. 333-69216).

	Exhibit No. 4	Stock Option Agreement is incorporated by reference to Exhibit B to Form S-4 Amendment No. 2 filed on November 20, 2001 (File No. 333-69216).

	Exhibit No. 4.1	Stock Incentive Plan is incorporated by reference to Form S-8 filed on February 26, 2002 (File No. 333-83410).

	Exhibit No. 10	Employment contracts of certain officers incorporated by reference to Form S-4 Amendment No. 3 filed on December 3, 2001 (File No. 333-69216).

	Exhibit No. 99.1	§ 906 Certification

	(b.) Reports on Form 8-K.

	None.

- 21 -

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

VIRGINIA FINANCIAL GROUP, INC.

/s/ O.R. Barham, Jr.

O.R. Barham, Jr.

President and Chief Executive Officer

November 12, 2002

/s/ Jeffrey W. Farrar

Jeffrey W. Farrar, CPA

Executive Vice President and Chief Financial Officer

November 12, 2002

CERTIFICATIONS

I, O. R. Barham, Jr., certify that:

1. I have reviewed this quarterly report on Form 10-Q of Virginia Financial Group, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results

of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

(a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

(b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

(c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

(a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: November 12, 2002

/s/ O. R. Barham, Jr.

O. R. Barham, Jr.

President and Chief Executive Officer

I, Jeffrey W. Farrar, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Virginia Financial Group, Inc.;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

(b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

(c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

Date: November 12, 2002

/s/ Jeffrey W. Farrar

Jeffrey W. Farrar, CPA

Executive Vice President and Chief Financial Officer

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