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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
  FORM 10-Q (Mark One) 
 For the quarterly period ended September 30, 2004 OR [  ] 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 0-25135 Bank of Commerce Holdings  California
(State or other jurisdiction of incorporation or organization)
    
    94-2823865
(I.R.S. Employer Identification No.)1951 Churn Creek Road Redding, California
(Address of principal executive offices)
    
    96002
(Zip code)
 Registrants telephone number, including area code: (530) 224-3333 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value per share 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 [  ] Indicate by a check mark whether the registrant is an accelerated filer (as defined in Rule 126-2 of the Exchange
Act)
Yes [  ] No [X] Outstanding shares of Common Stock, no par value, as of October 31, 2004: 8,502,539 1




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BANK OF COMMERCE HOLDINGS & SUBSIDIARIES Index to Form 10-Q Page:PART I. FINANCIAL INFORMATIONItem 1. Financial StatementsConsolidated Condensed Balance Sheets
September 30, 2004, December 31, 2003 and September 30, 2003
    
    
    3Consolidated Condensed Statements of Income
Three and nine months ended September 30, 2004 and 2003
    
    
    4Consolidated Condensed Statements of Cash Flows
Three and nine months ended September 30, 2004 and 2003
    
    
    5Notes to Consolidated Condensed Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis
of Financial Condition and Results of Operations
    
    
    10Corporate Overview
    
    
    10Executive Overview
    
    
    12Sources of Income
    
    
    13Financial Highlights  Results of Operations
    
    
    13Net Interest Income and Net Interest Margin
    
    
    13Liquidity
    
    
    14Capital Management
    
    
    14Short term borrowings
    
    
    15Provision for loan losses
    
    
    15Factors that may affect future results
    
    
    15Specific risks to operations in California
    
    
    16Critical accounting policies
    
    
    17Average balances, Interest Income/Expense rates and yields
    
    
    19Volume/ Rate analysis
    
    
    20Noninterest Income
    
    
    21Noninterest Expense
    
    
    21Income taxes
    
    
    22Asset quality
    
    
    23Allowance for loan and lease losses (ALLL)
    
    
    24Securities portfolio
    
    
    25Item 3. Quantitative and Qualitative Disclosure about Market Risk
    
    
    27Item 4. Controls and Procedures
    
    
    28PART II. OTHER INFORMATIONItem 1. Legal proceedings
    
    
    31Item 2. Changes in Securities, use of proceeds and Issuers Purchase of Equity Securities
    
    
    31Item 3. Defaults Upon Senior Securities
    
    
    31Item 4. Submission of Matters to a Vote of Security Holders
    
    
    31Item 5. Other Information
    
    
    31Item 6. Exhibits and Reports on Form 8-K
    
    
    31SIGNATURES
    
    
    32EXHIBITS
    
    
    33,34,35EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32
 2




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PART I. FINANCIAL INFORMATION 
  BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
 
 Condensed Consolidated Balance Sheets
 (Unaudited)
 September 30,
    
    December 31,
    
    September 30,Dollar amounts in thousands
    
    2004
    
    2003
    
    2003ASSETSCash and due from banks
    
    $
    13,816
    
    
    $
    23,844
    
    
    $
    25,315Federal funds sold and securities purchased under agreements to
resell
    
    
    12,155
    
    
    
    8,195
    
    
    
    23,380Cash and cash equivalents
    
    
    25,971
    
    
    
    32,039
    
    
    
    48,695Securities available-for-sale
    
    
    78,475
    
    
    
    70,034
    
    
    
    64,238Securities held-to-maturity, at cost (estimated fair value of $534
at September 30, 2004, $1,460 at December 31, 2003
and $1,715 at September 30, 2003)
    
    
    490
    
    
    
    1,391
    
    
    
    1,619Loans, net of the allowance for loan losses of $3,732 at
September 30, 2004, $3,675 at December 31, 2003 and $3,965
at September 30, 2003
    
    
    306,531
    
    
    
    278,204
    
    
    
    278,028Bank premises and equipment, net
    
    
    5,589
    
    
    
    5,813
    
    
    
    5,652Other assets
    
    
    11,496
    
    
    
    13,677
    
    
    
    10,635TOTAL ASSETS
    
    $
    428,552
    
    
    $
    401,158
    
    
    $
    408,867LIABILITIES AND STOCKHOLDERS EQUITYDemand  noninterest bearing
    
    $
    79,409
    
    
    $
    71,222
    
    
    $
    73,228Demand  interest bearing
    
    
    108,348
    
    
    
    94,051
    
    
    
    101,778Savings
    
    
    25,112
    
    
    
    22,197
    
    
    
    22,230Certificates of deposits
    
    
    139,104
    
    
    
    140,069
    
    
    
    144,627Total deposits
    
    
    351,973
    
    
    
    327,539
    
    
    
    341,863Securities sold under agreements to repurchase
    
    
    1,489
    
    
    
    3,749
    
    
    
    5,498Federal Home Loan Bank borrowings
    
    
    30,000
    
    
    
    30,000
    
    
    
    20,000Other liabilities
    
    
    4,266
    
    
    
    4,359
    
    
    
    7,301Guaranteed
Preferred Beneficial Interests in Companys Junior Subordinated Debt payable to unconsolidated subsidiary
grantor trust
    
    
    5,000
    
    
    
    5,000
    
    
    
    5,000Total Liabilities
    
    
    392,728
    
    
    
    370,647
    
    
    
    379,662Commitments and contingencies (note 8)Stockholders Equity:Preferred stock, no par value, 2,000,000 authorized
no shares issued and outstanding in 2004 and 2003
    
    
    
    
    
    
    
    
    
    
    Common stock , no par value, 10,000,000 shares
authorized; 8,502,539 shares issued and outstanding
at September 30, 2004, 8,130,174 at December 31, 2003
and 8,124,174 at September 30, 2003
    
    
    10,714
    
    
    
    9,540
    
    
    
    8,952Retained earnings
    
    
    25,416
    
    
    
    21,236
    
    
    
    20,681Accumulated other comprehensive (loss) , net of tax
    
    
    (306
    )
    
    
    (265
    )
    
    
    (428
    )Total Stockholders equity
    
    
    35,824
    
    
    
    30,511
    
    
    
    29,205TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    428,552
    
    
    $
    401,158
    
    
    $
    408,867
 See accompanying notes to condensed consolidated financial statements. 3




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BANK OF COMMERCE HOLDINGS & SUBSIDIARIES 
 Condensed Consolidated Statements of Income (Unaudited)
 Three and nine months ended September 30, 2004 and 2003
 Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,
    
    September 30,
    
    September 30,Amounts in thousands, except for per share data
    
    2004
    
    2003
    
    2004
    
    2003Interest income:Interest and fees on loans
    
    $
    4,627
    
    
    $
    4,399
    
    
    $
    13,416
    
    
    $
    13,312Interest on tax exempt securities
    
    
    58
    
    
    
    52
    
    
    
    171
    
    
    
    84Interest on U.S. government securities
    
    
    567
    
    
    
    354
    
    
    
    1,549
    
    
    
    783Interest on federal funds sold and
securities purchased under agreements to
resell
    
    
    49
    
    
    
    42
    
    
    
    90
    
    
    
    162Interest on other securities
    
    
    0
    
    
    
    0
    
    
    
    7
    
    
    
    0Total interest income
    
    
    5,301
    
    
    
    4,847
    
    
    
    15,233
    
    
    
    14,341Interest expense:Interest on demand deposits
    
    
    114
    
    
    
    110
    
    
    
    314
    
    
    
    351Interest on savings deposits
    
    
    26
    
    
    
    31
    
    
    
    79
    
    
    
    102Interest on time deposits
    
    
    711
    
    
    
    864
    
    
    
    2,106
    
    
    
    2,798Securities sold under agreements to repurchase
    
    
    0
    
    
    
    4
    
    
    
    2
    
    
    
    10Interest on FHLB and other borrowing expense
    
    
    113
    
    
    
    46
    
    
    
    271
    
    
    
    175Interest on junior subordinated debt payable to
unconsolidated subsidiary
grantor trust
    
    
    68
    
    
    
    60
    
    
    
    180
    
    
    
    131Total interest expense
    
    
    1,032
    
    
    
    1,115
    
    
    
    2,952
    
    
    
    3,567Net interest income
    
    
    4,269
    
    
    
    3,732
    
    
    
    12,281
    
    
    
    10,774Provision for loan losses
    
    
    131
    
    
    
    40
    
    
    
    420
    
    
    
    415Net interest income after provision for
loan losses
    
    
    4,138
    
    
    
    3,692
    
    
    
    11,861
    
    
    
    10,359Noninterest income:Service charges on deposit accounts
    
    
    133
    
    
    
    94
    
    
    
    358
    
    
    
    250Payroll and benefit processing fees
    
    
    81
    
    
    
    79
    
    
    
    260
    
    
    
    245Earnings on
cash surrender value 
Bank owned life insurance
    
    
    52
    
    
    
    57
    
    
    
    160
    
    
    
    176Net gain on sale of securities available-for-sale
    
    
    0
    
    
    
    12
    
    
    
    0
    
    
    
    88Net gain on sale of loans
    
    
    2
    
    
    
    25
    
    
    
    38
    
    
    
    99Merchant credit card service income, net
    
    
    139
    
    
    
    112
    
    
    
    330
    
    
    
    307Mortgage brokerage fee income
    
    
    64
    
    
    
    112
    
    
    
    112
    
    
    
    224Other income
    
    
    102
    
    
    
    95
    
    
    
    304
    
    
    
    300Total non-interest income
    
    
    573
    
    
    
    586
    
    
    
    1,562
    
    
    
    1,689Noninterest expense:Salaries and related benefits
    
    
    1,500
    
    
    
    1,409
    
    
    
    4,261
    
    
    
    4,063Occupancy and equipment expense
    
    
    395
    
    
    
    374
    
    
    
    1,127
    
    
    
    1,087FDIC insurance premium
    
    
    11
    
    
    
    12
    
    
    
    36
    
    
    
    37Data processing fees
    
    
    69
    
    
    
    52
    
    
    
    185
    
    
    
    141Professional service fees
    
    
    177
    
    
    
    161
    
    
    
    619
    
    
    
    549Deferred compensation expense
    
    
    71
    
    
    
    65
    
    
    
    207
    
    
    
    189Stationery and Supplies
    
    
    48
    
    
    
    58
    
    
    
    156
    
    
    
    178Postage
    
    
    25
    
    
    
    22
    
    
    
    73
    
    
    
    77Directors expense
    
    
    67
    
    
    
    68
    
    
    
    225
    
    
    
    182Other expenses
    
    
    278
    
    
    
    238
    
    
    
    856
    
    
    
    759Total non-interest expense
    
    
    2,641
    
    
    
    2,459
    
    
    
    7,745
    
    
    
    7,262Income before income taxes
    
    
    2,070
    
    
    
    1,819
    
    
    
    5,678
    
    
    
    4,786Provision for income taxes
    
    
    803
    
    
    
    565
    
    
    
    2,138
    
    
    
    1,721Net Income
    
    $
    1,267
    
    
    $
    1,254
    
    
    $
    3,540
    
    
    $
    3,065Basic earnings per share
    
    $
    0.15
    
    
    $
    0.15
    
    
    $
    0.43
    
    
    $
    0.38Weighted average shares  basic
    
    
    8,260
    
    
    
    8,091
    
    
    
    8,192
    
    
    
    8,001Diluted earnings per share
    
    $
    0.15
    
    
    $
    0.15
    
    
    $
    0.42
    
    
    $
    0.37Weighted average shares  diluted
    
    
    8,641
    
    
    
    8,430
    
    
    
