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

_______________________

FORM 10-Q

For the quarterly period ended March 31, 2003

For the transition period from __________ to ___________

__________________________________

Commission File Number: 000-25081

(970) 476-2002
(Registrant’s telephone number, including area code)

N/A
(Former name, former address and former fiscal year, if changed since last report)

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  T  No  ¨.

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes     ¨     No     T

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: As of April 30, 2003, there were 5,665,154 shares of common stock ($1.00 par value per share) outstanding.

VAIL BANKS, INC.

FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2003

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PART I   FINANCIAL INFORMATION

Item 1.       FINANCIAL STATEMENTS

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VAIL BANKS, INC.
Consolidated Statements of Income and Comprehensive Income
(in thousands, except share data)

The accompanying unaudited notes are an integral part of these consolidated financial statements

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VAIL BANKS, INC.
Consolidated Statements of Cash Flows
(in thousands)

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VAIL BANKS, INC.
Consolidated Statements of Cash Flows (Continued)
(in thousands)

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VAIL BANKS, INC.

Notes to Unaudited Consolidated Financial Statements

1.    ORGANIZATION AND BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements include the accounts of Vail Banks, Inc. (Vail Banks) and its wholly owned subsidiaries, WestStar Bank (WestStar), Vail Banks Statutory Trust I, and Vail Banks Statutory Trust II. WestStar and Vail Banks own a combined 54.04% interest in Avon 56 Limited and WestStar owns a 100% interest in First Western Mortgage Services which are also included in the accompanying consolidated financial statements. All entities are collectively referred to as “the Company.” All significant intercompany accounts and transactions have been eliminated in consolidation.

The accompanying unaudited consolidated financial statements, which are for interim periods, do not include all disclosures provided in the consolidated financial statements as of December 31, 2002. These interim unaudited consolidated financial statements and the notes thereto should be read in conjunction with the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2002.

In the opinion of the Company, all adjustments necessary, consisting of only normal recurring items, have been included for a fair presentation of the accompanying consolidated financial statements. Operating results for the three months ended March 31, 2003, are not necessarily indicative of the results that may be expected for the full year.

Certain reclassifications have been made to the 2002 financial statements to conform to the 2003 presentation.

2.    INVESTMENT SECURITIES

Investment securities consist of the following:

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The following table presents the components of investment income for the three months ended March 31, 2003 and 2002.

3.     LOANS

Gross loans consist of the following:

As of March 31, 2003 and December 31, 2002, $106,000 and $172,000, respectively, of deposit account overdrafts have been reclassified to loans.

In the ordinary course of business, the Company had loans receivable from directors, executive officers and principal shareholders (holders of more than five percent of the outstanding shares of common stock) of the Company and their affiliates as follows:

4.     PROVISION AND ALLOWANCE FOR LOAN LOSSES

Transactions in the allowance are summarized as follows:

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5.    BORROWINGS

WestStar is a member of the Federal Home Loan Bank of Topeka (FHLB) and, as a regular part of its business, obtains both short and long-term advances from this FHLB. Advances are collateralized primarily by FHLB stock owned by WestStar and loans secured by certain mortgages or deeds of trust. As of March 31, 2003, the Company’s total borrowing capacity was $121.0 million of which $43.2 million of borrowings were outstanding ($11.2 million was short-term and $32.0 million was long-term) and $24.0 million in the form of stand-by irrevocable letters of credit issued by the FHLB were pledged as collateral for uninsured public fund deposits.

WestStar has established an unsecured, overnight federal funds line with Bankers’ Bank of the West that expires on August 31, 2003. As of March 31, 2003, this authorized borrowing line totaled $41.5 million with $0 outstanding.

WestStar has also established overnight federal funds lines with First Tennessee Bank, N.A. (First Tennessee) totaling $20.0 million. If drawn upon, $10.0 million will be a secured line and $10.0 million will be an unsecured line. These lines are subject to cancellation by First Tennessee at any time upon the occurrence of certain conditions. As of March 31, 2003, no amounts were outstanding under the lines.

