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 June 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 x No o.

As of August 2, 2002, there were 7,302,006 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 $209,130,000.

VIRGINIA FINANCIAL GROUP, INC.

INDEX

PART I - FINANCIAL INFORMATION

			Page No.

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		13-17

ITEM 3	Quantitative and Qualitative Disclosures About Market Risk		18

	PART II - OTHER INFORMATION

ITEM 1	Legal Proceedings		18

ITEM 2	Change in Securities		18

ITEM 3	Defaults Upon Senior Securities		18

ITEM 4	Submission of Matters to a Vote of Security Holders		18

ITEM 5	Other Information		19

ITEM 6	Exhibits and Reports on Form 8-K		19

		SIGNATURES	20

- 2 -

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

			JUNE 30, 2002		DECEMBER 31, 2001

			(unaudited)
ASSETS
Cash and due from depository institutions			$	37,491	$	42,573
Federal funds sold				29,227		20,908
Interest-bearing deposits in banks				519		556
Securities (market value: 2002, $300,862; 2001, $266,082)				300,358		265,773
Loans held for sale				6,926		17,384
Loans receivable, net				659,147		658,416
Bank premises and equipment				19,796		20,111
Interest receivable				5,857		5,656
Other real estate owned				100		547
Intangibles				1,787		1,866
Other assets				7,809		6,914

Total Assets			$	1,069,017	$	1,040,704

LIABILITIES
Deposits:
	Noninterest-bearing demand deposits		$	161,621	$	146,850
	Savings and interest-bearing demand deposits			351,570		337,030
	Time deposits			407,778		413,579

		Total deposits		920,969		897,459

Securities sold under agreements to repurchase				16,325		16,430
Federal funds purchased				—		500
Federal Home Loan Bank advances				12,260		12,300
Short-term borrowings				903		1,053
Interest payable				2,179		2,579
Other liabilities				3,892		3,677

	Total Liabilities			956,528		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 7,302,006 shares in 2002 and 7,286,400 in 2001)				36,510		36,432
Capital surplus				11,516		11,332
Retained earnings				60,508		57,060
Accumulated other comprehensive income				3,955		1,882

	Total Stockholders’ Equity			112,489		106,706

Total Liabilities and Stockholders’ Equity			$	1,069,017	$	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 JUNE 30,
				2002		2001

				(unaudited)		(unaudited)
Interest Income
	Interest and fees on loans			$	12,392	$	14,023
	Interest on deposits in other banks				2		24
	Interest on investment securities:
		Taxable			188		162
	Interest and dividends on securities available for sale:
		Taxable			2,166		2,001
		Nontaxable			851		733
		Dividends			86		57
	Interest income on federal funds sold				120		414

			Total Interest Income		15,805		17,414
Interest Expense
	Interest on deposits				5,651		7,964
	Interest on Federal Home Loan Bank advances				200		242
	Interest on federal funds purchased and securities sold under agreements to repurchase				63		166
	Interest on other short-term borrowings				1		6

			Total Interest Expense		5,915		8,378

	Net Interest Income				9,890		9,036
Less: Provision for loan losses					400		461

	Net Interest Income after Provision for Loan Losses				9,490		8,575
Other Income
	Service charges on deposit accounts				1,063		884
	Commissions and fees from fiduciary activities				742		706
	Investment fee income				159		98
	Other operating income				334		225
	Gain on sale of available for sale securities				237		99
	Gain on sale of other real estate owned				10		14
	Gain on sale of mortgage loans				560		682

			Total Other Income		3,105		2,708

Other Expense
	Compensation and employee benefits				5,082		4,595
	Net occupancy and equipment expense				1,039		998
	Computer services				423		412
	Professional fees				275		189
	Other operating expenses				1,851		1,547

			Total Other Expense		8,670		7,741

	Income Before Income Tax Expense				3,925		3,542
Income tax expense					1,000		951

	Net Income			$	2,925	$	2,591

Earnings per Share, basic				$	.40	$	.35

Earnings per Share, diluted				$	.40	$	.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)

				SIX MONTHS ENDED JUNE 30,
				2002		2001

				(unaudited)		(unaudited)
Interest Income
	Interest and fees on loans			$	25,077	$	28,194
	Interest on deposits in other banks				4		46
	Interest on investment securities:
		Taxable			350		324
	Interest and dividends on securities available for sale:
		Taxable			4,261		4,359
		Nontaxable			1,709		1,405
		Dividends			158		114
	Interest income on federal funds sold				264		586