    8,494
    
    
    
    8,283
 See accompanying notes to condensed consolidated financial statements. 4




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BANK OF COMMERCE HOLDINGS & SUBSIDIARIES 
 Condensed Consolidated Statements of Cash Flows (Unaudited)
 Nine months ended September 30, 2004 and 2003
 September 30,
    
    September 30,Dollars in thousands
    
    2004
    
    2003Cash flows from operating activities:Net Income
    
    $
    3,540
    
    
    $
    3,065Adjustments to reconcile net income to net
cash provided by operating activities:Provision for loan losses
    
    
    420
    
    
    
    415Provision for depreciation and amortization
    
    
    468
    
    
    
    425Compensation expense associated with stock options
    
    
    2
    
    
    
    17Gain on sale of securities available for sale
    
    
    0
    
    
    
    (88
    )Amortization of investment premiums and accretion of
discounts, net
    
    
    (189
    )
    
    
    307Gain on sale of loans
    
    
    (38
    )
    
    
    (99
    )Proceeds from sales of loans originated for sale
    
    
    638
    
    
    
    1,419Loans originated for sale
    
    
    (600
    )
    
    
    (1,093
    )Effect of changes in:Other assets
    
    
    2,660
    
    
    
    2,020Deferred loan fees
    
    
    136
    
    
    
    (35
    )Other liabilities
    
    
    546
    
    
    
    3,775Net cash provided by operating activities
    
    
    7,583
    
    
    
    10,128Cash flows from investing activities:Proceeds from maturities of available-for-sale securities
    
    
    27,524
    
    
    
    14,713Proceeds from sales of available-for-sale securities
    
    
    0
    
    
    
    15,244Proceeds from maturities of held-to-maturity securities
    
    
    895
    
    
    
    796Purchases of available-for-sale securities
    
    
    (36,289
    )
    
    
    (62,979
    )Loan originations, net of principal repayments
    
    
    (28,884
    )
    
    
    1,679Purchases of premises and equipment
    
    
    (244
    )
    
    
    (710
    )Net cash used by investing activities
    
    
    (36,998
    )
    
    
    (31,257
    )Cash flows from financing activities:Net increase in deposits
    
    
    24,435
    
    
    
    27,416Net decrease in securities sold under agreement to repurchase
    
    
    (2,260
    )
    
    
    1,793Proceeds from Federal Home Loan Bank advances
    
    
    90,000
    
    
    
    35,000Repayments of Federal Home Loan Bank advances
    
    
    (90,000
    )
    
    
    (33,000
    )Proceeds from issuance of Junior Subordinated Debt
    
    
    0
    
    
    
    5,000Common stock transactions, net
    
    
    1,172
    
    
    
    (977
    )Net cash provided by financing activities
    
    
    23,347
    
    
    
    35,232Net increase (decrease) in cash and cash equivalents
    
    
    (6,068
    )
    
    
    14,103Cash and cash equivalents, beginning of period
    
    
    32,039
    
    
    
    34,592Cash and cash equivalents, end of period
    
    $
    25,971
    
    
    $
    48,695Supplemental disclosures:Cash paid during the period for:Income taxes
    
    $
    1,315
    
    
    $
    1,752Interest
    
    
    3,565
    
    
    
    3,505
 See accompanying notes to condensed consolidated financial statements. 5




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BANK OF COMMERCE HOLDINGS & SUBSIDIARIES 
  1. Consolidation and Basis of Presentation The unaudited condensed consolidated financial statements include the accounts
of Bank of Commerce Holdings (the Holding Company) and its subsidiaries
Redding Bank of Commerce (RBC or the Bank) and Bank of Commerce Mortgage.
On May 18, 2004, by majority shareholder vote, the Holding Company (Redding
Bancorp) amended the Articles of Incorporation to change the Companys name to
Bank of Commerce Holdings. The new name proves to be more reflective of the
multiple financial holdings of the Company as well as more geographically open
to expansion opportunities. All significant inter-company balances and transactions have been eliminated.
All such adjustments are of a normal recurring nature. The financial
information contained in this report reflects all adjustments that in the
opinion of management are necessary for a fair presentation of the results of
the interim periods. Certain reclassifications have been made to the prior
period consolidated financial statements to conform to the current financial
statement presentation. The accounting and reporting policies of the Company conform to accounting
principles generally accepted in the United States of America and general
practices within the banking industry. In preparing the consolidated financial
statements, management is required to make estimates and assumptions that
affect the reported amounts of assets and liabilities as of the date of the
balance sheet and revenue and expenses for the period. Actual results could
differ from those estimates. The accompanying unaudited condensed consolidated financial statements should
be read in conjunction with the financial statements and related notes
contained in the Companys 2003 Annual Report to Shareholders. The results of
operations and cash flows for the 2004 interim periods shown in this report are
not necessarily indicative of the results for any future interim period or the
entire fiscal year. For purposes of reporting cash flows, cash and cash equivalents include cash on
hand, amounts due from banks, federal funds sold and repurchase agreements.
Generally, federal funds are sold for a one-day period and securities purchased
under agreements to resell are for no more than a 90-day period. 2. Stock Split On July 21, 2004, the Board of Directors declared a three-for-one stock split
on the Companys common stock. All references to per share information and the
number of shares authorized, issued and outstanding for 2004 and 2003 have been
adjusted to reflect the stock split on a retroactive basis. 3. Recent Accounting pronouncements The meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments In March 2004, the FASB ratified the consensuses reached by the Emerging Issues
Task Force (EITF) regarding Issue 03-1, The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments.Issue 03-1 provides
guidance in the recognition and measurement of other-than-temporary impairment
for certain securities, including:  
    
    All debt securities and equity securities that are subject to the
scope of SFAS No. 115, Accounting for Certain Investments in Debt and
Equity Securities; and
    
    Equity securities that are not subject to the scope of SFAS No. 115
and that are accounted for under the cost method of accounting, or cost
method investments. Issue 03-1 also provides guidance on disclosure requirements for
other-than-temporary impairment for cost method investments. The guidance in
these areas are effective for fiscal years ending after June 15, 2004. The
implementation of these areas of Issue 03-1 is not anticipated to have a
material impact on our financial statements. The Company has previously adopted
the disclosure provisions of Issue 03-1 for debt and equity investments that
are accounted for under SFAS No.115. Those requirements were effective for
fiscal years ending after December 15, 2003. 6




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BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements The Meaning of Other-Than-Temporary Impairment and Its application to Certain
Investments (continued) On September 30, 2004, the FASB issued a proposed Board-directed Staff
Position, FSP EITF Issue 03-1-a, Implementation Guidance for the Application of
Paragraph 16 of EITF issue No. 03-1, The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments.The proposed FSP would
provide implementation guidance with respect to debt securities that are
impaired solely due to interest rates and/or sector spreads and analyzed for
other-than-temporary impairment under paragraph 16 of Issue 03-1. The Board has
asked the FASB staff to delay the effective date for the measurement and
recognition guidance contained in paragraphs 10-20 of Issue 03-1. This delay
does not suspense the requirement to recognize other-than-temporary impairments
as required by existing authoritative literature. The delay of the effective
date for paragraphs 10-20 of Issue 03-1 will be superseded concurrent with the
final issuance of FSB EITF Issue 03-1-a. Application of Accounting Principles to Loan Commitments(SAB105)On March 9,
2004, the Securities and Exchange Commission issued Staff Accounting Bulletin
No. 105 Application of Accounting Principles to Loan Commitments(SAB 105),
which specifies that servicing assets embedded in commitments for loans to be
held for sale should be recognized only when the servicing asset has been
contractually separated from the association loans by sale or securitization.
SAB 105 is effective for commitments entered into after March 31, 2004. SAB 105
has had no effect on the Companys results of operations or financial
condition. 4. Earnings per Share Basic earnings per share exclude dilution and is computed by dividing net
income by the weighted-average number of common shares outstanding for the
period. Diluted earnings per share reflects the potential dilution that could
occur if securities or other contracts to issue common stock were exercised or
converted into common stock or resulted in the issuance of common stock that
then shared in the earnings of the entity. The following table displays the
computation of earnings per share for the three and nine months ended September
30, 2004 and 2003. (Amounts in thousands, except per share data) Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,
    
    September 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Basic EPS Calculation:Numerator (net income)
    
    $
    1,267
    
    
    $
    1,254
    
    
    $
    3,540
    

    
    $
    3,065Denominator (average common
shares outstanding)
    
    
    8,260
    
    
    
    8,091
    
    
    
    8,192
    
    
    
    8,001Basic earnings per Share
    
    $
    0.15
    
    
    $
    0.15
    
    
    $
    0.43
    
    
    $
    0.38Diluted EPS Calculation:Numerator (net income)
    
    $
    1,267
    
    
    $
    1,254
    
    
    $
    3,540
    
    
    $
    3,065Denominator:Average common shares outstanding
    
    
    8,260
    
    
    
    8,091
    
    
    
    8,192
    
    
    
    8,001Options
    
    
    381
    
    
    
    339
    
    
    
    302
    
    
    
    2828,641
    
    
    
    8,430
    
    
    
    8,494
    
    
    
    8,283Diluted earnings per Share
    
    $
    0.15
    
    
    $
    0.15
    
    
    $
    0.42
    
    
    $
    0.37
 5. Stock Option Plans The Company accounts for its stock option plan under the intrinsic value method
in accordance with the provisions of Accounting Principles Board (APB) Opinion
No. 25, Accounting for Stock Issued to Employees, and related interpretations.
As such, compensation expense is recorded only if the current market price of
the underlying stock exceeds the exercise price on the date of the grant. 7




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BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements As required by the Statement of Financial Accounting Standards, (SFAS) No.
123, Accounting for Stock-Based Compensationas amended by SFAS No. 148,
Accounting for Stock-Based Compensation  Transition and Disclosure,the
Company provides pro forma net income and pro forma earnings per share
disclosures for employee stock option grants. The following table illustrates
the effect on net income and earnings per share as if the Company had applied
the fair value recognition provisions of SFAS No. 123, Accounting for
Stock-Based Compensation,to stock-based employee compensation. Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,
    
    September 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net incomeAs reported
    
    $
    1,267
    
    
    $
    1,254
    
    
    $
    3,540
    
    
    $
    3,065Deduct:Total
stock-based
employee
compensation
expense
determined
under fair
value based
method for
all awards,
net of related
tax effects
    
    
    (37
    )
    
    
    (19
    )
    
    
    (112
    )
    
    
    (57
    )Pro forma net income
    
    $
    1,230
    
    
    $
    1,235
    
    
    $
    3,428
    
    
    $
    3,008Earnings per share:Basic  as reported
    
    $
    0.15
    
    
    $
    0.15
    
    
    $
    0.43
    
    
    $
    0.38Basic  pro forma
    
    $
    0.15
    
    
    $
    0.15
    
    
    $
    0.42
    
    
    $
    0.37Diluted  as reported
    
    $
    0.15
    
    
    $
    0.15
    
    
    $
    0.42
    
    
    $
    0.37Diluted  pro forma
    
    $
    0.14
    
    
    $
    0.14
    
    
    $
    0.40
    
    
    $
    0.36
 The fair value of options granted during 2004 and 2003 is estimated using a
binomial option-pricing model with the following assumptions: volatility of
30.87% and 22.75%, risk-free interest rate of 3.43% and 3.27% expected
dividends of $0.23 per share per year, annual dividend rate of 3.15% and 1.98%,
assumed forfeiture rate of zero and an expected life of seven years. 6. Comprehensive Income The Companys total comprehensive income was as follows: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,
    
    September 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net Income as reported
    
