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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 Quarter ended September 30, 2002

(   )

Transition report pursuant to Section 13 or 15(d)) of the Securities Exchange Act of 1934   For Transition Period from                     to       Commission File Number 000-30447

VALLEY COMMUNITY BANCSHARES, INC.

(253) 848-2316
(Registrant’s telephone number, including area code)

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 reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes   [X]      No   [   ]

The number of shares of the issuer’s Common Stock, $1.00 par value, outstanding at November 1, 2002 was 1,126,866.

Table of Contents

VALLEY COMMUNITY BANCSHARES, INC.
AND SUBSIDIARIES
INDEX TO QUARTERLY REPORT ON FORM 10-Q

						Page
PART I				FINANCIAL INFORMATION
Item 1.				Financial Statements
				Condensed Consolidated Balance Sheet — September 30, 2002 and December 31, 2001			1
				Condensed Consolidated Statement of Income — Three and Nine Months Ended September 30, 2002 and 2001			2
				Condensed Consolidated Statement of Cash Flows — Nine Months Ended September 30, 2002 and 2001			3
				Notes to Condensed Consolidated Financial Statements			4
Item 2.				Management’s Discussion and Analysis of Financial Condition And Results of Operation			8
Item 3.				Quantitative and Qualitative Disclosures about Market Risk			20
Item 4.				Controls and Procedures			21
FORWARD-LOOKING STATEMENTS							21
PART II				OTHER INFORMATION			22
				Signatures			23
				Certifications			24

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Item 1. FINANCIAL STATEMENTS

VALLEY COMMUNITY BANCSHARES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
(unaudited)
(dollars in thousands)

					September 30,				December 31,
					2002				2001
ASSETS
	Cash and due from banks				$	6,981			$	4,584
	Interest-bearing deposits with banks					11,231				14,083
	Federal funds sold					1,247
	Securities available-for-sale					33,213				31,350
	Federal Home Loan Bank stock					398				478
						53,070				50,495
	Loans					111,655				100,755
	Less allowance for loan losses					1,320				1,156
			Loans, net			110,335				99,599
	Accrued interest receivable					795				777
	Premises and equipment, net					6,065				5,831
	Real estate held for investment					224				224
	Other assets					491				248
			Total assets		$	170,980			$	157,174
LIABILITIES
	Deposits
		Noninterest-bearing			$	29,391			$	24,770
		Interest-bearing				116,878				109,930
			Total deposits			146,269				134,700
	Other borrowed funds					616				334
	Accrued interest payable					276				390
	Other liabilities					1,462				589
			Total liabilities			148,623				136,013
STOCKHOLDERS’ EQUITY
	Common stock, par value $1 per share; 5,000,000 shares authorized; 1,126,866 and 1,126,750 shares issued and outstanding at September 30, 2002 and December 31, 2001, respectively					1,127				1,127
	Additional paid-in capital					15,955				15,953
	Retained earnings					4,662				3,776
	Accumulated other comprehensive income, net of tax					613				305
			Total stockholders’ equity			22,357				21,161
			Total liabilities and stockholders’ equity		$	170,980			$	157,174

The accompanying notes are an integral part of these financial statements

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VALLEY COMMUNITY BANCSHARES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(unaudited)
(dollars in thousands, except for per share amounts)

				Three Months Ended								Nine Months Ended
				September 30,								September 30,
				2002				2001				2002				2001
INTEREST INCOME
	Interest and fees on loans			$	2,081			$	2,042			$	6,027			$	6,116
	Interest on federal funds sold and deposits in banks				87				192				255				619
	Interest on securities				365				438				1,131				1,242
		Total interest income			2,533				2,672				7,413				7,977
INTEREST EXPENSE
	Interest on deposits				467				854				1,443				2,768
	Interest on federal funds and other short-term borrowings				2				3				5				12
		Total interest expense			469				857				1,448				2,780
		Net interest income			2,064				1,815				5,965				5,197
PROVISION FOR LOAN LOSSES					76								167				62
		Net interest income after provision for loan losses			1,988				1,815				5,798				5,135
NONINTEREST INCOME
	Service charges				121				96				344				284
	Gain on sale of investment securities, net				1				44				54				54
	Origination fees on mortgage loans brokered				40				20				79				85
	Other operating income				40				92				184				241
		Total noninterest income			202				252				661				664
NONINTEREST EXPENSE
	Salaries				630				541				1,750				1,590
	Employee benefits				149				129				446				411
	Occupancy				128				144				383				425
	Equipment				102				126				340				385
	Other operating expenses				421				381				1,231				1,198
		Total noninterest expense			1,430				1,321				4,150				4,009
INCOME BEFORE INCOME TAX					760				746				2,309				1,790
PROVISION FOR INCOME TAX					257				220				747				521
NET INCOME				$	503			$	526			$	1,562			$	1,269
EARNINGS PER SHARE
	Basic			$	0.45			$	0.46			$	1.39			$	1.12
	Diluted			$	0.44			$	0.46			$	1.37			$	1.10
	Weighted average shares outstanding				1,126,777				1,133,588				1,126,759				1,133,588
	Weighted average diluted shares outstanding				1,137,073				1,151,067				1,137,337				1,151,971