6.      SHAREHOLDERS’ EQUITY

Stock Repurchase Plan

On October 15, 2002, the Company’s Board of Directors reauthorized the Company’s stock repurchase program, allowing additional repurchases of up to $10 million through October 2003. Since inception of the program in March 2001, the Company has repurchased 1,023,790 shares at an average cost of $11.57 per share. During the first quarter 2003, the Company repurchased 139,500 common shares at an average cost of $12.12.

Restricted Stock

The Company accounts for its restricted stock grants in accordance with Accounting Principles Board (APB) Opinion No. 25. Accordingly, compensation expense is recorded over the vesting period of the restricted stock equal to the value of the restricted shares using the market price of the stock on the grant date. On February 18, 2003, the Board granted 112,005 shares of restricted stock to several officers of the Company. The Company is recognizing compensation expense of $1.3 million ratably over the vesting period of 10 years.

Earnings Per Share

Basic earnings per share represents net income available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share is computed similar to basic earnings per share, except that the weighted average common shares outstanding is increased to include the number of additional common shares that would have been outstanding if dilutive potential common shares had been issued. Common equivalent shares are not included where inclusion would be anti-dilutive.

The following table presents the net income and weighted average common shares outstanding used to calculate earnings per share for the three months ended March 31, 2003 and 2002:

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During the three months ended March 31, 2003 and 2002, options to purchase an average of 72,000 shares of common stock at average exercise prices of $12.23 and $12.14 per share, respectively, were outstanding, but were not included in the computation of diluted earnings per share because the exercise prices of these options were greater than the average market prices of the common stock during such quarter.

Stock Options

On February 10, 2003, the Board approved the grant of 26,000 stock options to employees and directors of the Company.

The Company accounts for its stock options in accordance with SFAS No. 123, Accounting for Stock-Based Compensation, which permits entities to expense over the vesting period the fair value of stock-based awards as measured on the date of grant. Alternatively, SFAS 123 allows entities to apply the provisions of APB Opinion No. 25 while disclosing pro forma net income and pro forma earnings per share for employee stock option grants made in 1995 and future years as if the fair-value-based method defined in SFAS 123 had been applied. The Company has elected to apply the accounting provisions of APB Opinion No. 25 to employee stock option grants and provide the pro forma disclosure provisions of SFAS 123. Accordingly, stock-based compensation expense for employee option grants is not recognized in the consolidated financial statements, as options granted under the Plan generally have an exercise price equal to the market value of the underlying common stock on the date of grant. However, during May 2002, approximately 20,000 stock options were granted at a strike price below market value. The Company recognized $1,000 of compensation expense during the quarter ended March 31, 2003 related to these options. Any non-employee stock option grants are accounted for under SFAS 123.

The fair value of each employee stock option grant was estimated on the date of grant using the Black-Scholes option-pricing model. The following weighted-average assumptions were used:

Had the Company determined compensation cost based on the fair value accounting provisions prescribed by SFAS 123 and using the assumptions listed above, the Company’s net income and earnings per share would have been adjusted to the pro forma amounts indicated below:

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7.     REGULATORY MATTERS

As of March 31, 2003, the Company met all capital adequacy requirements to which it was subject. As of that date, the Company had Tier 1 and Total Risk-Based Capital ratios of 13.57% and 14.99%, respectively, and a Leverage ratio of 9.59%. Regulatory guidelines permit the Company’s trust preferred securities to be included in the calculation of Tier 1 and Total Risk-Based capital, subject to certain limitations.

As of March 31, 2003, WestStar met all capital adequacy requirements to which it was subject and exceeded the minimum ratios to be designated as “well-capitalized.” As of March 31, 2003, WestStar had Tier 1 and Total Risk-Based Capital ratios of 13.04% and 13.94%, respectively, and a Leverage ratio of 9.21%.

