Tableof Contents

 

 

 

**UNITEDSTATES****SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-K**

 

| **x**                                                 | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE**     |
|-------------------------------------------------------|-------------------------------------------------------------------------|
| ** **                                            | **SECURITIES  EXCHANGE ACT OF 1934**                                    |
| ** **                                            | ** **                                                              |
| **For  the fiscal year ended December 31, 2008** |
| ** **                                            | ** **                                                              |
| **OR**                                                |
| ** **                                            | ** **                                                              |
| **o**                                                 | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE** |
| ** **                                            | **SECURITIES  EXCHANGE ACT OF 1934**                                    |

 

**OAKVALLEY BANCORP**

(Exact name ofregistrant as specified in its charter)

 

| **California**                                                   | ** ** | **26-2326676**                        |
|------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction  of incorporation or organization) | ** ** | (I.R.S. Employer  Identification No.) |
|                                                             | ** ** |                                  |
| **125  North Third Avenue****Oakdale, California**               | ** ** | **95361**                             |
| (Address of  principal executive offices)                        | ** ** | (Zip Code)                            |

 

**(209)848-2265**

(Registrant’stelephone number including area code)

 

Securities registeredpursuant to  Section 12(b) ofthe Act:

 

| **Title  of each class** | ** ** | **Name  of each exchange on which registered** |
|--------------------------|------------|------------------------------------------------|
| Common Stock             |       | The NASDAQ Stock  Market, LLC                  |

 

Securities registeredpursuant to  Section 12(g) ofthe Act:

 

**None**

(Title of class)

 

Indicate by checkmark if the registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act.
|   | Yes  o | No  x |
|--------|------------------|-----------------|

 

Indicate by checkmark if the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Exchange

Act.
|   | Yes  o | No  x |
|--------|------------------|-----------------|

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file

such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.          Yes  x                                          No  o

 

Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-Kis not contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,a non-accelerated filer, or a smaller reporting company. See definitions of “largeaccelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2of the Exchange Act. (Check one):

 
| Large  accelerated filer o |   | Accelerated  filer o |   | Non-accelerated  filer o    |   | Smaller  reporting company x |
|----------------------------|--------|----------------------|--------|-----------------------------|--------|------------------------------|
|                       |   |                 |   | (Do not check if  a         |   |                         |
|                       |   |                 |   | smaller  reporting company) |   |                         |

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).
|   | Yes  o | No  x |
|--------|------------------|-----------------|

 

As of December 31, 2008, the aggregatemarket value of the registrant’s common stock held by non-affiliates of theregistrant was $37,480,902 based on the closing price.

 

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the latest practicable date.

 

| **Common Stock, No Par Value** | ** ** | **Outstanding at March 30, 2009** |
|----------------------------------------------------|------------|-------------------------------------------------------|
| [Common Stock,  No par value per share]            |       | 7,661,627 shares                                      |

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

| **Document** | ** ** | **Parts  Into Which Incorporated** |
|--------------|------------|------------------------------------|
| NONE         |       |                               |

 

 

 

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Tableof Contents

 

**TABLEOF CONTENTS**

 
| **PART  I**    |                                                                                                                  | 3      |
|----------------|-----------------------------------------------------------------------------------------------------------------------|--------|
| ITEM  1 -      | DESCRIPTION  OF BUSINESS                                                                                              | 3      |
| ITEM  1A -     | RISK  FACTORS                                                                                                         | 16     |
| ITEM 1B -      | UNRESOLVED STAFF  COMMENTS                                                                                            | 16     |
| ITEM  2 -      | DESCRIPTION  OF PROPERTY                                                                                              | 16     |
| ITEM 3 -       | LEGAL PROCEEDINGS                                                                                                     | 16     |
| ITEM 4 -       | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                  | 16     |
|           |                                                                                                                  |   |
| **PART II**    |                                                                                                                  | 17     |
| ITEM 5 -       | MARKET FOR  REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERS PURCHASES  OF EQUITY SECURITIES. | 17     |
| ITEM 6 -       | SELECTED  CONSOLIDATED FINANCIAL DATA                                                                                 | 18     |
| ITEM 7-        | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                           | 19     |
| ITEM 8 -       | FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA                                                                          | 51     |
| ITEM 9 -       | CHANGES IN  AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                                 | 51     |
| ITEM 9A -      | CONTROLS AND  PROCEDURES                                                                                              | 51     |
| ITEM 9B-       | OTHER INFORMATION                                                                                                     | 51     |
|           |                                                                                                                  |   |
| **PART  III**  |                                                                                                                  | 52     |
| ITEM 10 -      | DIRECTORS,  EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE                                                               | 52     |
| ITEM 11 -      | EXECUTIVE  COMPENSATION                                                                                               | 57     |
| ITEM 12 -      | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER  MATTERS                      | 60     |
| ITEM 13 -      | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE                                            | 62     |
| ITEM 14 -      | PRINCIPAL  ACCOUNTANT FEES AND SERVICES                                                                               | 63     |
|           |                                                                                                                  |   |
| **PART IV**    |                                                                                                                  | 64     |
| ITEM 15 -      | EXHIBITS AND  FINANCIAL STATEMENTS                                                                                    | 64     |
|           |                                                                                                                  |   |
| **SIGNATURES** | 66                                                                                                                    |

 

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**PART I**

 

**ITEM1.  BUSINESS OF OAK VALLEY BANCORP**

 

**Overviewof the Business**

 

Oak Valley Bancorp wasincorporated on April 1, 2008 in California for the purpose of becomingOak Valley Community Bank’s parent bank holding company. Effective July 3,2008, Oak Valley Bancorp acquired all of the outstanding capital stock of OakValley Community Bank. The principal office of Oak Valley Bancorp is located at125 North Third Avenue, Oakdale, California 95361 and its principal telephoneis (209) 848-2265.

 

Oak Valley Bancorp isauthorized to issue 50,000,000 shares of common stock, without par value, ofwhich 7,661,627 are issued and outstanding, and 10,000,000 shares of preferredstock, without par value, of which 13,500 Series A preferred stock sharesare issued or outstanding.

 

Oak Valley Community Bankcommenced operations in May 1991.  We are an insured bank under theFederal Deposit Insurance Act and are a member of the Federal Reserve. Since its formation, the Bank has provided basic banking services toindividuals and business enterprises in Oakdale, California and the surroundingareas. The focus of the Bank is to offer a range of commercial banking servicesdesigned for both individuals and small to medium-sized businesses in the twomain areas of service of the Bank: the Central Valley and the Eastern Sierras.

 

The Bank offers acomplement of business checking and savings accounts for its business customers. The Bank also offers commercial and real estate loans, as well as lines ofcredit.  Real estate loans are generally of a short-term nature for bothresidential and commercial purposes.  Longer-term real estate loans aregenerally made with adjustable interest rates and contain normal provisions foracceleration.  The Bank introduced a mortgage-lending program, CommunityBank Lending Exchange (“CBLX”), at the beginning of 2003.  At December 31,2008, the Bank has originated $205 million in loans for funding by CBLX.

 

The Bank also offersother services for both individuals and businesses including online banking,remote deposit capture, merchant services, night depository, extended hours,traveler’s checks, wire transfer of funds, note collection, and automatedteller machines in a national network.  The Bank does not currently offerinternational banking or trust services although the Bank may make suchservices available to the Bank’s customers through financial institutions withwhich the Bank has correspondent banking relationships.  The Bank does notoffer stock transfer services nor does it directly issue credit cards.

 

**Expansion**

 

*BranchExpansion.*    Over the past few years,our network of branches and loan production offices have been expanded geographically.As of December 31, 2008, we maintained twelve full-service branch offices(in addition to our main office). Beginning in October 1995, we startedour geographic expansion outside of Oakdale, by opening a Loan ProductionOffice in Sonora, California. We subsequently  opened a branch in Sonoraand branches in Modesto.  In September 2000, we expanded into theEastern Sierra, opening a branch in Bridgeport, California under the nameEastern Sierra Community Bank.  Since that time we have added branches inMammoth Lakes and Bishop. During 2005 and through the first part of 2006, weaggressively increased our presence in the Central Valley, by openingbranches.  In March 2007 our corporate headquarters expanded byadding an adjacent historical building located in downtown Oakdale to itscomplex.  We intend to continue our growth strategy in future yearsthrough the opening of additional branches and loan production offices as ourneeds and resources permit.

 

*BankHolding Company Reorganization.*  Effective July 3,2008, we entered into a bank holding company reorganization, whereby each ofthe Bank’s outstanding shares of common stock converted into an equal number ofshares of common stock in Oak Valley Bancorp, which currently owns the Bank asits wholly-owned subsidiary. Management believes that operating the Bank withina holding company structure will, among other things, provide greater operatingflexibility than is currently enjoyed by Oak Valley Community Bank; facilitatethe acquisition of related businesses as opportunities arise; improve the Bank’sability to diversify; enhance the Bank’s ability to remain competitive in thefuture with other companies in the financial services industry that areorganized in a holding company structure; and improve the Bank’s ability toraise capital to support growth.  The reorganization was approved by thevote of the majority of the issued and outstanding shares of common stock.

 

**BusinessSegments**

 

We operate in two primarybusiness segments: Retail Banking and Commercial Banking.  We determineoperating results of each segment based on an internal management system thatallocates certain expenses to each segment. These segments are described in additional detail below:

 

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*RetailBanking.*  The Bank offers a range of checking andsavings accounts, including NOW and Super NOW accounts, overdraft protection,passbook savings accounts, certificates of deposit, money market certificates,and Individual Retirement Accounts (“IRA”).  To satisfy the lending needsof individuals in its service area, the Bank offers real estate and home equityfinancing, as well as consumer, automobile, and home improvement loans.

 

*CommercialBanking*.  The Bank offers a range of deposit and lendingservices to business customers.  More specifically, the Bank offers avariety of commercial loans for virtually any business, professional, oragricultural need. These include short-term working capital, operating lines ofcredit, equipment purchases, leasehold improvements, commercial real estateacquisitions or refinancing.  Currently, virtually all of the Bank’sbusiness relationships are with customers located in the San Joaquin,Stanislaus, Tuolumne, Inyo and Mono Counties.

 

**PrimaryMarket Area**

 

We conduct business fromour main office in Oakdale, a city of approximately 19,300 located inStanislaus County, California. Oakdale is approximately 15 miles from Modestoand sits at the foothills of the Sierra Nevada Mountains, at the edge of theCalifornia Central Valley agricultural area.  Through our branches, weserve customers in the Central Valley, from Fresno to Sacramento, and infoothill locations. We also reach into the Highway 395 corridor in the EasternSierras and in the towns of Bishop, Mammoth and Bridgeport.  Our lendingactivities are primarily focused in the counties of Stanislaus and San Joaquinand other surrounding counties within the Central Valley.  The CentralValley area has a total population of over 3 million.

 

The Central Valley areahas the highest concentration of agricultural workforce in California,primarily operating in farming, forestry, or fishing.  The unemploymentrates of the California Central Valley area, throughout the counties that arewithin the Bank’s primary market areas, have historically been higher than thenational average.  The effects of the national housing crisis and creditcrunch, and the effects of the national economic slowdown and cutbacks inconsumer spending have contributed to an increase in the unemployment ratewithin our primary market area since last year. The number of job losses in theCentral Valley are soaring and the unemployment rate is nearing 20 percent insome cities. Riverbank’s unemployment rate is 19.8 percent, the unemploymentrate in Patterson is 18.5 percent, and in Stockton the unemployment rate is15.8 percent.  Similar upward trends injob losses have been observed in Merced, Tuolumne, Calaveras and MariposaCounties as well.  The commercial real estate market in the Central Valleyarea is experiencing a sizable decline due to the slowing demand from buyersdirectly affected by the housing market downturn.  Vacancies rates forretail, office and industrial spaces have risen since 2007 and will continue torise in 2009.  Economic forecasts indicate that the impact from localhousing market has impacted jobs, primarily related to construction, credit andrelated services and may continue to increase moving forward.

 

Despite the economicchallenges that we are currently experiencing in the markets in which weoperate, we believe that we operate in areas of the country that have soundeconomic fundamentals, driven by a variety of factors, which will provide uswith continued lending and growth opportunities in the future.  Some ofthese factors includes the significant role of the agriculture industry in thecreation of jobs through direct employment or related services; a developed networkof transportation infrastructure including interstate freeways, nearby deepwater ports, two major railroad providing local intermodal yards, and access tointernational airports in the Bay Area.  The California transportationcommissioners announced on the March 11, 2009 that it will spend $46.7million of state stimulus money to replace two aging bridges on Highway 99 inMerced County.  Such improvement of localinfrastructure coupled with an inventory of available and affordable industrialland and buildings, dependable and affordable labor, and a quality of life andlow cost of living,  could lead topopulation growth in the California Central Valley. These projects couldalso help to create new employment opportunities in the area.

 

**LendingActivities**

 

*General.*    Ourloan policies set forth the basic guidelines and procedures by which we conductour lending operations. These policies address the types of loans available,underwriting and collateral requirements, loan terms, interest rate and yieldconsiderations, compliance with laws and regulations and our internal lendinglimits. Our Board of Directors reviews and approves our loan policies on anannual basis. We supplement our own supervision of the loan underwriting andapproval process with periodic loan audits by experienced external loanspecialists who review credit quality, loan documentation and compliance withlaws and regulations. We engage in a full complement of lending activities,including:

 

·commercial real estate loans,

 

·commercial business lending and trade finance,

 

·Small Business Administration lending, and

 

·consumer loans, including automobile loans, home mortgages, credit lines andother personal loans.

 

As part of our efforts toachieve long-term stable profitability and respond to a changing economicenvironment in the California 

 

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Central Valley, weconstantly evaluate a variety of options to augment our traditional focus bybroadening the services and products we provide. Possible avenues of growthinclude more branch locations, expanded days and hours of operation and newtypes of lending.

 

*LoanProcedures.*    Loan applications may beapproved by the Director Loan Committee of our Board of Directors, or by ourmanagement or lending officers, to the extent of their loan authority. OurBoard of Directors authorizes our lending limits. Our President and ChiefCredit Officer are responsible for evaluating the authority limits forindividual credit officers and recommending lending limits for all otherofficers to the board of directors for approval.

 

We grant individuallending authority to our President, Chief Credit Officer, and to some departmentmanagers. Our highest management lending authority is combined administrativelending authority for unsecured and secured lending of $1,500,000, whichrequires the approval of our President or Chief Credit Officer. Loans for whichdirect and indirect borrower liability exceeds an individual’s lendingauthority are referred to our Board of Directors Loan Committee.

 

At December  31,2008, our authorized legal lending limits were $9.5 million for unsecuredloans plus an additional $15.9 million for specific secured loans. Legallending limits are calculated in conformance with California law, whichprohibits a bank from lending to any one individual or entity or its relatedinterests an aggregate amount which exceeds 15% of primary capital plus the allowancefor loan losses on an unsecured basis, plus an additional 10% on a securedbasis. Our primary capital plus allowance for loan losses at December 31,2008 totaled $63.6 million.

 

We seek to mitigate therisks inherent in our loan portfolio by adhering to certain underwritingpractices. The review of each loan application includes analysis of theapplicant’s prior credit history, income level, cash flow and financialcondition, tax returns, cash flow projections, and the value of any collateralto secure the loan, based upon reports of independent appraisers and audits ofaccounts receivable or inventory pledged as security. In the case of realestate loans over a specified amount, the review of collateral value includesan appraisal report prepared by an independent, Bank-approved, appraiser.

 

*RealEstate Loans.*    We offer commercial realestate loans to finance the acquisition of new or the refinancing of existingcommercial properties, such as shopping centers, office buildings, industrialbuildings, warehouses, hotels, automotive industry facilities and multipledwellings. At December 31, 2008, real estate loans constituted 83% of ourloan portfolio, of which 63% were commercial loans.

 

Commercial real estateloans typically have 10-year maturities with up to 25-year amortization ofprincipal and interest and loan-to-value ratios of not more than 75% of theappraised value or purchase price, whichever is lower. We usually impose aprepayment penalty during the period within 3 to 5 years of the date of theloan.

 

Construction loans arecomprised of loans on commercial, residential and income producing propertiesthat generally have terms of 1 year, with options to extend for additionalperiods to complete construction and to accommodate the lease-up period. Weusually require 15% equity capital investment by the developer and loan tovalue ratios of not more than 75% of anticipated completion value.

 

Miniperm loans financethe purchase and/or ownership of commercial properties, includingowner-occupied and income producing properties. We also offer miniperm loans astake-out financing with our construction loans. Miniperm loans are generallymade with an amortization schedule ranging from 20 to 25 years, with alump sum balloon payment due in 3 to 5 years.

 

Equity lines of creditare revolving lines of credit collateralized by junior deeds of trust onresidential real properties. They generally bear a rate of interest that floatswith our base rate or the prime rate, and have maturities of 10 years. Fromtime to time, we purchase participation interests in loans made by otherfinancial institutions. These loans are subject to the same underwritingcriteria and approval process as loans made directly by us.

 

Our real estate loans aretypically collateralized by first or junior deeds of trust on specificcommercial properties and equity lines of credit, and are subject to corporateor individual guarantees from financially capable parties, as available. Theproperties collateralizing real estate loans are principally located in ourprimary market areas of the California Central Valley and the EasternSierra.  Real estate loans typically bear an interest rate that floatswith our base rate, prime rate or another established index.

 

Our real estate portfoliois subject to certain risks, including (i) downturns in the Californiaeconomy, (ii) interest rate increases, (iii) reduction in real estatevalues in the California Central Valley, (iv) increased competition inpricing and loan structure, and (v) environmental risks, including naturaldisasters.  As a result of the high concentration of the real estate loanin our loan portfolio, the current difficulties in the real estate marketscould cause significant increases in nonperforming loans, which would reduce ourprofits.  A decline in real estate values could cause some of our mortgageloans to become inadequately collateralized, which would expose us to a greaterrisk of loss.  Additionally, a decline in real estate values couldadversely affect our portfolio of commercial real estate loans and could resultin a decline in the origination of such loans.  However, we strive toreduce the exposure to such risks and seek to continue to maintain high qualityin our real estate loans by (a) reviewing each loan request and each loanrenewal individually, (b) using a dual signature approval system for theapproval of each loan request for loans over a certain dollar amount, (c) adheringto written loan policies, including, among other factors, minimum collateralrequirements, maximum loan-to-value

 

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ratio requirements, cashflow requirements and personal guarantees, (d) performing secondaryappraisals from time to time, (e) conducting external independent creditreview, and (f) conducting environmental reviews, where appropriate. Wereview each loan request on the basis of our ability to recover both principaland interest in view of the inherent risks.   We monitor and stresstest our entire portfolio, evaluating debt coverage ratios and loan-to-valueratios, on a quarterly basis.  We monitor trends and evaluate exposurederived from simulated stressed market conditions.  The portfolio isstratified by owner classification (either owner occupied or non-owneroccupied), product type, geography and size.

 

As of December 31,2008, the aggregate loan-to-value of the entire commercial real estateportfolio was 54.9%.  Historical data suggests that the Bank continues tomaintain strong LTV, which may serve as a cushion against precipitousreductions in real estate values.  Non-owner occupied real estatecomprises 50.3% of the Bank’s total commitments, as of December 31,2008.  The loan-to-value on the non-owner occupied segment was 51.4%, asof December 31, 2008.  The highest concentration by product type isoffice space, which comprised 16.7% of total loan commitments outstanding, asof December 31, 2008.  Our portfolio diversity in terms of bothproduct types and geographic distribution, combined with strong debt coverageratios, a low aggregate loan-to-value and a high percentage of owner-occupiedproperties, significantly mitigate the risks associated with excessivecommercial real estate concentration. These elements contribute strength to ouroverall real estate portfolio despite the current weakness in the real estatemarket.

 

*        Commercial Business Lending.*    We offercommercial loans to sole proprietorships, partnerships and corporations, withan emphasis on the real estate related industry. These commercial loans includebusiness lines of credit and commercial term loans to finance operations, toprovide working capital or for specific purposes, such as to finance the purchaseof assets, equipment or inventory. Since a borrower’s cash flow from operationsis generally the primary source of repayment, our policies provide specificguidelines regarding required debt coverage and other important financialratios.

 

Lines of credit areextended to businesses or individuals based on the financial strength andintegrity of the borrower and are secured primarily by real estate, accountsreceivable and inventory, and have a maturity of one year or less. Such linesof credit bear an interest rate that floats with our base rate, the prime rate,LIBOR or another established index.

 

Commercial term loans aretypically made to finance the acquisition of fixed assets, refinance short-termdebts or to finance the purchase of businesses. Commercial term loans generallyhave terms from one to five years. They may be collateralized by the assetbeing acquired or other available assets and bear interest rates which eitherfloats with the Bank’s base rate, prime rate, LIBOR or another established indexor is fixed for the term of the loan.

 

We also provide otherbanking services tailored to the small business market. We have focusedrecently on diversifying our loan portfolio, which has led to an increase incommercial real estate and commercial business loans to small and medium sizedbusinesses.

 

Our portfolio ofcommercial loans is also subject to certain risks, including (i) downturnsin the California economy, (ii) interest rate increases; and (iii) thedeterioration of a borrower’s or guarantor’s financial capabilities. We attemptto reduce the exposure to such risks through (a) reviewing each loanrequest and renewal individually, (b) requiring a dual signature approvalsystem, (c) mandating strict adherence to written loan policies, and (d) performingexternal independent credit review. In addition, we monitor loans based onshort-term asset values on a monthly or quarterly basis. In general, during theterm of the relationship, we receive and review the financial statementsof  our borrowing customers on an ongoing basis, and we promptly respondto any deterioration that we note.

 

*SmallBusiness Administration Lending Services.*    SmallBusiness Administration, or SBA, lending, forms an important part of ourbusiness. Our SBA lending service places an emphasis on minority-ownedbusinesses. Our SBA market area includes the geographic areas encompassed byour full-service banking offices in the California Central Valley and in theEastern Sierra. Our SBA Loan Department has attained “Preferred Lender” status,which permits us to approve SBA guaranteed loans directly. As an SBA PreferredLender, we provide quicker and more efficient service to our clientele,enabling them to obtain SBA loans in order to acquire new businesses, expandexisting businesses, and acquire locations in which to do business, withouthaving to go through the time consuming SBA approval process.

 

Although ourparticipation in the SBA program is subject to the legislative power ofCongress and the continued maintenance of our approved status by the SBA, wehave no reason to believe that this program (and our participation therein)will not continue, particularly in view of the lengthy duration of the SBAprogram nationally.

 

*ConsumerLoans.*    Consumer loans include personalloans, auto loans, home improvement loans, home mortgage loans, revolving linesof credit and other loans typically made by banks to individual borrowers. Weprovide consumer loan products in an effort to diversify our product line.

 

Our consumer loanportfolio is subject to certain risks, including:

 

·amount of credit offered to consumers in the market,

 

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·interest rate increases, and

 

·consumer bankruptcy laws which allow consumers to discharge certain debts.

 

We attempt to reduce theexposure to such risks through the direct approval of all consumer loans by:

 

·reviewing each loan request and renewal individually,

 

·using a dual signature system of approval,

 

·strictly adhering to written credit policies and,

 

·performing external independent credit review.

 

**DepositActivities and Other Sources of Funds**

 

Our primary sources offunds are deposits and loan repayments. Scheduled loan repayments are arelatively stable source of funds, whereas deposit inflows and outflows andunscheduled loan prepayments (which are influenced significantly by generalinterest rate levels, interest rates available on other investments, competition,economic conditions and other factors) are not as stable. Customer depositsalso remain a primary source of funds, but these balances may be influenced byadverse market changes in the industry. We may resort to other borrowings, onan as needed basis, as follows:

 

·on a short-term basis to compensate for reductions in deposit inflows at lessthan projected levels, and

 

·on a longer-term basis to support expanded lending activities and to match thematurity of repricing intervals of assets.