The accompanying notes are an integral part of these financial statements

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VALLEY COMMUNITY BANCSHARES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(unaudited)
(dollars in thousands, except for per share amounts)

					Nine Months Ended
					September 30,
					2002				2001
CASH FLOWS FROM OPERATING ACTIVITIES
	Net income				$	1,562			$	1,269
	Adjustments to reconcile net income to net cash from operating activities:
		Provisions for loan losses				167				62
		Depreciation				268				349
		Deferred income tax				6				2
		Net amortization on securities				136				47
		FHLB stock dividends				(24	)			(24	)
		Gain on sale of securities available-for-sale				(54	)			(54	)
		Loss on sale of premises and equipment				41				2
		Amortization of intangible assets				18
	Changes in operating assets and liabilities:
		Increase (decrease) in accrued interest receivable				(18	)			92
		Increase (decrease) in other assets				(215	)			163
		Decrease in accrued interest payable				(114	)			(69	)
		Increase in other liabilities				731				74
			Net cash from operating activities			2,504				1,913
	Net increase in federal funds sold					(1,247	)
	Net decrease (increase) in interest-bearing deposits with banks					2,852				(11,179	)
	Purchase of securities available-for-sale					(12,786	)			(15,650	)
	Proceeds from sales of securities available-for-sale					5,567				3,055
	Proceeds from maturities of securities available-for-sale					5,741				12,679
	Federal Home Loan Bank stock redeemed					104
	Net increase in loans					(10,903	)			(3,801	)
	Additions to premises and equipment					(468	)			(258	)
	Purchase of intangible assets					(144	)
			Net cash from investing activities			(11,284	)			(15,154	)
CASH FLOWS FROM FINANCING ACTIVITIES
	Net increase in deposits					11,569				14,722
	Net increase (decrease) in short-term borrowed funds					186				(48	)
	Increase in other borrowed money					96
	Stock options exercised					2
	Cash dividends paid					(676	)			(623	)
			Net cash from financing activities			11,177				14,051
NET INCREASE IN CASH AND DUE FROM BANKS						2,397				810
CASH AND DUE FROM BANKS, beginning of year						4,584				4,466
CASH AND DUE FROM BANKS, at end of period					$	6,981			$	5,276
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
	Cash payments for
		Interest			$	1,562			$	2,849
		Income taxes				778				167
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES
	Unrealized gains (losses) on securities available-for-sale				$	467			$	582
	Deferred tax on unrealized (gains) losses on securities available-for-sale					(159	)			(198	)
	Held-to-maturity securities transferred to securities available-for-sale									279

The accompanying notes are an integral part of these financial statements

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VALLEY COMMUNITY BANCSHARES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1 — Basis of Presentation

Valley Community Bancshares, Inc. (the “Company”) has prepared the condensed consolidated financial statements of the Company for the three-month and nine-month periods ended September 30, 2002 and September 30, 2001 without audit by the Company’s independent auditors. However, the financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America for interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of the Company’s management, all adjustments consisting of normal recurring accruals necessary for a fair presentation of the financial condition and results of operations for the interim periods included herein have been made. The consolidated balance sheet of the Company as of December 31, 2001 has been derived from the audited consolidated balance sheet of the Company as of that date. The results of operations for the three-months and nine months ended September 30, 2002, are not necessarily indicative of the results to be anticipated for the year ending December 31, 2002.

Certain information and note disclosures normally included in the Company’s annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. Therefore, these consolidated financial statements and notes thereto should be read in conjunction with a reading of the financial statements for the year ended December 31, 2001 and notes thereto included in the Company’s Form 10-K filed with the Securities and Exchange Commission. Certain amounts in the 2001 financial statements have been reclassified to conform to the 2002 presentation.