8.     SEGMENT INFORMATION

Information about reportable segments and reconciliation of such information to the consolidated financial statements as of and for the three months ended March 31 is as follows:

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9.      RECENT ACCOUNTING PRONOUNCEMENTS

During June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. This statement is effective for exit or disposal activities initiated after December 31, 2002. These activities may include sale or termination of a line of business, the closure of business activities in a particular location, the relocation of business activities from one location to another, changes in management structure, and a fundamental reorganization that affects the nature and focus of operations. The Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and requires companies to recognize liabilities associated with exit or disposal activities at the time that they are incurred rather than at the date of a commitment to the exit or disposal plan. The Company adopted this standard on January 1, 2003. Adoption of this standard did not have an effect on the Company’s consolidated financial condition or results of operations.

10.      SUBSEQUENT EVENTS

On April 22, 2003, the Board of Directors declared a regular quarterly dividend of $0.06 per share payable on May 19, 2003 to shareholders of record on May 5, 2003.

On April 25, 2003, the Board approved the grant of 18,272 shares of restricted stock to an officer of the Company. The Company is recognizing compensation expense of $226,000 ratably over the vesting period of 10 years.

Between April 1, 2003 and April 30, 2003, the Company repurchased 70,900 shares of common stock at a total cost of $868,000, or $12.25 per share. These transactions would have materially changed the number of shares outstanding at March 31, 2003, had these transactions occurred prior to quarter-end.

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Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, statements about our plans, objectives, expectations and intentions and other statements contained in this report that are not historical facts. When used in this report, the words “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressions are generally intended to identify forward-looking statements. These forward-looking statements are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. Actual results may differ materially from the results discussed in these forward-looking statements as a result of the impact of economic conditions and interest rates, loan losses, risks related to the execution of the Company’s growth strategy, the possible loss of key personnel, factors that could affect the Company’s ability to compete in its trade areas, changes in regulations and government policies and other factors discussed in the Company’s filings with the Securities and Exchange Commission. Vail Banks does not intend to update any forward-looking statements whether written or oral, relating to matters discussed in this Quarterly Report on Form 10-Q.

Basis of Presentation

The following discussion and analysis provides information regarding the Company’s financial condition as of March 31, 2003, and its results of operations for the three months ended March 31, 2003, in comparison to the three months ended March 31, 2002. The following discussion should be read in conjunction with the unaudited consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q, and in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.

Overview

Net income was $975,000 for the three months ended March 31, 2003, down from $1.5 million for the three months ended March 31, 2002, a decrease of 36%.

Diluted earnings per share for the three months ended March 31, 2003, was $0.17 compared to $0.26 for the three months ended March 31, 2002, a decrease of 35%.

The annualized return on average assets was 0.69% for the quarter ended March 31, 2003, compared to 1.09% for the quarter ended March 31, 2002.

The annualized return on average equity was 5.99% for the quarter ended March 31, 2003, compared to 9.63% for the quarter ended March 31, 2002.

Results of Operations

Net Interest Income. Net interest income, on a fully tax-equivalent basis (FTE), decreased by $873,000, or 13% to $5.7 million for the three months ended March 31, 2003 from $6.6 million for the three months ended March 31, 2002. The net interest margin on an FTE basis was 4.89% for the first quarter 2003 as compared to 5.76% for the first quarter 2002. Net interest margin is influenced by the level and relative mix of earning assets, interest bearing liabilities, non-interest bearing liabilities and shareholders’ equity as well as the cost of interest bearing liabilities as compared to the yield on earnings assets. The decrease in net interest margin during first quarter 2003 was primarily due to (1) the 50 basis point interest rate cut implemented by the Federal Reserve in November 2002, (2) a shift in the mix of earning assets from higher yielding loans to lower yielding investments and federal funds sold, (3) an increase in higher cost borrowings relative to lower cost deposits as a result of the Company’s leverage strategy, and (4) an increase in the deferral of loan fees in the first quarter of 2003 when compared with first quarter 2002. During the first quarter 2003, the Company deferred $375,000 ($240,000, or $0.04 diluted earnings per share, after tax) in loan fees,

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reflecting a more conservative approach that more closely recognizes loan fee income over the lives of the related loans. A portion of the deferral also included fees on long-term loans now being funded with long-term borrowings. A substantial portion of such deferred fees will be recognized as income in subsequent quarters of calendar year 2003. The net interest margin on an FTE basis would have been 5.21% including the recognition of deferred fees. Vail Banks has experienced increased liquidity as the result of a decrease in loan demand attributable to the soft economy and more conservative underwriting policies and an increase in deposits. In response, the Company capitalized on the low interest rate environment and its wholesale funding source to extend fixed rate financing to several customers, thereby locking in a spread. Between March 31, 2002 and March 31, 2003 the Company’s borrowings increased $13.2 million and investments increased $36.8 million, while at the same time deposits remained unchanged and loans dropped $35.8 million.