 

We offer a variety ofaccounts for depositors, which are designed to attract both short-term andlong-term deposits. These accounts include certificates of deposit, or “CDs”,regular savings accounts, money market accounts, checking and negotiable orderof withdrawal, or “NOW”, accounts, installment savings accounts, and individualretirement accounts, or “IRAs”. These accounts generally earn interest at ratesestablished by management based on competitive market factors and management’sdesire to increase or decrease certain types or maturities of deposits. Asneeds arise, we augment these customer deposits with brokered deposits. Themore significant deposit accounts offered by us are described below:

 

*Certificatesof Deposit.*    We offer several types of CDswith a maximum maturity of five years. The substantial majority of our CDs havea maturity of one to twelve months and typically pay simple interest creditedmonthly or at maturity.

 

*RegularSavings Accounts.*    We offer savingsaccounts that allow for unlimited deposits and withdrawals, provided thatdepositors maintain a $100 minimum balance. Interest is compounded daily andcredited quarterly.

 

*MoneyMarket Account.*    Money market accountspay a variable interest rate that is tiered depending on the balance maintainedin the account. Minimum opening balances vary. Interest is compounded daily andpaid monthly.

 

*Checkingand NOW Accounts.*    Checking and NOWaccounts are generally non-interest and interest bearing accounts,respectively, and may include service fees based on activity and balances. NOWaccounts pay interest, but require a higher minimum balance to avoid servicecharges.

 

*FederalHome Loan Bank Borrowings.*    Tosupplement our deposits as a source of funds for lending or investment, we borrowfunds in the form of advances from the Federal Home Loan Bank. We regularlymake use of Federal Home Loan Bank advances as part of our interest rate riskmanagement, primarily to extend the duration of funding to match the longerterm fixed rate loans held in the loan portfolio as part of our growthstrategy.

 

As a member of theFederal Home Loan Bank system, we are required to invest in Federal Home LoanBank stock based on a predetermined formula. Federal Home Loan Bank stock is arestricted investment security that can only be sold to other Federal Home LoanBank members or redeemed by the Federal Home Loan Bank. As of December 31,2008, we owned $3,803,700 in FHLB stock.

 

Advances from the FederalHome Loan Bank are typically secured by our entire real estate loan portfolio,which includes residential and commercial loans.  At December 31,2008, our borrowing limit with the Federal Home Loan Bank was approximately$107 million.

 

**InternetBanking**

 

Since August 1,2001, we have offered Internet banking service, which allows our customers toaccess their deposit accounts through the Internet. Customers are able toobtain transaction history and account information, transfer funds betweenaccounts and 

 

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make on-line billpayments. We intend to improve and develop our Internet banking products anddelivery channels as the need arises and our resources permit.

 

**OtherServices**

 

We also offer ATMmachines located at branch offices, and customer access to an ATM network.

 

**Marketing**

 

Our business plan reliesprincipally upon local advertising and promotional activity and upon personalcontacts by our directors, officers and shareholders to attract business and toacquaint potential customers with our personalized services. We emphasize ahigh degree of personalized client service in order to be able to provide foreach customer’s banking needs. Our marketing approach emphasizes the advantagesof dealing with an independent, locally-managed and state chartered bank tomeet the particular needs of consumers, professionals and business customers inthe community. Our management continually evaluates all of our banking serviceswith regard to their profitability and efforts and makes determinations basedon these evaluations whether to continue or modify our business plan, whereappropriate.

 

We do not currently haveany plans to develop any new lines of business which would require a materialamount of capital investment on our part.

 

**Competition**

 

*RegionalBranch Competition.*    We consider ourprimary service area to be composed of the counties of San Joaquin, Stanislaus,Tuolumne, Inyo and Mono Counties.  The banking business in Californiagenerally, and in our primary service area, specifically, is competitive withrespect to both loans and deposits and is dominated by a relatively smallnumber of major banks which have many offices operating over wide geographicareas.  These include Wachovia, Wells Fargo Bank, Bank of America and Bankof the West. We compete for deposits and loans principally with these banks, aswell as with savings and loan associations, thrift and loan associations,credit unions, mortgage companies, insurance companies, offerors of moneymarket accounts and other lending institutions.

 

Among the advantagescertain of these institutions have over us are their ability to financeextensive advertising campaigns and to allocate their investment assets to regionsof highest yield and demand, their ability to offer certain services, such asinternational banking and trust services which are not offered directly by theBank and, the ability by virtue of their greater total capitalization, to havesubstantially higher lending limits than we do.   In addition, as aresult of increased consolidation and the passage of interstate bankinglegislation there is and will continue to be increased competition among banks,savings and loan associations and credit unions for the deposit and loanbusiness of individuals and businesses.

 

In addition to competingwith savings institutions, commercial banks compete with other financialmarkets for funds.  For instance, yields on corporate and government debtsecurities and other commercial paper affect the ability of commercial banks toattract and hold deposits.  Commercial banks also compete for availablefunds with money market funds.

 

As of June 30, 2008,our primary service areas contained one hundred seventy-five (175) bankingoffices, with approximately $10.5 billion in total deposits.  As of June 30,2008, we had total deposits of approximately $358 million, which representedapproximately 3.42% of the total deposits in the Bank’s primary servicearea.  There can be no assurance that the Bank will maintain itscompetitive position against current and potential competitors, especiallythose with greater resources than the Bank.  The deposits of the four (4) largestcompeting banks averaged approximately $112 million per office as of June 30,2008.

 

In order to compete withmajor financial institutions in our primary service areas, we use to thefullest extent the flexibility that our independent status permits.  Thisincludes an emphasis on specialized services, local promotional activity, andpersonal contacts by our officers, directors and employees.  In the eventthat there are customers whose needs exceed our lending limits, we may arrangefor such loans on a participation basis with other financial institutions. We also assist customers who require other services that we do not offer byobtaining such services from correspondent banks.  However, no assurancecan be given that our continued efforts to compete with other financialinstitutions will be successful.

 

*OtherCompetitive Factors.*    Large commercialbank competitors have, among other advantages, the ability to financewide-ranging and effective advertising campaigns and to allocate theirinvestment resources to areas of highest yield and demand. Many of the major banksoperating in our market area, such as Wells Fargo Bank and Bank of America,offer certain services that we do not offer directly (but some of which weoffer through correspondent institutions). By virtue of their greater totalcapitalization, such banks also have substantially higher lending limits(restricted to a percentage of the bank’s total shareholders’ equity, dependingupon the nature of the loan transaction) than we do.

 

In addition to otherbanks, our competitors include savings institutions, credit unions, andnumerous non-banking institutions, such as finance companies, leasingcompanies, insurance companies, brokerage firms, and investment banking firms.In recent years, 

 

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increased competition hasalso developed from specialized finance and non-finance companies that offermoney market and mutual funds, wholesale finance, credit card, and other consumerfinance services, including on-line banking services and personal financesoftware. Strong competition for deposit and loan products affects the rates ofthose products as well as the terms on which they are offered to customers.

 

The more general competitivetrends in the industry include increased consolidation and competition. Strongcompetitors, other than financial institutions, have entered banking marketswith focused products targeted at highly profitable customer segments. Many ofthese competitors are able to compete across geographic boundaries and providecustomers increasing access to meaningful alternatives to banking services innearly all significant products areas. Mergers between financial institutionshave placed additional pressure on banks within the industry to streamlinetheir operations, reduce expenses, and increase revenues to remain competitive.Competition has also intensified due to the federal and state interstatebanking laws, which permit banking organizations to expand geographically, andthe California market has been particularly attractive to out-of-stateinstitutions. The Financial Modernization Act, which has made it possible forfull affiliations to occur between banks and securities firms, insurancecompanies, and other financial companies, is also expected to intensifycompetitive conditions.

 

Technological innovationshave also resulted in increased competition in the financial services industry.Such innovations have, for example, made it possible for non-depositoryinstitutions to offer customers automated transfer payment services that werepreviously considered traditional banking products. In addition, many customersnow expect a choice of several delivery systems and channels, includingtelephone, mail, home computer, ATMs, self-service branches and/or in-storebranches.

 

*BusinessConcentration.*    No individual or singlegroup of related accounts is considered material in relation to our totalassets or deposits, or in relation to our overall business. However,approximately 83% of our loan portfolio held for investment at December 31,2008 consisted of real estate-related loans, including construction loans,miniperm loans, real estate mortgage loans and commercial loans secured by realestate. Moreover, our business activities are currently focused primarily inCentral California, with the majority of our business concentrated in SanJoaquin, Stanislaus, Tuolumne, Inyo and Mono Counties.  Consequently, ourresults of operations and financial condition are dependent upon the generaltrends in the Central California economies and, in particular, the residentialand commercial real estate markets. In addition, the concentration of ouroperations in Central California exposes us to greater risk than other banking companieswith a wider geographic base in the event of catastrophes, such as earthquakes,fires and floods in this region.

 

**Employees**

 

As of December 31,2008, we had 123 employees (101 full-time employees and 22 part-timeemployees). None of our employees are currently represented by a union orcovered by a collective bargaining agreement. Management believes its employeerelations are satisfactory.

 

**BankHolding Company Regulation**

 

Upon effectiveness of thebank holding company  reorganization on July 2,2008, we became subject to regulation under the Bank Holding Company Act of1956, as amended (“BHCA”) which subjects Oak Valley Bancorp to Federal ReserveBoard reporting and examination requirements.  Under the FederalReserve Board’s regulations, a bank holding company is required to serve as asource of financial and managerial strength to its subsidiary banks.

 

The BHCA regulatesthe activities of holding companies including acquisitions, mergers, andconsolidations and, together with the Gramm-Leach Bliley Act of 1999, the scopeof allowable banking activities.

 

**GovernmentPolicies, Legislation, and RegulatoryInitiatives**

 

The banking and financialservices business in which we engage is highly regulated. Such regulation isintended, among other things, to protect depositors insured by the FDIC and theentire banking system. The commercial banking business is also influenced bythe monetary and fiscal policies of the federal government and the policies ofthe Board of Governors of the Federal Reserve System, also known as the FederalReserve Board. The Federal Reserve Board implements national monetary policies(with objectives such as curbing inflation and combating recession) by its open-marketoperations in United States Government securities, by adjusting the requiredlevel of reserves for financial intermediaries subject to its reserverequirements and by varying the discount rates applicable to borrowings bydepository institutions. The actions of the Federal Reserve Board in theseareas influence the growth of bank loans, investments and deposits and alsoaffects interest rates charged on loans and paid on deposits. Indirectly suchactions may also impact the ability of non-bank financial institutions tocompete with us. The nature and impact of any future changes in monetarypolicies cannot be predicted.

 

The laws, regulations andpolicies affecting financial services businesses are continuously under reviewby Congress and state legislatures and federal and state regulatory agencies.From time to time, legislation is enacted which has the effect of increasingthe cost of doing business, limiting or expanding permissible activities oraffecting the competitive balance between banks and other financialintermediaries. Proposals to change the laws and regulations governing theoperations and taxation of banks, bank holding

 

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companies and otherfinancial intermediaries are frequently made in Congress, in the Californialegislature and by various bank regulatory agencies and other professionalagencies. Changes in the laws, regulations or policies that impact us cannotnecessarily be predicted, but they may have a material effect on our businessand earnings.

 

As a Californiastate-chartered bank whose accounts are insured by the FDIC up to a maximum of$250,000 (as approved on October 10, 2008 by the FDIC through the end of2009), the Bank is subject to regulation, supervision and regular examinationby the California Department of Financial Institutions and the FDIC. Inaddition, although we are not a member of the Federal Reserve System, we aresubject to certain regulations of the Board of Governors of the Federal ReserveSystem. The regulations of these agencies govern most aspects of our business,including the filing of periodic reports, and activities relating to dividends,investments, loans, borrowings, capital requirements, certain check-clearingactivities, branching, mergers and acquisitions, reserves against deposits, andnumerous other areas. Supervision, legal action and examination of us by theFDIC is generally intended to protect depositors and is not intended for theprotection of our shareholders.

 

The following discussionof statutes and regulations affecting banks is only a summary and does notpurport to be complete. This discussion is qualified in its entirety byreference to such statutes and regulations. No assurance can be given that thereferenced statutes or regulations will not change in the future.

 

**CapitalAdequacy Requirements**

 

The federal bankingagencies have adopted risk-based minimum capital guidelines intended to providea measure of capital that reflects the degree of risk associated with a bankingorganization’s operations for both transactions reported on the balance sheetas assets and transactions which are recorded as off balance sheet items. Underthese guidelines, nominal dollar amounts of assets and credit equivalentamounts of off balance sheet items are multiplied by one of several riskadjustment percentages, which range from 0% for assets with low credit risk,such as federal banking agencies, to 100% for assets with relatively highcredit risk. The higher the category, the more risk a bank is subject to andthus the more capital that is required.

 

The guidelines divide abank’s capital into two tiers. Tier I includes common equity, retainedearnings, certain non-cumulative perpetual preferred stock, and minorityinterests in equity accounts of consolidated subsidiaries. Goodwill and otherintangible assets (except for mortgage servicing rights and purchased creditcard relationships, subject to certain limitations) are subtracted from Tier Icapital. Tier II capital includes, among other items, cumulative perpetual andlong-term, limited-life preferred stock, mandatory convertible securities, certainhybrid capital instruments, term subordinated debt and the allowance for loanlosses (subject to certain limitations). Certain items are required to bededucted from Tier II capital. Banks must maintain a total risk-based ratio of8%, of which at least 4% must be Tier I capital. As of December 31, 2008and 2007, our Total Risk-Based Capital Ratios were 13.3% and 11.1%,respectively, and our Tier 1 Risk-Based Capital Ratios were 12.1% and 10.0%,respectively.

 

In addition to therisk-based guidelines, federal banking regulators require banking organizationsto maintain a minimum amount of Tier 1 capital to total average assets,referred to as the leverage ratio. Banks that have received the highest ratingof the five categories used by regulators to rate banks and are notanticipating or experiencing any significant growth must maintain a ratio ofTier 1 capital (net of all intangibles) to adjusted total assets, or “LeverageCapital Ratio”, of at least 3%. All other institutions are required to maintaina leverage ratio of at least 100 to 200 basis points above the 3% minimum, fora minimum of 4% to 5%. Pursuant to federal regulations, banks must maintaincapital levels commensurate with the level of risk to which they are exposed,including the volume and severity of problem loans. As of December 31,2008 and 2007, our Leverage Capital Ratios were 11.8% and 9.4%, respectively.

 

Federal bankingregulators may set capital requirements higher than the minimums describedabove for financial institutions whose circumstances warrant it. For example, afinancial institution experiencing or anticipating significant growth may beexpected to maintain capital positions substantially above the minimumsupervisory levels without significant reliance on intangible assets.

 

**PromptCorrective Action Provisions**

 

Federal law requires eachfederal banking agency to take prompt corrective action to resolve the problemsof insured financial institutions, including but not limited to those that fallbelow one or more prescribed minimum capital ratios. The federal bankingagencies have by regulation defined the following five capital categories:

 

· “wellcapitalized” (Total Risk-Based Capital Ratio of 10%; Tier 1 Risk-Based CapitalRatio of 6%; and Leverage Ratio of 5%),

 

· “adequatelycapitalized” (Total Risk-Based Capital Ratio of 8%; Tier 1 Risk-Based CapitalRatio of 4%; and Leverage Ratio of 4% or 3% if the institution receives thehighest rating from its primary regulator),

 

· “undercapitalized”(Total Risk-Based Capital Ratio of less than 8%; Tier 1 Risk-Based CapitalRatio of less than 4%; or Leverage Ratio of less than 4% or 3% if theinstitution receives the highest rating from its primary regulator),

 

· “significantlyundercapitalized” (Total Risk-Based Capital Ratio of less than 6%; Tier 1Risk-Based Capital Ratio of less than 

 

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3%; or Leverage Ratioless than 3%), and

 

· “criticallyundercapitalized” (tangible equity to total assets less than 2%).

 

A bank may be treated asthough it were in the next lower capital category if, after notice and theopportunity for a hearing, the appropriate federal agency finds an unsafe or unsoundcondition or practice so warrants, but no bank may be treated as “criticallyundercapitalized” unless its actual capital ratio warrants such treatment.

 

At each successivelylower capital category, an insured bank is subject to increased restrictions onits operations. For example, a bank is generally prohibited from payingmanagement fees to any controlling persons or from making capitaldistributions, if to do so would make the bank “undercapitalized.” Asset growthand branching restrictions apply to undercapitalized banks, which are requiredto submit written capital restoration plans meeting specified requirements(including a guarantee by the parent holding company, if any). “Significantlyundercapitalized” banks are subject to broad regulatory authority, includingamong other things, capital directives, forced mergers, restrictions on therates of interest they may pay on deposits, restrictions on asset growth andactivities, and prohibitions on paying certain bonuses without FDIC approval.Even more severe restrictions apply to critically undercapitalized banks. Mostimportantly, except under limited circumstances, the appropriate federalbanking agency is required to appoint a conservator or receiver for an insuredbank not later than 90 days after the bank becomes criticallyundercapitalized.

 

In addition to measurestaken under the prompt corrective action provisions, insured banks may besubject to potential actions by federal regulators for unsafe or unsoundpractices in conducting their businesses or for violations of any law, rule,regulation or any condition imposed in writing by the agency or any writtenagreement with the agency. Enforcement actions may include the issuance ofcease and desist orders, termination of insurance of deposits (in the case of abank), the imposition of civil money penalties, the issuance of directives toincrease capital, formal and informal agreements, or removal and prohibitionorders against “institution-affiliated” parties.

 

**Dividends**

 

The payment ofcash dividends by the Bank to Oak Valley Bancorp is subject to restrictions setforth in the California Financial Code (the “Code”).  Prior to anydistribution from the Bank to Oak Valley Bancorp, a calculation is made toensure compliance with the provisions of the Code and to ensure that the Bankremains within capital guidelines set forth by the DFI and the FDIC. In theevent that the intended distribution from the Bank to Oak Valley Bancorpexceeds the restriction in the Code, advance approval from DFI is required.While advance approval may be required from the DFI for up to three years if weterminate our participation in the U.S. Treasury Capital Purchase Program,Management does not believe that these regulations will limit dividends fromthe Bank to meet the operating requirements of Bancorp for the foreseeablefuture. See Note 19 to the Consolidated Financial Statements in Item 8 of thisreport.

 

As long as the U.S.Treasury holds an equity position in us, we are restricted from increasing ourdividends per common share without prior approval from the U.S. Treasury until December 5,2011. We are also precluded from paying any dividends on common shares if weare in arrears on payment of dividends on preferred shares which are payablequarterly at an annual rate of 5%.

 

**Safetyand Soundness Standards**

 

Federal banking agencieshave also adopted guidelines establishing safety and soundness standards forall insured depository institutions. Those guidelines relate to internalcontrols, information systems, internal audit systems, loan underwriting anddocumentation, compensation and interest rate exposure. In general, thestandards are designed to assist the federal banking agencies in identifyingand addressing problems at insured depository institutions before capitalbecomes impaired. If an institution fails to meet these standards, theappropriate federal banking agency may require the institution to submit acompliance plan and institute enforcement proceedings, if an acceptablecompliance plan is not submitted.

 

**Premiumsfor Deposit Insurance**

 

 Our deposits are insured by the FDIC to themaximum amount permitted by law which is currently $250,000 per depositor. On October 14,2008, the FDIC announced the Temporary Transaction Account Guarantee Program tostrengthen confidence in the banking system. The new rule also allows, atthe participating FDIC-insured institutions’ option, full deposit insurancecoverage for non-interest bearing transaction accounts regardless of the dollaramount until December 31, 2009.  Wehave elected to participate in the program by paying a 10 basis point surchargeon the non-interest bearing transaction accounts over $250,000.  In addition, the FDIC has finalized a newpremium rate structure and has imposed a uniform increase in minimum assessmentfrom five cents to twelve cents annually for every $100 of domestic deposits oninstitutions that are assigned to the lowest risk category for the firstcalendar quarter of 2009.  Effective April 1,2009, assessment rates will be adjusted to differentiate for risk. Banks in thebest risk category will pay a base rate from twelve to sixteen cents per $100of deposits. Further, on February 27, 2009, the FDIC announced theimposition of a 20-basis-point emergency special assessment on all insureddepository institutions on June 30, 2009 (will be collected on September 30,2009). The rule also gives the FDIC the ability to impose future emergencyspecial assessments of up to 10 

 

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basis points ifnecessary.

 

**CommunityReinvestment Act**

 

We are subject to certainrequirements and reporting obligations involving the Community ReinvestmentAct, or “CRA”. The CRA generally requires federal banking agencies to evaluatethe record of financial institutions in meeting the credit needs of localcommunities, including low and moderate-income neighborhoods. The CRA furtherrequires that a record be kept of whether a financial institution meets itscommunity credit needs, which record will be taken into account when evaluatingapplications for, among other things, domestic branches, consummating mergersor acquisitions, or holding company formations. In measuring a bank’scompliance with its CRA obligations, the regulators now utilize aperformance-based evaluation system which bases CRA ratings on the bank’sactual lending service and investment performance, rather than on the extent towhich the institution conducts needs assessments, documents community outreachactivities or complies with other procedural requirements. In connection withits assessment of CRA performance, the FDIC assigns a rating of “outstanding,” “satisfactory,”“needs to improve” or “substantial noncompliance.” We were last examined forCRA compliance in August 15, 2005 and received a satisfactory CRAAssessment Rating.

 

**Anti-Money Laundering Regulations**

 

A series of banking lawsand regulations beginning with the Bank Secrecy Act in 1970 require banks toprevent, detect, and report illicit or illegal financial activities to thefederal government to prevent money laundering, international drug trafficking,and terrorism. Under the Uniting and Strengthening America by ProvidingAppropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001,financial institutions are subject to prohibitions against specified financialtransactions and account relationships as well as enhanced due diligence and “knowyour customer” standards in their dealings with high risk customers, foreignfinancial institutions, and foreign individuals and entities.  We have extensive controls to comply withthese requirements.

 

**Privacy and Data Security**

 

The Gramm-Leach BlileyAct (“GLBA”) of 1999 imposed requirements on financial institutions withrespect to consumer privacy.  The GLBAgenerally prohibits disclosure of consumer information to non-affiliated thirdparties unless the consumer has been given the opportunity to object and hasnot objected to such disclosure. Financial institutions are further required to disclose their privacypolicies to consumers annually.  The GLBAalso directs federal regulators, including the FDIC, to prescribe standards forthe security of consumer information.  Weare subject to such standards, as well as standards for notifying consumers inthe event of a security breach.  We mustdisclose our privacy policy to consumers and permit consumers to “opt out” ofhaving non-public customer information disclosed to third parties.  We are required to have an informationsecurity program to safeguard the confidentiality and security of customerinformation and to ensure proper disposal. Customers must be notified when unauthorized disclosure involves sensitivecustomer information that may be misused.

 

**OtherConsumer Protection Laws and Regulations**

 

Bank regulatory agenciesare increasingly focusing on compliance with consumer protection laws andregulations. Examination and enforcement has become intense, and banks havebeen advised to monitor compliance carefully with various consumer protectionlaws and their implementing regulations. For example, the federal InteragencyTask Force on Fair Lending issued a policy statement on discrimination in homemortgage lending describing three methods that federal agencies will use toprove discrimination: overt evidence of discrimination, evidence of disparatetreatment, and evidence of disparate impact. In addition to CRA and fairlending requirements, we are subject to numerous other federal consumerprotection statutes and regulations. Due to heightened regulatory concernrelated to compliance with consumer protection laws and regulations generally,we may incur additional compliance costs or be required to expend additionalfunds for investments in the local communities we serve.

 

**InterstateBanking and Branching The Riegle-Neal**

 

The Interstate Bankingand Branching Efficiency Act of 1994, or “Interstate Banking Act,” regulatesthe interstate activities of banks and bank holding companies and establishes aframework for nationwide interstate banking and branching. Since June 1,1997, a bank in one state has generally been permitted to merge with a bank inanother state without the need for explicit state law authorization. However,states were given the ability to prohibit interstate mergers of banks in theirown state by “opting-out” (enacting state legislation prohibiting such mergers)prior to June 1, 1997.