			Total Interest Income		31,823		35,028

Interest Expense
	Interest on deposits				11,534		15,904
	Interest on Federal Home Loan Bank advances				403		516
	Interest on federal funds purchased and securities sold under agreements to repurchase				153		367
	Interest on other short-term borrowings				4		15

			Total Interest Expense		12,094		16,802

	Net Interest Income				19,729		18,226
Less: Provision for loan losses					801		816

	Net Interest Income after Provision for Loan Losses				18,928		17,410
Other Income
	Service charges on deposit accounts				1,813		1,722
	Commissions and fees from fiduciary activities				1,593		1,321
	Investment fee income				312		175
	Other operating income				715		553
	Gain on sale of available for sale securities				231		173
	Gain on sale of other real estate owned				56		4
	Gain on sale of mortgage loans				1,246		1,103

			Total Other Income		5,966		5,051

Other Expense
	Compensation and employee benefits				9,798		8,734
	Net occupancy and equipment expense				2,049		2,062
	Computer services				845		818
	Professional fees				410		302
	Other operating expenses				3,601		3,095

			Total Other Expense		16,703		15,011

	Income Before Income Tax Expense				8,191		7,450
Income tax expense					2,104		2,034

	Net Income			$	6,087	$	5,416

Earnings per Share, basic				$	.84	$	.74

Earnings per Share, diluted				$	.83	$	.74

Dividends per Share				$	.36	$	.34

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 SIX MONTHS ENDED JUNE 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			—			—			—		5,416			5,416			5,416
Other Comprehensive Income, net of tax:
	Unrealized gains on securities available for sale during the period, net of tax of $990		—			—			—		—			1,922			—
	Less: reclassification adjustment, net of tax of $59		—			—			—		—			(114	)		—

Other comprehensive income			—			—			1,808					1,808			1,808

	Comprehensive income		—			—			—		—		$	7,224

Cash dividends			—			—			—		(2,555	)					(2,555	)
Stock options exercised			61			78			—		—			—			139
Repurchase of common stock			(104	)		(289	)		—		—			—			(393	)

Balance, June 30, 2001		$	36,518		$	11,627		$	2,009	$	55,147		$	—		$	105,301

Balance, January 1, 2002		$	36,432		$	11,332		$	1,882	$	57,060		$	—		$	106,706
Net income			—			—			—		6,087			6,087			6,087
Other Comprehensive Income, net of tax:
	Unrealized gains on securities available for sale during the period, net of tax of $1,146		—			—			—		—			2,225			—
	Add: reclassification adjustment, net of tax of $79		—			—			—		—			(152	)		—

	Other comprehensive income		—			—			2,073					2,073			2,073

	Comprehensive income		—			—			—		—		$	8,160

Cash dividends			—			—			—		(2,639	)					(2,639	)
Stock options exercised			78			206			—		—			—			284
Fractional shares paid in cash			—			(22	)		—		—			—			(22	)

Balance, June 30, 2002		$	36,510		$	11,516		$	3,955	$	60,508		$	—		$	112,489

See accompanying notes to consolidated financial statements.

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

						SIX MONTHS ENDED JUNE 30,
						2002			2001

						(unaudited)			(unaudited)
OPERATING ACTIVITIES
	Net income					$	6,087		$	5,416
	Adjustments to reconcile net income to net cash provided by operating activities:
		Provision for loan losses					801			816
		Deferred tax benefit					(323	)		(120	)
		Depreciation and amortization					1,067			1,118
		Pension expense					114			37
		Gain on sale of available for sale securities					(231	)		(173	)
		Gain on sale of other real estate owned					(56	)		(4	)
		Loss on sale of fixed assets					—			40
		Amortization of premiums and discounts on securities					308			4
		Gain on sale of mortgage loans					(1,246	)		(1,103	)
		Proceeds from sale of mortgage loans					91,384			62,802
		Origination of loans for sale					(79,680	)		(67,217	)
		Changes in assets and liabilities:
			(Increase) decrease in interest receivable				(201	)		563
			Increase in other assets				(1,649	)		(213	)
			Decrease in interest payable				(400	)		(209	)
			Increase in other liabilities				82			39