Interest income FTE decreased $912,000, or 10% for first quarter 2003 as compared to the same period in 2002 despite the fact that earning assets increased $10.3 million or 2% during the same period. Subsequent to March 31, 2002, the mix of earning assets shifted away from higher yielding loans toward lower yielding investment securities and federal funds sold. During first quarter 2003, average loans declined to 71% of earning assets as compared to 82% during first quarter 2002. During this time, loans had a yield of 8.09% as compared to the 4.64% yield on investment securities and 1.19% yield on federal funds sold. As a result of this shift, the total yield on average earnings assets decreased 94 basis points to 6.67% for first quarter 2003, as compared to 7.61% for first quarter 2002.

Interest expense decreased $39,000, or 2% for first quarter 2003 as compared to the same period during 2002. This decrease was primarily due to the 50 basis point decline in interest rates during November 2002 as well as the effect of maturing certificates of deposit renewing at significantly lower interest rates. This decrease was offset by an $11.1 million increase in average borrowings during first quarter 2003 as compared to first quarter 2002. As a result, the total cost of interest-bearing liabilities decreased 11 basis points to 2.09% for first quarter 2003, as compared to 2.20% for first quarter 2002. This decrease in cost of interest bearing liabilities, however, was not in proportion to the decrease in yield on average interest earning assets, resulting in an overall decrease in the net interest margin for first quarter 2003.

Non-Interest Income. Non-interest income decreased by $37,000, or 1%, to $2.88 million for the three months ended March 31, 2003, from $2.92 million for the three months ended March 31, 2002. This decrease over the first quarter of 2002 was primarily attributable to a decrease in deposit related service charges and other non-interest income, partially offset by an increase in mortgage broker fees. Deposit related income decreased $130,000, or 15%, from first quarter 2002 primarily due to a $111,000, or 19%, decrease in insufficient funds charges. Other non-interest income decreased $223,000, or 25%, from first quarter 2002 primarily due to the outsourcing of the Company’s merchant card program. This outsourcing accounted for a $122,000 reduction in other non-interest income and a $148,000 decrease in other non-interest expense from first quarter 2002, discussed below. Mortgage broker fees increased $316,000, or 28%, from first quarter 2002 due to increased refinancing activity as a result of continued low interest rates.

Non-Interest Expense. Non-interest expense increased by $106,000, or 2%, to $7.0 million for the three months ended March 31, 2003, from $6.9 million for the three months ended March 31, 2002. This increase is largely attributable to the increasing costs of employee related and occupancy expenses. Mortgage broker commissions increased $180,000, or 36%, from first quarter 2002 due to increased refinancing activity. These increases were offset by a $148,000 savings in expense related to the outsourcing of the merchant card program during first quarter 2003.

The efficiency ratio increased to 82% for the quarter ended March 31, 2003, from 73% for the quarter ended March 31, 2002. This increase in the efficiency ratio was due to the decline in revenue (net interest income plus non-interest income) of $946,000 during first quarter 2003 while non-interest expenses increased by $106,000 during the same period.

Income Taxes. The Company’s effective income tax rate (income tax expense as a percentage of pre-tax income) was 29.9% for the three months ended March 31, 2003 as compared to 35.5% for the three months ended March 31, 2002. This decrease in the effective income tax rate was primarily due to an increase in the deferred tax asset of $44,000 resulting from a change in the deferred income tax rate as well as an increase in tax-exempt interest income generated from municipal securities purchased during first quarter 2003.

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Financial Condition

The Company’s assets increased by $38.8 million or 7%, to $593.1 million as of March 31, 2003, from $554.3 million as of December 31, 2002.