Note 2 — Earnings per share

Basic earnings per share amounts are computed based on the weighted average number of shares outstanding during the period after giving retroactive effect to stock dividends and stock splits. Diluted earnings per share amounts are computed by determining the number of additional shares that are deemed outstanding due to stock options under the treasury stock method.

The following table sets forth the computation of basic and diluted earnings per share for the three-months and nine months ended September 30, 2002 and 2001 (dollars in thousands, except per share amounts).

VALLEY COMMUNITY BANCSHARES, INC.
Earnings Per Share

			Three Months Ended								Nine Months Ended
			September 30,								September 30,
			2002				2001				2002				2001
NUMERATOR:
Net income			$	503			$	526			$	1,562			$	1,269
DENOMINATOR:
Denominator for basic earnings per share:
	Weighted average shares			1,126,777				1,133,588				1,126,759				1,133,588
	Effect of diluted securities — stock options			10,296				17,479				10,578				18,383
Denominator for diluted earnings per share:
	Weighted average shares and assumed conversion of diluted stock options			1,137,073				1,151,067				1,137,337				1,151,971
Basic earnings per share			$	0.45			$	0.46			$	1.39			$	1.12
Diluted earnings per share			$	0.44			$	0.46			$	1.37			$	1.10

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Note 3 — Investment Securities

Investment securities have been classified according to management’s intent. The carrying amount of securities and their estimated fair values are as follows (in thousands):

September 30, 2002

Securities Available-For-Sale

December 31, 2001

Securities Available-For-Sale

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Note 4 — Loans

The major classifications of loans at September 30, 2002 and December 31, 2001 are summarized as follows (dollars in thousands):

VALLEY COMMUNITY BANCSHARES, INC.
Loan Portfolio
(dollars in thousands)

Note 5 — Allowance for Loan Losses

Management analyzes the loan portfolio to determine the adequacy of the allowance for loan losses and the appropriate provision required to maintain an adequate allowance. In assessing the adequacy of the allowance, management reviews the size, quality and risks of loans in the portfolio and considers factors such as specific known risks, past experience, the status and amount of nonperforming assets and economic conditions. A specific percentage is allocated to each major classification and not specifically reserved while additional amounts are added for individual loans considered to have specific loss potential. Loans identified as losses are charged-off. Based on total allocations, the provision is recorded to maintain the allowance at a level deemed appropriate by management. While management uses available information to recognize losses on loans, there can be no assurance that future additions to the allowance will not be necessary.

The allowance for loan losses at September 30, 2002 totaled $1,320,000 representing a net increase of $164,000 or 14.2% compared to $1,156,000 at December 31, 2001. The increase is primarily due to the increase in loans since December 31, 2001 and is not related to any specifically identified problem loan. Management believes that the allowance for loan losses at September 30, 2002 adequately reflects the risks in the loan portfolio. Various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank to recognize changes to the allowance based on their judgments of information available to them at the time of their examination.

The following table summarizes the activity in the allowance for loan losses (dollars in thousands):

VALLEY COMMUNITY BANCSHARES, INC.
Loan Loss Experience

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Note 6 — Impact of New Accounting Issues

During the year 2002 the Company adopted the following accounting standards issued by the Financial Accounting Standard Board.

Statement of Financial Accounting Standard (SFAS) No. 142, Goodwill and Other Intangible Assets, addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, Intangible Assets. It addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. This Statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. The Company implemented this statement effective January 1, 2002. Implementation of this statement did not result in a material impact on its financial position or results of operation.

Statement of Financial Accounting Standard (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This Statement supersedes FASB Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business (as previously defined in that Opinion). This Statement also amends ARB No. 51, Consolidated Financial Statements, to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. The Company implemented this statement effective January 1, 2002. Implementation of this statement did not result in a material impact on its financial position or results of operation.

Statement of Financial Standard (SFAS) No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. This Statement rescinds FASB Statement No. 4, Reporting Gains and Losses from Extinguishment of Debt, and an amendment of that Statement, FASB Statement No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. This Statement also rescinds FASB Statement No. 44, Accounting for Intangible Assets of Motor Carriers. This Statement amends FASB Statement No. 13, Accounting for Leases, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. This Statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The Company implemented this statement effective April 1, 2002. Implementation of this statement did not result in a material impact on its financial position or results of operations.