    $
    1,267
    
    
    $
    1,254
    
    
    $
    3,540
    
    
    $
    3,065Other comprehensive income
net of tax:Unrealized holding (loss)gain
on
securities available for sale
    
    
    743
    
    
    
    (530
    )
    
    
    (41
    )
    
    
    (463
    )Reclassification adjustment for
gain on available for sale
securities
    
    
    (0
    )
    
    
    (35
    )
    
    
    (0
    )
    
    
    (95
    )Total other comprehensive income
    
    
    743
    
    
    
    (565
    )
    
    
    (41
    )
    
    
    (558
    )Total comprehensive income
    
    $
    2,010
    
    
    $
    689
    
    
    $
    3,499
    
    
    $
    2,507
 8




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##### Table of Contents



BANK OF COMMERCE HOLDINGS & SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements 7. Junior Subordinated Debentures (Trust Preferred Securities) During 2003, Bank of Commerce Holdings (formerly Redding Bancorp) formed a
wholly-owned Delaware statutory business trust, Bank of Commerce Holdings
Trust, which issued $5.0 million of guaranteed preferred beneficial interests
in Bank of Commerce Holdings junior subordinated debentures (the Trust
Notes). These debentures qualify as Tier 1 capital under Federal Reserve Board
guidelines. The proceeds from the issuance of the Trust Notes were transferred
from the subsidiary grantor trust to the Holding Company and from the Holding
Company to the Bank as additional capital. The Trust Notes accrue and pay
distributions on a quarterly basis at 3 month London Interbank Offered Rate
(LIBOR) plus 3.30%. The rate at September 30, 2004 was 4.90%. The rate
increase is capped at 2.75% annually and the lifetime cap is 12.5%. The final
maturity on the Trust Notes is March 18, 2033, and the debt allows for
prepayment after five years on the quarterly payment date. 8. Commitments and contingent liabilities Lease Commitments The Company leases certain facilities at which
it conducts its operations. Future minimum lease commitments under all
non-cancelable operating leases as of September 30, 2004 are below: (Dollars in
thousands)2004
    
    $
    772005
    
    $
    3592006
    
    $
    3712007
    
    $
    3772008
    
    $
    383Thereafter
    
    $
    1,226Total
    
    $
    2,793
 Legal Proceedings The Company is involved in various pending and
threatened legal actions arising in the ordinary course of business. The
Company maintains reserves for losses from legal actions, which are both
probable and estimable. In the opinion of management, the disposition of
claims, currently pending will not have a material adverse affect on the
Companys financial position or results of operations. Off-Balance
Sheet Financial Instruments In the ordinary course of
business, the Company enters various types of transactions, which involve
financial instruments with off-balance sheet risk. These instruments
include commitments to extend credit and standby letter of credits, which
are not reflected in the accompanying consolidated balance sheets. These
transactions may involve, to varying degrees, credit and interest rate
risk more than the amount, if any recognized in the consolidated balance
sheets. 9. Federal Home Loan Bank Advances FHLB
Advances  Included in other borrowings are advances from the Federal
Home Loan Bank of San Francisco (FHLB) totaling $30,000,000 as of
September 30, 2004 and $20,000,000 as of September 30, 2003. The FHLB
advances bear fixed rates of interest ranging from 1.25% to 1.92%.
Interest is payable on a monthly basis. FHLB advances due as follows:
$10,000,000 maturing October 24, 2004 at 1.25%, $10,000,000 maturing
January 24, 2005 at 1.92%, and $10,000,000 maturing on February 4, 2005 at
1.39%. These borrowings are secured by an investment in FHLB stock and
certain real estate mortgage loans which have been specifically pledged to
the FHLB pursuant to their collateral requirements. Based upon the level
of FHLB advances, the Company was required to hold a minimum investment in
FHLB stock of $1,663,000 and to pledge $36,248,343 of its real estate
mortgage loans to the FHLB as collateral as of September 30, 2004. 9




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward looking statements and risk factors This discussion and information in the accompanying financial statements
contains certain forward-looking statements, which are made pursuant to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
Such statements are subject to risks and uncertainties that could cause actual
results to differ materially from those stated. These risks and uncertainties
include the Companys ability to maintain or expand its market share and net
interest margins, or to implement its marketing and growth strategies. Further,
actual results may be affected by the Companys ability to compete on price and
other factors with other financial institutions; customer acceptance of new
products and services; and general trends in the banking and the regulatory
environment, as they relate to the Companys cost of funds and return on
assets. The reader is advised that this list of risks is not exhaustive and
should not be construed as any prediction by the Company as to which risks
would cause actual results to differ materially from those indicated by the
forward-looking statements. Readers are cautioned not to place undue reliance
on these forward-looking statements. For additional information concerning risks and uncertainties related to the
Company and its operations please refer to the Companys Annual Report on Form
10-K for the year ended December 31, 2003 under the heading Risk factors that
may affect results. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date hereof. The Company
undertakes no obligation to revise or publicly release the results of any
revision to these forward-looking statements to reflect events or circumstances
after the date hereof or to reflect the occurrence of unanticipated events. The following sections discuss significant changes and trends in financial
condition, capital resources and liquidity of the Company from December 31,
2003 to September 30, 2004. Also discussed are significant trends and changes
in the Companys results of operations for the three and nine-months ended
September 30, 2004, compared to the same period in 2003. The consolidated
financial statements and related notes appearing elsewhere in this report are
condensed and unaudited. The following discussion and analysis is intended to
provide greater detail of the Companys financial condition and results. 
 Corporate Overview Bank of Commerce Holdings (the Holding Company) is a financial holding
company (FHC) registered under the Bank Holding Company Act of 1956, as
amended, and was incorporated in California on January 21, 1982, for the
purpose of organizing, as a wholly owned subsidiary, Redding Bank of Commerce
(the Bank). The Holding Company elected to change to a FHC in 2000. As a
financial holding company, the Holding Company is subject to the Financial
Holding Company Act and to supervision by the Board of Governors of the Federal
Reserve System (FRB). The Holding Companys principal business is to serve
as a holding company for Redding Bank of Commerce, Bank of Commerce Mortgage, a
California corporation (formerly Redding Service Corporation), and for other
banking or banking-related subsidiaries which the Holding Company may establish
or acquire (collectively the Company). The Holding Company also has an
unconsolidated subsidiary, Bank of Commerce Holdings Trust. During 2003, Bank
of Commerce Holdings formed a wholly-owned Delaware statutory business trust,
Bank of Commerce Holdings Trust, which issued $5.0 million of guaranteed
preferred beneficial interests in Bank of Commerce Holdings junior subordinated
debentures (the Trust Notes). These debentures qualify as Tier 1 capital
under Federal Reserve Board guidelines. 10




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##### Table of Contents



MANAGEMENTS DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) The Bank was incorporated as a California banking corporation on November 25,
1981, and received its certificate of authority to begin banking operations on
October 22, 1982. The Bank operates four full service branch facilities. The
Bank established its first full service branch at 1177 Placer Street, Redding,
California, and opened for business on October 22, 1982. On November 1, 1988,
the Bank received a certificate of authority to establish and maintain a loan
production office in Citrus Heights, California. On September 1, 1998, the
Bank relocated the loan production office to 2400 Professional Drive in
Roseville, California. On March 1, 1994, the Bank received a certificate of authority to open a second
full-service branch at 1951 Churn Creek Road in Redding, California. On June
30, 2000, the Bank received a certificate of authority to convert the loan
production office in Roseville to a full service banking facility under the
name Roseville Bank of Commerce, a division of Redding Banking of Commerce. On June 15, 2001, the Bank acquired the deposit liabilities of First Plus Bank
at Citrus Heights, California and has renamed the facility Roseville Bank of
Commerce at Sunrise, a division of Redding Bank of Commerce. On February 22,
2002, the Roseville Bank of Commerce at Eureka Road, a division of Redding Bank
of Commerce, relocated to its permanent location at 1504 Eureka Road, Suite
100, Roseville, California. On February 16, 2004, Redding Service Corporation, an affiliate of Redding Bank
of Commerce and a wholly-owned subsidiary of the Holding Company, changed its
name to Bank of Commerce Mortgage (the Mortgage Company), an affiliate of
Redding Bank of Commerce. The principal business of the subsidiary is mortgage
brokerage services. Before the formation of the subsidiary, mortgage banking
services were performed as a department of the Bank. On July 1, 2004, Bank of
Commerce Mortgage relocated to its permanent location at 1024 Mistletoe Lane in
Redding, California. On May 18, 2004, by majority shareholder vote, the Holding Company (Redding
Bancorp) amended the Articles of Incorporation to change the Companys name to
Bank of Commerce Holdings. The new name proves to be more reflective of the
multiple financial holdings of the Company as well as more geographically open
to expansion opportunities. On May 24, 2004 the Company was approved to list on the NASDAQ National Market
under the trading symbol BOCH (Bank of Commerce Holdings). The listing became
live on June 15, 2004. On July 21, 2004, the Board of Directors declared a three-for-one stock split
on the Companys common stock. The decision to declare the stock split was
intended to make it easier for our current and future investors to enjoy
ownership in our Company. On September 21, 2004 the Board of Directors passed a resolution for a $0.23
per share cash dividend to be paid during the fourth quarter to stockholders of
record as of October 1, 2004 payable on October 22, 2004, contingent on
financial results. The Holding Companys principal source of income is dividends from its
subsidiaries. The Holding Company conducts its corporate business operations
at the administrative office of the Bank located at 1951 Churn Creek Road,
Redding, California 96002. The Company conducts its business operations in two
geographic market areas, Redding and Roseville, California. The Company
considers Upstate California to be the major market area of the Bank. The
three Internet addresses of the Company are reddingbankofcommerce.com,
rosevillebankofcommerce.com, and bankofcommercemortgage.com. The Bank is principally supervised and regulated by the California
Department of Financial Institutions (DFI) and the Federal Deposit Insurance
Corporation (FDIC), and conducts a general commercial banking business in the
counties of El Dorado, Placer, Shasta, and Sacramento, California. 11




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MANAGEMENTS DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Through the Bank and mortgage subsidiaries, the Company provides a wide range
of financial services and products. The services offered by the Bank include
those traditionally offered by commercial banks of similar size and character
in California. Products such as checking, interest-bearing checking (NOW) and
savings accounts, money market deposit accounts, commercial, construction, and
term loans, travelers checks, safe deposit boxes, collection services and
electronic banking activities. The primary focus of the Bank is to provide
services to the business and professional community of its major market area,
including Small Business Administration loans, payroll and accounting packages,
benefit administration and billing services. The Bank currently does not offer
trust services or international banking services. The services offered by the
Mortgage Company include single and multi-family residential financing,
refinancing and equity lines of credit. Most of the Banks customers are small to medium sized businesses,
professionals and other individuals with medium to high net worth, and most of
the Banks deposits are obtained from such customers. The Bank emphasizes
servicing the needs of local businesses and professionals and individuals
requiring specialized services. The primary business strategy of the Bank is
to focus on its lending activities. The Banks principal lines of lending are
(i) commercial, (ii) real estate construction and (iii) commercial and
residential real estate. The majority of the loans of the Bank are direct
loans made to individuals and small businesses in the major market area of the
Bank and are secured by real estate. See -Risk Factors That May Affect
Results-Dependence on Real Estate in the Companys 2003 Annual Report on Form
10-K. A relatively small portion of the loan portfolio of the Bank consists of
loans to individuals for personal, family or household purposes. The Bank
accepts real estate, listed and unlisted securities, savings and time deposits,
automobiles, machinery and equipment and other general business assets such as
accounts receivable and inventory as collateral for loans. The Companys goal
is to be a premier provider of financial services to the business and
professional community of its major market area including Small Business
Administration (SBA) loans, commercial building financing, credit card
services, payroll accounting packages, lock box and billing programs. The
Company measures premier performance by monitoring key operating ratios to high
performing peer information on a national level, and model strategies to meet
or exceed such goals. 
 Executive Overview Our Company was established to make a profitable return while serving the
financial needs of the business and professional communities of our markets. We
are in the financial services business, and no line of financial services is
beyond our charter as long as it serves the needs of businesses, professionals
and consumers in our communities. The mission of our Company is to provide its
stockholders with a safe, profitable return on their investment, over the long
term. Management will attempt to minimize risk to our stockholders by making
prudent business decisions, will maintain adequate levels of capital and
reserves, and will maintain effective communications with stockholders. Our Companys most valuable asset is its customers. We will consider their
needs first when we design our products. High-quality customer service is an
important mission of our Company, and how well we accomplish this mission will
have a direct influence on our profitability. Our vision is to embrace changes in the industry and develop profitable
business strategies that allow us to maintain our customer relationships and
build new ones. Our competitors are no longer just banks. We must compete with
financial powerhouses that want our core business. The flexibility provided by
the Financial Holding Company Act will become increasingly important. We have
developed strategic plans that evaluate additional financial services and
products that can be delivered to our customers efficiently and profitably.
Producing quality returns is, as always, a top priority. The Companys long term success rests on the shoulders of the leadership team
to effectively work to enhance the performance of the Company. As a financial
services company, we are in the business of taking risk. Whether we are
successful depends largely upon whether we take the right risks and get paid
appropriately for the risks we take. Our governance structure enables us to
manage all major aspects of the Companys business effectively through an
integrated process that includes financial, strategic, risk and leadership
planning. 12