					Net cash provided by operating activities		16,057			1,796

INVESTING ACTIVITIES
	Proceeds from sale of securities available for sale						27,858			9,290
	Proceeds from maturities of investment securities						250			13,345
	Proceeds from maturities and principal payments of securities available for sale						27,509			53,935
	Purchase of securities available for sale						(87,111	)		(53,888	)
	Purchase of premises and equipment						(707	)		(2,523	)
	Proceeds from sale of premises and equipment						34			28
	Additions to other real estate						(25	)		(54	)
	Proceeds from sale of other real estate						678			566
	Net increase in loans						(1,682	)		(17,940	)

				Net cash (used in) provided by investing activities			(33,196	)		2,759

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

			SIX MONTHS ENDED JUNE 30,
			2002			2001

			(unaudited)			(unaudited)
FINANCING ACTIVITIES
	Net increase in demand, money market and savings deposits			29,311			16,093
	Net (decrease) increase in time deposits			(5,800	)		10,107
	Payments of Federal Home Loan Bank advances			(40	)		(3,040	)
	Net (decrease) increase in repurchase agreements			(105	)		4,803
	Net decrease in federal funds purchased			(500	)		(6,000	)
	Net (decrease) increase in short-term borrowings			(150	)		249
	Fractional shares paid			(22	)		—
	Repurchase of common stock			—			(393	)
	Stock options exercised			284			139
	Cash dividends paid on common stock			(2,639	)		(2,555	)

		Net cash provided by financing activities		20,339			19,403

		Increase in cash and cash equivalents		3,200			23,958
CASH AND CASH EQUIVALENTS
	Beginning of the period			64,037			43,710

	End of the period		$	67,237		$	67,668

Supplemental Schedule of Noncash Investing Activities
	Unrealized gain on securities available for sale		$	3,168		$	2,736

	Other real estate acquired in settlement of loans		$	150		$	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
JUNE 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 June 30, 2002 and December 31, 2001, and the results of operations and cash flows for the six months ended June 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 six month period ended June 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

Securities Held to Maturity:			June 30, 2002

			(unaudited)
	U.S. Treasury Securities	$	2,499	$	2,551
	Obligations of States and Political Subdivisions		7,544		7,996

		$	10,043	$	10,547


		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


Securities Available for Sale:
			June 30, 2002

			(unaudited)
	U.S. Treasury Securities	$	21,060	$	21,538
	U.S. Government Securities		91,581		93,361
	Obligations of States and Political Subdivisions		84,924		87,602
	Corporate Bonds		15,058		15,397
	Mortgage-backed securities		55,223		56,299
	Other Securities		16,430		16,118

		$	284,276	$	290,315

- 9 -

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

	December 31, 2001

U.S. Treasury Securities	$	8,459	$	8,893
U.S. Government agencies		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):

		June 30, 2002			December 31, 2001

		(unaudited)
Real estate loans:
	Construction	$	49,857		$	61,899
	Secured by farmland		2,685			2,698
	Secured by 1 – 4 family residential		244,672			248,877
	Other real estate loans		230,520			207,220
Loans to farmers (except secured by real estate)			1,823			2,615
Commercial and industrial loans (except those secured by real estate)			74,017			75,057
Loans to individuals for personal expenditures			55,434			60,180
All other loans			9,733			9,041

			668,741			667,587
Less:
	Deferred loan fees		(780	)		(905	)
	Allowance for loan losses		(8,814	)		(8,266	)

		$	659,147		$	658,416

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

	June 30, 2002			December 31 2001			June 30, 2001

		(unaudited)						(unaudited)
Balance at January 1	$	8,266		$	7,383		$	7,383
Recoveries added to the allowance		157			608			124
Loan losses charged to the allowance		(410	)		(1,103	)		(605	)
Provision recorded to expense		801			1,378			816

Balance at end of period	$	8,814		$	8,266		$	7,718

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

6.	Short-term Borrowings:

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

		June 30, 2002		December 31, 2001

		(unaudited)
Federal Reserve borrowings	$	903	$	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 three months ended June 30, 2002 or the year ended December 31, 2001.

7.	Federal Home Loan Bank Advances:

	The Corporation’s fixed-rate, long-term debt of $12,260,000 at June 30, 2002 matures through 2010. At June 30, 2002, the interest rates on fixed-rate, long-term debt ranged from 5.33% to 7.07%. One advance totaling $260 thousand at June 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 6.48% at June 30, 2002.

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

2002	$	40
2003		3,080
2004		80
2005		4,060
2010		5,000

	$	12,260

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
JUNE 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 June 30, 2002 and 2001.