Statement of Financial Accounting Standard (SFAS) No. 146, Accounting for Costs Associated with Exit or Disposal Activities, addresses financial accounting and reporting for the treatment of costs associated with exit or disposal activities. This Statement improves financial reporting by requiring that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. This Statement replaces EITF Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity. The provisions of this Statement are to be applied prospectively to exit or disposal activities initiated after December 31, 2002. The Company does not expect the Statement will result in a material impact on its financial position or results of operations.

Statement of Financial Accounting Standard (SFAS) No. 147, Acquisitions of Certain Financial Institutions — an amendment of FASB Statements No. 72 and 144 and FASB Interpretation No. 9. The provisions of this Statement that relate to the application of the purchase method of accounting applies to all acquisitions of financial institutions, except 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. 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 intangible assets and credit cardholder intangible assets. This Statement is effective for acquisitions for which the date of acquisition is on or after October 1, 2002. The Company does not expect the Statement will result in a material impact on its financial position or results of operations.

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Valley Community Bancshares, Inc.

Valley Community Bancshares, Inc. (the “Company”) is a bank holding company registered under the Bank Holding Company Act of 1956, as amended. The Company was organized and incorporated under the laws of the State of Washington as a holding company for its principal banking subsidiary, Puyallup Valley Bank, a state chartered, Federal Deposit Insurance Corporation (the “FDIC”) insured commercial bank, through a reorganization completed on July 1, 1998. The Company conducts its business primarily through Puyallup Valley Bank, but in January 1999 the Company opened Valley Bank, a state chartered FDIC insured commercial bank subsidiary located in Auburn, Washington. Puyallup Valley Bank and Valley Bank are referred to as the “Banks” in this Form 10-Q.

The Company’s main office is located in Puyallup, Washington, which also serves as the main office of Puyallup Valley Bank. Valley Bank is located in Auburn, Washington. The Banks provide a full range of commercial banking services to small and medium-sized businesses, professionals and other individuals through banking offices located in Puyallup, Auburn, and Kent, Washington, and their environs.

The principal source of the Company’s revenue are (i) interest and fees on loans; (ii) deposit service charges; (iii) merchant credit card processing fees; (iv) interest bearing deposits with banks; (v) interest on investments (principally government securities) and (vi) origination fees on mortgage loans brokered. The Bank’s lending activity consists of short-to-medium-term commercial and consumer loans, including operating loans and lines of credit, equipment loans, automobile loans, recreational vehicle and truck loans, personal loans or lines of credit, home improvement loans and rehabilitation loans. The Banks also offer cash management services, merchant credit card processing, safe deposit boxes, wire transfers, direct deposit of payroll and social security checks, automated teller machine access, and automatic drafts for various accounts.

Puyallup Valley Bank

Puyallup Valley Bank is a Washington state-chartered commercial bank, which commenced operations in October 1973. The Bank provides full-service banking to businesses and residents within the Puyallup community and its surrounding area. Puyallup Valley Bank places particular emphasis on serving the small to medium-sized business segment of the market by making available a line of banking products tailored to their needs, with those services delivered by experienced professionals concerned with building long-term relationships. Puyallup Valley Bank conducts business out of six full-service offices and one drive-up facility.

On May 16, 2002, Puyallup Valley Bank purchased various tangible and intangible assets of Puget Sound Mortgage Brokers, Inc., a Washington Corporation located in Puyallup Washington. The purchase price was not material to Puyallup Valley Bank or to the consolidated financial condition and results of operations of the Company. The purchase was made to further enhance the Bank’s mortgage banking operations. The mortgage operation will be operated as a division of the Bank using the name Puget Sound Mortgage Brokers and will operate in a leased facility.

Valley Bank

Valley Bank is a Washington state-chartered commercial bank, which commenced operations in January 1999. The Bank provides full-service banking to businesses and residents within the Auburn and Kent communities and its surrounding area. Valley Bank offers commercial banking services to small and medium size businesses, professionals and retail customers in the Bank’s market area. Valley Bank conducts business out of two full-service offices.

On September 5, 2002 Valley Bank opened a new banking facility in Kent Washington. The new office will initially operate in a leased facility until a permanent facility can be located.

Both Puyallup Valley Bank and Valley Bank are wholly owned subsidiaries of the Company.

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During November 2002, the Board of Directors of both Puyallup Valley Bank and Valley Bank entered into an agreement to merge the two banks. It is anticipated the merger will occur during the first quarter of 2003. The banks entered into this agreement for several reasons, including, better customer service, operational efficiency, and cost improvement.