Federal funds sold balances decreased by $4.8 million, or 10%, to $45.2 million as of March 31, 2003 from $50.0 million at December 31, 2002. Investment securities increased to $110.9 million as of March 31, 2003, compared to $62.0 million as of December 31, 2002, a 79% increase. During this period, quality loan demand remained flat while deposits continued to grow, resulting in additional cash inflows to invest. In response, the Company capitalized on the low interest rate environment and its wholesale funding source to extend fixed rate financing to several customers, thereby locking in a spread. Between December 31, 2002 and March 31, 2003, FHLB borrowings increased $13.2 million, or 44%.

As of March 31, 2003, loans held for sale decreased $4.1 million, or 42%, from December 31, 2002. The ending balance of loans held for sale at any particular date is dependent on the timing of the closing and ultimate funding of these loans by the outside investor. Thus, an increase or decrease in the ending balance is primarily a function of this timing and not indicative of trends in mortgage loan demand.

Gross loans increased $839,000, or less than 1%, from December 31, 2002.

Premises and equipment decreased by $635,000, or 2%, from $39.0 million as of December 31, 2002, to $38.4 million as of March 31, 2003. This decrease was mainly attributable to $580,000 of depreciation expense and the transfer of $274,000 of idle assets to other assets, offset by the purchase of $219,000 of premises and equipment primarily related to equipment upgrades and the remodeling of branches.

Deposits increased by $27.6 million, or 6%, from $428.7 million as of December 31, 2002, to $456.3 million as of March 31, 2003. The increase in deposits was largely attributable to a $16.6 million increase in public funds between December 31, 2002 and March 31, 2003. Public funds increased during this time frame due, to some degree, to customer property tax deposits.

Asset Quality

Provision and Allowance for Loan Losses. Provision expense for the three months ended March 31, 2003, was $125,000 compared to no provision for the three months ended December 31, 2002 and $212,000 recorded in the three months ended March 31, 2002. The allowance for loan losses of $3.4 million as of March 31, 2003, decreased 10% from the $3.7 million level as of December 31, 2002 and it represents 1.02% of total loans and 109% of non-performing loans as of March 31, 2003. Although gross loans increased $839,000, or less than 1%, between December 31, 2002 and March 31, 2003, non-performing loans decreased $645,000, or 17% during the same time period. Accordingly, the $366,000 decrease in the allowance for loan losses from December 31, 2002 reflects the Company’s revised estimate of probable losses in the loan portfolio.

The amount of the provision for loan losses is based on regular evaluations of the loan portfolio, with particular attention directed toward non-performing, delinquent, and other potential problem loans. During these evaluations, consideration is also given to such factors as management’s evaluation of specific loans, the level and composition of delinquent and non-performing loans, historical loan loss experience, results of examinations by regulatory agencies, external and internal asset review processes, the market value of collateral, the strength and availability of guarantees, concentrations of credit and other judgmental factors.

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The following table presents, for the periods indicated, an analysis of the allowance for loan losses and other related data.

Non-Performing Assets. The following table presents information regarding non-performing assets as of the dates indicated:

The Company believes that it has adequate collateral to recover the majority of the balance of the nonaccrual loans. Foreclosed properties are recorded at the lower of cost or fair value less estimated costs to sell. All anticipated losses are recorded at the time of transfer from loans. Management is not aware of any significant adverse trends relating to its loan portfolio.

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Liquidity

Liquidity is a measure of the Company’s ability to meet its commitments and obligations with available funds. These commitments may include paying dividends to shareholders, funding new loans for borrowers, funding withdrawals by depositors, paying general and administrative expenses, and funding capital expenditures. Historically, the Company’s primary source of funds has been customer deposits. Scheduled loan repayments are a relatively stable source of funds. Deposit inflows and unscheduled loan repayments, which are influenced by fluctuations in the general level of interest rates, returns available on other investments, competition, economic conditions and other factors, are relatively unstable. Other sources of liquidity include sale or maturity of investment securities and the ability to borrow funds. Company borrowing may be used on a short-term basis to compensate for reductions in other sources of funds (such as deposit inflows at less than projected levels). Company borrowing may also be used on a longer-term basis to support expanded lending and investing activities and to match the maturity or repricing intervals of assets.