 

Since 1995, adequatelycapitalized and managed bank holding companies have been permitted to acquirebanks located in any state, subject to two exceptions: first, any state maystill prohibit bank holding companies from acquiring a bank which is less thanfive years old; and second, no interstate acquisition can be consummated by abank holding company if the acquirer would control more than 10% of thedeposits held by insured depository institutions nationwide or 30% or more ofthe deposits held by insured depository institutions in any state in which thetarget bank has branches.

 

A bank may establish andoperate*de novo* branches in anystate in which the bank does not maintain a branch, if that state has 

 

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enacted legislation toexpressly permit all out-of-state banks to establish branches in that state.

 

In 1995, Californiaenacted legislation to implement important provisions of the Interstate BankingAct and to repeal California’s previous interstate banking laws, which werelargely preempted by the Interstate Banking Act.

 

The changes effected bythe Interstate Banking Act and California laws have increased competition inour market by permitting out-of-state financial institutions to enter ourmarket areas directly or indirectly. We believe that the Interstate Banking Acthas contributed to the accelerated consolidation of the banking industry.Although many large out-of-state banks have already entered the Californiamarket as a result of this legislation, it is not possible to predict theprecise impact of this legislation on us and the competitive environment inwhich we operate.

 

**USAPatriot Act of 2001**

 

On October 26, 2001,President Bush signed the USA Patriot Act of 2001, or “Patriot Act”. The PatriotAct was enacted in response to the terrorist attacks in New York, Pennsylvaniaand Washington, D.C. on September 11, 2001, and is intended to strengthenU.S. law enforcement’s and the intelligence community’s ability to workcohesively to combat terrorism on a variety of fronts. The potential impact ofthe Patriot Act on financial institutions is significant and wide ranging. TheAct contains sweeping anti-money laundering and financial transparency laws andrequires various regulations, including:

 

·due diligence requirements for financial institutions that administer,maintain, or manage private bank accounts or correspondent accounts fornon-U.S. persons,

 

·standards for verifying customer identification at account opening,

 

· rules topromote cooperation among financial institutions, regulators, and lawenforcement entities in identifying parties that may be involved in terrorismor money laundering,

 

·reports by non-financial trades and business filed with the Treasury Department’sFinancial Crimes Enforcement Network for transactions exceeding $10,000, and

 

·filing of suspicious activities reports if they believe a customer may beviolating U.S. laws and regulations.

 

Currently we are unableto quantify the impact the Patriot Act has had or may in the future have on ourfinancial condition or results of operations.

 

**TheSarbanes-Oxley Act of 2002**

 

On July 30, 2002,President Bush signed into law The Sarbanes-Oxley Act of 2002, or “Sarbanes-OxleyAct”. The Sarbanes-Oxley Act addresses accounting oversight and corporategovernance matters relating to the operations of public companies. During 2003,the Commission issued a number of regulations under the directive of theSarbanes-Oxley Act significantly increasing public company governance-related obligationsand filing requirements, including:

 

·the establishment of an independent public oversight of public companyaccounting firms by a board that will set auditing, quality and ethicalstandards for and have investigative and disciplinary powers over suchaccounting firms,

 

·the enhanced regulation of the independence, responsibilities and conduct ofaccounting firms which provide auditing services to public companies,

 

·the increase of penalties for fraud related crimes,

 

·the enhanced disclosure, certification, and monitoring of financial statements,internal financial controls and the audit process, and

 

·the enhanced and accelerated reporting of corporate disclosures and internalgovernance.

 

Furthermore, in November 2003,in response to the directives of the Sarbanes-Oxley Act, Nasdaq adoptedsubstantially expanded corporate governance criteria for the issuers ofsecurities quoted on the Nasdaq markets. The new Nasdaq rules govern,among other things, the enhancement and regulation of corporate disclosure andinternal governance of listed companies and of the authority, role andresponsibilities of their boards of directors and, in particular, of “independent”members of such boards of directors, in the areas of nominations, corporategovernance, compensation and the monitoring of the audit and internal financialcontrol processes.

 

The Sarbanes-Oxley Act,the Commission rules promulgated thereunder, and the new Nasdaq governancerequirements have required the Bank to review its current procedures andpolicies to determine whether they comply with the new legislation and its 

 

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implementing regulations.Oak Valley Bancorp will be primarily responsible for ensuring compliance withSarbanes-Oxley and the Nasdaq governance rules, as applicable. Although theimpact these new requirements will have upon the Oak Valley Bancorp’s and theBank’s operations is not entirely clear, the Bank has already experienced anincrease in expenditures associated with certain outside professional costsnecessary for compliance.

 

**The Emergency EconomicStabilization Act of 2008 and its Related Government Policies, Legislations,and Regulations**

 

Dramatic negativedevelopments in the latter half of 2007 in the subprime mortgage market and thesecuritization markets for such loans, together with volatility in oil pricesand other factors, have resulted in uncertainty in the financial markets ingeneral and a related economic downturn, which continued through 2008 and isanticipated to continue through 2009. Dramatic declines in the housing market,with decreasing home prices and increasing delinquencies and foreclosures, havenegatively impacted the credit performance of mortgage and construction loansand resulted in significant write-downs of assets by many financialinstitutions. In addition, the values of real estate collateral supporting manycommercial and residential loans have declined and may continue to decline.General downward economic trends, reduced availability of commercial credit andincreasing unemployment have negatively impacted the credit performance ofcommercial and consumer credit, resulting in additional write-downs. Concernsover the stability of the financial markets and the economy have resulted indecreased lending by many financial institutions to their customers and to eachother. This market turmoil and tightening of credit has led to increasedcommercial and consumer delinquencies, lack of customer confidence, increasedmarket volatility and widespread reduction in general business activity.Competition among depository institutions for deposits has increasedsignificantly. Bank and bank holding company stock prices have been negativelyaffected as has the ability of banks and bank holding companies to raisecapital or borrow in the debt markets compared to recent years. Bank regulatorshave been very aggressive in responding to concerns and trends identified inexaminations, and this has resulted in the increased issuance of formal andinformal enforcement orders and other supervisory actions requiring action toaddress credit quality, liquidity and risk management and capital adequacy, aswell as other safety and soundness concerns.

 

On October 3, 2008,the Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted torestore confidence and stabilize the volatility in the U.S. banking system andto encourage financial institutions to increase their lending to customers andto each other. Initially introduced as the Troubled Asset Relief Program (“TARP”),the EESA authorized the United States Department of the Treasury (“U.S.Treasury”) to purchase from financial institutions and their holding companiesup to $700 billion in mortgage loans, mortgage-related securities and certainother financial instruments, including debt and equity securities issued byfinancial institutions and their holding companies. Initially, $350 billion wasmade immediately available to the U.S. Treasury. On January 15, 2009, theremaining $350 billion was released to the U.S. Treasury.

 

On October 14, 2008,the U.S. Treasury announced its intention to inject capital into nine largeU.S. financial institutions under the TARP Capital Purchase Program (the “TARPCPP”), and since has injected capital into many other financial institutions,including the Company. The U.S. Treasury initially allocated $250 billiontowards the TARP CPP

 

In order to participatein the TARP CPP, financial institutions were required to adopt certainstandards for executive compensation and corporate governance. These standardsgenerally apply to the Chief Executive Officer, Chief Financial Officer and thethree next most highly compensated senior executive officers. The standardsinclude (1) ensuring that incentive compensation for named seniorexecutives does not encourage unnecessary and excessive risks that threaten thevalue of the financial institution; (2) required clawback of any bonus orincentive compensation paid to a senior executive based on statements ofearnings, gains or other criteria that are later proven to be materiallyinaccurate; (3) prohibition on making golden parachute payments to seniorexecutives; and (4) agreement not to deduct for tax purposes executivecompensation in excess of $500,000 for each senior executive. The Company hascomplied with these requirements and will continue to comply.

 

The bank regulatoryagencies, U.S. Treasury and the Office of Special Inspector General, alsocreated by the EESA, have issued guidance and requests to the financialinstitutions that participated in the TARP CPP to document their plans and useof TARP CPP funds and their plans for addressing the executive compensationrequirements associated with the TARP CPP. The Company has received andresponded to that request.

 

On February 17,2009, the American Recovery and Reinvestment Act of 2009 (“ARRA”) was signedinto law by President Obama. The ARRA includes a wide variety of programsintended to stimulate the economy and provide for extensive infrastructure,energy, health, and education needs. In addition, the ARRA imposes certain newexecutive compensation and corporate expenditure limits on all current andfuture TARP recipients, including the Company, until the institution has repaidthe U.S. Treasury, which is now permitted under the ARRA without penalty andwithout the need to raise new capital, subject to the U.S. Treasury’sconsultation with the recipient’s appropriate regulatory agency.

 

The ARRA executivecompensation standards are more stringent than those currently in effect underthe TARP CPP or those previously proposed by the U.S. Treasury. The newstandards include (but are not limited to); (i) prohibitions on bonuses,retention awards and other incentive compensation, other than restricted stockgrants which do not fully vest during the TARP CPP period up to one-third of anemployee’s total annual compensation, (ii) prohibitions on goldenparachute payments for departures, (iii) an expanded clawback of bonuses,retention awards, and incentive compensation if payment is based on materiallyinaccurate statements of earnings, revenues, gains or other criteria, (iv) prohibitionson compensation plans that encourage manipulation of reported earnings, (v) retroactivereview of bonuses, retention awards and other compensation previously providedby TARP CPP recipients if found by 

 

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the U.S. Treasury to beinconsistent with the purposes of TARP CPP or otherwise contrary to publicinterest, (vi) required establishment of a company-wide policy regarding “excessiveor luxury expenditures,” and (vii) inclusion in a participant’s proxystatements for annual shareholder meetings of a nonbinding “Say on Pay”shareholder vote on the compensation of executives.

 

On February 23,2009, the U.S. Treasury and the Federal bank regulatory agencies issued a JointStatement providing further guidance with respect to the Capital AssistanceProgram announced February 10, 2009, including: (i) that should the “stresstest” assessments of the major banks initiated February 25, 2009 indicatethat an additional capital buffer is warranted, institutions will have anopportunity to turn first to private sources of capital otherwise; thetemporary capital buffer will be made available from the government; (ii) suchadditional government capital will be in the form of mandatory convertiblepreferred shares, which would be converted into common equity shares only asneeded over time to keep banks in a well-capitalized position and can beretired under improved financial conditions before the conversion becomesmandatory; and (iii) previous capital injections under the TARP CPP willalso be eligible to be exchanged for the mandatory convertible preferredshares. The conversion of preferred shares to common equity shares would enableinstitutions to maintain or enhance the quality of their capital by increasingtheir tangible common equity capital ratios; however, such conversions wouldnecessarily dilute the interests of existing shareholders.

 

On February 25,2009, the first day the Capital Assistance Program was initiated, the U.S. Treasuryreleased the actual terms of the program, stating that the purpose of theCapital Assistance Program is to restore confidence throughout the financialsystem that the nation’s largest banking institutions have a sufficient capitalcushion against larger than expected future losses, should they occur due to amore severe economic environment, and to support lending to creditworthyborrowers. Under the terms of the Capital Assistance Program, eligible U.S.banking institutions with assets in excess of $100 billion on a consolidatedbasis are required to participate in coordinated supervisory assessments, whichare forward-looking “stress test” assessments to evaluate the capital needs ofthe institution under a more challenging economic environment. Should thisassessment indicate the need for the bank to establish an additional capitalbuffer to withstand more stressful conditions, these institutions may accessthe Capital Assistance Program immediately as a means to establish anynecessary additional buffer or they may delay the Capital Assistance Programfunding for six months to raise the capital privately. Eligible U.S. bankinginstitutions with assets below $100 billion may also obtain capital from theCapital Assistance Program. The Capital Assistance Program is an additionalprogram from the TARP CPP and is open to eligible institutions regardless ofwhether they participated in the TARP CPP. The deadline to apply to participate in the Capital Assistance Programis May 25, 2009. Recipients of capital under the Capital AssistanceProgram will be subject to the same executive compensation requirements as ifthey had received TARP CPP.

 

**EnvironmentalRegulations**

 

In the course of ourbusiness, we may foreclose and take title to real estate, and could be subjectto environmental liabilities with respect to these properties. We may be heldliable to a governmental entity or to third parties for property damage,personal injury, investigation and clean-up costs incurred by these parties inconnection with environmental contamination, or may be required to investigateor clean up hazardous or toxic substances, or chemical releases at a property.The costs associated with investigation or remediation activities could besubstantial. In addition, as the owner or former owner of a contaminated site,we may be subject to common law claims by third parties based on damages andcosts resulting from environmental contamination emanating from the property.If we ever become subject to significant environmental liabilities, ourbusiness, financial condition, liquidity and results of operations could bematerially and adversely affected.

 

**OtherPending and Proposed Legislation**

 

Other legislative andregulatory initiatives which could affect us and the banking industry, ingeneral, are pending and additional initiatives may be proposed or introducedbefore the United States Congress, the California legislature and othergovernmental bodies in the future. Such proposals, if enacted, may furtheralter the structure, regulation and competitive relationship among financialinstitutions, and may subject us to increased regulation, disclosure andreporting requirements. In addition, the various banking regulatory agenciesoften adopt new rules and regulations to implement and enforce existinglegislation. We cannot predict whether, or in what form, any such legislationor regulations may be enacted or the extent to which our business would beaffected thereby.

 

**Available Information**

 

The Companymaintains an Internet website athttp://www.ovcb.com.  The Company makes available its annualreports on Form 10-K, quarterly reports on Form 10-Q, current reportson Form 8-K and amendments to such reports filed or furnished pursuant to Section 13(a) or15(d) of the Securities Exchange Act of 1934, as amended, and otherinformation related to the Company free of charge, through this site as soon asreasonably practicable after it electronically files those documents with, orotherwise furnishes them to, the SEC. The Company’s internet website and theinformation contained therein or connected thereto are not intended to beincorporated into this annual report on Form 10-K.

 

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**ITEM1A.  RISK FACTORS**

 

Not applicable.

 

**ITEM 1B.  UNRESOLVEDSTAFF COMMENTS**

 

None.

 

**ITEM2. PROPERTIES**

 

Our main office islocated in a complex at 125 North Third Avenue, Oakdale, CA 95361, in downtownOakdale.  The building has an automated teller machine and onsiteparking.  The Bank’s complex occupies approximately 20,000 square feet ofspace.

 
| **Property Location and  Address** | ** ** | **Square  Footage** | ** ** | **Monthly Rent** | ** ** | **Lease  Expiration Date** | ** ** | **Lease  Extension Options** | ** ** |
|----------------------------------------------|------------|---------------------|------------|-----------------------|------------|---------------------------------|------------|-----------------------------------|------------|
| ** **                                   | ** ** | ** **          | ** ** | ** **            | ** ** | ** **                      | ** ** | ** **                        | ** ** |
| Oakdale, 125 N.  3rd Ave.               |       | 9,600               |       | n/a*                  |       | n/a*                            |       | n/a                               |       |
| Oakdale, 338 F  Street                       |       | 9,860               |       |                  |       | 3/2017                          |       | three, 5-year term  extensions    |       |
| Sonora                                       |       | 2,500               |       |                  |       | 4/2010                          |       | n/a                               |       |
| Modesto, 12th & I Street            |       | 4,500               |       |                  |       | 3/2016                          |       | two, 5-year term  extensions      |       |
| Bridgeport                                   |       | 2,875               |       | n/a*                  |       | n/a*                            |       | n/a                               |       |
| Mammoth Lakes                                |       | 1,856               |       | n/a*                  |       | n/a*                            |       | n/a                               |       |
| Bishop                                       |       | 3,680               |       |                  |       | 8/2014                          |       | two, 5-year term  extensions      |       |
| Modesto Dale                                 |       | 4,500               |       |                  |       | 3/2015                          |       | two, 5-year term  extensions      |       |
| Turlock                                      |       | 2,400               |       |                  |       | 1/2015                          |       | two, 5-year term  extensions      |       |
| Patterson                                    |       | 2,100               |       | n/a*                  |       | n/a*                            |       | n/a*                              |       |
| Escalon                                      |       | 3,500               |       |                  |       | 4/2021                          |       | two, 5-year term  extensions      |       |
| Ripon                                        |       | 1,800               |       |                  |       | 1/2011                          |       | two, 5-year term  extensions      |       |
| Stockton                                     |       | 8,000               |       |                  |       | 12/2022                         |       | two, 5-year term  extensions      |       |

 

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* The Bank owns thisproperty.

 

Management has determinedthat all of its premises are adequate for its present and anticipated level ofbusiness.

 

**ITEM3. LEGAL PROCEEDINGS**

 

From time to time, theCompany is a party to claims and legal proceedings arising in the ordinarycourse of business. Our management evaluates its exposure to these claims andproceedings individually and in the aggregate and provides for potential losseson such litigation if the amount of the loss is estimable and the loss isprobable.

 

We believe that there areno material litigation matters at the current time. Although the results ofsuch litigation matters and claims cannot be predicted with certainty, webelieve that the final outcome of any such claims and proceedings will not havea material adverse impact on the Company’s financial position, liquidity, orresults of operations.

 

**ITEM4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

No matters were submittedto our shareholders during the fourth quarter of the year ended December 31,2008 covered by this report.

 

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**PART II**

 

**ITEM5. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT’S COMMON EQUITY AND RELATEDSTOCKHOLDER MATTERS.**

 

**PriceRange of Common Stock**

 

The common stock of theBank was traded on The NASDAQ OTCBB under the symbol “OVYB” until January 14,2009.  On January 15, 2009 ourcommon stock began trading on The NASDAQ Capital Market under the symbol “OVLY.”  The following table sets forth the high andlow closing bid prices (which reflect prices between dealers and do not includeretail markup, markdown or commission and may not represent actualtransactions) for the current year and the three calendar years ended December 31,2008, 2007 and 2006, respectively.  From time to time, during the periodsindicated, trading activity in our common stock was infrequent.  Thesource of the quotes is The Nasdaq Stock Market, LLC.

 
| ** **                                    | ** ** | **Closing Sale Price(1)(2)** | ** ** |
|-----------------------------------------------|------------|----------------------------------------|------------|
| **For Calendar Quarter Ended** | ** ** | **High**                               | ** ** | **Low** | ** ** |
|                                          |       |                                   |       |   |   |
| June 30,  2006                           |       | 16.75                                  |       | 13.35 |   |
| September 30,  2006                      |       | 16.00                                  |       | 12.75 |   |
| December 31,  2006                       |       | 14.75                                  |       | 12.55 |   |
| March 31,  2007                          |       | 13.03                                  |       | 10.80 |   |
| June 30,  2007                           |       | 11.35                                  |       | 10.90 |   |
| September 30,  2007                      |       | 11.00                                  |       | 9.17 |   |
| December 31,  2007                       |       | 10.05                                  |       | 7.52 |   |
| March 31,  2008                          |       | 8.49                                   |       | 8.49 |   |
| June 30,  2008                           |       | 8.00                                   |       | 6.50 |   |
| September 30,  2008                      |       | 7.50                                   |       | 6.30 |   |
| December 31,  2008                       |       | 7.00                                   |       | 3.55 |   |

 

On March 27, 2009the closing price of our common stock was $4.25 per share; and there wereapproximately 545 shareholders of record of the common stock and 7,661,627outstanding shares of common stock.

 

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*(1) *Figuresin the table have been retroactively adjusted to reflect a three-for-two stocksplit in January 2005 and a three-for-two stock split in January 2006.

 

*(2) *Figurethrough June 30, 2008 refer to Bank common stock prices.

 

**Dividends**

 

Our ability to pay anycash dividends will depend not only upon our earnings during a specifiedperiod, but also on our meeting certain capital requirements.

 

Shareholders are entitledto receive dividends only when and if dividends are declared by our Board ofDirectors. Although we have paid dividends in the past, it is no guarantee thatwe will continue paying cash dividends in the future.

 

Prior to the bank holdingcompany reorganization in 2008, the Bank has historically declared and paid adividend on its common stock every year since 1996.  Dividends for theyear ended December 31, 2008, 2007 and 2006 were $0.075, $0.19 and $0.19per share of common stock, respectively.

 

The following table showsstock splits declared for the four years ended December 31, 2008:

 
| **Declaration Date** | ** ** | **Payable Date** | ** ** | **Record Date** | ** ** | **Type**                  | ** ** |
|---------------------------|------------|-----------------------|------------|----------------------|------------|---------------------------|------------|
| ** **                | ** ** | ** **            | ** ** | ** **           | ** ** | ** **                | ** ** |
| November 17,  2004   |       | January 14, 2005 |       | January 3, 2005 |       | Three-for-two stock split |       |
| November 16,  2005   |       | January 17, 2006 |       | January 3, 2006 |       | Three-for-two stock split |       |

 

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**EquityCompensation Plan Information**

 

The following tableprovides information as of December 31, 2008 with respect to shares of ourcommon stock that are  issued andcurrently outstanding under the Bank’s 1998 Restated Stock Option Plan (the “1998Restated Stock Option Plan”), and the number of shares that are authorized tobe issued under the Company’s 2008 Stock Option Plan (the “2008 Equity Plan”)Figures in the table have been retroactively adjusted to reflect three-for-twostock splits in August 2005 and 2006.

 
| ** **                                              | ** ** | **A**                                                                                                                | ** ** | **B**                                                                                | ** ** | **C**                                                                                                                                                                                                         | ** ** |
|---------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Plan Category**                                  | ** ** | **Number of Securities to be Issued  Upon  Exercise of Outstanding Options** | ** ** | **Weighted Average Exercise Price of  Outstanding Options** | ** ** | **Number of Securities Remaining Available for  Future Issuance Under 2008 Equity Plan  (Excluding Securities Reflected in  Column A)** | ** ** |
| Equity  Compensation Plans Approved by Shareholders     |       | 420,455                                                                                                              |       | $                                                                                    | 6.97       |                                                                                                                                                                                                          | 1,500,000  |   |
| Equity  Compensation Plans Not Approved by Shareholders |       |                                                                                                                 |       | Not applicable                                                                  |       | 0                                                                                                                                                                                                             |       |
| Total                                                   |       | 420,455                                                                                                              |       | $                                                                                    | 6.97       |                                                                                                                                                                                                          | 1,500,000  |   |

 

**Recent Sales of UnregisteredSecurities**

 

On December 5, 2008,the Company completed the sale to the U.S. Treasury of $13.5 million ofpreferred stock and warrants as part of the TARP CPP pursuant to an exemptionunder Section 4(2) of the Securities Act of 1933, as amended.  Pursuant to the terms of  such offering, the Company issued and sold tothe U.S. Treasury (i) 13,500 shares of the Company’s Series A FixedRate Cumulative Perpetual Preferred Stock, having a liquidation preference of$1,000 per share and (ii) a warrant to purchase up to 350,346 shares ofthe Company’s common stock, no par value. Under the terms of the TARP CPP, theCompany is prohibited from increasing dividends on its common stock, and frommaking certain repurchases of equity securities, including its common stock,without the U.S. Treasury’s consent. Furthermore, as long as the preferred stock issued to the U.S. Treasuryis outstanding, dividend payments and repurchases or redemptions relating tocertain equity securities, including the Company’s common stock, are prohibiteduntil all accrued and unpaid dividends are paid on such preferred stock,subject to certain limited exceptions. Restrictions related to the payment ofdividends on common stock are disclosed under “Dividends” of the section aboveof this Form 10-K.

 

**ITEM6.  SELECTED CONSOLIDATED FINANCIAL DATA**

 

Notapplicable.

 

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**ITEM7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF~~~~OPERATION**

 

**Forward-LookingStatements**

 

Thisdiscussion of financial results includes forward-looking statements within themeaning of Section 27A of the Securities Act of 1933, as amended, (the “1933Act”) and Section 21E of the Securities Exchange Act of 1934, as amended,(the “1934 Act”). Those sections of the 1933 Act and 1934 Act provide a “safeharbor” for forward-looking statements to encourage companies to provideprospective information about their financial performance so long as theyprovide meaningful, cautionary statements identifying important factors thatcould cause actual results to differ significantly from projected results.