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued) We define risks to include not only credit, market and liquidity risk  the
traditional concerns for financial institutions  but also operational risks,
including risks related to systems, processes or external events, as well as
legal, regulatory and reputation risks. Our management processes, structures
and policies help to ensure compliance with laws and regulations and provide
clear lines for decision-making and accountability. Results are important, but
equally important is how we achieve those results. Our core values and
commitment to high ethical standards is material to sustaining public trust and
confidence in our Company. For additional information concerning risks and
uncertainties related to the Company and its operations please refer to the
Companys Annual Report on Form 10-K for the year ended December 31, 2003 under
the heading of Risk Management. 
 Sources of Income The Company derives its income from two principal sources: (i) net interest
income, which is the difference between the interest income it receives on
interest-earning assets and the interest expense it pays on interest-bearing
liabilities, and (ii) fee income, which includes fees earned on deposit
services, income from SBA lending, electronic-based cash management services,
mortgage brokerage fee income and merchant credit card processing services.
The income of the Bank depends to a great extent on net interest income. These
interest rate factors are highly sensitive to many factors, which are beyond
the Companys control, including general economic conditions, inflation,
recession, and the policies of various governmental and regulatory agencies, in
particular, the Federal Reserve Board. Because of the Banks predisposition to
variable rate pricing and non-interest bearing demand deposit accounts, the
Bank is considered asset sensitive. As a result, the Company is adversely
affected by declining interest rates. 
 Financial Highlights - Results of Operations Net income for the third quarter of 2004 totaled $1,267,000 an increase of
1.04% from the $1,254,000 reported for the same quarterly period of 2003. On
the same basis, diluted earnings per common share for the third quarter of 2004
were $0.15, compared to $0.15 for the same period of 2003. Return on average
assets (ROA) and return on average equity (ROE) for the third quarter of 2004
were 1.21% and 13.15%, respectively, compared with 1.29% and 14.51%,
respectively, for the third quarter of 2003. Net income for the nine-month period ended September 30, 2004 totaled
$3,540,000, an increase of 15.5% over net income reported for the same
nine-month period ended September 30, 2003. On the same basis, diluted earnings
per common share for the nine-months ended September 30, 2004 was $0.42,
compared to $0.37 for the same nine-month period in 2003, a 13.5% increase. ROA
was 1.17% and ROE was 12.73% for the first nine-months of 2004 compared with
1.08% and 12.80%, respectively, for the same nine-month period of 2003. 
 Net Interest Income and Net Interest Margin Net interest income is the primary source of the Companys income. Net interest
income represents the excess of interest and fees earned on interest-earning
assets (loans, securities and Federal Funds sold) over the interest paid on
deposits and borrowed funds. Net interest margin is net interest income
expressed as a percentage of average earning assets. Net interest income for
the quarter ended September 30, 2004 was $4.27 million compared with $3.73
million for the same period in 2003 an increase of 14.4%. Net interest income
for the nine-months ended September 30, 2004 was $12.28 million compared with
$10.77 million for the same nine-month period in 2003, an increase of 13.99%. Average earning assets for the nine-months ended September 30, 2004 increased
$24.8 million or 7.2% compared with the same period in the prior year. Loans,
the largest component of earning assets, increased $6.2 million or 2.2% on
average compared with the prior year period. Average securities increased $27.8
million or 69.8% over the prior period. Overall, the yield on earning assets
decreased to 5.47% for the nine-month period compared to 5.52% for the same
period in the prior year. The decrease is primarily due to new loan production
priced at lower rates, available funds being invested into the security
portfolio while loan growth remained relatively level for the period. 13




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued) Average interest-bearing liabilities for the nine-months ended September 30,
2004 increased $8.7 million or 3.1% compared with the prior year period. Of
this increase, $7.6 million was in core deposit growth (interest-bearing demand
and savings accounts), generally the least expensive deposit categories, while
certificates of deposit decreased by $9.9 million. Demand deposits increased by
$8.9 million or 14.6% over the prior nine-month period. Federal Home Loan Bank
borrowings increased $10.0 million compared with the prior year period. The
Companys strategy is to replace higher costing funding sources with increases
in core deposits and Federal Home Loan Bank borrowings to supplement loan
growth and to leverage into securities to improve the spread in the margin.
Borrowings are kept short and repaid as core deposit growth increases. The overall cost of interest-bearing liabilities for the first nine-months 2004
was 1.36% compared with 1.69% for the first nine-months of 2003, a 17.36%
decrease. The decrease was combined as a result of decreases in the volume of
time deposits and rates paid on time deposits. Time deposits were replaced with
growth in core demand and interest-bearing deposits. The net effect of the changes discussed above resulted in an increase of
$1,507,000 or 13.99% in net interest income for the nine-month period ended
September 30, 2004 from the same period in 2003. Net interest margin increased
26 basis points to 4.41% from 4.15% for the same period a year ago. 
 Liquidity The objective of liquidity management is to ensure that the Company can
efficiently meet the borrowing needs of our customers, withdrawals of our
depositors and other cash commitments under both normal operating conditions
and under unforeseen and unpredictable circumstances of industry or market
stress. The Asset Liability Management Committee (ALCO) establishes and monitors
liquidity guidelines that require sufficient asset-based liquidity to cover
potential funding requirements and to avoid over-dependence on volatile, less
reliable funding markets. In addition to the immediately liquid resources of
cash and due from banks and federal funds sold, asset liquidity is supported by
debt securities in the available for sale security portfolio and wholesale
lines of credit with the Federal Home Loan Bank and borrowing lines with other
financial institutions. Customer core deposits have historically provided the
Company with a source of relatively stable and low-cost funds. During 2004, the
Company formed an Internal ALCO Roundtable that meets on an every two-week
basis to monitor economic conditions and establish strategies to maintain and
increase the net interest margin while monitoring appropriate liquidity levels. The Companys consolidated liquidity position remains adequate to meet
short-term and long-term future contingencies. At September 30, 2004, the
Company had overnight investments of $12.2 million and available lines of
credit of at the Federal Home Loan bank of approximately $72.4 million, and two
federal funds borrowing lines with correspondent banks of $15.0 million. 
 Capital Management The Company uses capital to fund organic growth, pay dividends and repurchase
its shares. The objective of effective capital management is to produce above
market long-term returns by using capital when returns are perceived to be high
and issuing capital when costs are perceived to be low. The Companys potential
sources of capital include retained earnings, common and preferred stock
issuance and issuance of subordinated debt and trust preferred securities. Total shareholder equity increased from December 31, 2003 by $5.3 million to
$35.8 million at September 30, 2004. The increase was a result of earnings of
$3.5 million, $1.8 million from exercises of stock options, including tax
benefits, and a decrease in accumulated other comprehensive income of
approximately $41,000. 14




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##### Table of Contents



MANAGEMENTS
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Continued) Actual
    
    WellCapitalized
    
    MinimumCapitalCapital
    
    Ratio
    
    Requirement
    
    RequirementThe CompanyLeverage
    
    $
    41,130,309
    
    
    
    9.79
    %
    
    
    n/a
    
    
    
    4.0
    %Tier 1 Risk-Based
    
    
    41,130,309
    
    
    
    11.94
    %
    
    
    n/a
    
    
    
    4.0
    %Total Risk-Based
    
    
    44,862,258
    
    
    
    13.02
    %
    
    
    n/a
    
    
    
    8.0
    %Redding Bank of CommerceLeverage
    
    $
    39,083,937
    
    
    
    9.36
    %
    
    
    5.0
    %
    
    
    4.0
    %Tier 1 Risk-Based
    
    
    39,083,937
    
    
    
    11.34
    %
    
    
    6.0
    %
    
    
    4.0
    %Total Risk-Based
    
    
    42,815,886
    
    
    
    12.43
    %
    
    
    10.00
    %
    
    
    8.0
    %
 
 Short term borrowings The Bank actively uses Federal Home Loan Bank (FHLB) advances as a source of
wholesale funding to support growth strategies as well as to provide liquidity.
At September 30, 2004, all of the banks FHLB advances were fixed rate, fixed
term borrowings without call or put option features. At September 30, 2004, the Bank had $30 million in FHLB short-term advances
outstanding at an average rate of 1.30% compared to $20 million at an average
rate of 1.63% at September 30, 2003. 
 Provision for loan losses The Companys most significant management accounting estimate is the
appropriate level for the allowance for loan and lease losses. The Company
follows a methodology for calculating the appropriate level for the allowance
for loan and lease losses as discussed under Asset Quality and Allowance for
Loan and Lease Losses (ALLL) in this document. Provision for loan losses of $420,000 were provided for the nine-months ended
September 30, 2004 compared with $415,000 for the same period of 2003. Redding
Bank of Commerces allowance for loan losses was 1.20% of total loans at
September 30, 2004 and 1.41% at September 30, 2003, while its ratio of
non-performing assets to total assets was 0.70% at September 30, 2004, compared
to 0.89% at September 30, 2003. Year-to-date net charge-offs of $363,384 were
primarily related to a partial write down on one credit that was fully
reserved, compared to net recoveries of $1,000 in the same period last year. 
 Factors that may affect future results As a financial services company, our earnings are significantly affected by
general business and economic conditions. These conditions include short-term
and long-term interest rates, inflation, monetary supply, fluctuations in both
debt and equity capital markets, and the strength of the United States economy
and local economies in which we operate. For example, an economic downturn,
increase in unemployment, or other events that negatively impact household
and/or corporate incomes could decrease the demand for the Companys loan and
non-loan products and services and increase the number of customers who fail to
pay interest or principal on their loans. Geopolitical conditions can also affect our earnings. Acts or threats of
terrorism, actions taken by the United States or other governments in response
to acts or threats of terrorism and our military conflicts including the
aftermath of the war with Iraq, could impact business conditions in the United
States. 15