As of March 31, 2003, the Company had cash and cash equivalents (including federal funds sold) of $67.2 million and investment securities of $110.9 million. Almost 96% of the Company’s investment portfolio is classified as available-for-sale and can be readily sold to meet liquidity needs. Based on current plans and business conditions, the Company expects that its cash, cash equivalents, investment securities and available borrowing capacity under its credit facilities, together with any amounts generated from operations, will be sufficient to meet the Company’s liquidity requirements for the next 12 months. However, there can be no assurance that the Company will not be required to seek other financing sooner or that such financing, if required, will be available on terms satisfactory to the Company.

Cash Flows

Net Cash from Operating Activities

During the three-month period ended March 31, 2003, cash of $4.7 million was provided by operating activities consisting primarily of net income of $975,000 plus non-cash expenses of $957,000 and net decreases in operating assets and liabilities of $2.7 million. Non-cash expenses consisted primarily of $580,000 of depreciation and amortization expense on premises and equipment, a $125,000 loan loss provision and $113,000 of net amortization of premiums on investment securities. The net decrease in operating assets and liabilities was primarily due to a $4.1 million decrease in loans held for sale offset by a $729,000 decrease in interest payable and other liabilities, a $350,000 increase in interest receivable and a $311,000 increase in other assets.

During the three-month period ended March 31, 2002, cash of $4.0 million was provided by operating activities consisting primarily of net income of $1.5 million plus non-cash expenses of $840,000 and net decreases in operating assets and liabilities of $1.7 million. Non-cash expenses consisted primarily of $578,000 of depreciation and amortization expense on premises and equipment and a $212,000 loan loss provision. The net decrease in operating assets and liabilities was primarily due to a $1.8 million decrease in loans held for sale, a $318,000 increase in interest payable and other liabilities, a $220,000 increase in other assets, and a $224,000 increase in interest receivable. The decrease in loans held for sale was primarily due to reduced loan demand as mortgage interest rates began to rise.

Net Cash from Investing Activities

During the three-month period ended March 31, 2003, cash of $51.2 million was used for investing activities. These outflows consisted primarily of the purchase of $59.8 million of investment securities and a $1.7 million increase in loans, offset by the maturity and/or calls of $10.4 million of investment securities.

During the three-month period ended March 31, 2002, cash of $9.9 million was used for investing activities. These outflows consisted primarily of the purchase of $37.8 million of investment securities and the purchase of $1.0 million of premises and equipment, offset by a $24.0 million decrease in loans, the maturity and/or calls of $4.6 million of investment securities and $308,000 of proceeds from sales of foreclosed properties.

Net Cash from Financing Activities

During the three-month period ended March 31, 2003, cash of $38.8 million was provided by financing activities consisting primarily of an increase in deposits of $27.6 million and the receipt of $13.2 million of proceeds from FHLB advances, offset by the repurchase of $1.7 million of common stock and the payment of dividends on common stock of $343,000.

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During the three-month period ended March 31, 2002, cash of $22.3 million was provided by financing activities consisting primarily of an increase in deposits of $13.7 million and the receipt of $8.9 million of proceeds from FHLB advances, offset by the payment of dividends on common stock of $287,000.

Borrowings

WestStar is a member of the Federal Home Loan Bank of Topeka (FHLB) and, as a regular part of its business, obtains both short and long-term advances from this FHLB. Advances are collateralized primarily by FHLB stock owned by WestStar and loans secured by certain mortgages or deeds of trust. As of March 31, 2003, the Company’s total borrowing capacity was $121.0 million of which $43.2 million of borrowings were outstanding ($11.2 million was short-term and $32.0 million was long-term) and $24.0 million in the form of stand-by irrevocable letters of credit issued by the FHLB were pledged as collateral for uninsured public fund deposits.

WestStar has established an unsecured, overnight federal funds line with Bankers’ Bank of the West that expires on August 31, 2003. As of March 31, 2003, this authorized borrowing line totaled $41.5 million with $0 outstanding.