 

Ourforward-looking statements include descriptions of plans or objectives ofManagement for future operations, products or services, and forecasts of ourrevenues, earnings or other measures of economic performance. Forward-lookingstatements can be identified by the fact that they do not relate strictly tohistorical or current facts. They often include the words “believe,” “expect,” “intend,”“estimate” or words of similar meaning, or future or conditional verbs such as “will,”“would,” “should,” “could” or “may.”

 

Forward-lookingstatements are based on Management’s current expectations regarding economic,legislative, and regulatory issues that may impact our earnings in futureperiods. A number of factors - many of which are beyond Management’s control -could cause future results to vary materially from current Management’sexpectations. Such factors include, but are not limited to, general economicconditions, the current financial turmoil in the United States and abroad,changes in interest rates, deposit flows, real estate values and competition;changes in accounting principles, policies or guidelines; changes inlegislation or regulation; and other economic, competitive, governmental, regulatoryand technological factors affecting our operations, pricing, products andservices. Forward-looking statements speak only as of the date they are made.We do not undertake to update forward-looking statements to reflectcircumstances or events that occur after the date the forward-lookingstatements are made or to reflect the occurrence of unanticipated events.

 

The following discussionexplains the significant factors affecting our operations and financialposition for the periods presented, and includes the statistical disclosuresrequired by Securities and Exchange Commission Guide 3 (“Statistical Disclosureby Bank Holding Companies”).  Thediscussion should be read in conjunction with our financial statements and thenotes related thereto which appear elsewhere in this registration statement.

 

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**Introduction**

 

Effective July 3,2008, Oak Valley Community Bank became a subsidiary of Oak Valley Bancorp, anewly established bank holding company. Oak Valley Bancorp operates Oak ValleyCommunity Bank as a community bank in the general commercial banking business,with our primary market encompassing the California Central Valley aroundOakdale and Modesto, and the Eastern Sierras.**** As such, unless otherwisenoted, all references are about Oak Valley Community Bank.

 

In the bank holdingcompany reorganization, each outstanding shares of common stock of the bank wasexchange for an equal number of shares of common stock of Oak Valley Bancorp,which now owns the Bank as its wholly-owned subsidiary. Management believesthat operating the Bank within a holding company structure will, among otherthings:

 

·provide greater operating flexibility than is currently enjoyed by us.

 

·facilitate the acquisition of related businesses as opportunities arise.

 

·improve our ability to diversify.

 

·enhance our ability to remain competitive in the future with other companies inthe financial services industry that are organized in a holding companystructure.

 

·enhance our ability to raise capital to support growth.

 

As of December 31,2008, we had approximately $508 million in total assets, $422 million in totalloans, and $378 million in total deposits.

 

Over the past few years,our network of branches and loan production offices have been expandedgeographically. We currently maintain twelve full-service offices.  We intend to continue our growth strategy infuture years through the opening of additional branches and loan productionoffices as our needs and resources permit.

 

**2008 KeyPerformance Indicators**

 

We believe the followingwere key indicators of our performance for operations during 2008:

 

·our total assets increased to $508 million at the end of 2008, or an increaseof 11.9%, from $454 million at the end of 2007.

 

·our total deposits increased slightly to $378 million at the end of 2008, or anincrease of 0.2%, from $377 million at the end of 2007.

 

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·our total net loans grew to $422 million at the end of 2008, or an increase of10.3%, from $382 million at the end of 2007.

 

·our ratio of total non-performing loans to total loans decreased to 1.1% at December 31,2008 from 2.4% at December 31, 2007. Management deems that the size of the ratio of non-performing assets tototal loans is moderate and manageable, and reserves have been takenappropriately.

 

· net interest income increased $1.7 million or8.9% in 2008 compared to 2007, mainly as a result of an increase in the netinterest margin from 4.53% to 4.72% and an increase in average earning assetsof $16.5 million.

 

· provision for loan losses increased $1.6 millionor 294% to $2.2 million in 2008 compared to $555,000 in 2007.

 

·total noninterest income increased to $2.52 million in 2008, or an increase of14.8%, from $2.20 million in 2007. We primarily attribute this increase to ourefforts to expand our deposit account base and diversify our non-interestrevenue sources.

 

·total noninterest expense increased from $14.2 million in 2007 to $17.9 millionin 2008, reflecting the expanded personnel and premises associated with ourbusiness growth, including the recent opening of new branch offices.  Another primary component of the increase wasmarket value write downs on other real estate owned of $1.6 million.

 

These items, as well asother factors, contributed to the decrease in net income available to commonshareholders for 2008 to $2.10 million from $3.93 million in 2007, whichtranslates into $0.27 per diluted common share in 2008 and $0.52 per dilutedcommon share in 2007.

 

**2009Outlook**

 

As we begin our strategicbusiness plan for 2009, we are continuing to pursue opportunities for growth inour existing markets, as well as opportunities to expand into new marketsthrough*  de novo*   branching.Further, we expect that our portfolio of unsecured business loans and consumerloans will overall experience additional growth in 2009 as a result of targetmarketing efforts in these areas.

 

In 2009, we arecontinuing to focus on loan and account growth and managing our net interestmargin, while attempting to control expenses and credit losses and manage ourbusiness to achieve our net income and other objectives. We are also continuingto utilize strategies to control other operating expenses. These efforts areimportant for us to continue to attract new accounts and grow loans. However,we will continue to strive to be more efficient and focus on controlling thegrowth of these expenses so that they grow more slowly than the growth inloans.

 

Although interest ratesdecreased in 2008, we have maintained a stable net interest margin withcontinued growth in net interest income, which we expect to continue in 2009.In light of current difficult economic conditions, protracted low interest

 

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rates or a furtherdecrease in interest rates will likely pressure our net interest margindownwards. This will in turn decrease the growth rate and net interest income.Should interest rates increase later in 2009, our yield on earnings assets islikely to increase and we could then determine to increase the interest rateswe pay on our deposit accounts or change our promotional or other interestrates on new deposits in marketing activation programs to attempt to achieve acertain net interest margin. Any increases in the rates we charge on accountscould have an effect on our efforts to attract new customers and grow loans,particularly with the continuing competition in the commercial and consumerlending industry. The economies and real estate markets in our primary marketareas will continue to be significant determinants of the quality of our assetsin future periods and, thus, our results of operations, liquidity and financialcondition. Current economic indicators suggest that the national economy andthe economies in our primary market areas are facing a downturn but the lengthand severity of it are difficult to predict.

 

For 2009, managementremains focused on the above challenges and opportunities and other factorsaffecting the business similar to the factors driving 2008 results as discussedin this section.

 

**CriticalAccounting Policies**

 

The discussion andanalysis of our financial condition and results of operations is based upon ourfinancial statements, which have been prepared in accordance with accountingprinciples generally accepted in the United States of America. The preparationof these financial statements requires management to make estimates andjudgments that effect the reported amounts of assets and liabilities, revenuesand expenses, and related disclosures of contingent assets and liabilities atthe date of our financial statements. Actual results may differ from theseestimates under different assumptions or conditions.

 

*AssetImpairment Judgments*

 

Certain of our assets arecarried in our statements of financial condition at fair value or at the lowerof cost or fair value. Valuation allowances are established when necessary torecognize impairment of such assets. We periodically perform analyses to testfor impairment of various assets. In addition to our impairment analysesrelated to loans, another significant impairment analysis relates to other thantemporary declines in the value of our securities.

 

Our available for saleportfolio is carried at estimated fair value, with any unrealized gains andlosses, net of taxes, reported as accumulated other comprehensive income instockholders” equity. We conduct a periodic review and evaluation of thesecurities portfolio to determine if the value of any security has declinedbelow its carrying value and whether such decline is other than temporary. Ifsuch decline is deemed other than temporary, we would adjust the carryingamount of the security by writing down the security to fair market valuethrough a charge to current period income. The market values of our securitiesare significantly affected by changes in interest rates.

 

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In general, as interestrates rise, the market value of fixed-rate securities will decrease; asinterest rates fall, the market value of fixed-rate securities will increase.With significant changes in interest rates, we evaluate our intent and abilityto hold the security for a sufficient time to recover the recorded principalbalance. Estimated fair values for securities are based on published orsecurities dealers” market values.

 

*Allowancefor Loan Losses*

 

Accounting for allowancefor loan losses involves significant judgment and assumptions by management andis based on historical data and management’s view of the current economicenvironment. At least on a quarterly basis, our management reviews themethodology and adequacy of allowance for loan losses and reports itsassessment to the Board of Directors for its review and approval.

 

We base our allowance forloan losses on an estimation of probable losses inherent in our loan portfolio.Our methodology for assessing loan loss allowances are intended to reduce thedifferences between estimated and actual losses and involves a detailedanalysis of our loan portfolio, in three phases:

 

·the specific review of individual loans,

 

·the segmenting and review of loan pools with similar characteristics inaccordance with SFAS No. 5, “Accounting for Contingencies,” and

 

·our judgmental estimate based on various subjective factors:

 

   The first phase of our methodology involves the specific review of individualloans to identify and measure impairment. We evaluate each loan by use of arisk rating system, except for homogeneous loans, such as automobile loans andhome mortgages. Specific risk rated loans are deemed impaired if all amounts,including principal and interest, will likely not be collected in accordancewith the contractual terms of the related loan agreement. Impairment forcommercial and real estate loans is measured either based on the present valueof the loan’s expected future cash flows or, if collection on the loan iscollateral dependent, the estimated fair value of the collateral, less sellingand holding costs.

 

The second phase involvesthe segmenting of the remainder of the risk rated loan portfolio into groups orpools of loans, together with loans with similar characteristics, forevaluation in accordance with SFAS No. 5. We determine the calculated lossratio to each loan pool based on its historical net losses and benchmark itagainst the levels of other peer banks.

 

In the third phase, weconsider relevant internal and external factors that may affect thecollectability of loan portfolio and each group of loan pool. The factorsconsidered are, but are not limited to:

 

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·concentration of credits,

 

·nature and volume of the loan portfolio,

 

·delinquency trends,

 

·non-accrual loan trend,

 

·problem loan trend,

 

·loss and recovery trend,

 

·quality of loan review,

 

·lending and management staff,

 

·lending policies and procedures,

 

·economic and business conditions, and

 

·other external factors.

 

Our management estimatesthe probable effect of such conditions based on our judgment, experience andknown or anticipated trends. Such estimation may be reflected as an additionalallowance to each group of loans, if necessary. Management reviews theseconditions with our senior credit officers. To the extent that any of theseconditions is evidenced by a specifically identifiable problem credit orportfolio segment as of the evaluation date, managements’ estimate of theeffect of such condition may be reflected as a specific allowance applicable tosuch credit or portfolio segment. Where any of these conditions is notevidenced by a specific, identifiable problem credit or portfolio segment as ofthe evaluation date, management’s evaluation of the inherent loss related tosuch condition is reflected in the unallocated allowance

 

Central to our creditrisk management and our assessment of appropriate loss allowance is our loan riskrating system. Under this system, the originating credit officer assignsborrowers an initial risk rating based on a thorough analysis of each borrower’sfinancial capacity in conjunction with industry and economic trends. Approvalsare made based upon the amount of inherent credit risk specific to thetransaction and are reviewed for appropriateness by senior line and creditadministration personnel. Credits are monitored by line and creditadministration personnel for deterioration in a borrower’s financial conditionwhich may impact the ability of the borrower to perform under the contract.Although management has allocated a portion of the allowance to specific loans,specific loan pools, and off-balance sheet credit exposures (which are reportedseparately as part of other liabilities), the adequacy of the allowance isconsidered in its entirety.

 

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*Non-AccrualLoan Policy*

 

Interest on loans iscredited to income as earned and is accrued only if deemed collectible. Accrualof interest is discontinued when a loan is over 90 days delinquent or ifmanagement believes that collection is highly uncertain. Generally, paymentsreceived on nonaccrual loans are recorded as principal reductions. Interestincome is recognized after all principal has been repaid or an improvement inthe condition of the loan has occurred that would warrant resumption ofinterest accruals.

 

*Stock-BasedCompensation*

 

Effective January 1,2006, the Bank adopted the provisions of Statement of Financial AccountingStandards (“SFAS”) No. 123R,   ShareBased Payments.  SFAS No. 123Rrequires companies to recognize in the income statement the grant-date fairvalue of stock options and other equity-based forms of compensation issued toemployees over the employees” requisite service period (generally the vestingperiod).  The Bank  uses straight-line recognition of expensesfor awards with graded vesting.  The Bankutilizes a binomial pricing model for all grants. Expected volatility is basedon the historical volatility of the price of the Bank’s stock. The Bank useshistorical data to estimate option exercise and stock option forfeiture rateswithin the valuation model. The expected term of options granted for thebinomial model is derived from applying a historical suboptimal exercise factorto the contractual term of the grant. For binomial pricing, the risk-free ratefor periods is equal to the U.S. Treasury yield at the time of grant andcommensurate with the contractual term of the grant.

 

*OtherReal Estate Owned*

 

Other real estate owned,which represents real estate acquired through foreclosure, or deed in lieu offoreclosure in satisfaction of commercial and real estate loans, is carried atthe lower of cost or estimated fair value less the estimated selling costs ofthe real estate. The fair value of the property is based upon a currentappraisal. The difference between the fair value of the real estate collateraland the loan balance at the time of transfer is recorded as a loan charge offif fair value is lower. Subsequent to foreclosure, management periodicallyperforms valuations and the OREO property is carried at the lower of carryingvalue or fair value, less costs to sell. The determination of a property’s estimated fair value incorporates (1) revenuesprojected to be realized from disposal of the property, (2) constructionand renovation costs, (3) marketing and transaction costs, and (4) holdingcosts (e.g., property taxes, insurance and homeowners” association dues). Anysubsequent declines in the fair value of the OREO property after the date oftransfer are recorded through a write-down of the asset. Any subsequentoperating expenses or income, reduction in estimated fair values, and gains orlosses on disposition of such properties are charged or credited to currentoperations.

 

*Impactof SAB No. 108*

 

In September 2006,the SEC’s Office of the Chief Accountant and Divisions of Corporation Financeand Investment Management released SAB No. 108,

 

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“Considering the Effectsof Prior Year Misstatements when Quantifying Misstatements in Current YearFinancial Statements” (“SAB 108”), that provides interpretive guidance on howthe effects of the carryover or reversal of prior year misstatements should beconsidered in quantifying a current year misstatement. The SEC staff believesthat registrants should quantify errors using both a balance sheet and anincome statement approach and evaluate whether either approach results inquantifying a misstatement that, when all relevant quantitative and qualitativefactors are considered, is material. This pronouncement was effective forfiscal years ending after November 15, 2006. The Company initially adoptedSAB 108 in conjunction with the filing of this Form 10. This change inaccounting policy was retrospectively applied in accordance with Statement ofFinancial Accounting Standards No. 154, Accounting Changes and ErrorCorrections.  The adoption of SAB 108 hadno material impact on the Company’s financial position, results of operations,or cash flows, although we made certain adjustments that resulted in a decreaseof net income of $43,227 for the year ended December 31, 2007 (a decreaseof $0.01 in basic and diluted earnings per share), and $105,102 for the yearended December 31, 2006 (a decrease of $0.01 in basic and diluted earningsper share), respectively.   See note 1 tothe December 31, 2008 financial statements for further discussion.

 

**Overview**

 

We recorded net incomeavailable to common shareholders for the year ended December 31, 2008 of$2,098,010 or $0.27 per diluted common share compared to $3,925,121 or $0.52per diluted common share for the year ended December 31, 2007. Thedecrease in net income available to common shareholders for the year ended December 31,2008 was primarily due to an increase of $3,652,424 in non-interest expense,which included a market value write down on other real estate owned of$1,553,881, and an increase in the provision for loan loss of $1,633,139.  Partially offsetting these factors was anincrease in net interest income of $1,684,248, an increase in non-interestincome of $324,798 and a decrease in income tax provision of $1,513,225.

 

**Resultsof Operation**

 

**NetInterest Income and Net Interest Margin**

 

Our primary source ofrevenue is net interest income, which is the difference between interest andfees derived from earning assets and interest paid on liabilities obtained tofund those assets. Our net interest income is affected by changes in the leveland mix of interest-earning assets and interest- bearing liabilities, referredto as volume changes. Our net interest income is also affected by changes inthe yields earned on assets and rates paid on liabilities, referred to as ratechanges. Interest rates charged on our loans are affected principally by thedemand for such loans, the supply of money available for lending purposes andcompetitive factors. Those factors are, in turn, affected by general economicconditions and other factors beyond our control, such as federal

 

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economic policies, thegeneral supply of money in the economy, legislative tax policies, thegovernmental budgetary matters, and the actions of the Federal Reserve Board.

 

Net interest incomeincreased $1.7 million or 8.9% to $20.5 million for the year ended December 31,2008, compared to $18.8 million in 2007. Net interest spread and net interest margin were 4.33% and 4.72%,respectively, for the year ended December 31, 2008, compared to 3.87% and4.53%, respectively, for the year ended December 31, 2007. The increase inthe net interest margin in 2008 was principally attributable to the change inthe deposit mix from high cost certificates of deposit to lower cost coredeposit accounts which caused the rate on interest-bearing liabilities todecrease faster than the rate on earning assets.  Changes in volume resulted in an increase innet interest income of $830,000 for the year of 2008 compared to the year 2007,and changes in interest rates and the mix resulted in an increase in netinterest income of $938,000 for the year 2008 versus the year 2007.

 

For a detailed analysisof interest income and interest expense, see the “Average Balance Sheets” andthe “Rate/Volume Analysis” below.

 

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| ** **                                       | ** ** | **Distribution, Yield and Rate Analysis of Net Income** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **For the Years Ended December 31,**                              | ** ** |
| ** **                                       | ** ** | **2008**                                                                                   | ** ** | **2007** | ** ** |
| ** **                                       | ** ** | **Average  Balance**                                                                       | ** ** | **Interest  Income/  Expense** | ** ** | **Avg  Rate/  Yield** | ** ** | **Average  Balance** | ** ** | **Interest  Income/  Expense** | ** ** | **Avg Rate/  Yield** | ** ** |
| **Assets:**                                      |       |                                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Earning assets:                                  |       |                                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Gross loans  (1) (2)                        |       | $                                                                                          | 400,821    |   | $ | 27,638 |   | 6.90 | % | $ | 381,316 |   | $ | 30,175 |   | 7.91 | % |
| Securities of  U.S. government agencies          |       | 2,450                                                                                      |       | 73 |   | 2.98 | % | 8,322 |   | 405 |   | 4.86 | % |
| Other investment  securities (2)                 |       | 31,489                                                                                     |       | 1,600 |   | 5.08 | % | 26,687 |   | 1,278 |   | 4.79 | % |
| Federal funds  sold                              |       | 1,227                                                                                      |       | 18 |   | 1.47 | % | 3,122 |   | 159 |   | 5.10 | % |
| Interest-earning  deposits                       |       | 37                                                                                         |       | 2 |   | 4.36 | % | 76 |   | 4 |   | 5.56 | % |
| Total  interest-earning assets                   |       | 436,024                                                                                    |       | 29,331 |   | 6.73 | % | 419,523 |   | 32,021 |   | 7.63 | % |
| Total  noninterest earning assets                |       | 16,256                                                                                     |       |   |   |   |   | 26,771 |   |   |   |   |   |
| Total Assets                                     |       | $                                                                                          | 452,280    |   |   |   |   |   | $ | 446,294 |   |   |   |   |   |
| **Liabilities  and Shareholders’ Equity:**  |       |                                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                   |       |                                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Money market  deposits                           |       | 149,202                                                                                    |       | 3,578 |   | 2.40 | % | 125,574 |   | 4,539 |   | 3.62 | % |
| NOW deposits                                     |       | 54,160                                                                                     |       | 386 |   | 0.71 | % | 53,634 |   | 565 |   | 1.05 | % |
| Savings deposits                                 |       | 15,563                                                                                     |       | 259 |   | 1.66 | % | 16,745 |   | 558 |   | 3.33 | % |
| Time  certificates of $100,000 or more           |       | 40,172                                                                                     |       | 1,576 |   | 3.92 | % | 66,006 |   | 3,432 |   | 5.20 | % |
| Other time  deposits                             |       | 44,846                                                                                     |       | 1,441 |   | 3.21 | % | 49,118 |   | 2,133 |   | 4.34 | % |
| Other borrowings                                 |       | 59,666                                                                                     |       | 1,492 |   | 2.50 | % | 34,384 |   | 1,779 |   | 5.17 | % |
| Total  interest-bearing liabilities              |       | 363,609                                                                                    |       | 8,732 |   | 2.40 | % | 345,461 |   | 13,006 |   | 3.76 | % |
| Noninterest-bearing  liabilities:                |       |                                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing  deposits                    |       | 61,554                                                                                     |       |   |   |   |   | 58,468 |   |   |   |   |   |
| Other  liabilities                               |       | 3,131                                                                                      |       |   |   |   |   | 3,543 |   |   |   |   |   |
| Total  noninterest-bearing liabilities           |       | 64,685                                                                                     |       |   |   |   |   | 62,011 |   |   |   |   |   |
| Shareholders’  equity                       |       | 23,986                                                                                     |       |   |   |   |   | 38,822 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity |       | $                                                                                          | 452,280    |   |   |   |   |   | $ | 446,294 |   |   |   |   |   |
| Net interest  income                             |       |                                                                                       |       | $ | 20,599 |   |   |   |   |   | $ | 19,015 |   |   |   |
| Net interest  spread (3)                         |       |                                                                                       |       |   |   | 4.33 | % |   |   |   |   | 3.87 | % |
| Net interest  margin (4)                         |       |                                                                                       |       |   |   | 4.72 | % |   |   |   |   | 4.53 | % |

 

----

*(1)**      *Loan fees have beenincluded in the calculation of interest income. Loan fees were approximately$1,024,000 and $1,331,000 for the years ended December 31, 2008,**~~~~**and 2007, respectively.

*(2)**      *Yields on municipalsecurities and loans have been adjusted to their fully-taxable equivalents,based on a federal marginal tax rate of 34.0%.

 

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*(3) *Representsthe average rate earned on interest-earning assets less the average rate paidon interest-bearing liabilities.

*(4) *Representsnet interest income as a percentage of average interest-earning assets.