Results of Operations

The Company earned net income of $503,000 or $0.44 per diluted share for the three months ended September 30, 2002, compared to net income of $526,000 or $0.46 per diluted share, for the three months ended September 30, 2001, an decrease of 4.4 percent. The Company’s return on average assets was 1.19 percent for the three months ended September 30, 2002, compared to 1.30 percent for the three months ended September 30, 2001.

The Company earned net income of $1,562,000 or $1.37 per diluted share for the nine months ended September 30, 2002, compared to net income of $1,269,000 or $1.10 per diluted share, for the nine months ended September 30, 2001, an increase of 23.1 percent. The Company’s return on average assets was 1.29 percent for the nine months ended September 30,2002, compared to 1.10 percent for the nine months ended September 30, 2001.

The decrease in net income for the three-month period ended September 30, 2002 was primarily the result of lower noninterest income, higher provisions for loan losses and increased noninterest expense, partially offset by increased net interest income. The increase in net income for the nine-month period ended September 30, 2002 was primarily the result of an increase in net interest income, offset by higher provisions for loan losses and increased noninterest expense. A significant decrease in the Company’s cost of funds favorably impact net interest income during both the three-month and nine-month periods. The increased staffing levels of Valley Bank’s new Kent facility and Puget Sound Mortgage Brokers significantly increased salaries and employee benefits during the three-month period.

Because of the new Kent office, management anticipates higher operating costs. Profitability of the Company will be negatively impacted until the new office generates sufficient revenue to offset the added operating costs. It is anticipated the new office will not breakeven until its third year of operation. The Company further anticipates the Kent office will lose up to $250,000 during the three-year period.

The Company’s net income is derived principally from the operating results of its banking subsidiaries, namely Puyallup Valley Bank and Valley Bank. Puyallup Valley Bank is a well-established commercial bank and generates the majority of the Company’s operating income.

Puyallup Valley Bank earned net income of $541,000 and $1,541,000 for the three and nine months ended September 30, 2002 compared to $476,000 and $1,237,000 for the three and nine months ended September 30, 2001. Puyallup Valley Bank’s increase in earnings resulted from an increase in net interest income, partially offset by lower non-interest income, an increase in the provision for loan losses and by an increase in the provision for income tax.

Valley Bank incurred a loss of $14,000 for the three months ended September 30, 2002 and earned net income of $46,000 for the nine months ended September 30, 2002 compared to net income of $36,000 and $34,000 for the three and nine months ended September 30, 2001. Valley Bank’s earnings were negatively impacted by the costs of the new Kent facility discussed above.

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The following table shows the various performance ratios for the Company for the three and nine months ended September 30, 2002 and 2001, respectively:

VALLEY COMMUNITY BANCSHARES, INC.
Selected Financial Data ¹
(dollars in thousands, except per share amounts)

			Three Months Ended								Nine Months Ended
			September 30,								September 30,
			2002				2001				2002				2001
Financial Performance
	Net Income		$	503			$	526			$	1,562			$	1,269
	Average Assets			168,391				160,707				162,316				154,430
	Average Stockholders’ Equity			22,145				20,807				21,563				20,365
	Return on Assets (net income divided by average assets)			1.19	%			1.30	%			1.29	%			1.10	%
	Return on Equity (net income divided by average equity)			9.01	%			10.03	%			9.69	%			8.33	%
	Net Interest Margin (net interest income (tax adjusted) Divided by earning assets)			5.34	%			4.94	%			5.41	%			4.97	%
	Efficiency Ratio (noninterest expense divided by noninterest income plus net interest income)			63.11	%			63.91	%			62.63	%			68.40	%
	Ratio of noninterest income to average assets			3.37	%			3.26	%			3.42	%			3.47	%

Net Interest Income

The component contributing most significantly to the Company’s net income is net interest income, which is the difference between interest earned on earning assets (primarily loans and investments) and interest paid on interest bearing liabilities (deposits and borrowings). The volume of and yields earned on earning assets and the volume of and the rates paid on interest bearing liabilities determine net interest income. Interest earned and interest paid is also affected by general economic conditions, particularly changes in market interest rates, and by government policies and the action of regulatory authorities. Net interest income, with tax-exempt income adjusted to a tax-equivalent basis, divided by average earning assets is referred to as net interest margin. For the three months ended September 30, 2002 the Company’s net interest margin was 5.34 percent compared to 4.94 percent for the three months ended September 30, 2001. For the nine months ended September 30, 2002 the Company’s net interest margin was 5.41 percent compared to 4.97 percent for the nine months ended September 30, 2001.