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##### Table of Contents



MANAGEMENTS DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) The Board of Governors of the Federal Reserve System regulates the supply of
money and credit in the United States. Its policies determine in large part our
cost of funds for lending and investing and the return we earn on those loans
and investments, both of which impact our net interest margin, and can
materially affect the value of financial instruments we hold. Its policies can
also affect our borrowers, potentially increasing the risk of failure to repay
their loans. Changes in Federal Reserve Board policies are beyond our control
and hard to predict or anticipate. We operate in a highly competitive industry that could become even more
competitive because of legislative, regulatory and technological changes and
continued consolidation. Banks, securities firms and insurance companies can
now merge creating a financial holding company that can offer virtually any
type of financial service, including banking, securities underwriting,
insurance (agency and underwriting) and merchant banking. Technology has
lowered barriers to entry and made it possible for non-banks to offer products
and services traditionally provided by banks, such as automatic transfer and
automatic payment systems. Many of our competitors have fewer regulatory
constraints and some have lower cost structures. The holding company, subsidiary bank and nonbank subsidiary are heavily
regulated at the federal and state levels. This regulation is to protect
depositors, federal deposit insurance funds and the banking system as a whole,
not investors. Congress and state legislatures and federal and state regulatory
agencies continually review banking laws, regulations and policies for possible
changes. Changes to statutes, regulations or regulatory policies including
changes in interpretation and implementation could affect us in substantial and
unpredictable ways including limiting the types of financial services and
products we may offer. Our failure to comply with the laws, regulations or
policies could result in sanctions by regulatory agencies and damage our
reputation. For more information, refer to the Supervision and Regulation
section in the Companys 2003 Form 10-K. Our success depends, in part, on our ability to adapt our products and services
to evolving industry standards. There is increasing pressure on financial
services companies to provide products and services at lower prices. This can
reduce our net interest margin and revenues from fee-based products and
services. In addition, the widespread adoption of new technologies, including
internet-based services, could require us to make substantial expenditures to
modify or adapt our existing products and services. Our success depends, in
large part, on our ability to attract and retain key people. Competition for
the best people can be intense. The holding company is a separate and distinct legal entity from its
subsidiaries. It receives substantially all of its revenues from dividends
from its subsidiaries. These dividends are the principal source of funds to
pay dividends on the holding companys common stock and interest and principal
on its debt. Various federal and state laws and regulations limit the amount
of dividends that our bank may pay to the holding company. For more
information, refer to Dividends and Other Distributions in the Companys
2003 Form 10-K. Advances and changes in technology can significantly affect the business and
operations of the Company. The Company faces many challenges included the
increased demand for providing computer access to bank accounts and the
systems to perform banking transactions electronically. The Companys ability
to compete depends on its ability to continue to adapt its technology on a
timely and cost-effective basis to meet these requirements. The Companys
business and operations are susceptible to negative impacts from computer
system failures, communication and energy disruption and unethical individuals
with the technological ability to cause disruptions or failures of the
Companys data processing systems. During 2004, the Companys provider of core
processing software (Aurum Technology- ABS System) was acquired by Fidelity
National Financial, Inc. (FNF). FNF is a Fortune 500 provider of products
and solutions to financial institutions, with over $7.7 billion in revenues
and $1.3 billion in cash flows. FNF offers a competitive solution to core
processing. The Company has assurances from FNF that software support and
releases would continue to be compliant with Federal regulations. 
 Specific Risks to operations in California Our operations are located entirely in the State of California, which in
recent years has experienced economic disruptions that are unique to the
state. We can offer no assurances that the critical impact of the California
economic crisis will not have a material adverse affect on our customers or
on our business and results of operations. 16




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##### Table of Contents



MANAGEMENTS DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) 
 Critical Accounting Policies The Securities and Exchange Commission (SEC) issued disclosure guidance for
critical accounting policies. The SEC defines critical accounting policies
as those that require application of managements most difficult, subjective or
complex judgements, often as a result of the need to make estimates about the
effect of matters that are inherently uncertain and may change in future
periods. Our accounting policies are integral to understanding the results reported.
Accounting policies are described in detail in Note 2 of the NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS in the Companys 2003 Annual report on Form
10-K. Not all of significant accounting policies presented in Note 2 to the
Consolidated Financial Statements contained in the Companys 2003 Annual Report
on Form 10-K require management to make difficult, subjective or complex
judgements or estimates. Preparation of financial statements The preparation of these financial statements requires management to make
estimates and judgements that affect the reported amount of assets,
liabilities, revenues and expenses. On an ongoing basis, management evaluates
the estimates used. Estimates are based upon historical experience, current
economic conditions and other factors that management considers reasonable
under the circumstances. Use of estimates These estimates result in judgements regarding the carrying values of assets
and liabilities when these values are not readily available from other sources,
as well as assessing and identifying the accounting treatments of contingencies
and commitments. Actual results may differ from these estimates under different
assumptions or conditions. Generally Accepted Accounting Principles in the United States of America The Companys financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America (GAAP). The
Companys significant accounting policies are presented in Note 2 to the
Consolidated Financial Statements contained in the Companys 2003 Annual Report
on Form 10-K. The Company follows accounting policies typical to the community commercial
banking industry and in compliance with various regulations and guidelines as
established by the Financial Accounting Standards Board (FASB) and the Banks
primary federal regulator, the FDIC. The following is a brief description of
our current accounting policies involving significant management judgments.
Accounting principles generally accepted in the United States of America
(GAAP), itself may change over time, having impact over the reporting of the
Companys financial activity. Although the economic substance of the Companys
transactions would not change, alterations in GAAP could affect the timing or
manner of accounting or reporting. Allowance for Loan and Lease Losses (ALLL) The Allowance for loan losses is managements best estimate of the probable
losses that may be sustained in our loan portfolio. The allowance is based on
two basic principles of accounting. (1) SFAS No.5 which requires that losses be
accrued when they are probable of occurring and estimable and (2) SFAS No. 114,
which requires that losses be accrued based on the differences between that
value of collateral, present value of future cash flows or values that are
observable in the secondary market and the loan balance. The Company performs
periodic and systematic detailed evaluations of its lending portfolio to
identify and estimate the inherent risks and assess the overall collectibility.
These evaluations include general conditions such as the portfolio composition,
size and maturities of various segmented portions of the portfolio such as
secured, unsecured, construction, and Small Business Administration (SBA). 17




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##### Table of Contents



MANAGEMENTS DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Additional factors include concentrations of borrowers, industries,
geographical sectors, loan product, loan classes and collateral types; volume
and trends of loan delinquencies and non-accrual; criticized and classified
assets and trends in the aggregate in significant credits identified as watch
list items. There are several components to the determination of the adequacy
of the ALLL. Each of these components is determined based upon estimates that
can and do change when the actual events occur. The Company estimates the SFAS
No. 5 portion of the ALLL based on the segmentation of its portfolio. For those
segments that require an ALLL, the Company estimates loan losses on a monthly
basis based upon its ongoing loan review process and analysis of loan
performance. The Company follows a systematic and consistently applied approach to select
the most appropriate loss measurement methods and support its conclusions and
rationale with written documentation. One method of estimating loan losses for
groups of loans is through the application of loss rates to the groups
aggregate loan balances. Such rates typically reflect historical loss
experience for each group of loans, adjusted for relevant economic factors over
a defined period of time. The Company evaluates and modifies its loss
estimation model as needed to ensure that the resulting loss estimate is
consistent with GAAP. For individually impaired loans, SFAS No. 114 provides guidance on the
acceptable methods to measure impairment. Specifically, SFAS No. 114 states
that when a loan is impaired, the Company should measure impairment based on
the present value of expected future principal and interest cash flows
discounted at the loans effective interest rate, except that as a practical
expedient, a creditor may measure impairment based on a loans observable
market price or the fair value of collateral, if the loan is collateral
dependent. When developing the estimate of future cash flows for a loan, the
Company considers all available information reflecting past events and current
conditions, including the effect of existing environmental factors. Revenue recognition The Companys primary sources of revenue are interest income. Interest income
is recorded on an accrual basis. Note 2 to the Consolidated Financial
Statements contained in the Companys 2003 Annual Report on Form 10-K offers an
explanation of the process for determining when the accrual of interest income
is discontinued on an impaired loan. Stock-based Compensation The Company applies Accounting Principles Board (APB) Opinion No. 25 and
related interpretations in accounting for stock options. Under APB No. 25,
compensation cost for stock options is measured as the excess, if any, of the
fair market value of the Companys stock at the date of grant over the amount
the employee or director must pay to acquire the stock. Because the Companys
stock option plans provides for the issuance of options at a price of no less
than the fair market value at the date of grant, no compensation cost is
required to be recognized for the stock option plans. Had compensation costs for the stock option plans been determined based upon
the fair value at the date of grant consistent with SFAS No. 123, Accounting
for Stock Based Compensation, the Companys net income and earnings per share
would have been reduced. The reduction in the Companys net income had
compensation costs been determined in accordance with FAS No. 123 would have
been $112,000 and $57,000 for the nine-months ended September 30, 2004 and
2003, respectively. There would have been $0.02 per share decrease in diluted
earnings per share in 2004 and $0.01 per share decrease in 2003. The amount of the reduction for the fiscal years 2001 through 2003 is disclosed
in Note 13 to the Consolidated Financial Statements contained in the 2003
Annual Report on Form 10-K, based upon the assumptions listed therein. 18




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##### Table of Contents



MANAGEMENTS DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Income Taxes The Company accounts for income taxes under the asset liability method. Under
the asset and liability method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using currently enacted tax rates applied to such taxable income in the years
in which those temporary differences are expected to be recovered or settled.
The effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date. If future
income should prove non-existent or less than the amount of deferred tax assets
within the tax years to which they may be applied, the asset may not be
realized and our net income will be reduced. Our deferred tax assets are
described further in Note 12 of the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
in the Companys 2003 Annual Report on Form 10-K. The following table presents the Companys daily average balance
sheet information together with interest income and yields earned on
average interest-bearing assets and interest expense and rates paid on
average interest-bearing liabilities. Average balances are average daily
balances. 
 Table 1. Average Balances, Interest Income/Expense and Yields/Rates Paid (Unaudited, Dollars in thousands)
 Nine Months Ended
    
    Nine Months EndedSeptember 30, 2004
    
    September 30, 2003Average
    
    
    
    
    
    Yield/
    
    Average
    
    
    
    
    
    Yield/Balance
    
    Interest
    
    Rate
    
    Balance
    
    Interest
    
    RateEarning AssetsPortfolio Loans
    
    $
    293,101
    
    
    $
    13,416
    
    
    
    6.10
    %
    
    $
    286,885
    
    
    $
    13,312
    
    
    
    6.19
    %Tax-exempt Securities
    
    
    6,604
    
    
    
    171
    
    
    
    3.45
    %
    
    
    2,974
    
    
    
    84
    
    
    
    3.77
    %US Government Securities
    
    
    61,106
    
    
    
    1,549
    
    
    
    3.38
    %
    
    
    36,908
    
    
    
    783
    
    
    
    2.83
    %Federal Funds Sold
    
    
    10,324
    
    
    
    90
    
    
    
    1.16
    %
    
    
    19,500
    
    
    
    162
    
    
    
    1.11
    %Other Securities
    
    
    0
    
    
    
    7
    
    
    
    0.00
    %
    
    
    79
    
    
    
    0
    
    
    
    3.38
    %Average Earning Assets
    
    $
    371,135
    
    
    $
    15,233
    
    
    
    5.47
    %
    
    $
    346,346
    
    
    $
    14,341
    
    
    
    5.52
    %Cash & Due From Banks
    
    $
    17,935
    
    
    
    
    
    
    
    
    
    
    $
    21,369Bank Premises
    
    
    5,718
    
    
    
    
    
    
    
    
    
    
    
    5,479Allowance for Loan and Lease Losses
    
    
    ( 3,789
    )
    
    
    
    
    
    
    