WestStar has also established overnight federal funds lines with First Tennessee Bank, N.A. (First Tennessee) totaling $20.0 million. If drawn upon, $10.0 million will be a secured line and $10.0 million will be an unsecured line. These lines are subject to cancellation by First Tennessee at any time upon the occurrence of certain conditions. As of March 31, 2003, no amounts were outstanding under the lines.

Dividends

Payment of dividends is at the discretion of the Board and is determined by taking into account the earnings, capital levels, cash requirements, and the financial condition of Vail Banks and WestStar, as well as applicable government regulations and other relevant factors. On April 22, 2003, the Board declared a regular quarterly dividend of $0.06 per share payable on May 19, 2003 to shareholders of record on May 5, 2003.

Stock Repurchase Plan

On October 15, 2002, the Company’s Board of Directors reauthorized the Company’s stock repurchase program, allowing additional repurchases of up to $10 million through October 2003. Since inception of the program in March 2001, the Company has repurchased 1,023,790 shares at an average cost of $11.57 per share. During the first quarter 2003, the Company repurchased 139,500 common shares at an average cost of $12.12.

Capital Resources

As of March 31, 2003, shareholders’ equity had decreased $1.3 million, or 2%, to $65.5 million from $66.8 million as of December 31, 2002. This decrease is primarily related to the repurchase of common stock at a cost of $1.7 million, the payment of common stock dividends of $343,000 and a decrease in accumulated other comprehensive income of $299,000 related to decreased unrealized gains on investment securities available for sale, offset by the retention of $975,000 of earnings.

As of March 31, 2003 and 2002, the Company met all capital adequacy requirements to which it was subject. As of March 31, 2003, the Company had Tier 1 and Total Risk-Based Capital ratios of 13.57% and 14.99%, respectively, and a Leverage ratio of 9.59%. Regulatory guidelines permit the Company’s trust preferred securities to be included in the calculation of Tier 1 and Total Risk-Based capital, subject to certain limitations. As of March 31, 2002, the Company had Tier 1 and Total Risk-Based Capital ratios of 12.46% and 14.11%, respectively, and a Leverage ratio of 9.50%.

As of March 31, 2003 and March 31, 2002, WestStar met all capital adequacy requirements to which it was subject and exceeded the minimum ratios to be designated as “well-capitalized.” As of March 31, 2003, WestStar had Tier 1 and Total Risk-Based Capital ratios of 13.04% and 13.94%, respectively, and a Leverage ratio of 9.21%. As of March 31, 2002, WestStar had Tier 1 and Total Risk-Based Capital ratios of 12.01% and 13.12%, respectively, and a Leverage ratio of 9.15%.

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Recent Accounting Pronouncements

During June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. This statement is effective for exit or disposal activities initiated after December 31, 2002. These activities may include sale or termination of a line of business, the closure of business activities in a particular location, the relocation of business activities from one location to another, changes in management structure, and a fundamental reorganization that affects the nature and focus of operations. The Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and requires companies to recognize liabilities associated with exit or disposal activities at the time that they are incurred rather than at the date of a commitment to the exit or disposal plan. The Company adopted this standard on January 1, 2003. Adoption of this standard did not have an effect on the Company’s consolidated financial condition or results of operations.

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Item 3.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Quantitative Disclosures About Market Risk

The table below provides information about the Company’s financial instruments as of December 31, 2002 that are sensitive to changes in interest rates.

INTEREST RATE SENSITIVE LIABILITIES

(a)     These interest rates are not adjusted to reflect tax equivalent yields.
(b)     The above amounts represent scheduled maturities and do not include prepayments that may occur.

Qualitative Disclosures About Market Risk

Market risk is the exposure to loss resulting from changes in interest rates, foreign currency exchange rates, commodity prices and equity prices. The primary market risk to which the Company is exposed is interest rate risk arising from the instruments and transactions entered into by the Company. They include loans, securities available for sale, deposit liabilities, and borrowings. Interest rate risk occurs when interest-sensitive assets and liabilities reprice at different times as market interest rates change. Interest-sensitive assets and liabilities are those that are subject to repricing in the near term, including both variable rate instruments and those fixed rate instruments that are approaching maturity. For example, if fixed-rate assets are funded with floating-rate debt, the spread between asset and liability rates will decline or turn negative if rates increase. Additionally, interest rate risk results from changing spreads between asset and liability rates.