Interest income was $2,533,000 for the three months ended September 30, 2002 compared to $2,672,000 for the three months ended September 30, 2001. Interest income was $7,413,000 for the nine months ended September 30, 2002 compared to $7,977,000 for the three months ended September 30, 2001. The three-month and nine month decrease was primarily the result of a significant decrease in the yield earned on earning assets. The yield on interest-earning assets decreased to 6.53 percent for the three months ended September 30, 2002 compared to 7.22 percent during the same period a year ago. The yield on interest-earning assets decreased to 6.70 percent for the nine months ended September 30, 2002 compared to 7.58 percent during the same period a year ago. The decrease in interest income was primarily the result of a lower yield realized on interest bearing deposits with banks, investment securities, and loans. The yield decrease reflects an overall decline in market interest rates resulting from a soft economic environment.

Interest expense was $469,000 for the three months ended September 30, 2002 compared to $857,000 for the three months ended September 30, 2001. Interest expense was $1,448,000 for the nine months ended September 30, 2002 compared to $2,780,000 for the nine months ended September 30, 2001. The cost of funds decreased to 1.60 percent for the three months ended September 30, 2002 compared to 3.01 percent during the same period a year ago. The cost of funds decreased to 1.73 percent for the nine months ended September 30, 2002 compared to 3.45 percent during the same period a year ago. The decrease for both the three-month and nine month periods was due to a decrease in the Company’s cost of funds resulting from an overall decline in market interest rates.

During the three and nine months ended September 30, 2002, market interest rates continue to be at historical lows as a result of a slow national and regional economy and because of an aggressively accommodating Federal Reserve monetary policy. During the three and nine month periods ended September 30, 2002, net interest margin increased as a result of cost of funds decreasing faster than interest earned on interest earning assets. The cost of funds decrease resulted from certificates of deposit having shorter maturities than interest earning assets. In addition, the Company lowered the interest rate on deposits with administrated rates such as NOW, savings, and money market accounts. In

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periods of increasing interest rates, the Company’s net interest income and margin may decrease because the Company has a significant amount of interest bearing liabilities subject to repricing when compared to interest earning assets. This maybe somewhat offset because the rate paid on deposits with administered interest rates generally do not increase as rapidly as an account whose rates change with market interest rates.

The following table sets forth information concerning the Company’s average balance and average interest rates earned or paid, interest rate spread and net interest margin:

VALLEY COMMUNITY BANCSHARES, INC.
AVERAGE BALANCES AND INTEREST RATES EARNED/PAID
(dollars in thousands)

				For the Three Months Ended September 30,
				2002												2001
				Average				Revenue/				Yield/				Average				Revenue/				Yield/
				Balance				Expense				Rate				Balance				Expense				Rate
ASSETS
Interest-earning assets
	Loans (including fees) 1			$	110,616			$	2,081				7.46	%		$	97,747			$	2,042				8.29	%
	Investment securities 2 3				32,215				404				4.97	%			31,680				468				5.86	%
	Interest bearing deposits with banks				12,175				76				2.48	%			18,933				192				4.02	%
	Federal funds sold				835				3				1.41	%
	Federal Home Loan Bank Stock				491				8				6.46	%			462				8				6.87	%
		Total Interest-earning assets			156,332				2,572				6.53	%			148,822				2,710				7.22	%
	Total noninterest-earning assets				12,059												11,885
	TOTAL ASSETS			$	168,391											$	160,707
Interest-bearing liabilities
	Deposits			$	115,627				467				1.60	%		$	112,531				854				3.01	%
	Other borrowed funds				496				2				1.60	%			423				3				2.81	%
		Total Interest-bearing liabilities			116,123				469				1.60	%			112,954				857				3.01	%
	Noninterest-bearing liabilities				30,123												26,946
	Stockholders’ equity				22,145												20,807
	TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY			$	168,391											$	160,707
Net interest spread								$	2,103				4.93	%						$	1,853				4.21	%
Margin Analysis
	Interest income/earning assets							$	2,572				6.53	%						$	2,710				7.22	%
	Interest expense/earning assets								469				1.19	%							857				2.28	%
	Net interest margin							$	2,103				5.34	%						$	1,853				4.94	%