 

**Rate/VolumeAnalysis**

 

The following table belowsets forth certain information regarding changes in interest income andinterest expense of Oak Valley Community Bank for the periods indicated. For each category of earning assets andinterest bearing liabilities, information is provided on changes attributableto (i) changes in volume (change in average volume multiplied by oldrate); and (ii) changes in rates (change in rate multiplied by old averagevolume). Changes in rate/volume (change in rate multiplied by the change involume) have been allocated to the changes due to volume and rate in proportionto the absolute value of the changes due to volume and rate prior to theallocation.

 
| ** **                              | ** ** | **Rate/Volume Analysis of Net Interest Income** | ** ** |
|-----------------------------------------|------------|--------------------------------------------------------------------------|------------|
| ** **                              | ** ** | **For the Year Ended December 31,**             | ** ** | **For the Year Ended December 31,** | ** ** |
| ** **                              | ** ** | **2008 vs. 2007**                                              | ** ** | **2007 vs. 2006** | ** ** |
| ** **                              | ** ** | **Increases (Decreases)**                                           | ** ** | **Increases (Decreases)** | ** ** |
| ** **                              | ** ** | **Due to Change In**                                      | ** ** | **Due to Change In** | ** ** |
| ** **                              | ** ** | **Volume**                                                               | ** ** | **Rate** | ** ** | **Total** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Total** | ** ** |
| **Interest  income:**                   |       |                                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Net loans (1)                           |       | $                                                                        | 1,543      |   | $ | (4,078 | ) | $ | (2,535 | ) | $ | 2,831 |   | $ | 356 |   | $ | 3,187 |   |
| Securities of  U.S. government agencies |       | (286                                                                     | )          | (46 | ) | (332 | ) | (77 | ) | (38 | ) | (115 | ) |
| Other Investment  securities            |       | 230                                                                      |       | 91 |   | 321 |   | (48 | ) | 81 |   | 33 |   |
| Federal funds  sold                     |       | (97                                                                      | )          | (45 | ) | (142 | ) | 36 |   | (1 | ) | 35 |   |
| Interest-earning  deposits              |       | (2                                                                       | )          | 0 |   | (2 | ) | (1 | ) | 3 |   | 2 |   |
| Total interest  income                  |       | 1,388                                                                    |       | (4,078 | ) | (2,690 | ) | 2,741 |   | 401 |   | 3,142 |   |
| **Interest  expense:**                  |       |                                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Money market  deposits                  |       | $                                                                        | 854        |   | $ | (1,816 | ) | $ | (962 | ) | $ | 272 |   | $ | 232 |   | $ | 504 |   |
| Super NOW  deposits                     |       | 6                                                                        |       | (184 | ) | (178 | ) | 51 |   | (29 | ) | 22 |   |
| Savings deposits                        |       | (39                                                                      | )          | (260 | ) | (299 | ) | (147 | ) | 54 |   | (93 | ) |
| Time  certificates of $100,000 or more  |       | (1,343                                                                   | )          | (512 | ) | (1,855 | ) | (222 | ) | 467 |   | 245 |   |
| Other time deposits                     |       | (185                                                                     | )          | (506 | ) | (691 | ) | (128 | ) | 42 |   | (86 | ) |
| Other borrowings                        |       | 1,308                                                                    |       | (1,597 | ) | (289 | ) | 818 |   | 234 |   | 1,052 |   |
| Total interest  expense                 |       | 601                                                                      |       | (4,875 | ) | (4,274 | ) | 644 |   | 1,000 |   | 1,644 |   |
| Change in net  interest income          |       | $                                                                        | 787        |   | $ | 797 |   | $ | 1,584 |   | $ | 2,097 |   | $ | (599 | ) | $ | 1,498 |   |

 

----

*(1)**      *Loanfees have been included in the calculation of interest income. Loan fees were

 

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approximately $1,024,000 and $1,331,000 for the yearsended December 31, 2008 and 2007, respectively.

 

**Provisionfor Loan Losses**

 

The provision for loanlosses was $2,188,139 for the year ended December 31, 2008, compared to$555,000 for the year 2007.  Nonperformingloans were $4.72 million at December 31, 2008 and $9.81 million at December 31,2007, or 1.10% and 2.54%, respectively, of total loans. Nonperforming loans areprimarily in nonperforming real estate construction and development loans. Theallowance for loan losses was $5.57 million and $4.51 million at December 31,2008 and 2007, or 1.30% and 1.16%, respectively, of total loans. Netcharge-offs were $1,110,000 in 2008 compared to $397,000 in 2007.  The increase in net charge-offs in 2008 wasprimarily due to the economic downturn and the effect on the housing market.

 

The Bank maintains theallowance for loan losses at a level that it considers to be adequate toprovide for credit losses inherent in its loan portfolio. Management determinesthe level of the allowance by performing a quarterly analysis that considersconcentrations of credit, past loss experience, current economic conditions,the amount and composition of the loan portfolio (including nonperforming andpotential problem loans), estimated fair value of underlying collateral, andother information relevant to assessing the risk of loss inherent in the loanportfolio. As a result of management’s analysis, a range of the potentialamount of the allowance for loan losses is determined.

 

The Bank will continue tomonitor the adequacy of the allowance for loan losses and make additions to theallowance in accordance with the analysis referred to above. Because ofuncertainties inherent in estimating the appropriate level of the allowance forloan losses, actual results may differ from management’s estimate of creditlosses and the related allowance.

 

The following table setsforth the amount of total loans outstanding (excluding unearned income) and thepercentage distributions in each category, as of the dates indicated.

 

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| ** **                                         | ** ** | **Distribution of Loans and Percentage Composition of Loan Portfolio Amount Outstanding as of  December 31,** | ** ** |
|----------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                         | ** ** | **2008**                                                                                                                                                                       | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                         | ** ** | **(Dollars in Thousands)**                                                                                                                                           | ** ** |
|                                               |       |                                                                                                                                                                           |       |   |   |   |   |   |   |   |   |
| Commercial real  estate                            |       | $                                                                                                                                                                              | 268,742    |   | $ | 208,309 |   | $ | 233,110 |   | $ | 212,901 |   | $ | 175,641 |   |
| Commercial                                         |       | 37,302                                                                                                                                                                         |       | 45,497 |   | 41,077 |   | 31,349 |   | 22,156 |   |
| Real estate  construction                          |       | 73,321                                                                                                                                                                         |       | 83,173 |   | 60,269 |   | 37,717 |   | 36,457 |   |
| Agriculture                                        |       | 25,917                                                                                                                                                                         |       | 31,430 |   | 27,527 |   | 22,390 |   | 13,016 |   |
| Residential real  estate and consumer              |       | 22,895                                                                                                                                                                         |       | 19,400 |   | 16,409 |   | 13,752 |   | 11,225 |   |
| Unearned income                                    |       | (1,035                                                                                                                                                                         | )          | (1,038 | ) | (1,233 | ) | (1,345 | ) | (1,188 | ) |
|                                               |       |                                                                                                                                                                           |       |   |   |   |   |   |   |   |   |
| Total loans, net  of unearned income               |       | 427,142                                                                                                                                                                        |       | 386,771 |   | 377,160 |   | $ | 316,764 |   | $ | 257,307 |   |
|                                               |       |                                                                                                                                                                           |       |   |   |   |   |   |   |   |   |
| Participation  loans sold and serviced by the Bank |       | $                                                                                                                                                                              | 9,759      |   | $ | 1,314 |   | $ | 3,488 |   | $ | 3,838 |   | $ | 3,872 |   |
|                                               |       |                                                                                                                                                                           |       |   |   |   |   |   |   |   |   |
| Commercial real  estate                            |       | 62.9                                                                                                                                                                           | %          | 53.9 | % | 61.8 | % | 67.2 | % | 68.3 | % |
| Commercial                                         |       | 8.7                                                                                                                                                                            | %          | 11.8 | % | 10.9 | % | 9.9 | % | 8.6 | % |
| Real estate  construction                          |       | 17.2                                                                                                                                                                           | %          | 21.5 | % | 16.0 | % | 11.9 | % | 14.2 | % |
| Agriculture                                        |       | 6.1                                                                                                                                                                            | %          | 8.1 | % | 7.3 | % | 7.1 | % | 5.1 | % |
| Residential real  estate and consumer              |       | 5.3                                                                                                                                                                            | %          | 5.0 | % | 4.4 | % | 4.3 | % | 4.4 | % |
| Unearned income                                    |       | (0.2                                                                                                                                                                           | )%         | (0.3 | )% | (0.3 | )% | (0.4 | )% | (0.5 | )% |
|                                               |       |                                                                                                                                                                           |       |   |   |   |   |   |   |   |   |
| Total loans, net  of unearned income               |       | 100.0                                                                                                                                                                          | %          | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % |

 

The following table showsthe contractual maturity distribution and repricing intervals of theoutstanding loans in our portfolio, as of December 31, 2008. In addition,the table shows the distribution of such loans between those with variable orfloating interest rates and those with fixed or predetermined interest rates.

 

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| ** **                                       | ** ** | **Loan Maturities and Repricing Schedule  At December 31, 2008** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **Within**                                                                                          | ** ** | **After One  But Within** | ** ** | **After** | ** ** | ** ** | ** ** |
| **(Dollars in thousands)**                       | ** ** | **One Year**                                                                                        | ** ** | **Five Years** | ** ** | **Five Years** | ** ** | **Total** | ** ** |
| ** **                                       | ** ** | ** **                                                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Commercial real  estate                          |       | $                                                                                                   | 51,315     |   | $ | 178,999 |   | $ | 38,428 |   | $ | 268,742 |   |
| Commercial                                       |       | 21,934                                                                                              |       | 12,719 |   | 2,649 |   | 37,302 |   |
| Real estate  construction                        |       | 61,193                                                                                              |       | 12,113 |   | 15 |   | 73,321 |   |
| Agriculture                                      |       | 18,374                                                                                              |       | 6,375 |   | 1,168 |   | 25,917 |   |
| Residential real  estate and consumer            |       | 1,040                                                                                               |       | 6,301 |   | 15,554 |   | 22,895 |   |
| Unearned income                                  |       | (372                                                                                                | )          | (523 | ) | (140 | ) | (1,035 | ) |
| Total loans, net  of unearned income             |       | $                                                                                                   | 153,484    |   | $ | 215,984 |   | $ | 57,674 |   | $ | 427,142 |   |
|                                             |       |                                                                                                |       |   |   |   |   |   |   |
| Loans with  variable (floating) interest rates   |       | $                                                                                                   | 119,490    |   | $ | 151,650 |   | $ | 37,732 |   | $ | 308,872 |   |
| Loans with  predetermined (fixed) interest rates |       | $                                                                                                   | 33,994     |   | $ | 64,333 |   | $ | 19,943 |   | $ | 118,270 |   |

 

The majority of theproperties taken as collateral are located in Northern California. We employstrict guidelines regarding the use of collateral located in less familiarmarket areas. The recent decline in Northern California real estate value isoffset by the low loan-to-value ratios in our commercial real estate portfolioand high percentage of owner-occupied properties.

 

***Nonperforming Assets***

 

Nonperforming assetsconsist of loans on non-accrual status, loans 90 days or more past due andstill accruing interest, loans restructured, where the terms of repayment havebeen renegotiated resulting in a reduction or deferral of interest orprincipal, and other real estate owned (“OREO”).

 

Loans are generallyplaced on non-accrual status when they become 90 days past due, unlessmanagement believes the loan is adequately collateralized and in the process ofcollection. The past due loans may or may not be adequately collateralized, butcollection efforts are continuously pursued. Loans may be restructured bymanagement when a borrower has experienced some changes in financial status,causing an inability to meet the original repayment terms, and where we believethe borrower will eventually overcome those circumstances and repay the loan infull. OREO consists of properties acquired by foreclosure or similar means andwhich management intends to offer for sale.

 

The Bank hadnonperforming loans of $4.72 million at December 31, 2008, as compared to$9.81 million at December 31, 2007 and no nonperforming loans at December 31,2006, 2005 and 2004, respectively.  Theratio of nonperforming loans over total loans was 1.10% and 2.54% at December 31,2008 and 2007, respectively, as compared with 0.0% in the prior three year-endperiods.

 

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In addition, the Bankheld two residential development OREO properties with a market value of $2.75million as of December 31, 2008. The Bank did not possess any OREO during any of the year-end periodsfrom 2004 through 2007.

 

Management believes thatthe reserve provided for nonperforming loans, together with the tangiblecollateral, were adequate as of December 31, 2008. See “Allowance for LoanLosses” below for further discussion. Except as disclosed above, as of December 31,2008, management was not aware of any material credit problems of borrowersthat would cause it to have serious doubts about the ability of a borrower tocomply with the present loan payment terms. However, no assurance can be giventhat credit problems may exist that may not have been brought to the attentionof management.

 

The following tableprovides information with respect to the components of our nonperforming assetsas of the dates indicated.  (The figuresin the table are net of the portion guaranteed by the U.S. Government):

 

**NonperformingAssets**

 
| ** **                                                                              | ** ** | **At December 31,**        | ** ** |
|-----------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                              | ** ** | **2008**                             | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                              | ** ** | **(Dollars in Thousands)** | ** ** |
| ** **                                                                              | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Nonaccrual  loans(1)**                                                                |       |                                 |       |   |   |   |   |   |   |   |   |
| Commercial real  estate                                                                 |       | $                                    | 2,115      |   | $ | 1,127 |   | $ | 0 |   | $ | 0 |   | $ | 0 |   |
| Commercial                                                                              |       | 0                                    |       | 0 |   | 0 |   | 0 |   | 0 |   |
| Real estate  construction                                                               |       | 1,963                                |       | 7,960 |   | 0 |   | 0 |   | 0 |   |
| Agriculture                                                                             |       | 0                                    |       | 0 |   | 0 |   | 0 |   | 0 |   |
| Residential real  estate and consumer                                                   |       | 0                                    |       | 0 |   | 0 |   | 0 |   | 0 |   |
|                                                                                    |       |                                 |       |   |   |   |   |   |   |   |   |
| Total                                                                                   |       | $                                    | 4,078      |   | $ | 9,087 |   | 0 |   | $ | 0 |   | 0 |   |
|                                                                                    |       |                                 |       |   |   |   |   |   |   |   |   |
| ***Loans  90 days or more past due and still accruing (as to principal or interest):*** |       |                                 |       |   |   |   |   |   |   |   |   |
| Commercial real  estate                                                                 |       | $                                    | 0          |   | $ | 0 |   | $ | 0 |   | $ | 0 |   | $ | 0 |   |
| Commercial                                                                              |       | 0                                    |       | 0 |   | 0 |   | 0 |   | 4 |   |
| Real estate  construction                                                               |       | 643                                  |       | 721 |   | 0 |   | 0 |   | 0 |   |
| Agriculture                                                                             |       | 0                                    |       | 0 |   | 0 |   | 0 |   | 1 |   |
| Residential real  estate and consumer                                                   |       | 0                                    |       | 0 |   | 0 |   | 0 |   | 0 |   |
|                                                                                    |       |                                 |       |   |   |   |   |   |   |   |   |
| Total                                                                                   |       | 643                                  |       | 721 |   | 0 |   | 0 |   | 5 |   |
|                                                                                    |       |                                 |       |   |   |   |   |   |   |   |   |
| **Restructured  loans(2)**                                                              |       |                                 |       |   |   |   |   |   |   |   |   |
| Commercial real  estate                                                                 |       | $                                    | 0          |   | $ | 0 |   | $ | 0 |   | $ | 0 |   | $ | 0 |   |
| Commercial                                                                              |       | 0                                    |       | 0 |   | 0 |   | 0 |   | 0 |   |
| Real estate  construction                                                               |       | 0                                    |       | 0 |   | 0 |   | 0 |   | 0 |   |
| Agriculture                                                                             |       | 0                                    |       | 0 |   | 0 |   | 0 |   | 0 |   |
| Residential real  estate and consumer                                                   |       | 0                                    |       | 0 |   | 0 |   | 0 |   | 0 |   |
|                                                                                    |       |                                 |       |   |   |   |   |   |   |   |   |
| Total                                                                                   |       | 0                                    |       | 0 |   | 0 |   | 0 |   | 0 |   |
|                                                                                    |       |                                 |       |   |   |   |   |   |   |   |   |
| Total  nonperforming loans                                                              |       | 4,721                                |       | 9,808 |   | 0 |   | 0 |   | 5 |   |
| Other real  estate owned                                                                |       | 2,746                                |       | 0 |   | 0 |   | 0 |   | 0 |   |
|                                                                                    |       |                                 |       |   |   |   |   |   |   |   |   |
| Total  nonperforming assets                                                             |       | $                                    | 7,467      |   | $ | 9,808 |   | $ | 0 |   | $ | 0 |   | $ | 0 |   |
|                                                                                    |       |                                 |       |   |   |   |   |   |   |   |   |
| Nonperforming  loans as a percentage of total loans                                     |       | 1.10                                 | %          | 2.54 | % | 0.00 | % | 0.00 | % | 0.00 | % |
| Nonperforming  assets as a percentage of total loans and other real estate owned        |       | 1.74                                 | %          | 2.54 | % | 0.00 | % | 0.00 | % | 0.00 | % |
| Allowance for  loan losses as a percentage of nonperforming loans                       |       | 117.97                               | %          | 45.95 | % | — |   | — |   | — |   |

 

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*(1) *Duringthe fiscal year ended December 31, 2008 and 2007, no interest incomerelated to these loans was included in net income while on nonaccrual status.Additional interest income of approximately $135,000 and $233,000 would havebeen recorded during the year ended December 31, 2008 and 2007,respectively, if these loans had been paid in accordance with their originalterms.

*(2) *A“restructured loan” is one the terms of which were renegotiated to provide areduction or deferral of interest or principal because of deterioration in thefinancial position of the borrower.

 

*Allowancefor Loan Losses*

 

In anticipation of creditrisk inherent in our lending business, we set aside allowances through chargesto earnings. Such charges are not only made for the outstanding loan portfolio,but also for off-balance sheet items, such as commitments to extend credits orletters of credit. The charges made for the outstanding loan portfolio arecredited to the allowance for loan losses, whereas charges for off-balancesheet items are credited to the reserve for off-balance sheet items, which ispresented as a component of other liabilities. The provision for loan losses isdiscussed in the section entitled “Provision for Loan Losses” above.

 

The rapid growth of ourloan portfolio in the past five years has required more reserves for probableloan losses. The allowance for loan losses increased by 23.6%, or $1,063,000,to $5.57 million at December 31, 2008, as compared with $4.51 million at December 31,2007. Such allowances were $4.34 million, $3.98 million, and $3.27 million at December 31,2006, 2005, and 2004, respectively. Despite the rapid growth of our loanportfolio, the increases in loan loss allowances have been sufficient tomaintain a stable allowance for loan losses as a percentage of total loans, asreflected in the ratios of  1.30, 1.16,1.15, 1.16 and 1.20, at the end of 2008, 2007, 2006, 2005 and 2004,respectively.

 

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In light of the currentweakness in the economic environment, and specifically in the real estateconstruction sector, reserves have been increased to recognize such increasedrisk.  Diversification, lowloan-to-values, strong credit quality and enhanced credit monitoring contributeto a reduction in the portfolio’s overall risk, and help to offset the economicrisk.  The impact of the increasingeconomic weakness will continue to be monitored, and adjustments to theprovision for loan loss will be made accordingly.  As evidenced in 2008, the weak businessclimate adversely impacted the financial conditions of some of our clients andincreased our net loan charge-off to $1,110,000, compared to $397,000, $13,000,$1,000 and $4,000 in 2007, 2006, 2005 and 2004, respectively.

 

Management reviews theseconditions with our senior credit officers. To the extent that any of theseconditions is evidenced by a specifically identifiable problem credit orportfolio segment as of the evaluation date, management’s estimate of theeffect of such condition may be reflected as a specific allowance applicable tosuch credit or portfolio segment. Where any of these conditions is notevidenced by a specific, identifiable problem credit or portfolio segment as ofthe evaluation date, management’s evaluation of the inherent loss related to suchcondition is reflected in the unallocated allowance. Although management hasallocated a portion of the allowance to specific loan categories, the adequacyof the allowance is considered in its entirety.

 

Although managementbelieves the allowance at December 31, 2008 was adequate to absorb lossesfrom any known and inherent risks in the portfolio, no assurance can be giventhat economic conditions which adversely affect our service areas or othervariables will not result in increased losses in the loan portfolio in thefuture.

 

As of December 31,2008, our allowance for loan losses consisted of amounts allocated to threephases of our methodology for assessing loan loss allowances, as follows (seedetails of methodology for assessing allowance for loan losses in the sectionentitled “Critical Accounting Policies”):

 
| **Phase of Methodology (Dollars in Thousands)** | ** ** | **As of: December 31, 2008** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| Specific review  of individual loans                                     |       | $                                                | 768        |   |
| Review of pools  of loans with similar characteristics                   |       | $                                                | 4,801      |   |
| Judgmental  estimate based on various subjective factors                 |       | $                                                | —     |   |

 

The table belowsummarizes, for the periods indicated, loan balances at the end of each period,the daily averages during the period, changes in the allowance for loan lossesarising from loans charged off, recoveries on loans previously charged off,additions to the allowance and certain ratios related to the allowance for loanlosses:

 

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**Allowancefor Loan Losses**

(in thousands)

** **
| ** **                                                                       | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| **Balances:**                                                                    |       |     |       |     |       |     |       |     |       |     |       |
| Average total gross  loans outstanding during period                             |       | $        | 400,821    |     | $          | 381,316  |       | $        | 345,063    |     | $          | 276,277 |   | $ | 220,526 |   |
| Total gross loans  outstanding at end of period                                  |       | $        | 428,177    |     | $          | 387,809  |       | $        | 378,393    |     | $          | 318,108 |   | $ | 258,495 |   |
| **Allowance  for loan losses:**                                                  |       |     |       |     |       |     |       |     |       |     |       |
| **Balances  at beginning of period**                                             |       | $        | 4,507      |     | $          | 4,341    |       | $        | 3,976      |     | $          | 3,272 |   | $ | 2,338 |   |
|                                                                             |       |     |       |     |       |     |       |     |       |     |       |
| **Actual  charge-offs:**                                                         |       |     |       |     |       |     |       |     |       |     |       |
| Commercial real  estate                                                          |       | 0        |       | 0        |       | 0        |       | 0        |       | 0        |       |
| Commercial                                                                       |       | 11       |       | 0        |       | 0        |       | 1        |       | 5        |       |
| Real estate  construction                                                        |       | 1,062    |       | 366      |       | 0        |       | 0        |       | 0        |       |
| Agriculture                                                                      |       | 0        |       | 0        |       | 0        |       | 0        |       | 0        |       |
| Residential real  estate and consumer                                            |       | 42       |       | 35       |       | 15       |       | 0        |       | 0        |       |
| Total  charge-offs                                                               |       | 1,115    |       | 402      |       | 15       |       | 1        |       | 5        |       |
|                                                                             |       |     |       |     |       |     |       |     |       |     |       |
| **Recoveries  on loans previously charged off**                                  |       |     |       |     |       |     |       |     |       |     |       |
| Commercial real  estate                                                          |       | 0        |       | 0        |       | 0        |       | 0        |       | 0        |       |
| Commercial                                                                       |       | 0        |       | 0        |       | 0        |       | 0        |       | 0        |       |
| Real estate  construction                                                        |       | 0        |       | 0        |       | 0        |       | 0        |       | 0        |       |
| Agriculture                                                                      |       | 0        |       | 0        |       | 0        |       | 0        |       | 0        |       |
| Residential real  estate and consumer                                            |       | 5        |       | 5        |       | 2        |       | 0        |       | 1        |       |
| Total recoveries                                                                 |       | 5        |       | 5        |       | 2        |       | 0        |       | 1        |       |
|                                                                             |       |     |       |     |       |     |       |     |       |     |       |
| Net loan  charge-offs/(recoveries)                                               |       | 1,110    |       | 397      |       | 13       |       | 1        |       | 4        |       |
|                                                                             |       |     |       |     |       |     |       |     |       |     |       |
| Provision for  loan losses                                                       |       | 2,188    |       | 555      |       | 595      |       | 705      |       | 938      |       |
|                                                                             |       |     |       |     |       |     |       |     |       |     |       |
| Reclassification  of reserve related to off-balance-sheet commitments            |       | (16      | )          | 8        |       | (217     | )          | 0        |       | 0        |       |
|                                                                             |       |     |       |     |       |     |       |     |       |     |       |
| Balance at end  of period                                                        |       | $        | 5,569      |     | $          | 4,507    |       | $        | 4,341      |     | $          | 3,976 |   | $ | 3,272 |   |
|                                                                             |       |     |       |     |       |     |       |     |       |     |       |
| Ratios:                                                                          |       |     |       |     |       |     |       |     |       |     |       |
| Net loan  charge-offs/(recoveries) to average total loans                        |       | 0.28     | %          | 0.10     | %          | 0.00     | %          | 0.00     | %          | 0.00     | %          |
| Allowance for  loan losses to total loans at end of period                       |       | 1.30     | %          | 1.16     | %          | 1.15     | %          | 1.16     | %          | 1.20     | %          |
| Net loan  charge-offs (recoveries) to allowance for loan losses at end of period |       | 19.93    | %          | 8.81     | %          | 0.29     | %          | 0.02     | %          | 0.11     | %          |
| Net loan  charge-offs (recoveries) to provision for loan losses                  |       | 50.73    | %          | 71.57    | %          | 2.12     | %          | 0.10     | %          | 0.38     | %          |

 

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The table belowsummarizes, for the periods indicated, the balance of the allowance for loanlosses and the percentage of each type of loan balance at the end of eachperiod (See “Loan Portfolio” above for a description of each type of loanbalance):

 

**Allocationof the Allowance for Loan Losses**

 
| ** **                            | ** ** | **Amount Outstanding as of December 31,** | ** ** |
|---------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                            | ** ** | **2008**                                                           | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                            | ** ** | **(Dollars in Thousands)**                               | ** ** |
|                                  |       |                                                               |       |   |   |   |   |   |   |   |   |
| **Applicable  to:**                   |       |                                                               |       |   |   |   |   |   |   |   |   |
| Commercial real  estate               |       | $                                                                  | 3,329      |   | $ | 2,672 |   | $ | 2,755 |   | $ | 2,693 |   | $ | 2,350 |   |
| Commercial                            |       | 806                                                                |       | 663 |   | 413 |   | 364 |   | 262 |   |
| Real estate  construction             |       | 997                                                                |       | 837 |   | 885 |   | 691 |   | 514 |   |
| Agriculture                           |       | 210                                                                |       | 189 |   | 162 |   | 118 |   | 65 |   |
| Residential real  estate and consumer |       | 227                                                                |       | 147 |   | 126 |   | 110 |   | 81 |   |
|                                  |       |                                                               |       |   |   |   |   |   |   |   |   |
| **Total  Allowance**                  |       | $                                                                  | 5,569      |   | $ | 4,507 |   | $ | 4,341 |   | $ | 3,976 |   | $ | 3,272 |   |

 

**NoninterestIncome**

 

Noninterest income was$2.5 million for the year ended December 31, 2008, compared to $2.2million for the year 2007. Service charge income was $1.3 million for the year2008 compared to $1.1 million for the year 2007 as a result of the increasenumber of core deposit accounts.  Theaggregate number of DDA, Now, Money Market and Savings accounts increased by19% to 16,602 at December 31, 2008 as compared to 13,946 accounts as of December 31,2007.  In 2008, Earnings on cashsurrender value of life insurance increased by $195,000 due to the purchase of$4.74 million in life insurance policies on certain officers.  The Bank continues to evaluate its depositproduct offerings with the intention of continuing to expand its offerings tothe consumer and business depositors.