    
    
    
    ( 4,049
    )Other Assets
    
    
    10,981
    
    
    
    
    
    
    
    
    
    
    
    9,970Average Total Assets
    
    $
    401,980
    
    
    
    
    
    
    
    
    
    
    $
    379,115Interest Bearing LiabilitiesDemand Interest Bearing
    
    $
    99,796
    
    
    $
    314
    
    
    
    0.42
    %
    
    $
    92,930
    
    
    $
    351
    
    
    
    0.50
    %Savings Deposits
    
    
    23,176
    
    
    
    79
    
    
    
    0.45
    %
    
    
    22,415
    
    
    
    102
    
    
    
    0.61
    %Certificates of Deposit
    
    
    137,621
    
    
    
    2,106
    
    
    
    2.04
    %
    
    
    147,506
    
    
    
    2,798
    
    
    
    2.53
    %Borrowings
    
    
    29,785
    
    
    
    453
    
    
    
    2.03
    %
    
    
    18,866
    
    
    
    316
    
    
    
    2.23
    %290,378
    
    
    $
    2,952
    
    
    
    1.36
    %
    
    
    281,717
    
    
    $
    3,567
    
    
    
    1.69
    %Non interest Demand
    
    
    70,373
    
    
    
    
    
    
    
    
    
    
    
    61,395Other Liabilities
    
    
    4,140
    
    
    
    
    
    
    
    
    
    
    
    4,070Shareholder Equity
    
    
    37,089
    
    
    
    
    
    
    
    
    
    
    
    31,933Average Liabilities and
Shareholders Equity
    
    $
    401,980
    
    
    
    
    
    
    
    
    
    
    $
    379,115Net Interest Income and Net Interest
Margin
    
    
    
    
    
    $
    12,281
    
    
    
    4.41
    %
    
    
    
    
    
    $
    10,774
    
    
    
    4.15
    %
 19




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##### Table of Contents



MANAGEMENTS DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) The following tables set forth changes in interest income and expense for each
major category of earning assets and interest-bearing liabilities, and the
amount of change attributable to volume and rate changes for the periods
indicated. Changes attributable to rate/volume have been allocated to volume
changes. Table 2. Analysis of Changes in Net Interest Income September 30, 2004 over September 30, 2003(Dollars in thousands)
    
    Volume
    
    Rate
    
    TotalIncrease(Decrease) In Interest
IncomePortfolio Loans
    
    $
    291
    
    
    $
    (187
    )
    
    $
    104Tax-exempt Securities
    
    
    94
    
    
    
    (7
    )
    
    
    87US Government Securities
    
    
    614
    
    
    
    152
    
    
    
    766Federal Funds Sold
    
    
    (80
    )
    
    
    8
    
    
    
    (72
    )Other Securities
    
    
    7
    
    
    
    0
    
    
    
    7Total Increase (Decrease)
    
    $
    926
    
    
    $
    (34
    )
    
    $
    892Increase(Decrease) In
Interest ExpenseInterest Bearing Demand
    
    $
    19
    
    
    $
    (56
    )
    
    $
    (37
    )Savings Deposits
    
    
    3
    
    
    
    (26
    )
    
    
    (23
    )Certificates of Deposit
    
    
    (150
    )
    
    
    (542
    )
    
    
    (692
    )Borrowings
    
    
    165
    
    
    
    (28
    )
    
    
    137Total Increase (Decrease)
    
    $
    37
    
    
    $
    (652
    )
    
    $
    (615
    )Net Increase
    
    $
    889
    
    
    $
    618
    
    
    $
    1,507
 Net interest income was $12.28 million for the first nine-months of 2004
compared with $10.77 million for the same period in 2003 (Tables 1 and 2). The
increase in net interest income is nearly balanced between an increase volume
of earning assets totaling $889,000 and a reduction in cost of funding totaling
$618,000 adding $1,507,000 to net interest margin for the period. Average earning assets for the first nine-months of 2004 were $371.1 million
compared with $346.3 million for the same period in 2003, an increase of $24.8
million or 7.2%. Portfolio loans is the single largest component of earning
assets and average portfolio loans increased $6.2 million or 2.2% over the same
period in 2003. Average securities increased $27.8 million or 69.8% over the
prior period. While the average volume of earning assets increased, the average yield
decreased to 5.47% in 2004 from 5.52% in 2003. The decrease is primarily due to
new loan production priced at lower rates, available funds being invested into
the security portfolio while loan growth remained relatively level for the
period. Offsetting the decline in yield on earning assets was the decrease in the cost
of interest bearing liabilities to 1.36% in 2004 compared to 1.69% in 2003. The
decrease was due to increases in the volume of core deposits (interest-bearing
checking and savings) while certificates of deposits decreased by $9.9 million.
Demand deposits increased by $8.9 million or 14.6% reflective of the Company
strategy to increase focus on core deposit development. As a result of these changes, the interest spread (the difference between
the yield on earning assets and the cost of interest bearing liabilities)
increased 0.26% to 4.41% for the nine-months ended September 30, 2004 compared
with 4.15% for the same period in the prior year. 20




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued) 
 Noninterest Income The Companys non-interest income consists of service charges on deposit
accounts, other fee income, processing fees for credit card payments and gains
or losses on security sales. The following table sets forth a summary of
noninterest income for the periods indicated. Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,
    
    September 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Noninterest incomeService charges on deposit accounts
    
    $
    133
    
    
    $
    94
    
    
    $
    358
    
    
    $
    250Payroll and benefit processing fees
    
    
    81
    
    
    
    79
    
    
    
    260
    
    
    
    245Earnings on cash surrender value -
Bank owned insurance
    
    
    52
    
    
    
    57
    
    
    
    160
    
    
    
    176Net gain on sale of securities available-for-sale
    
    
    0
    
    
    
    12
    
    
    
    0
    
    
    
    88Net gain on sale of loans
    
    
    2
    
    
    
    25
    
    
    
    38
    
    
    
    99Merchant credit card service income, net
    
    
    139
    
    
    
    112
    
    
    
    330
    
    
    
    307Mortgage brokerage fee income
    
    
    64
    
    
    
    112
    
    
    
    112
    
    
    
    224Other Income
    
    
    102
    
    
    
    95
    
    
    
    304
    
    
    
    300Total Noninterest income
    
    $
    573
    
    
    $
    586
    
    
    $
    1,562
    
    
    $
    1,689
 Noninterest income decreased $13,000 or 2.3% for the quarter ended September
30, 2004 over September 30, 2003. The decrease relates to reduced volume of
mortgage brokerage activities and related fee income. Service charges on
deposit accounts increased by 41.5% over the prior quarterly period due to
growth in core deposits and the introduction of an overdraft privilege product.
Current quarter gains on sales of securities available-for-sale were $0
compared to the same quarter in 2003 with gains of $12,000. Noninterest income decreased $127,000 or 7.5% for the nine-months ended
September 30, 2004 over September 30, 2003. The decrease for the nine-month
period is also related to the reduced volume of mortgage brokerage activities
and related fee income. At September 30, 2004 gains on sales of securities
available-for-sale were $0 compared with $88,000 at September 30, 2003. Net
gains on sales of loans were $38,000 for September 30, 2004 compared with
$99,000 at September 30, 2003. Service charges on deposit accounts increased by
$108,000 or 43.2% over the same nine-month period a year ago, reflective of the
growth in core deposit relationships and the introduction of an overdraft
privilege product. Mortgage activities lag the prior year due to a significant
drop in refinancing activity. Mortgage brokerage fee income decreased 50.0%
over the nine-month period ended September 30, 2003. 
 Noninterest Expense Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,
    
    September 30,
    
    September 30,(Dollars in
Thousands)
    
    2004
    
    2003
    
    2004
    
    2003Noninterest ExpenseSalaries and related benefits
    
    $
    1,500
    
    
    $
    1,409
    
    
    $
    4,261
    
    
    $
    4,063Occupancy and equipment expense
    
    
    395
    
    
    
    374
    
    
    
    1,127
    
    
    
    1,087FDIC insurance premium
    
    
    11
    
    
    
    12
    
    
    
    36
    
    
    
    37Data processing fees
    
    
    69
    
    
    
    52
    
    
    
    185
    
    
    
    141Professional service fees
    
    
    177
    
    
    
    161
    
    
    
    619
    
    
    
    549Deferred compensation expense
    
    
    71
    
    
    
    65
    
    
    
    207
    
    
    
    189Stationery and Supplies
    
    
    48
    
    
    
    58
    
    
    
    156
    
    
    
    178Postage
    
    
    25
    
    
    
    22
    
    
    
    73
    
    
    
    77Directors expense
    
    
    67
    
    
    
    68
    
    
    
    225
    
    
    
    182Other expenses
    
    
    278
    
    
    
    238
    
    
    
    856
    
    
    
    759Total Noninterest expense
    
    $
    2,641
    
    
    $
    2,459
    
    
    $
    7,745
    
    
    $
    7,262
 21




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##### Table of Contents



MANAGEMENTS DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued) Noninterest expense for the quarter ended September 30, 2003 was $2.6 million,
an increase of $182,000 or 7.4% over the same period a year ago. Salaries and
employee benefits increased $91,000 or 6.5% over the same period a year ago. Professional service expense increased $16,000 or 9.9% for the quarter ended
September 30, 2004 over the quarter ended September 30, 2003. Professional
service expense consists of assessments, audit expenses, legal expenses and
other outside services. Filing expenses attributed to the NASDAQ National
listing totaled $100,000 representing all of the increase in professional
service expense. Non-interest expense for the nine-months ended September 30, 2004 was $7.7
million, an increase of $483,000 or 6.7% over the same nine-month period a year
ago. Salaries and employee benefits increased $198,000 or 4.9% over the same
nine-month period a year ago. Data processing expenses increased $44,000 or
31.2% over the same nine-month period a year ago. Professional service expense
includes the NASDAQ National filing fees totaling $100,000 paid during the
second quarter. 
 Income Taxes The Companys effective tax rate varies with changes in the relative amounts of
its non-taxable income and non-deductible expenses. The increase in the
Companys tax provision is attributable to decreases in non-taxable income
related to a reduction in the municipal security portfolio and reclassification
of enterprise zone qualified credits. The following table reflects the Companys tax provision and the related
effective tax rate for the periods indicated. (Dollars in thousands) Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,
    
    September 30,
    
    September 30,Income Taxes
    
    2004
    
    2003
    
    2004
    
    2003Tax provision
    
    $
    803
    
    
    $
    565
    
    
    $
    2,138
    
    
    $
    1,721Effective tax rate
    
    
    38.8
    %
    
    
    31.1
    %
    
    
    37.7
    %
    
    
    36.0
    %
 The Companys provision for income taxes includes both federal and state income
taxes and reflects the application of federal and state statutory rates to the
Companys net income before taxes. The principal difference between statutory
tax rates and the Companys effective tax rate is the benefit derived from
investing in tax-exempt securities and enterprise zone qualifying loans.
Increases and decreases in the provision for taxes reflect changes in the
Companys net income before tax. Income tax expense through the third quarter 2004 was $2,138,000 as
compared to $1,721,000 through the third quarter period in 2003. The
increase in tax expense is attributed to increased income for the
period. 22




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##### Table of Contents



MANAGEMENTS DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued) 
 Asset Quality The Company concentrates its lending activities primarily within in El Dorado,
Placer, Sacramento and Shasta Counties, California, and the location of the
Banks four full service branches, specifically identified as Upstate
California. The Company manages its credit risk through diversification of its loan
portfolio and the application of underwriting policies and procedures and
credit monitoring practices. Although the Company has a diversified loan
portfolio, a significant portion of its borrowers ability to repay the loans
is dependent upon the professional services and commercial real estate
development industry sectors. Generally, the loans are secured by real estate
or other assets and are expected to be repaid from the cash flows of the
borrower or proceeds from the sale of collateral. The following table sets forth the amounts of loans outstanding by category as
of the dates indicated:  Portfolio Loans
    