	2002			2001

	Shares	Per Share Amount		Shares	Per Share Amount

Basic earnings per share	7,291,941	$	.40	7,304,424	$	.35

Effect of dilutive securities:
Stock options	26,946			19,982

Diluted earnings per share	7,318,887	$	.40	7,324,406	$	.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 six month periods ended June 30, 2002 and 2001.

	2002			2001

	Shares		Per Share Amount	Shares		Per Share Amount

Basic earnings per share	7,289,346	$	.84	7,306,429	$	.74

Effect of dilutive securities:
Stock options	23,727			15,420

Diluted earnings per share	7,313,073	$	.83	7,321,849	$	.74

- 12 -

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 Bank’s 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 Bank’s 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 Bank’s calculation of the loss embedded in the individual loan. In addition to impairment testing, the Bank’s 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 June 30, 2002 amounted to $2.93 million or $.40 per share, compared to earnings of $2.59 million or $.35 per share for the quarter ended June 30, 2001. Net income increased 12.9% and diluted earnings per share increased 14.3% compared to second 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 second quarter produced an annualized return on average assets of 1.12% and an annualized return on average equity of 10.74%, compared to prior year ratios of 1.08% and 10.03%, respectively.

For the six months ended June 30, 2002, VFGI’s earnings was $6.09 million of $.83 per diluted share, compared to $5.42 million or $.74 per diluted share in 2001. This earnings growth represents an increase of 12.4% in net income and a 12.2% increase in diluted earnings per share.

Net Interest Income

Net interest income increased $854 thousand or 9.5% to $9.89 million for the three months ended June 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 June 30, 2002 was 4.27%, compared to 4.20% for the second quarter 2001. Average earning assets for the quarter ended June 30, 2002 increased $72.59 million to $977.73 million, an increase of 8.0% over $905.14 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 months ended June 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 $515 thousand and $457 thousand in 2002 and 2001, respectively.

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

			Quarter ended June 30,

			2002						2001

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

				(in thousands)						(in thousands)
Securities
	Taxable		$	209,925	$	2,451	4.77	%	$	147,534	$	2,259	6.13	%
	Tax-exempt (1)			74,279		1,289	7.02	%		62,943		1,088	6.91	%

		Total securities		284,204		3,740	5.38	%		210,477		3,347	6.36	%
Loans, net				664,316		12,458	7.63	%		653,587		14,086	8.64	%
Interest earning bank deposits				139		2	1.81	%		2,283		24	3.80	%
Federal funds sold				29,071		120	1.66	%		38,788		414	4.28	%

		Total earning assets	$	977,730	$	16,320	6.80	%	$	905,135	$	17,871	7.91	%

Interest-bearing deposits:
	Checking		$	115,684	$	309	1.08	%	$	97,650	$	453	1.86	%
	Money market			127,030		601	1.90	%		100,907		831	3.30	%
	Savings			100,329		396	1.58	%		88,485		633	2.87	%
	Certificates of deposit:
		Less than $100,000		328,030		3,426	4.19	%		331,262		4,777	5.78	%
		$100,000 and more		85,289		919	4.31	%		83,969		1,270	6.07	%

	Total interest-bearing deposits			756,362		5,651	3.00	%		702,273		7,964	4.55	%
Federal funds and repurchase agreements				17,719		63	1.43	%		17,454		166	3.83	%
Other short term borrowings				541		1	1.18	%		598		5	3.75	%
FHLB of Atlanta borrowings				12,423		200	6.46	%		14,362		242	6.76	%

		Total interest-bearing liabilities	$	787,045	$	5,915	3.11	%	$	734,687	$	8,377	4.57	%

Net interest income					$	10,405					$	9,494
Interest rate spread							3.68	%					3.34	%
Interest expense as a percent of average earning assets							2.43	%					3.71	%
Net interest margin							4.27	%					4.20	%

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

Non Interest Income

Noninterest income increased $397 thousand to $3.1 million for the three months ended June 30, 2002, an increase of 14.7% over the comparative period in 2001. Income from service charges on deposit accounts totaled $1.1 million for the second quarter, an increase of 20.2% 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 12.1% increase in fee income for the quarter, with gross fees of $901 thousand compared to $804 thousand in 2001. This increase was a result of substantially higher fee based assets as well as increased income from retail brokerage fees. Fee income from gains on sale of secondary market mortgages amounted to $560 thousand for the second quarter, a decrease of $122 thousand or 17.9% compared to $682 thousand in 2001.