 

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**NoninterestIncome**

**(Dollarsin thousands)**

** **
| ** **                                          | ** ** | **For the Years Ended December 31,** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                          | ** ** | **2008**                                                      | ** ** | **2007** | ** ** |
| ** **                                          | ** ** | **(Amount)**                                                  | ** ** | **(%)** | ** ** | **(Amount)** | ** ** | **(%)** | ** ** |
| Service charges  on deposit accounts                |       | $                                                             | 1,299      |   | 51.5 | % | $ | 1,090 |   | 49.6 | % |
| Earnings on cash  surrender value of life insurance |       | 370                                                           |       | 14.7 | % | 175 |   | 8.0 | % |
| Mortgaged  Commissions                              |       | 101                                                           |       | 4.0 | % | 195 |   | 8.9 | % |
| Other income                                        |       | 752                                                           |       | 29.8 | % | 737 |   | 33.5 | % |
| Total                                               |       | $                                                             | 2,522      |   | 100.0 | % | $ | 2,198 |   | 100.0 | % |
|                                                |       |                                                          |       |   |   |   |   |   |   |
| Average assets                                      |       | $                                                             | 452,280    |   |   |   | $ | 446,294 |   |   |   |
| Noninterest  income as a % of average assets        |       |                                                          |       | 0.6 | % |   |   | 0.5 | % |

 

**NoninterestExpense**

 

Noninterest expense was$17.9 million for the year ended December 31, 2008, an increase of $3.7million or 25.7% compared to $14.2 million for the year ended 2007. Salariesand employee benefits increased $720,000 and occupancy expense increase of$472,000, due in part to the addition of a new branch in Stockton and theaddition of a Bank’s commercial lending team located in the new Stocktonbranch.  Another primary component oftotal non-interest expense was OREO expenses of $1.6 million in 2008 comparedto none in 2007.  Other operatingexpenses increased by $642,000 which includes additional FDIC and DFIassessments of $153,000 in 2008 compared to 2007.

 

The following table setsforth a summary of noninterest expenses for the periods indicated:

 

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**NoninterestExpense**

**(Dollarsin thousands)**

** **
| ** **                                     | ** ** | **For the Years Ended December 31,** | ** ** |
|------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                     | ** ** | **2008**                                                      | ** ** | **2007** | ** ** |
| ** **                                     | ** ** | **(Amount)**                                                  | ** ** | **(%)** | ** ** | **(Amount)** | ** ** | **(%)** | ** ** |
| Salaries and  employee benefits                |       | $                                                             | 9,306      |   | 52.1 | % | $ | 8,586 |   | 60.4 | % |
| Occupancy  expenses                            |       | 2,695                                                         |       | 15.1 | % | 2,223 |   | 15.6 | % |
| Data processing  fees                          |       | 765                                                           |       | 4.3 | % | 542 |   | 3.8 | % |
| Telephone  expenses                            |       | 295                                                           |       | 1.6 | % | 254 |   | 1.8 | % |
| OREO expenses                                  |       | 1,554                                                         |       | 8.7 | % | — |   | 0.0 | % |
| Other operating  expenses                      |       | 3,251                                                         |       | 18.2 | % | 2,609 |   | 18.4 | % |
| Total                                          |       | $                                                             | 17,866     |   | 100.0 | % | $ | 14,213 |   | 100.0 | % |
|                                           |       |                                                          |       |   |   |   |   |   |   |
| Average assets                                 |       | $                                                             | 452,280    |   |   |   | $ | 446,294 |   |   |   |
| Noninterest  expenses as a % of average assets |       |                                                          |       | 4.0 | % |   |   | 3.2 | % |

 

Management anticipatesthat noninterest expense will continue to increase as we continue togrow.  However, management remains committed to cost-control and efficiency,and we expect to keep these increases to a minimum relative to growth.

 

**IncomeTax Expense**

 

The effective income taxrate on income from continuing operations was 27.5% for the year ended December 31,2008 compared to 37.3% for the year 2007. The disparity between the effective tax rates in 2008 as compared to2007 is primarily due to tax credits from California Enterprise Zones and lowincome housing projects as well as tax free-income on loans within theseenterprise zones and municipal securities and loans that comprise a largerproportion of pre-tax income in 2008 as compared to prior years.

 

**FinancialCondition**

 

The Bank’s total assetswere $508.2 million at December 31, 2008 compared to $454.3 million at December 31,2007, an increase of $53.9 million or 11.9%. Net loans increased $39.3 million,investments increased $8.1 million, bank premises and equipment increased $1.0million and interest receivable and other assets increased $7.2 million, whilecash and cash equivalents decreased $4.4 million.

 

Loans gross of theallowance for loan losses were $428.2 million at December 31, 2008,compared to $387.8 million at December 31, 2007, an increase of $40.4million or 10.4%. The increase was primarily due to increase of $60.4 millionor 29% in the commercial real estate loans and a $3.5 million increase inresidential real estate and consumer loans. These were offset by decreases of$8.2 million, $9.9 million and $5.5 million in commercial, real estateconstruction and agriculture loans, respectively.  All loan categories slightly decreased orremained relatively unchanged as a percentage of total loans, due to theincrease in commercial real estate loans, which increased from approximately53.9% to 62.9% of total loans.

 

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Deposits increased$901,000 or 0.2% to $378.2 million at December 31, 2008 compared to $377.3million at December 31, 2007. Time deposits decreased by $9.2 million,much of which was transferred by customers to money market accounts asevidenced by an increase of $18.9 million in money market accounts.  All other deposit types recognized a slightdecrease compared to the prior year.

 

Short-term borrowingsincreased $22.5 million to $50.5 million at December 31, 2008, compared to$28.0 million at December 31, 2007 while long-term debt increased to $18.5million at December 31, 2008, compared to $3.0 million at December 31,2007. The increase in long-term debt was due to the Bank deciding to utilize along-term FHLB fixed rate advance and thus reducing the level of short-termFHLB advances. The Bank uses short-term borrowings, primarily short-term FHLBadvances, to fund short-term liquidity needs and manage net interest margin.

 

Equity increased $15.6million or 36.9% to $58.0 million at December 31, 2008, compared to $42.4million at December 31, 2007.  TheBank was selected to participate in the U.S. Treasury Capital Purchase Program(“TCPP”) which resulted in the issuance of $13.5 million in preferredstock.  The Bank intends to use thecapital to increase credit availability to local, creditworthy, businesses andconsumers. The preferred stock shares have a 5% coupon for 5 years and 9% thereafter.Warrants to purchase 350,346 shares of common stock at a per share exerciseprice of $5.78 are attached and fully exercisable. The warrants expire 10 yearsafter the issuance date. The securities issued to the Treasury will beaccounted for as components of regulatory Tier 1 capital.  See Note 12 to the Consolidated FinancialStatements in Item 8 of this report for further discussion regarding ourparticipation in the TCPP.

 

**Liquidity**

 

Liquidity to meetborrowers’ credit and depositors’ withdrawal demands is provided by maturingassets, short-term liquid assets that can be converted to cash and the abilityto attract funds from depositors. Additional sources of liquidity may includeinstitutional deposits, advances from the FHLB and other short-term borrowings,such as federal funds purchased.

 

Since our deposit growthstrategy emphasizes core deposit growth we have avoided relying on brokereddeposits as a consistent source of funds. The only brokered deposit the Bank holds are from CDARS, a certificateof deposit program that exchanges funds with other network banks to offer fullFDIC insurance coverage to the customer. The bank had$10.5 million in brokered deposits as of December 31, 2008 and none at December 31,2007.

 

At December 31, 2008and December 31, 2007, the Bank had total FHLB advances outstanding of$69.0 million and $31.0 million, respectively. At December 31, 2008 and December 31, 2007, the Bank hadsufficient collateral to borrow an additional $38.1 million and $68.0 million,respectively.  In addition, the Bank hadlines of credit to purchase overnight federal funds with its correspondentbanks totaling $20 million.  No 

 

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advances were made onthese lines of credit as of December 31, 2008 and December 31, 2007.

 

Oak Valley Bancorp’sliquidity depends primarily on dividends paid to it as sole shareholder of theBank. The Bank’s ability to pay dividends to Oak Valley Bancorp withoutregulatory approval will depend on whether the Bank will be in a position topay dividends.

 

The following chartsummarizes certain contractual obligations of the Bank as of December 31,2008 (dollars in thousands):

 
| **Contractual Obligations**   | ** ** | **Less than 1  Year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than 5  years** | ** ** | **Total** | ** ** |
|------------------------------------|------------|---------------------------------|------------|--------------------|------------|--------------------|------------|----------------------------------|------------|-----------|------------|
| FHLB borrowings                    |       | $                               | 50,500     |               | $          | 18,500             |       | $                                | —     |      | $          | — |   | $ | 69,000 |   |
| Operating lease  obligations       |       | 803                             |       | 1,545              |       | 1,595              |       | 3,950                            |       | 7,893     |       |
| Investment in  limited partnership |       | 37                              |       | —             |       | —             |       | —                           |       | 37        |       |
| Supplemental  retirement plans     |       | 20                              |       | 48                 |       | 72                 |       | 764                              |       | 904       |       |
| Time deposit  maturities           |       | 71,638                          |       | 18,608             |       | 313                |       | 43                               |       | 90,602    |       |
|                               |       |                            |       |               |       |               |       |                             |       |      |       |
| Total                              |       | $                               | 122,998    |               | $          | 38,701             |       | $                                | 1,980      |      | $          | 4,757 |   | $ | 168,436 |   |

 

**Returnon Equity and Assets**

 

The following table setsforth certain information regarding our return on equity and assets for theperiods indicated:

 
| ** **                | ** ** | **At December 31, 2008** | ** ** | **At December 31, 2007** | ** ** |
|---------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
| Return on  average assets |       | 0.46                                    | %          | 0.88                                    | %          |
| Return on  average equity |       | 4.77                                    | %          | 10.11                                   | %          |
| Dividend payout  ratio    |       | 27.38                                   | %          | 36.81                                   | %          |
| Equity to assets  ratio   |       | 11.41                                   | %          | 9.33                                    | %          |

 

**Off-BalanceSheet Arrangements**

 

During the ordinarycourse of business, we provide various forms of credit lines to meet thefinancing needs of our customers. These commitments, which represent a creditrisk to us, are not represented in any form on our balance sheets.

 

As of December 31,2008, and 2007, we had commitments to extend credit of $63.1 million and $81.4million, respectively.  Obligations under standby letters of credit were$3.53 million, and $1.14 million, for 2008, and 2007, respectively,and there were no obligations under commercial letters of credit for eitherperiod.

 

The effect on ourrevenues, expenses, cash flows and liquidity from the unused portion of thecommitments to provide credit cannot be reasonably predicted because there isno guarantee that the lines of credit will be used. For more informationregarding our off balance sheet arrangements, see Note 14 to our 2008 year endfinancial statements 

 

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located elsewhere in thisreport.

 

**InvestmentActivities**

 

Investments are a keysource of interest income. Management of our investment portfolio is set inaccordance with strategies developed and overseen by our Investment Committee.Investment balances, including cash equivalents and interest-bearing depositsin other financial institutions, are subject to change over time based on ourasset/liability funding needs and interest rate risk management objectives. Ourliquidity levels take into consideration anticipated future cash flows and allavailable sources of credits and are maintained at levels management believesare appropriate to assure future flexibility in meeting anticipated fundingneeds.

 

*CashEquivalents and Interest-bearing Deposits in other Financial Institutions*

 

The Bank holds federalfunds sold, unpledged available-for-sale securities and salable governmentguaranteed loans to help meet liquidity requirements and provide temporaryholdings until the funds can be otherwise deployed or invested.  As of December 31, 2008, and 2007, wehad $765,000 and $3.81 million, respectively, in federal funds sold.

 

*InvestmentSecurities*

 

Management of ourinvestment securities portfolio focuses on providing an adequate level ofliquidity and establishing an interest rate-sensitive position, while earningan adequate level of investment income without taking undue risk. Investmentsecurities that we intend to hold until maturity are classified asheld-to-maturity securities, and all other investment securities are classifiedas available-for-sale.  Currently, all ofour investment securities are classified as available-for-sale. The carryingvalues of available-for-sale investment securities are adjusted for unrealizedgains or losses as a valuation allowance and any gain or loss is reported on anafter-tax basis as a component of other comprehensive income.

 

Our investment securitiesholdings increased by $8.1 million, or 24.2%, to $41.4 million at December 31,2008, compared to holdings of $33.3 million at December 31, 2007.  Accordingly, total investment securities as apercentage of total assets increased to 8.2% as compared to 7.3% at December 31,2007.  As of December 31, 2008,$34.5 million of the investment securities were pledged to secure certaindeposits.

 

As of December 31,2008, the total unrealized loss on securities that were in a loss position forless than 12 continuous months was $99,719 with an aggregate fair value of$13,074,953.  The total unrealized losson securities that were in a loss position for greater than 12 continuousmonths was $100,152 with an aggregate fair value of $5,779,473.

 

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The following tablesummarizes the book value and market value and distribution of our investmentsecurities as of the dates indicated:

 

**Investment Securities Portfolio**

 
| ** **                             | ** ** | **As of December 31, 2008** | ** ** | **As of December 31, 2007** | ** ** | **As of December 31, 2006** | ** ** |
|----------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                             | ** ** | **Amortized**                                   | ** ** | ** **                                      | ** ** | **Amortized**                                   | ** ** | ** ** | ** ** | **Amortized** | ** ** | ** ** | ** ** |
| **Dollars in Thousands**     | ** ** | **Cost**                                        | ** ** | **Market Value**                           | ** ** | **Cost**                                        | ** ** | **Market Value** | ** ** | **Cost** | ** ** | **Market Value** | ** ** |
| **Available-for-Sale:**                |       |                                            |       |                                            |       |                                            |       |   |   |   |   |   |   |
| Securities of U.S. government agencies |       | $                                               | 25,541     |                                            | $          | 26,085                                          |       | $ | 24,875 |   | $ | 24,962 |   | $ | 27,464 |   | $ | 27,250 |   |
| Collateralized mortgage obligations    |       | 3,439                                           |       | 3,485                                           |       | 4,024                                           |       | 3,961 |   | 6,219 |   | 6,020 |   |
| Municipal securities                   |       | 9,971                                           |       | 9,902                                           |       | 2,343                                           |       | 2,400 |   | 2,903 |   | 2,979 |   |
| SBA Pools                              |       | 1,820                                           |       | 1,779                                           |       | 2,054                                           |       | 2,049 |   | — |   | — |   |
| Asset Backed Security                  |       | 198                                             |       | 198                                             |       | —                                          |       | — |   | — |   | — |   |
| Total investment securities            |       | $                                               | 40,969     |                                            | $          | 41,449                                          |       | $ | 33,296 |   | $ | 33,373 |   | $ | 36,586 |   | $ | 36,249 |   |

 

As of December 31,2008 , a total of four U.S. Government agencies, one collateralized mortgageobligations and two SBA pools make up the total amount of securities in anunrealized loss position for greater than 12 months.  Management periodically evaluates each available-for-saleinvestment security in an unrealized loss position to determine if theimpairment is temporary or other than temporary.  Management has determined that no investmentsecurity is other than temporarily impaired. The unrealized losses are due solely to interest rate changes and theBank has the ability and intent to hold all investment securities withidentified impairments resulting from interest rate changes to the earlier ofthe forecasted recovery or the maturity of the underlying investmentsecurity.  As of December 31, 2008,we did not have any investment securities that constituted 10% or more of thestockholders’ equity of any third party issuer.

 

The following tablesummarizes the maturity and repricing schedule of our investment securities attheir amortized cost and their weighted average yields at December 31,2008:

 

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**InvestmentMaturities and Repricing Schedule**

**(Dollarsin Thousands)**

** **
| ** **                              | ** ** | ** **                    | ** ** | ** **                      | ** ** | **After One But**    | ** ** | **After Five But**  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|-------------------------------|------------|---------------------------------|------------|--------------------------------|------------|-------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                              | ** ** | **Within One Year** | ** ** | **Within Five Years** | ** ** | **Within Ten Years** | ** ** | **After Ten Years** | ** ** | **Total**  | ** ** |
| ** **                              | ** ** | **Amount**                    | ** ** | **Yield**                       | ** ** | **Amount**                     | ** ** | **Yield**                     | ** ** | **Amount** | ** ** | **Yield**  | ** ** | **Amount** | ** ** | **Yield**  | ** ** | **Amount** | ** ** | **Yield** | ** ** |
| **Available-for-sale:**                 |       |                          |       |                            |       |                           |       |                          |       |       |       |       |       |       |       |       |       |   |   |   |   |
| Securities of  U.S. government agencies |       | $                             | 88         |                            | 4.59       | %                              | $          | 823                           |       | 4.25       | %          | $          | 2,488      |       | 5.28       | %          | $          | 22,141 |   | 5.25 | % | $ | 25,541 |   | 5.22 | % |
| Collateralized  mortgage obligations    |       | 0                             |       | 0                               | %          | 0                              |       | 0                             | %          | 0          |       | 0          | %          | 3,439      |       | 4.12       | %          | 3,439 |   | 4.12 | % |
| Municipal  securities                   |       | 510                           |       | 5.81                            | %          | 851                            |       | 5.47                          | %          | 8,610      |       | 5.90       | %          | 0          |       | 0          | %          | 9,971 |   | 5.86 | % |
| SBA Pools                               |       | 0                             |       | 0                               | %          | 0                              |       | 0                             | %          | 0          |       | 0          | %          | 1,821      |       | 1.41       | %          | 1,821 |   | 1.41 | % |
| Asset Backed  Security                  |       | 0                             |       | 0                               | %          | 198                            |       | 6.49                          | %          | 0          |       | 0          | %          | 0          |       | 0          | %          | 198 |   | 6.49 | % |
| Total Investment  Securities            |       | $                             | 598        |                            | 5.63       | %                              | $          | 1,872                         |       | 5.04       | %          | $          | 11,098     |       | 5.76       | %          | $          | 27,401 |   | 4.86 | % | $ | 40,969 |   | 5.12 | % |

 

 Interest income and yields in the above tablehave not been adjusted to a fully tax equivalent basis.

 

**OtherEarning Assets**

 

For various businesspurposes, we make investments in earning assets other than the interest-earningsecurities discussed above. Before 2007, the only other earning assets held byus were insignificant amounts of Federal Home Loan Bank stock, Federal ReserveBank stock and the cash surrender value on the Bank Owned Life Insurances (“BOLI”).Balances of the Federal Home Loan Bank stock, Federal Reserve Bank stock andthe BOLI cash surrender value as of December 31, 2008 were $3.8 million,$751,000 and $9.9 million, respectively. The BOLI increase of $5.1 million was primarily due to the purchase of$4.7 million in BOLI policies for certain officers.

 

During 2007, we investedin a low-income housing tax credit funds (“LIHTCF”) to promote ourparticipation in CRA activities. We committed to invest $1 million, over thenext two to three years. We anticipate receiving the return following this twoto three year period in the form of tax credits and tax deductions over thenext fifteen years.

 

The balances of otherearning assets as of December 31, 2008 and December 31, 2007 were asfollows:

 
| **Dollars in Thousands** | ** ** | **Balance as of December  31, 2008** | ** ** | **Balance as of December  31, 2007** | ** ** |
|------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| Type                               | ** ** | ** **                                               | ** ** | ** **                                               | ** ** |
| BOLI                               |       | $                                                        | 9,859      |                                                     | $          | 4,749 |   |
| LIHTCF                             |       | $                                                        | 846        |                                                     | $          | 323 |   |
| Federal Reserve  Bank Stock        |       | $                                                        | 751        |                                                     | $          | 670 |   |
| Federal Home  Loan Bank Stock      |       | $                                                        | 3,804      |                                                     | $          | 2,283 |   |

 

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**Depositsand Other Sources of Funds**

 

*Deposits*

 

Total deposits at December 31,2008, and 2007 were $378.2 million, and $377.3 million, respectively,representing an increase of $0.9 million or 0.2%, in 2008. The average depositsfor the years ended December 31, 2008 decreased $4.0 million or 1.1% to$365.5 million compared to $369.5 million at December 31, 2007.

 

Deposits are the Bank’sprimary source of funds. Due to strategic emphasis by management, core deposits(consisting of DDA, NOW, Money Market and Savings accounts) increased by 3.7%in 2008 to $287.6 million at December 31, 2008.  As a result, the percentage of core depositsto total deposits increased to 76.0% from 73.5% as of December 31, 2008 ascompared to December 31, 2007.  Theaverage rate paid on time deposits in denominations of $100,000 or more was3.92% and 5.20% for the years ended December 31, 2008, and 2007,respectively. See “Net Interest Income and Net Interest Margin” for furtherdiscussion.