    September 30, 2004
    
    December 31, 2003Commercial and financial
    
    $
    105,697
    
    
    $
    104,508Real estate-construction
    
    
    67,944
    
    
    
    66,742Real estate-commercial
    
    
    130,037
    
    
    
    102,952Real estate  mortgage
    
    
    6,440
    
    
    
    7,086Installment
    
    
    381
    
    
    
    452Other loans
    
    
    394
    
    
    
    633Less:Net deferred loan fees
    
    
    (630
    )
    
    
    (494
    )Allowance for loan losses
    
    
    (3,732
    )
    
    
    (3,675
    )Total net loans
    
    $
    306,531
    
    
    $
    278,204
 The Companys practice is to place an asset on nonaccrual status when one of
the following events occur: (i) any installment of principal or interest is 90
days or more past due (unless in managements opinion the loan is well secured
and in the process of collection). (ii) Management determines the ultimate
collection of principal or interest to be unlikely or (iii) the terms of the
loan have been renegotiated due to a serious weakening of the borrowers
financial condition. Nonperforming loans are loans that are on nonaccrual, are
90 days past due and still accruing or have been restructured. Net portfolio loans have increased $28.3 million or 10.2% at September 30, 2004
over $278.2 million at December 31, 2003. The portfolio mix reflects a slight
decrease in commercial and financial loans, offset by increases in commercial
real estate and construction portfolios. The balance of the portfolio remains
relatively consistent with the mix at December 31, 2003, with commercial and
financial loans of approximately 34%, real estate construction of 22% and
commercial real estate at 42%. Impaired loans are loans for which it is
probable that the Bank will not be able to collect all amounts due and payable.
The Bank had outstanding balances of $2,989,837 and $4,028,004 in impaired
loans that had impairment allowances of $770,000 and $837,000 as of September
30, 2004 and December 31, 2003, respectively. The Banks allowance for loan and lease losses was 1.20% of total loans at
September 30, 2004 and 1.41% at September 30, 2003, while its ratio of
non-performing assets to total assets was 0.70% at September 30, 2004, compared
to 0.89% at September 30, 2003. Year-to-date net charge-offs of $363,384 were
primarily related to a partial write down on one credit that was fully
reserved, compared to net recoveries of $1,000 in the same period last year. 23




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##### Table of Contents



MANAGEMENTS DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued) The following table sets forth a summary of the Companys nonperforming assets
as of the dates indicated: (Dollars in thousands) Non-performing assets
    
    September 30, 2004
    
    December 31, 2003Non-accrual loans
    
    $
    2,990
    
    
    $
    3,93190 days past due and still
accruing interest
    
    
    0
    
    
    
    7122,990
    
    
    
    4,643Other Real Estate Owned
    
    
    0
    
    
    
    0Total non-performing assets
    
    $
    2,990
    
    
    $
    4,643
 
 Allowance for Loan and Lease Losses (ALLL) The allowance for loan and lease losses is managements estimate of the amount
of probable loan losses in the loan portfolio. The Company determines the
allowance for loan losses based on an ongoing evaluation. The evaluation is
inherently subjective because it requires material estimates, including the
amounts and timing of cash flows expected to be received on impaired loans.
Those estimates may be susceptible to significant change. The Company makes
provisions to the ALLL on a regular basis through charges to operations that

are reflected in the Companys statements of income as a provision for loan
losses. When a loan is deemed uncollectible, it is charged against the
allowance. Any recoveries of previously charged-off loans are credited back to
the allowance. There is no precise method of predicting specific losses or
amounts that ultimately may be charged-off on particular categories of the loan
portfolio. The Companys allowance for loan and lease losses is the accumulation of
various components that are calculated based upon independent methodologies.
All components of the allowance for loan losses represent an estimation
performed pursuant to SFAS No. 5, Accounting for Contingencies or SFAS No. 114,
Accounting by Creditors for Impairment of a Loan. Managements estimate of each
SFAS No. 5 Accounting for Contingencies component is based on certain
observable data that management believes is the most reflective of the
underlying loan losses being estimated. Changes in the amount of each component
of the allowance for loan losses are directionally consistent with changes in
the observable data, taking into account the interaction of the SFAS No. 5
components over time. An essential element of the methodology for determining the allowance for loan
and lease losses is the Companys loan risk evaluation process, which includes
loan risk grading individual commercial, construction, commercial real estate
and most consumer loans. Loans are assigned loan risk grades based on the
Companys assessment of conditions that affect the borrowers ability to meet
its contractual obligations under the loan agreement. That process includes
reviewing borrowers current financial information, historical payment
experience, loan documentation, public information, and other information
specific to each individual borrower. Loans are reviewed on an annual or
rotational basis or as management become aware of information affecting the
borrowers ability to fulfill its obligations. Loan risk grades carry a dollar
weighted risk percentage. The ALLL is a general reserve available against the total loan portfolio. It is
maintained without any inter-allocation to the categories of the loan
portfolio, and the entire allowance is available to cover loan losses. While
management uses available information to recognize losses on loans, future
additions to the allowance may be necessary based on changes in economic
conditions. In addition, various regulatory agencies, as an integral part of
the examination process, periodically review the Companys ALLL. Such agencies
may require the Company to provide additions to the allowance based on their
judgment of information available to them at the time of their examination.
Accordingly, it is not possible to predict the effect future economic trends
may have on the level of the provision for loan losses in future periods. In
addition to the ALLL, an allowance for unfunded loan commitments and letters of
loan is determined using estimates of the probability of funding. This reserve
is carried as a liability on the condensed consolidated balance sheet. The ALLL should not be interpreted as an indication that charge-offs in future
periods will occur in the stated amounts or proportions. 24




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##### Table of Contents



MANAGEMENTS DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued) The following table summarizes the activity in the ALLL reserves for the
periods indicated. (Dollars in thousands)
    
    Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,
    
    September 30,
    
    September 30,Allowance for Loan Losses
    
    2004
    
    2003
    
    2004
    
    2003Beginning balance for Loan Losses
    
    $
    3,618
    
    
    $
    3,925
    
    
    $
    3,675
    
    
    $
    3,549Provision for Loan Losses
    
    
    131
    
    
    
    40
    
    
    
    420
    
    
    
    415Charge offs:Commercial
    
    
    (18
    )
    
    
    (0
    )
    
    
    (367
    )
    
    
    (7
    )Real Estate
    
    
    (0
    )
    
    
    (0
    )
    
    
    0
    
    
    
    0Other
    
    
    (0
    )
    
    
    (1
    )
    
    
    0
    
    
    
    (1
    )Total Charge offs
    
    
    (18
    )
    
    
    (1
    )
    
    
    (367
    )
    
    
    (8
    )Recoveries:Commercial
    
    
    1
    
    
    
    1
    
    
    
    4
    
    
    
    9Real Estate
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0Total Recoveries
    
    
    1
    
    
    
    1
    
    
    
    4
    
    
    
    9Ending Balance
    
    $
    3,732
    
    
    $
    3,965
    
    
    $
    3,732
    
    
    $
    3,965ALLL to total loans
    
    
    1.20
    %
    
    
    1.41
    %
    
    
    1.20
    %
    
    
    1.41
    %Net Charge offs to average loans
    
    
    0.12
    %
    
    
    0.00
    %
    
    
    0.12
    %
    
    
    0.00
    %
 
 Securities Portfolio The securities portfolio is integral to our asset liability management process.
The decision to purchase or sell securities is based upon current assessment of
economic and financial conditions, including the interest rate environment,
liquidity and regulatory requirements, and the relative mix of cash on hand.
Total available-for-sale securities increased $14.2 million or 22.2% for the
nine-months of 2004. For the nine-months ended September 30, 2004, there were
fourteen purchases totaling $36.3 million, no sales to date and maturities
totaling $12.4 million. Purchases to the portfolio were primarily in the U.S.
Government Agency and Mortgage Back sectors. As of September 30, 2004, the Company has pledged $1.0 million of securities
for treasury, tax and loan accounts, $7.6 million for deposits of public funds
and approximately $1.5 million for collateralized repurchase agreements. The following table summarizes the amortized cost of the Companys
available-for-sale securities held on the dates indicated. as of September 30, 2004Amortized
    
    Unrealized
    
    Unrealized
    
    Estimated(Dollars in thousands)
    
    Costs
    
    Gains
    
    Losses
    
    Fair ValueU.S. government & agencies
    
    $
    30,764
    
    
    $
    40
    
    
    $
    (362
    )
    
    $
    30,442Obligations of state and
political subdivisions
    
    
    6,519
    
    
    
    69
    
    
    
    (102
    )
    
    
    6,486Mortgage backed securities
    
    
    41,712
    
    
    
    0
    
    
    
    (165
    )
    
    
    41,547Total
    
    $
    78,995
    
    
    $
    109
    
    
    $
    (629
    )
    
    $
    78,475
 (Dollars in thousands)
    
    as of September 30, 2003Amortized
    
    Unrealized
    
    Unrealized
    
    EstimatedCosts
    
    Gains
    
    Losses
    
    Fair ValueU.S. government & agencies
    
    $
    25,347
    
    
    $
    59
    
    
    $
    (464
    )
    
    $
    24,942Obligations of state and
political subdivisions
    
    
    6,442
    
    
    
    311
    
    
    
    (481
    )
    
    
    6,272Mortgage backed securities
    
    
    33,117
    
    
    
    11
    
    
    
    (104
    )
    
    
    33,024Total
    
    $
    64,906
    
    
    $
    381
    
    
    $
    (1,049
    )
    
    $
    64,238
 25




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##### Table of Contents



MANAGEMENTS DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued) At September 30, 2004, the Companys securities available-for-sale shown below
have been in a continuous loss position for periods less than 12 months as
shown below: Less than 12 months
    
    12 months or more
    
    TotalFair
    
    Unrealized
    
    Fair
    
    Unrealized
    
    Fair
    
    UnrealizedValue
    
    Losses
    
    Value
    
    Losses
    
    Value
    
    LossesU.S. Treasury Securities and
Obligations of U.S. Agencies
    
    $
    12,591
    
    
    $
    14
    
    
    $
    7,649
    
    
    $
    348
    
    
    $
    20,240
    
    
    $
    362Obligations of State and
Political Subdivisions
    
    $
    1,408
    
    
    $
    43
    
    
    $
    2,442
    
    
    $
    59
    
    
    $
    3,850
    
    
    $
    102Mortgage-backed Securities
    
    $
    21,789
    
    
    $
    77
    
    
    $
    19,758
    
    
    $
    88
    
    
    $
    41,547
    
    
    $
    165Total temporarily impaired
securities
    
    $
    35,788
    
    
    $
    134
    
    
    $
    29,849
    
    
    $
    495
    
    
    $
    65,637
    
    
    $
    629
 Securities are classified as either held-to-maturity or available-for-sale at
the time of purchase. Securities that the Company has the intent and ability to
hold to maturity are designated held-to-maturity and are stated at amortized
cost. Although the Company has the intent and ability to hold
available-for-sale securities, the Company has determined that
available-for-sale securities might be sold before maturity to support its
asset liability management strategies. Accordingly, available-for-sale
securities are stated at fair value based on quoted market prices. Economic
factors may affect market pricing over the stated maturity of the security,
including changes in interest rates. Unrealized gains and losses on
available-for-sale securities are excluded from earnings and are reported in
accumulated other comprehensive income (loss), net of income taxes where
applicable. The Company recognizes an impairment charge when the decline in the
fair value of its investments below the cost basis is judged to be other than
temporary. As of September 30, 2004, thirty-one securities were in a loss
position due to changes in interest rates. The Company has determined the loss
position to be temporary and no impairment charges have occurred. Realized
gains and losses are determined on a specific identification basis and are
included in results of operations. Security income is accrued when earned and
included in interest income. The Company requires a credit rating of A or
higher on its initial acquisition of investments and maintains an average
rating of AAA on the overall portfolio. 26