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The Company’s Asset/Liability Management Committee manages interest rate risk. The principal objective of asset/liability management is to manage the levels of interest-sensitive assets and liabilities to minimize net interest income fluctuations in times of fluctuating market interest rates. To effectively measure and manage interest rate risk, the Company uses computer simulations that determine the impact on net interest income of numerous interest rate scenarios, balance sheet trends and strategies. These simulations cover the following financial instruments: short-term financial instruments, investment securities, loans, deposits, and borrowings. These simulations incorporate assumptions about balance sheet dynamics, such as loan and deposit growth and pricing, changes in funding mix, and asset and liability repricing and maturity characteristics. Simulations are run under various interest rate scenarios to determine the impact on net income and capital. From these computer simulations, interest rate risk is quantified and appropriate strategies are developed and implemented. During 2002 and the first three months of 2003, the Company did not use interest rate derivative financial instruments as an asset/liability management tool to hedge mismatches in interest rate exposures.

During the first three months of 2003, Vail Banks experienced increased liquidity, which was used in part to purchase longer-term investment securities. While the liquidity position increased, the overall balance sheet restructuring decreased the asset sensitive nature of the balance sheet. Therefore, Vail Banks was less sensitive to changes in interest rates at March 31, 2003 than at December 31, 2002.

During the remainder of 2003, the Company will face risk primarily from the possibility of lower interest rates. Although the Company’s gap position is slightly positive at March 31, 2003, due to the low level of deposit rates, the bank is more sensitive to downward changes in rates. If rates fall, asset yields will decline faster than the cost of interest bearing liabilities, leading to a decline in the margin. The extent of this decline will depend on the degree to which retail deposit rates change relative to market rates. The 525 basis point reduction in short-term rates by the Federal Reserve Bank since December 2000 effectively repriced a significant portion of the Company’s loan portfolio. While it also produced an opportunity to reduce funding costs, at the current level of interest rates, further reductions in funding costs may be limited.

Item 4.     CONTROLS AND PROCEDURES

Company management, including the president and chief financial officer, supervised and participated in an evaluation of the Company’s disclosure controls and procedures (as defined in rules of the Securities and Exchange Commission) within the 90 days prior to the filing of this report. Based on, and as of the date of, that evaluation, the Company’s president and chief financial officer have concluded that the Company’s disclosure controls and procedures were effective in accumulating and communicating information to management, including the president and chief financial officer, as appropriate to allow timely decisions regarding required disclosures of that information under the Securities and Exchange Commission’s rules and forms and that the disclosure controls and procedures are designed to ensure that the information required to be disclosed in reports that are filed or submitted under the Securities and Exchange Act of 1934, as amended, are recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

There were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.

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PART II OTHER INFORMATION

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

(a)     Exhibits

99.1	Certification by Lisa M. Dillon, President of the Company, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.2	Certification by Peter G. Williston, Senior Executive Vice President and Chief Financial Officer of the Company, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(b)     Reports on Form 8-K

No reports were filed during the first quarter of 2003.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Quarterly Report on Form 10-Q to be signed on its behalf by the undersigned thereunto duly authorized.

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302 CERTIFICATION FOR FORM 10-Q

CERTIFICATIONS

I, Lisa M. Dillon, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Vail Banks, Inc. (the registrant);
    
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 officer 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:

5. The registrant’s other certifying officer 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):

6. The registrant’s other certifying officer 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: May 7, 2003

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302 CERTIFICATION FOR FORM 10-Q

CERTIFICATIONS

I, Peter G. Williston, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Vail Banks, Inc. (the registrant);
    
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 officer 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:

5. The registrant’s other certifying officer 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):

6. The registrant’s other certifying officer 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: May 7, 2003

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