 

The following tablessummarize the distribution of average daily deposits and the average dailyrates paid for the periods indicated:

 
| ** **                                        | ** ** | **Average Deposits** | ** ** |
|---------------------------------------------------|------------|---------------------------|------------|
| ** **                                        | ** ** | **2008**                  | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                        | ** ** | **Average**               | ** ** | **Average** | ** ** | **Average** | ** ** | **Average** | ** ** | **Average** | ** ** | **Average** | ** ** |
| **Dollars in Thousands**                | ** ** | **Balance**               | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Rate** | ** ** |
| ** **                                        | ** ** | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Demand, noninterest-bearing                       |       | $                         | 61,554     |   | 0.00 | % | $ | 58,468 |   | 0.00 | % | $ | 49,966 |   | 0.00 | % |
| Money market                                      |       | 149,202                   |       | 2.40 | % | 125,574 |   | 3.62 | % | 117,635 |   | 3.43 | % |
| NOW                                               |       | 54,160                    |       | 0.71 | % | 53,634 |   | 1.05 | % | 49,071 |   | 1.11 | % |
| Savings                                           |       | 15,563                    |       | 1.66 | % | 16,745 |   | 3.33 | % | 21,644 |   | 3.01 | % |
| Time certificates of deposit of $100,000  or more |       | 40,172                    |       | 3.92 | % | 66,007 |   | 5.20 | % | 70,937 |   | 4.49 | % |
| Other time deposits                               |       | 44,846                    |       | 3.21 | % | 49,118 |   | 4.34 | % | 52,124 |   | 4.26 | % |
| Total deposits                                    |       | $                         | 365,497    |   | 1.98 | % | $ | 369,546 |   | 3.04 | % | $ | 361,377 |   | 2.94 | % |

 

The scheduled maturitiesof our time deposits in denominations of $100,000 or greater at December 31,2008 are, as follows:

 

**Maturitiesof Time Deposits of $100,000 or More**

**(Dollarsin Thousands)**

 
| Three months or  less                  |   | $     | 19,121 |   |
|----------------------------------------|--------|-------|--------|--------|
| Over three  months through six months  |   | 7,462 |   |
| Over six months  through twelve months |   | 7,512 |   |
| Over twelve  months                    |   | 9,945 |   |
| Total                                  |   | $     | 44,040 |   |

 

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Because our client baseis comprised primarily of commercial and industrial accounts, individualaccount balances are generally higher than those of consumer-oriented banks. Anumber of clients carry deposit balances of more than 1% of our total deposits,but only one customer had a deposit balance of more than 3% of total depositsin 2008.

 

The only brokered depositthe Bank holds are from CDARS, a certificate of deposit program that exchangesfunds with other network banks to offer full FDIC insurance coverage to thecustomer.  The bank had $10.5 million inbrokered deposits as of December 31, 2008 and none at December 31,2007.

 

**FHLBBorrowings**

 

Although deposits are theprimary source of funds for our lending and investment activities and forgeneral business purposes, we may obtain advances from the Federal Home LoanBank of San Francisco (“FHLB”) as an alternative to retail deposit funds. Ouroutstanding FHLB advances increased by $38.0 million to $69.0 million atyear-end 2008 compared to the prior year as a result of our emphasis onmanaging non-relationship, high cost CD’s.  See “Liquidity Management”below for the details on the FHLB borrowings program.

 

The following table is asummary of FHLB borrowings for fiscal years 2008 and 2007:

 
| **Dollars in Thousands**                     | ** ** | **2008** | ** ** | **2007** | ** ** |
|----------------------------------------------|------------|----------|------------|----------|------------|
| Balance at  year-end                         |       | $        | 69,000     |     | $          | 31,000 |   |
| Average balance  during the year             |       | $        | 59,441     |     | $          | 33,455 |   |
| Maximum amount  outstanding at any month-end |       | $        | 79,100     |     | $          | 61,125 |   |
| Average interest  rate during the year       |       | 2.50     | %          | 5.17     | %          |
| Average interest  rate at year-end           |       | 1.51     | %          | 4.70     | %          |

 

**Asset/LiabilityManagement**

 

Management seeks toascertain optimum and stable utilization of available assets and liabilities asa vehicle to attain our overall business plans and objectives. In this regard,management focuses on measurement and control of liquidity risk, interest raterisk and market risk, capital adequacy, operation risk and credit risk.

 

**LiquidityManagement**

 

Maintenance of adequateliquidity requires that sufficient resources be available at all time to meetour cash flow requirements. Liquidity in a banking institution is 

 

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required primarily toprovide for deposit withdrawals and the credit needs of its customers and totake advantage of investment opportunities as they arise. Liquidity managementinvolves our ability to convert assets into cash or cash equivalents withoutincurring significant loss, and to raise cash or maintain funds withoutincurring excessive additional cost. For this purpose, we maintain a portion ofour funds in cash and cash equivalents, loans and securities available forsale. Our liquid assets at December 31, 2008 and 2007 totaledapproximately $60.9 million, and $59.9 million, respectively.  Our liquidity level measured as thepercentage of liquid assets to total assets was 12.0%, and 13.2% at December 31,2008, and 2007, respectively.

 

As a secondary source ofliquidity, we rely on advances from the FHLB to supplement our supply oflendable funds and to meet deposit withdrawal requirements. Advances from theFHLB are typically secured by a portion of our loan portfolio and stock issuedby the FHLB. The FHLB determines limitations on the amount of advances byassigning a percentage to each eligible loan category that will count towardsthe borrowing capacity.  As of December 31,2008, our borrowing capacity from the FHLB was about $107 million and theoutstanding balance was $69 million, or approximately 64% of our borrowingcapacity.  We also maintain 2 lines ofcredit with correspondent banks to purchase up to $20 million in federal funds.

 

**CapitalResources and Capital Adequacy Requirements**

 

In the past two years,our primary source of capital has been internally generated operating incomethrough retained earnings. At December 31, 2008, total shareholders’ equityincreased to $58.0 million, representing an increase of $15.6 million from December 31,2007.  In December 2008, the Bankwas selected to participate in the U.S. Treasury Capital Purchase Program whichdemonstrates the confidence the U.S. Treasury Department has in the stabilityof the Bank. The Bank issued $13.5 million in preferred stock and intends touse the capital to increase credit availability to local, creditworthy,businesses and consumers. The preferred stock shares have a 5% coupon for 5 yearsand 9% thereafter. Warrants to purchase 350,346 shares of common stock at a pershare exercise price of $5.78 are attached and fully exercisable. The warrantsexpire 10 years after the issuance date. The securities issued to the Treasurywill be accounted for as components of regulatory Tier 1 capital.

 

As of December 31,2008, we had no material commitments for capital expenditures other than thepreferred stock dividend payments due to the U.S. Treasury Department.

 

We are subject to variousregulatory capital requirements administered by federal banking agencies.Failure to meet minimum capital requirements can trigger regulatory actionsthat could have a material adverse effect on our financial statements andoperations. Under capital adequacy guidelines and the regulatory framework for 

 

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prompt corrective action,we must meet specific capital guidelines that rely on quantitative measures ofour assets, liabilities and certain off-balance-sheet items as calculated underregulatory accounting practices. Our capital amounts and classification arealso subject to qualitative judgments by the regulators about components, riskweightings, and other factors. (See “Description of Business-Regulation andSupervision-Capital Adequacy Requirements” herein for exact definitions andregulatory capital requirements.)

 

As of December 31,2008, we were qualified as a “well capitalized institution” under theregulatory framework for prompt corrective action. The following table presentsthe regulatory standards for well-capitalized institutions, compared to ourcapital ratios as of the dates specified:

 
| ** **                              | ** ** | **Regulatory Well-  Capitalized Standards** | ** ** | **December 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|-----------------------------------------|------------|-------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| Total capital to  risk-weighted assets  |       | 10.0                                                  | %          | 13.3                            | %          | 11.1                            | %          |
| Tier I capital  to risk-weighted assets |       | 6.0                                                   | %          | 12.1                            | %          | 10.0                            | %          |
| Tier I capital  to average assets       |       | 5.0                                                   | %          | 11.8                            | %          | 9.4                             | %          |

 

**RecentlyIssued Accounting Standards**

 

In September 2006,the FASB issued Statement of Financial Accounting Standards No. 157, “FairValue Measurements,” (“SFAS 157”) which is effective for fiscal years beginningafter November 15, 2007 and for interim periods within those years. SFAS157 defines fair value, establishes a framework for measuring fair value andexpands the related disclosure requirements. This Statement applies under otheraccounting pronouncements that require or permit fair value measurements. TheStatement indicates, among other things, that a fair value measurement assumesthat the transaction to sell an asset or transfer a liability occurs in theprincipal market for the asset or liability or, in the absence of a principalmarket, the most advantageous market for the asset or liability. SFAS 157defines fair value based upon an exit price model. Relative to SFAS 157, theFASB proposed FASB Staff Positions (FSP) 157-a, 157-b, and 157-c. FSP 157-aamends SFAS 157 to exclude Financial Accounting Standards No. 13, “Accountingfor Leases,” and its related interpretive accounting pronouncements thataddress leasing transactions, while FSP 157-b delays the effective date of SFAS157 for all nonfinancial assets and nonfinancial liabilities, except those thatare recognized or disclosed at fair value in the financial statements on arecurring basis. FSP 157-c clarifies the principles in SFAS 157 on the fairvalue measurement of liabilities. Public comments on FSP 157-a and 157-b weredue in January 2008, while public comments on FSP 157-c were due in February 2008.The Company adopted this pronouncement effective January 1, 2008 and hasdetermined that this Standard has not had a material impact on the Company’sfinancial position, results of operations or cash flows.

 

In February 2007,the FASB issued Statement of Financial Accounting Standards No. 159, “TheFair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”),which permits entities to choose to measure many financial instruments andcertain other items at fair value. The objective is to improve financialreporting by 

 

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providing entities withthe opportunity to mitigate volatility in reported earnings caused by measuringrelated assets and liabilities using different measurement techniques.SFAS 159 requires additional disclosures related to the fair valuemeasurements included in the entity’s financial statements. This Statement iseffective for financial statements issued for fiscal years beginning after November 15,2007.  Accordingly, the Company adoptedSFAS in the first quarter of 2008.  TheCompany did not elect the fair value option for any of its financial assets orliabilities.

 

In December 2007,the FASB issued Statement of Financial Accounting Standards No. 141(revised 2007), “Business Combinations” (“SFAS 141(R)”), which replacesStatement of Financial Accounting Standards No. 141, “BusinessCombinations” (“SFAS 141”). SFAS 141(R) retains the underlying concepts ofSFAS 141 in that all business combinations are still required to be accountedfor at fair value under the acquisition method of accounting but SFAS 141(R) changedthe method of applying the acquisition method in a number of significantaspects. Acquisition costs will generally be expensed as incurred;noncontrolling interests will be valued at fair value at the acquisition date;in-process research and development will be recorded at fair value as anindefinite-lived intangible asset at the acquisition date; restructuring costsassociated with a business combination will generally be expensed subsequent tothe acquisition date; and changes in deferred tax asset valuation allowances andincome tax uncertainties after the acquisition date generally will affectincome tax expense. SFAS 141(R) is effective on a prospective basis forall business combinations for which the acquisition date is on or after thebeginning of the first annual period subsequent to December 15, 2008, withthe exception of the accounting for valuation allowances on deferred taxes andacquired tax contingencies. SFAS 141(R) amends SFAS 109 such thatadjustments made to valuation allowances on deferred taxes and acquired taxcontingencies associated with acquisitions that closed prior to the effectivedate of SFAS 141(R) would also apply the provisions of SFAS 141(R). Earlyadoption is not permitted. The Company is currently evaluating the potentialimpact this Statement may have on the Company’s future financial position,results of operations and cash flows.

 

In December 2007,the FASB issued Statement of Financial Accounting Standards No. 160, “NoncontrollingInterests in Consolidated Financial Statements-an amendment of ARB No. 51.”(“SFAS 160”). SFAS 160 is effective for fiscal years, and interim periodswithin those fiscal years, beginning on or after December 15, 2008, withearlier adoption prohibited. The Statement requires the recognition of anoncontrolling interest (minority interest) as equity in the consolidatedfinancial statements and separate from the parent’s equity. The amount of netincome attributable to the noncontrolling interest will be included inconsolidated net income on the face of the income statement. The Statement alsoamends certain of ARB No. 51’s consolidation procedures for consistencywith the requirements of SFAS 141(R). This Statement also includes expandeddisclosure requirements regarding the interests of the parent and its noncontrollinginterest. The Company is currently evaluating the potential impact thisStatement may have on the Company’s financial position, results of operationsand cash flows, but does not believe the impact of the adoption will bematerial.

 

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FASB Emerging Issues TaskForce (“EITF”) Issue No. 06-4, “Accounting for Deferred Compensation andPostretirement Benefit Aspects of Endorsement Split Dollar Life InsuranceArrangements.”  EITF 06-4 requires therecognition of a liability and related compensation expense for bank owned lifeinsurance policies with joint beneficiary agreements that provide a benefit toan employee that extends to post-retirement periods.  Under EITF 06-4, life insurance policiespurchased for the purpose of providing such benefits do not effectively settlean entity’s obligation to the employee. Accordingly, the entity must recognize a liability and relatedcompensation expense during the employee’s active service period based on thefuture cost of insurance to be incurred during the employee’s retirement.  If the entity has agreed to provide theemployee with a death benefit, then the liability for the future death benefitshould be recognized by following the guidance in SFAS 106, “Employer’sAccounting for Postretirement Benefits Other Than Pensions.”  EITF 6-04 was effective for fiscal yearsbeginning after December 17, 2007. The Bank adopted this pronouncement effective January 1, 2008 andhas recorded an initial liability of $119,842 with an offsetting adjustment toretained earning of $70,459 and deferred taxes of $49,383, pursuant to thisaccounting pronouncement.

 

**Impactof Inflation; Seasonality**

 

Inflation primarilyimpacts us by its effect on interest rates. Our primary source of income is netinterest income, which is affected by changes in interest rates. We attempt tolimit the impact of inflation on our net interest margin through management ofrate-sensitive assets and liabilities and the analysis of interest ratesensitivity. The effect of inflation on premises and equipment as well asnoninterest expenses has not been significant for the periods covered in thisreport. Our business is generally not seasonal.

 

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**ITEM8.  FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

 

Our consolidatedfinancial statements and the independent auditors’ report appear on pages F-1through F-33 of this Report and are incorporated into this Item 8 by reference.

 

**ITEM9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIALDISCLOSURE**

 

None.

 

**ITEM9A. CONTROLS AND PROCEDURES**

 

Our Chief ExecutiveOfficer and Chief Financial Officer, after evaluating the effectiveness of ourdisclosure controls and procedures as defined in Exchange Act Rules 13a-14(c) and15-d-14(c) as of the end of the period covered by this report (the “EvaluationDate”) have concluded that as of the Evaluation Date, our disclosure controlsand procedures were adequate and effective to ensure that material informationrelating to the Company and its subsidiary would be made known to them byothers within those entities, particularly during the period in which thisannual report was being prepared. Disclosure controls and procedures aredesigned to ensure that information required to be disclosed by us in thereports that we file or submit under the Exchange Act is recorded, processed,summarized and reported, within the time periods specified in the Commission’s rules andforms. Disclosure controls and procedures include, without limitation, controlsand procedures designed to ensure that information required to be disclosed byus in the reports that we file under the Exchange Act is accumulated andcommunicated to our management, including our Chief Executive Officer and ChiefFinancial Officer, as appropriate to allow timely decisions regarding requireddisclosure.

 

There were no significantchanges in our internal controls or in other factors that could significantlyaffect our internal controls subsequent to the Evaluation Date, nor anysignificant deficiencies or material weaknesses in such controls requiringcorrective actions. As a result, we did not take any corrective actions.

 

**ITEM9B. OTHER INFORMATION**

 

None.

 

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**PART III**

 

**ITEM 10 - DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS ANDCONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.**

 

***Directorsand Executive Officers***

 

The current executiveofficers and directors of the Bank and of Oak Valley Bancorp are as follows:

 

**DonaldBarton, 51**, has been a director of the Bank since 2006 and ofOak Valley Bancorp since 2008.  Mr. Barton is the managing partner atGoldRiver Orchards, a local walnut processing operation which his familystarted since 1912.  He is a Stanford graduate and earned his MBA fromSanta Clara University.  Mr. Barton is an Oakdale resident.

 

**ChristopherM. Courtney, 46,** has been the Bank’s President since August of2004 and a director since January 2007.  He has been Oak ValleyBancorp President and Director since May 2008. Previously, he has servedas the Bank’s Chief Credit Officer and Chief Operating Officer since 1999 and2000, respectively.  Mr. Courtney has 20 years of diverse bankingexperience, joining Oak Valley Community Bank in 1996, as a lender, afterworking for a major bank, a mid-size bank and a small community bank. Hegraduated from Wells Fargo Bank Credit Training Program in 1989. Mr. Courtneyhas a B.S. in Finance and a Masters in Business Administration from CaliforniaState University, Sacramento.  He is also a graduate of the Pacific CoastBanking School at the University of Washington.

 

**JamesL. “Jay” Gilbert, 64,** has been a Director of the Bank since1992 and of Oak Valley Bancorp since 2008.  Mr. Gilbert has lived inOakdale since 1946.  Mr. Gilbert is an owner of A.L.Gilbert Co, andhe has been involved in the feed and seed business as well as retail feedstores for 39 years.  Mr. Gilbert has also been engaged in and almondfarming for more than 30 years.

 

**ThomasA. Haidlen, 62,** has been a director of the Bank since 1992and of Oak Valley Bancorp since 2008.  Mr. Haidlen was born inOakdale and has resided in Oakdale for over 50 years.  He owns andoperates the Haidlen Ford Dealership in Oakdale; established in Oakdale in1955.

 

**MichaelQ. Jones, 63,** has been a director of the Bank since 2004 andof Oak Valley Bancorp since 2008.  Mr. Jones has been a resident ofSonora since 1974.  Mr. Jones has served as the Chairman ofCalifornia Gold Development Corporation since 1974, and has been the owner ofthe Prudential California Realty in Sonora since 2002.

 

**ArneJ. Knudsen, 70,** is a director of the Bank and of Oak ValleyBancorp.  Mr. Knudsen is also the Secretary of the Bank and of OakValley Bancorp.  Mr. Knudsen has been a resident of Oakdale since1960.  He owns and operates Knudsen Nursery, Inc., a wholesalenursery operation which he founded in 1959.

 

**RonaldC. Martin, 62,** has served as a director and Chief ExecutiveOfficer of the Bank since 1992.  He was also the Bank’s President until August 2004.He has been Oak Valley Bancorp Chief Executive Officer and a Director since May 2008.Mr. Martin began his banking career in 1977 with River City Bank inSacramento.  Between 1977 and 1987 he was employed in the Sacramento areaand from December 1987 to January 1992 he served as President andChief Executive Officer of Butte Savings in Chico, California.  Mr. Martinhas a B.S. in Finance from the University of Arizona.

 

**Richard A. McCarty, 37,** has been the Executive Vice Presidentand Chief Financial Officer since 2000 and Chief Administration Officer since2008.  He has been Oak Valley BancorpExecutive Vice President and Chief Financial Officer since May 2008.  Mr. McCarty first joined Oak Valley in1996, leaving in 1997 to work for Del Monte Foods Corporation, where he spenttwo years before returning to Oak Valley Community Bank in 1999.  Mr. McCartyhas a B.S. in Finance from California State University, Stanislaus.

 

**RogerM. Schrimp, 67,** has been a director of the Bank since 1992and of Oak Valley Bancorp since 2008.  Mr. Schrimp has practiced lawin Oakdale since 1967.  He is a senior partner in the Modesto Law Firm ofDamrell, Nelson, Schrimp, Pallios & Ladine, and owns and operates acattle ranch.

 

**DannyL. Titus, 64,** has been a director of the Bank since 1992 andof Oak Valley Bancorp since 2008.  Mr. Titus has served as thePresident of Situs Investments, Inc. since 1989 which manages real estateand investments.  During the period of from 1979 to 1988, Mr. Tituswas the general manager of Steelgard, Inc. which manufacturers portablebuildings.

 

**RichardJ. Vaughan, 71,** has been a director of the Bank since 1992and of Oak Valley Bancorp since 2008.  Mr. Vaughan owns VaughanFarms, operating in Waterford and Oakdale, California.  Mr. Vaughanhas been involved with agribusiness since 1961.

 

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***Corporate Governance Principles and Board Matters***

 

We are committed tohaving sound corporate governance principles. Having such principles isessential to running our business efficiently and to maintaining our integrityin the marketplace.

 

We have adopted a Code ofEthics that applies to our directors, executive officers, employees andconsultants.  Our Chief Executive Officerand all senior financial officers, including the Chief Financial Officer, arebound by such Code of Ethics which is posted on our Internet website at www.ovcb.com.

 

**BoardIndependence**

 

The Board has determinedthat each of the current directors standing for re-election, except for Messrs. Martinand Courtney, is independent under the Nasdaq director independence standardsset forth in Marketplace Rules 4200 and 4350, as currently in effect.

 

**DirectorQualifications**

 

We believe that ourdirectors should have the highest professional and personal ethics and values,consistent with longstanding our values and standards. They should have broadexperience at the policy-making level in business, government, or banking. Theyshould be committed to enhancing shareholder value and should have sufficienttime to carry out their duties and to provide insight and practical wisdombased on experience. Their service on other boards of public companies shouldbe limited to a number that permits them, given their individual circumstances,to perform responsibly all director duties. Each director must represent theinterests of all shareholders.

 

We also believe that itis necessary that the majority of our Board of Directors must be comprised ofindependent directors as set forth in the Nasdaq Marketplace Rules 4200and 4350 and desirable to have at least one financial expert on the Board ofDirectors who serves on our Audit Committee as set forth in Section 401(h) ofRegulation S-K under the federal securities laws. When consideringpotential director candidates, the Board also considers the candidate’scharacter, judgment, diversity, age, skills, including financial literacy, andexperience in the context of our needs and the Board of Directors.

 

**Identifyingand Evaluating Nominees for Directors**

 

The Board and theNominating Committee utilize a variety of methods for identifying andevaluating nominees for director. Directors regularly assess the appropriatesize of the Board, and whether any vacancies on the Board are expected due toretirement or otherwise. In the event that vacancies are anticipated, orotherwise arise, the Board considers various potential candidates for director.Candidates may come to the attention of the Board through current Boardmembers, shareholders or other persons. These candidates are evaluated atregular or special meetings of the Board and the independent directors meetingseparately, and may be considered at any point during the year. As describedabove, the Board considers properly submitted shareowner nominations forcandidates for the Board. Following verification of the shareowner status ofpersons proposing candidates, recommendations are aggregated and considered bythe Board at a regularly scheduled meeting, which is generally the first orsecond meeting prior to the issuance of the proxy statement for our annualmeeting. If any materials are provided by a shareholder with the nomination ofa director candidate, such materials are forwarded to the Board. In evaluatingsuch nominations, the Board seeks to achieve a balance of knowledge, experienceand capability on the Board.

 

**ShareholderCommunications with the Board of Directors**

 

The Board of Directorshas established a process for shareholders to communicate with the Board ofDirectors or with individual directors. Shareholders who wish to communicatewith the Board of Directors or with individual directors should direct writtencorrespondence to our Corporate Secretary, Arne J. Knudsen, at our principalexecutive offices located at 125 North Third Avenue, Oakdale, California 95361.Any such communication must contain (i) a representation that theshareholder is a holder of record of stock of the Bank, (ii) the name andaddress, as they appear on our books, of the shareholder sending suchcommunication and (iii) the class and number of shares that arebeneficially owned by such shareholder. The Corporate Secretary will forwardsuch communications to the Board of Directors or the specified individualdirector to whom the communication is directed unless such communication isunduly hostile, threatening, illegal or similarly inappropriate, in which casethe Corporate Secretary has the authority to discard the communication or totake appropriate legal action regarding such communication.

 

**DirectorCompensation and Indemnification Arrangements**

 

*DirectorFees.* Non-employee Directors receive a cash retainer inthe amount of $2,000 per month.  Directorswho are employees of the Bank do not receive any compensation for service as adirector.

 

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*DirectorRetirement Agreements.*  On August 21, 2001,the Board of Directors authorized the Bank to enter into Director RetirementAgreements with each director.  Theagreements are intended to encourage existing directors to remain directors ofthe Bank, assuring the Bank that it will have the benefit of the directors’experience and guidance in the years ahead.

 

For retirement after thelater of age 72 (the “Normal Retirement Age”), the Director RetirementAgreements provide an annual benefit during the director’s lifetime of $12,000for 10 years.  If a director retires orbecomes disabled before the Normal Retirement Age, he will receive a lump-sumpayment in an amount equal to the retirement liability balance accrued by theBank at the time of early retirement or disability.  If a change in control of the Bank occurs (asdefined in the Director Retirement Agreements) and a director’s serviceterminates within 24 months after the change in control, the director willreceive the retirement liability balance accrued by the Bank payable to thedirector for retirement at the Normal Retirement Age. In December of 2001,the Bank purchased insurance policies on the lives of its directors, paying thepremiums for these insurance policies with one lump-sum premium payment ofapproximately $1,045,000.  In 2008 wespent $1,580,000 in cash value premium paid to purchase additional BOLIinsurance coverage for directors.