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##### Table of Contents



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Market risk is the potential loss due to adverse changes in the market value or
yield of a position. This risk is inherent in the financial instruments
associated with loans, deposits, securities, short-term borrowings, long-term
debt and derivatives. Market-sensitive assets and liabilities are generated
through traditional banking business. Interest rate risk represents the most significant market risk exposure. The
goal of the Asset Liability Management (ALCO) Roundtable is to manage
interest rate sensitivity so that movements in interest rates do not adversely
affect net interest income. Interest rate risk is measured as the potential
volatility in our net interest income caused by changes in market interest
rates. Lending and deposit gathering create interest rate sensitive positions
on our balance sheet. Fluctuation in interest rates will ultimately affect both the level of interest
income and interest expense recorded as revenue. The fundamental objective of
the ALCO Roundtable is to enhance the economic value of the Company while
maintaining adequate liquidity and an exposure to interest rate risk deemed
acceptable by the Companys management. To estimate the effect of interest rate shock on the Companys net interest
income, management uses a model to prepare an analysis of interest rate risk.
An enhanced model was implemented during the third quarter 2004. The Risk
Analytics Interest Rate Risk Management model is a cash flow simulation model
using detailed securities, loan and deposit and market rate information. The
income pro-forma and present value equity calculations are performed in nine
different interest rate scenarios. All interest rate scenarios are immediate
and parallel with sustained shocks to all market rates in the model. The new model takes information feeds from the loan portfolio, deposit
portfolio, investment portfolio, balance sheet and income statement capturing
optionality in on-balance sheet assets and liabilities. Variables in interest
rate assumptions and budget information are updated on a quarterly basis. Such analysis calculates the change in net interest income given a change in
the federal funds rate of 100, 200 and 300 basis points up or down. All
changes are measured in dollars and percentages and are compared to projected
net interest income. At September 30, 2004, the estimated annualized reduction in net interest
income attributable to a 100 and 200 basis point decline in the federal funds
rate was $602,000 and $1,205,000, respectively. A similar and opposite result
would result attributable to a 100 or 200 basis point increase in the federal
funds rate. At December 31, 2003, the estimated annualized reduction in net
interest income attributable to a 100 and 200 basis point decline in the
federal funds rate was $575,000 and $1,149,000, respectively, with a similar
and opposite result attributable to a 100 and 200 basis point increase in the
federal funds rate. 27




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##### Table of Contents



ITEM 4. CONTROLS AND PROCEDURES As required by SEC rules, within 90 days prior to the date of this Form 10-Q,
the Company carried out an evaluation, under the supervision and with the
participation of the Companys management, including the Companys President
and Chief Executive Officer and with the Companys Chief Financial Officer, of
the effectiveness of the design and operation of the Companys disclosure
controls and procedures, pursuant to Exchange Act Rule 13a-14. As part of the evaluation of internal controls, the Company has formed a SOX
404 committee which has established the master plan for full documentation of
the Companys internal controls. The master plan consists of seven control
areas: Finance, Commercial Lending, Real Estate Lending, Operations, Human
Resources, Third Party Services, and Information Technology. The committee has
developed the following compliance framework and nine steps to compliance. SOX 404 Compliance Framework The purpose of this framework is to comply with the Sarbanes-Oxley Act, Section
404 (SOX 404). Under SOX 404, Bank of Commerce Holdings (BOCH) annual
reports must include a report on the oversight of the companys internal
controls for financial reporting. The internal control report must include the
following:  
    
    A statement of managements responsibility for establishing and
maintaining adequate internal control over financial reporting for the
company.  
    
    Managements assessment of the effectiveness of the companys internal
control over financial reporting as of the end of the companys most
recent fiscal year.  
    
    A statement identifying the framework used by management to evaluate
the effectiveness of the companys internal control over financial
reporting.  
    
    A statement that the registered public accounting firm that audited
the companys financial statements included in the annual report has
issued an attestation report on managements assessment of the
companys internal control over financial reporting. Under these new rules, BOCH is required to file the registered public
accounting firms attestation report as part of its annual report. Management
has adopted a nine-step methodology to meet the SOX 404; the methodology builds
on and is dependent on the previous step in the process: Step One: Plan and Scope In this initial step, management will form a SOX 404 Compliance Team. The SOX
404 Team will have representation from each major segment of the organization
including Finance, Operations, Lending, Human Resources, and Information
Technology. Each member of the team will contribute their respective skills
and experience to identify key risk areas and sub-areas to be included in the
scope of the project. The areas and sub-areas will be included in the scope if
those areas present risks in the initiation, recording, processing, and
reporting of financial information. Step Two: Perform Risk Assessment In step two, the SOX 404 Team will perform a risk assessment to better
understand how events can impact the Company business objectives and potential
for a material misstatement in Bank of Commerce Holdings financial reporting.
The risk assessments will be made with the perspectives of likelihood and
potential impact. Likelihood will be determined based on the following
criteria:  
    
    Probable The future event or events are likely to occur.
    
    Reasonably Possible The chance of the future event or events
occurring is more than remote but less than likely.
    
    Remote The chance of the future event or events is slight. 28




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##### Table of Contents



The impact or severity component will be determined based on whether the event
or events potentially expose BOCH to a risk of material misstatement. Step Three: Identify Significant Controls Step three consists of identifying the controls that mitigate the
aforementioned risks; application and general controls. Application controls
refer to the specific business processes supported and are designed to prevent
and detect unauthorized transactions. Application controls ensure
completeness, accuracy, authorization, and validity of transactions. General
controls apply to all segments of the organization and support secure and
continuous operation. Step Four: Document Controls In this stage of compliance, the SOX team will document its controls. The
objective of the documentation stage is to provide sufficient information to
allow the external auditors to fully and adequately understand the controls and
test their effectiveness. The process will be accomplished with the following
questions or criteria in mind:  
    
    What risk(s) does the control address?
    
    How does this control potentially impact financial reporting?
    
    Can this control be tested? Step Five: Evaluate Controls Step five consists of taking a step back and evaluating the organizations
control infrastructure. BOCH operates in the highly regulated banking
industry; a periodic and comprehensive assessment of the organizations control
structure is fundamental to the regulatory examination process. Nevertheless,
management will objectively and critically assess its control infrastructure
for both SOX 404 purposes and with an enterprise wide risk management
objective. Step Six: Evaluate Operational Effectiveness Evaluation of operational effectiveness in step six consists of initial and
ongoing testing. The objective of this step is to ensure the continuing value
of the organizations controls. BOCH control testing is conducted through both
internal audits and audits performed by external parties such as Audit One and
Knolls Audit Services. The scope and frequency of testing is determined
based on the aforementioned Risk Assessment (Step 2). Step Seven: Determine Material Weaknesses The goal of step six is to identify all weaknesses including potential
weaknesses that could possibly be deemed material weaknesses. The internal
control spectrum runs from inconsequential to material weaknesses. Determining
whether a deficiency is significantor materialis based on professional
judgment. Independent auditors will consider various factors such as the size
of operations, complexity and diversity of activities, organizational
structure, and the likelihood that the control deficiency should result in a
material misstatement of the organizations financial statements. An internalcontrol deficiencymay consist ofa design or operating deficiency.
Adesign deficiencyexists when a necessary control is missing or an existing
control is not properly designed; the control objective is not met on a
consistent basis. Anoperating deficiencyexists when a properly designed
control either is not operating as designed or the person performing a control
does not possess the necessary authority or qualifications to perform the
control effectively. Internal control deficiencies relevant to financial
reporting range from inconsequential internal control deficiencies to material
weaknesses in internal control: 29




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##### Table of Contents



A Significant Deficiencyis an internal control deficiency in a significant
control or an aggregation of such deficiencies that could result in a
misstatement of the financial statements that is more than inconsequential. AMaterial Weaknessis a significant deficiency or an aggregation of
significant deficiencies that precludes the entitys internal control from
providing reasonable assurance that material misstatements in the financial
statements will be prevented or detected on a timely basis by employees in the
normal course of performing their assigned functions. Step Eight: Document Results Test results will be documented; the results will form the basis for management
assertion and auditor attestation. As indicated in step six, BOCH will conduct
testing through both internal and external parties. Documentation will be in
the form of audit reports. Step Nine: Build Sustainability In this final step, management will ensure that Bank of Commerce Holdings
control infrastructure is sustainable. Sustainability is a process that
requires continuous support and evaluation. The SOX 404 Committee believes that the narrative documentation, flowcharts and
control worksheets will be complete by August 2005 allowing sufficient time for
testing prior to the December 31, 2005 deadline. As part of the disclosure controls and procedures, the Company has formed an
SEC Disclosure Committee. This committee reviews the quarterly filing to a
disclosure checklist to ensure that all functional areas of the Company have
participated in the disclosure review. Based upon that evaluation, the Companys President and Chief Executive Officer
along with the Companys Chief Financial Officer concluded that the Companys
disclosure controls and procedures are effective in timely alerting them to
material information relating to the Company (including its consolidated
subsidiaries) required to be included in this Form 10-Q. There have been no significant changes in the Companys internal controls, or
in other factors, which would significantly affect internal controls subsequent
to the date the Company carried out its evaluation. 30




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##### Table of Contents



PART II. Other Information 
 Item 1. Legal proceedings The Company is involved in various pending and threatened legal actions arising
in the ordinary course of business. The Company maintains reserves for losses
from legal actions, which are both probable and estimable. In the opinion of
management, the disposition of claims, currently pending will not have a
material adverse affect on the Companys financial position or results of
operations. 
 Item 2. Changes in securities, use of proceeds and Issuers Purchases of Equity
Securities At our regularly scheduled quarterly Bank of Commerce Holdings board meeting,
held on July 20, 2004  the Directors voted unanimously to declare a three for
one stock split to shareholders of record as of August 2, 2004 payable on
August 16, 2004. On September 21, 2004 the Board of Directors declared a $0.23 per share cash
dividend payable to stockholders of record as of October 1, 2004 payable on
October 22, 2004. 
 Item 3. Defaults upon Senior Securities N/A. 
 Item 4. Submission of Matters to a vote of Security Holders N/A. 
 Item 5. Other Information N/A. 
 Item 6A. Exhibits  (31)
    
    Certification of Chief Executive Officer pursuant to
Sarbanes-Oxley Act of 2002.(32)
    
    Certification of Chief Financial Officer pursuant to
Sarbanes-Oxley Act of 2002. Item 6B. Reports on Form 8-K Form 8-K dated November 2, 2004 announcing third
quarter operating results. Form 8-K dated September 24, 2004 resolution to
pay a $0.23 cash dividend
during the fourth quarter to Stockholders of record as of October 1, 2004,
payable on October 22, 2004 contingent on financial results. Form 8-K dated August 19, 2004 Bank of Commerce Mortgage affiliate contract. Form 8-K dated July 23, 2004 announcing second quarter operating results. Form 8-K dated
July 22, 2004 announcing Company three-for-one stock split. 31




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##### Table of Contents



SIGNATURES Following 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. BANK OF COMMERCE HOLDINGS
(Registrant) Date: November 4, 2004 /s/ Linda J. MilesLinda J. MilesExecutive Vice President &Chief Financial Officer
 32