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

Noninterest Expense

Operating expenses increased $929 thousand, or 12.0% to $8.7 million for the three months ended June 30, 2002, compared to $7.7 million for the same period in 2001. Of this increase, approximately $487 thousand represents increases in compensation and benefits associated with increased pension costs, higher health insurance costs and a larger compensation base. Nonrecurring expenses amounted to $270 thousand for the quarter, consisting of compensation associated with the acceleration of vesting on restricted stock awards 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 $3.0 million or .45% of loans and other property owned at June 30, 2002, compared to $4.3 million or .65% of loans and other property owned at June 30, 2001. The Company recorded a provision for loan losses of $400 thousand for the three month period ended June 30, 2002, compared to a provision of $461 thousand for the three month period ended June 30, 2001.

The following table provides information on nonperforming assets and loans contractually past due:

		June 30, 2002			December 31, 2001			June 30, 2001

Non accrual loans		$	2,938		$	2,751		$	1,729
Other real estate owned			100			547			602

	Total nonperforming assets	$	3,038		$	3,298		$	2,331

	Loans past due as to principal or interest for 90 days or more accruing interest	$	33		$	213		$	1,921

Nonperforming assets to total assets			.28	%		.34	%		.43	%

Nonperforming assets to loans and other property			.45	%		.53	%		.65	%

Allowance for loan losses as a percentage of loans receivable			1.32	%		1.24	%		1.19	%

Allowance for loan losses as a percentage of nonperforming assets			287.01	%		235.43	%		181.51	%

Net charge-offs as a percentage of average loans receivable			.04	%		.08	%		.07	%

The provision for loan losses recorded for the quarter was necessary to provide an adequate allowance for inherent estimated losses in an increasing loan portfolio. The increase in the allowance for loan losses as a percentage of loans is attributable to several factors. The increase is due partly to the changing composition of the portfolio, with an increase in higher risk non-residential real estate loans of $23.3 million from December 31, 2001. The portfolio makeup also has additional risk from a higher concentration of small business lending which is more sensitive to a recession.

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

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 June 30, 2002 of $112.49 million increased $5.78 million or approximately 5.4% from $106.71 million at December 31, 2001. This increase is primarily attributable to net income earned for the six months ended June 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 14.71% at June 30, 2002, compared to 13.98% at December 31, 2001, placing the Company in a well capitalized position as defined by regulators.

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

Tier 1 capital		$	106,747
Tier 2 capital			8,814
Total risk-based capital			115,561
Total risk-weighted assets			725,615
Average adjusted total assets			1,050,825

Capital ratios:
	Tier 1 risk-based capital ratio		14.71	%
	Total risk-based capital ratio		15.93	%
	Leverage ratio (Tier 1 capital to average adjusted total assets)		10.16	%
	Equity to assets ratio		10.52	%

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.

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

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.

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.

	None.

ITEM 3.	DEFAULTS UPON SENIOR SECURITIES.

	None.

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

	The annual meeting of stockholders of Virginia Financial Group, Inc. was held on April 17, 2002.

	The following directors were elected for terms expiring in 2005:

	FOR	AGAINST

E. Page Butler	5,008,978	77,427
Gregory L. Fisher	5,016,727	69,678
Christopher M. Hallberg	5,034,457	51,948
Martin F. Lightsey	5,035,883	50,522
James S. Quarforth	4,904,066	182,339

The following directors’ term of office continued after the meeting:

	Harry V. Boney, Jr.	Lee S. Baker
	Fred D. Bowers	O.R. Barham, Jr.
	Taylor E. Gore	Benham M. Black
	Jan S. Hoover	Presley W. Moore, Jr.
	W. Robert Jebson, Jr.	Thomas F. Williams, Jr.
	H. Wayne Parrish

Votes were cast in ratification of the selection of Yount, Hyde & Barbour, P.C. as external auditors of the Company for fiscal 2002.

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VIRGINIA FINANCIAL GROUP, INC.
PART II – OTHER INFORMATION

ITEM 5.	OTHER INFORMATION.

	Not applicable.

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

	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).

- 19 -

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
			August 13, 2002


			/s/ Jeffrey W. Farrar

			Jeffrey W. Farrar, CPA
			Executive Vice President - Chief Financial Officer
			August 13, 2002

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