 

Although the Bank expectsthe policies on the directors’ lives to serve as a source of funds for benefitspayable under the Director Retirement Agreements, the contractual entitlementsarising under the Director Retirement Agreements are not funded and remaincontractual liabilities of the Bank, payable upon each director’s terminationof service. The policy interests are divided between the Bank and eachdirector.  Under the Bank’s Split DollarAgreements and Split Dollar Policy endorsements with the directors, the Bank isentitled to any insurance policy death benefits remaining after payment to thedirector’s beneficiary.  The Bank expectsto recover the premium in full from its portion of the policies’ deathbenefits. If a director is terminated for cause, the Bank will not pay anybenefits under his Director Retirement Agreement.  For this purpose, the term “cause” means adirector’s gross negligence or gross neglect of duties, fraud, disloyalty,dishonesty or willful violation of law or significant bank policies inconnection with the director’s service that results in an adverse effect on theBank.

 

*StockOptions.*    None of the non-employeedirectors was granted any stock options during 2008. As of December 31,2008, the non-employee directors held outstanding, fully exercisable stockoptions to purchase the following amounts of our common stock, all withexercise prices ranging from $3.46 to $13.25 per share, and all with expirationdates no late than 2016:

 
| **Non-Employee Directors**   | ** ** | **Options** | ** ** |
|-----------------------------------|------------|-------------|------------|
| Donald Barton                     |       | 2,000       |       |
| James L. “Jay”  Gilbert |       | 2,500       |       |
| Thomas A.  Haidlen                |       | 3,375       |       |
| Michael Q. Jones                  |       | 2,250       |       |
| Arne J. Knudsen                   |       | 0           |       |
| Roger M. Schrimp                  |       | 0           |       |
| Danny L. Titus                    |       | 0           |       |
| Richard J.  Vaughan               |       | 16,875      |       |

 

*Indemnification.*    OurArticles of Incorporation limit the liability of our directors to us or ourshareholders for breaches of the directors’ fiduciary duties to the fullest extentpermitted by California law. In addition, our Articles of Incorporation andBylaws provide for mandatory indemnification of directors and officers to thefullest extent permitted by California law. We also maintain directors’ andofficers’ liability insurance.

 

***Board Structure and Committee Composition***

 

Our Board had 10directors and the following five committees:

 

·**Audit,

 

·**Loan

 

·**Investment,

 

·**Compensation,and

 

·**CRACommittee.

 

The membership during thelast fiscal year and the function of each of the committees are describedbelow. During 2008, the Board of the Bank held twelve meetings while the Boardof the Company held four meetings. . Each director attended at least 75% of allBoard and applicable committee meetings. Directors are encouraged to attendannual meetings of our shareholders. All ten directors attended the last annualmeeting of shareholders.

 

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**AuditCommittee**

 

We have aseparately-designated standing Audit Committee established in accordance with Section 3(a)(58)(A) ofthe Exchange Act. The Audit Committee assists the Board in fulfilling itsresponsibilities for general oversight of the integrity of our financialstatements, our compliance with legal and regulatory requirements, theindependent auditors’ qualifications and independence, the performance of ourinternal audit function and independent auditors, and risk assessment and risk management.Among other things, the Audit Committee prepares the Audit Committee report forinclusion in the annual proxy statement; annually reviews the Audit Committeecharter and the committee’s performance; appoints, evaluates and determines thecompensation of our independent auditors; reviews and approves the scope of theannual audit, the audit fee and the financial statements; reviews ourdisclosure controls and procedures, internal controls, internal audit function,and corporate policies with respect to financial information and earningsguidance; oversees investigations into complaints concerning financial matters;and reviews other risks that may have a significant impact on our financialstatements. The Audit Committee works closely with management as well as ourindependent auditors. The Audit Committee has the authority to obtain adviceand assistance from, and receive appropriate funding from us for, outsidelegal, accounting or other advisors as the Audit Committee deems necessary tocarry out its duties.

 

The Board of Directorshas adopted a written charter for the Audit Committee. In 2008 the members ofthe Audit Committee were Messrs. Schrimp (Chairman), Haidlen, Knudsen,Barton, Titus and Vaughan are members of the Audit Committee. The AuditCommittee held five meetings during fiscal 2008. The Board has determined thatall members of the Audit Committee are “independent” as that term is defined inRules 4200(a)(15) of the Nasdaq Marketplace Rule and Rule 10A-3(b)(1) underthe Exchange Act.

 

The Board of Directorshas determined that Mr. Schrimp is qualified as an “audit committeefinancial expert” under Item 401(h) of Regulation S-K.

 

**AuditCommittee Report**

 

The Audit Committeereports as follows with respect to the audit of our fiscal 2008 auditedfinancial statements:

 

Management is responsiblefor the Bank’s internal controls and the financial reporting process. Theindependent auditors are responsible for performing an independent audit of theBank’s financial statements in accordance with auditing standards generallyaccepted in the United States and to issue a report thereon. The AuditCommittee’s responsibility is to monitor and oversee these processes.

 

In this context, theAudit Committee has met and held discussions with management and theindependent auditors. Management represented to the Audit Committee that theBank’s financial statements were prepared in accordance with accountingprinciples generally accepted in the United States, and the Audit Committee hasreviewed and discussed the financial statements with management and theindependent auditors. The Audit Committee discussed with the independentauditors matters required to be discussed by Statement on Auditing Standards No. 61(Communication with Audit Committees).

 

The Bank’s independentauditors also provided to the Audit Committee the written disclosures requiredby Independence Standards Board Standard No. 1 (Independence Discussionswith Audit Committees), and the Audit Committee discussed with the independentauditors that firm’s independence and considered the compatibility of non-auditservices with the independent auditors’ independence.

 

**CompensationCommittee**

 

TheCompensation Committee establishes our compensation policy, determines thecompensation paid to our executive officers and non-employee directors,recommends executive incentive compensation plans and equity-based plansand approves other compensation plans and retirement plans. The CompensationCommittee approves corporate goals related to the compensation of the executiveofficers, evaluates the executive officers’ performance and compensates theexecutive officers based on this evaluation. Messrs. Schrimp (Chairman), Barton, Gilbert, Haidlen, Jones,Knudsen, Titus and Vaughan are current members of the Compensation Committee. TheCompensation Committee held two meetings during fiscal 2008.

 

The Board has determinedthat all members of the Compensation Committee are “independent” as that termis defined in Rule 4200(a)(15) of the Nasdaq Marketplace Rules.

 

*GeneralCompensation Policy.*    The CompensationCommittee’s policy is to provide our executive officers with compensationopportunities which are based upon their personal performance, the financialperformance of the Bank and their contribution to that performance and whichare competitive enough to attract and retain highly skilled individuals. Eachexecutive officer’s compensation package is comprised of three elements: (i) basesalary that is competitive with the market and reflects individual performance,(ii) annual variable performance awards payable in cash and tied to theachievement of annual financial, strategic and operational objectives inaddition to individual contributions to these objectives and (iii) long-termstock-based incentive awards designed to strengthen the mutual interest of ourexecutive officers and its shareholders. As an officer’s level ofresponsibility increases, a greater

 

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proportion of his or hertotal compensation will be dependent upon the company’s financial performanceand stock price appreciation rather than base salary.

 

*BaseSalary.*    Executive officer basesalaries are determined annually with reference to Bank and individualperformance. Base salaries are based on a number of measures, includingcomparisons with salaries and compensation programs of banks with comparable assetsize, capitalization and performance. Our current practice is not to provideemployment contracts to any of its executive officers. If any additionalemployment contracts should ever be considered necessary and beneficial to us,such a contract would require individual assessment by the Board of Directors.

 

*AnnualIncentives.*    The Committee considersannual Bank profitability goals and individual performance goals in determiningannual bonuses for the executive officers. Based on the foregoing factors andthe Bank’s performance in 2008, variable compensation was awarded to the Bank’sexecutive officers named in the Summary Compensation Table in the indicatedamounts.

 

*Long-termincentives.*    Stock option grants aremade at the discretion of the Board. Each grant is designed to align theinterests of the executive officer with those of the shareholders and provideeach individual with a significant incentive to manage the Bank from theperspective of an owner with an equity stake in the business. Each grant allowsthe officer to acquire shares of the Bank’s common stock at a fixed price pershare consistent with the market price on the grant date over a specifiedperiod of time (up to ten years). Each option becomes exercisable in a seriesof installments over a five year period, contingent upon the officer’scontinued employment with the Bank. Accordingly, the option will provide areturn to the executive officer only if he or she remains employed by the Bankduring the vesting period, and then only if the market price of the sharesappreciates over the option term.

 

The size of the optiongrant to each executive officer is set by the Compensation Committee at a levelthat is intended to create a meaningful opportunity for stock ownership basedupon the individual’s current position with the Bank, the individual’s personalperformance in recent periods and his or her potential for futureresponsibility and promotion over the option term. The Compensation Committeealso takes into account the number of unvested options held by the executiveofficer in order to maintain an appropriate level of equity incentive for thatindividual. The relevant weight given to each of these factors varies fromindividual to individual. The Compensation Committee has established certainguidelines with respect to the option grants made to the executive officers,but has the flexibility to make adjustments to those guidelines at itsdiscretion. Pending an assessment of the impact of ARRA on executivecompensation, the Compensation Committee has suspended any new option grants toour principal executive officer.

 

*Retirementplans.*    The Bank maintains a plan thatcomplies with the provisions of Section 401(k) of the InternalRevenue Code. Substantially all employees are eligible to participate in thisplan, and eligibility for participation commences upon hiring. The Bank’sexecutive officers are eligible to participate in this program, subject to anyapplicable tax laws.

 

**Loan Committee**

 

The Loan Committeemonitors the activities of our lending function utilizing information presentedto it by management at regular meetings. This includes, but is not limited to,the review of trends in outstanding credit relationships, key quality measures,significant borrowing relationships, large problem loans, industryconcentrations, all significant lending policies, and the adequacy of theallowance for loan losses. The Loan Committee also reviews lending-relatedreports from regulators, auditors, and internal personnel.

 

Each member of the Boardof Directors also served on the Loan Committee throughout 2008 and as of December 31,2008.  Mr. Haidlen serves asChairman of the Committee. The Director Loan Committee held 24 meetings duringfiscal 2008.

 

**Investment Committee**

 

The Investment Committeereviews, identifies and classifies our assets based on credit risk, inaccordance with regulatory guidelines. The Committee is also responsible forreviewing asset valuation and classification policies, as well as developingand monitoring asset disposition. In addition, the Committee reviews andmonitors the Bank’s investment portfolio, liquidity position and the risk ofour interest-earning assets in comparison to its interest-bearing liabilities.

 

Messrs. Courtney,Gilbert, Jones, Knudsen, Martin, Titus and Vaughn served on the InvestmentCommittee throughout 2008 and as of December 31, 2008. Mr. Vaughnserves as Chairman of the Committee. The Committee held four meetings duringfiscal 2008.

 

**CRACommittee**

 

The CRA Committee isresponsible for oversight of our performance under the requirements of theFederal Community Reinvestment Act of 1977 and similar state law requirements. Messrs. Courtney,Gilbert, Jones, Knudsen, Martin, Titus served on the CRA Committee throughout2008 and as of December 31, 2008. Mr. Titus serves as Chairman of theCommittee. The CRA Committee held three meetings during fiscal 2008.

 

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***Section 16(a) Beneficial Ownership Reporting Compliance***

 

Section 16(a) ofthe Securities Exchange Act of 1934, as amended, requires the Company’sofficers and directors, and persons who own more than 10% of a registered classof the Company’s equity securities, to file reports of ownership and changes inownership with the SEC. Officers, directors and greater than 10% shareholdersare required by SEC regulations to furnish the Company with copies of all Section 16(a) formsthey file. To the best knowledge of the Company, there are no holders with 10%or more of the Company’s common stock.

 

Basedsolely on a review of the copies of the reports furnished to us, or writtenrepresentations that no reports were required to be filed, we believe thatduring the fiscal year ended December 31, 2008 all Section 16(a) filingrequirements applicable to our directors, officers, and greater than 10%beneficial owners, if any, were complied with, except that Donald Barton failedto timely report three transactions on Form 4.

 

**ITEM 11 - EXECUTIVE COMPENSATION.**

 

***Summary of Cashand Certain Other Compensation***

 

The followingtable provides certain summary information concerning the compensation earned,by our Chief Executive Officer, and the two most highly compensated executiveofficers for services rendered in all capacities to us for the fiscal yearsended December 31, 2008 and 2007 in their respective executive officercapacities with the Bank:

 

**SUMMARYCOMPENSATION TABLE**

 
| ** **                        | ** ** | ** **                   | ** ** | ** ** | ** ** | ** **     | ** ** | **Long Term**  | ** ** |
|-----------------------------------|------------|------------------------------|------------|------------|------------|----------------|------------|---------------------|------------|
| ** **                        | ** ** | ** **                   | ** ** | ** ** | ** ** | ** **     | ** ** | **Compensation**    | ** ** |
| ** **                        | ** ** | ** **                   | ** ** | ** ** | ** ** | ** **     | ** ** | **Awards**          | ** ** |
| ** **                        | ** ** | ** **                   | ** ** | ** ** | ** ** | ** **     | ** ** | ** **          | ** ** | **Securities** | ** ** | **All** | ** ** |
| **Name and Principal**  | ** ** | **Annual Compensation** | ** ** | **Other**  | ** ** | **Underlying** | ** ** | **Other**           | ** ** |
| **Position**                      | ** ** | **Year**                     | ** ** | **Salary** | ** ** | **Bonus**      | ** ** | **Compensation(1)** | ** ** | **Options** | ** ** | **Compensation(2)** | ** ** |
| Ronald C. Martin                  |       | 2008                         |       | $          | 254,960    |           | $          | 48,000              |       | $ | 9,000 |   | — |   | $ | 75,748 |   |
| Director and CEO                  |       | 2007                         |       | $          | 248,000    |           | $          | 81,250              |       | $ | 9,000 |   | — |   | $ | 42,510 |   |
|                              |       |                         |       |       |       |           |       |                |       |   |   |   |   |
| Christopher M.  Courtney          |       | 2008                         |       | $          | 192,750    |           | $          | 50,000              |       | $ | 7,800 |   | — |   | $ | 64,564 |   |
| Director and  President           |       | 2007                         |       | $          | 187,000    |           | $          | 81,250              |       | $ | 7,800 |   | — |   | $ | 61,089 |   |
|                              |       |                         |       |       |       |           |       |                |       |   |   |   |   |
| Richard A.  McCarty               |       | 2008                         |       | $          | 163,825    |           | $          | 41,000              |       | $ | 7,800 |   | — |   | $ | 49,320 |   |
| Executive Vice  President CAO/CFO |       | 2007                         |       | $          | 159,000    |           | $          | 66,625              |       | $ | 7,800 |   | — |   | $ | 46,140 |   |

 

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(1)                             Reflectsautomobile allowances.

 

(2)                             Amountsshown for Mr. Martin include (a) for 2008, $57,466 representingexecutive salary continuation plan accrual which vests as described under “Employmentand Salary Continuation Agreements”, $14,094 in 401(k) plan matchingcontributions and $4,188 representing director retirement plan accrual; (b) for2007, $23,369 for accrued and unused vacation paid, $15,375 in 401(k) planmatching contributions and $3,766 representing director retirement planaccrual.

 

Amounts shown for Mr. Courtneyinclude (a) for 2008, $36,105 representing executive salary continuationplan accrual which vests as described under “Employment and Salary ContinuationAgreements”, $17,793 for accrued and unused vacation paid and $10,656 in 401(k) planmatching contributions; (b) for 2007, $34,017 representing executivesalary continuation plan accrual which vests as described under “Employment andSalary Continuation Agreements”, $15,822 for accrued and unused vacation paidand $11,250 in 401(k) plan matching contributions.

 

Amounts shown for Mr. McCartyinclude (a) for 2008, $27,953 representing executive salary continuationplan accrual which vests as described under “Employment and Salary ContinuationAgreements”, $10,711 for accrued and unused vacation paid and $10,656 in 401(k) planmatching contributions; (b) for 2007, $26,329 representing executivesalary continuation plan accrual which vests as described under “Employment andSalary Continuation Agreements”, $8,561 for accrued and unused vacation paidand $11,250 in 401(k) plan matching contributions.

 

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**OptionGrants in Last Fiscal Year**

 

No individual grants ofstock options were made during 2008 to each of the named executive officers inthe Summary Compensation Table.

 

**AggregatedOption Exercises and Fiscal Year-End Option Values**

 

The following tableprovides information about stock options exercised in 2008 and options held asof December 31, 2008 by each of the executive officers named in theSummary Compensation Table.  Actual gains on exercise, if any, will dependon the value of our common stock on the date on which the shares are sold.

 

**FISCAL2008 OPTION VALUES**

* *
| ** **               | ** ** | **Shares Acquired**      | ** ** | **Value**                | ** ** | **Number of Securities Underlying  Unexercised Options at  December 31, 2008 (#)(2)** | ** ** | **Value of Unexercised In-the-  money Options at December 31,  2008 ($)(2)** | ** ** |
|--------------------------|------------|-------------------------------|------------|--------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|
| ** **               | ** ** | **on Exercise (#)** | ** ** | **Realized ($)(1)** | ** ** | **Exercisable**                                                                                                               | ** ** | **Unexercisable**                                                                                                    | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| Ronald C. Martin         |       | 0                             |       | $                        | 0          |                                                                                                                          | 27,000     |                                                                                                                 | 6,750      |   | $ | 0 |   | $ | 0 |   |
| Christopher M.  Courtney |       | 10,125                        |       | 26,201                   |       | 67,500                                                                                                                        |       | 6,750                                                                                                                |       | 102,781 |   | 0 |   |
| Richard A.  McCarty      |       | 0                             |       | 0                        |       | 50,528                                                                                                                        |       | 4,500                                                                                                                |       | 82,550 |   | 0 |   |
|                     |       |                          |       |                     |       |                                                                                                                          |       |                                                                                                                 |       |   |   |   |   |
| Total                    |       | 10,125                        |       | $                        | 26,201     |                                                                                                                          | 145,028    |                                                                                                                 | 18,000     |   | $ | 185,330 |   | $ | 0 |   |

 

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*(1) *Thevalue realized of shares acquired on exercise was determined by subtracting theexercise price from the fair market value of the common stock on the exercisedate multiplied by the number of shares acquired on exercise

 

*(2) *Optionsgranted under our Stock Plans. “Exercisable” refers to those options which wereboth exercisable and vested while “Unexercisable” refers to those options whichwere unvested.

 

**EmploymentContracts, Termination of Employment and Change in Control Arrangements**

 

On August 21, 2001,the Board of Directors of the Bank approved Salary Continuation Agreementsbetween the Bank and Messrs. Courtney and McCarty.  Under the SalaryContinuation Agreements, Messrs. Courtney and McCarty are entitled toreceive maximum annual payments of $85,000 and $65,000, respectively, for aperiod of 20 years following their retirement at the age of 62 or upon a changein control, as defined in each salary continuation agreement. In the event ofdisability while employed at the Bank prior to the age of 62, either executivewill receive a benefit equal to the retirement liability balance accrued by theBank at the time of disability.  In the event of early termination, eitherexecutive will receive a vested portion of his retirement liability balance accruedby the Bank at the time of such early retirement.  The vesting schedule is20% per year of service beginning with the sixth year of service.  In theevent the Executive dies prior to termination of his salary continuationagreement, the beneficiary of such executive will receive from the Bank a lumpsum death benefit amount.

 

In December 2001,the Bank purchased insurance policies on the lives of Messrs. Courtney andMcCarty, paying the premiums for these insurance policies with one lump-sumpremium payment of approximately $590,000.  Under the Bank’s Split DollarAgreements and Split Dollar Policy endorsements, the policy interests aredivided between the Bank and such executives.  The Bank is entitled to anyinsurance policy death benefits remaining after payment to the executive’sbeneficiary.

 

If Messrs. Courtneyor McCarty are terminated for cause, the Bank will not pay any benefits underthe Salary Continuation Agreement.  For this purpose, the term “cause”means an executive’s gross negligence or gross neglect of duties, fraud,disloyalty, dishonesty or willful violation of law or significant bank policiesin connection with the executive’s service that results in an adverse effect onthe Bank.

 

In February 2008,the Board of Directors of the Bank approved an additional Salary ContinuationAgreement in the same form also for Ronald C. Martin. Under the Salary Continuation Agreement, Mr. Martinentitled to receive maximum annual payment of $48,000 for a period of 10 yearsfollowing his retirement at the age of 67 or upon a change in control, asdefined in the salary continuation agreement. In the event of disability whileemployed at the Bank prior to the age of 67, the executive will receive abenefit equal to the retirement liability balance accrued by the Bank at thetime of disability.  In the event of early termination, the executive willreceive a vested portion of his retirement liability balance accrued by theBank at the time of such early retirement.  The vesting schedule is 20%per year of service beginning with the first year of service.  In theevent the Executive dies prior to termination of his salary continuationagreement, the beneficiary of such executive will receive from the Bank a lumpsum death benefit amount.

 

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**Impact ofEmergency Economic Stabilization Act and American Recovery and Reinvestment Act**

 

As a participantin the U.S. Treasury Capital Purchase Program (CPP) under the EmergencyEconomic Stabilization Act (EESA), the Company will, as required, until suchtime as the U.S. Treasury ceases to own any securities of the Company, andduring the period in which any obligation arising from financial assistanceprovided under the CPP remains outstanding, take all necessary action to ensurethat its benefit and compensation arrangements applicable to its seniorexecutive officers and other highly compensated employees comply with Section 111(b) ofEESA.

 

On February 17,2009, the American Recovery and Reinvestment Act (ARRA) was signed into law. Section 7001of ARRA amended Section 111 of EESA in its entirety. While the U.S.Treasury must promulgate regulations to implement the restrictions and standardsset forth in Section 7001, ARRA, among other things, significantly expandsthe executive compensation restrictions previously imposed by EESA.  The Company will take all necessary action toensure that its current executive compensation arrangements comply with Section 7001of ARRA, as applicable.

 

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**ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS ANDMANAGEMENT AND RELATED STOCKHOLDER MATTERS.**

 

**Ownershipof Securities**

 

The followingtable sets forth certain information known to us with respect to the beneficialownership of our common stock as of March 30, 2009, by:

 

·**eachperson known by us to be a beneficial owner of five percent (5%) or more of ourcommon stock;

 

·**eachcurrent director, each of whom is a nominee for election as a director; and

 

·**allcurrent directors and executive officers as a group.

 

Our common stock is theonly class of voting securities outstanding. Beneficial ownership is determinedin accordance with the rules of the Securities and Exchange Commission andincludes voting and investment power with respect to the securities. Except asindicated in the notes following the table, and subject to applicable communityproperty laws, the persons named in the table have sole voting and investmentpower with respect to all shares of common stock shown as beneficially owned bythem. The percentage of beneficial ownership is based on 7,661,627 shares ofcommon stock outstanding as of March 30, 2009. In computing the number ofshares beneficially owned by a person and the percentage ownership of thatperson, shares of our common stock subject to options held by that person thatare currently exercisable or will become exercisable within 60 daysfollowing March 30, 2009 are deemed outstanding. However, these shares arenot deemed outstanding for the purpose of computing the percentage ownership ofany other person or entity.

*** ***
| ** **                                  | ** ** | **Common Stock Beneficially Owned (1)  on March 30, 2009** | ** ** |
|---------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|
| **Beneficial Owner**                   | ** ** | **Shares  Beneficially  Owned**                                                               | ** ** | **Vested  Option  Shares (2)** | ** ** | **Percentage of  Shares  Beneficially  Owned (3)** | ** ** |
| *Five  Percent Shareholder: (4)*            |       |                                                                                          |       |   |   |   |   |
| Patrick W.  Hopper                          |       | 711,707                                                                                       |       | N/A |   | 9.29 | % |
|                                        |       |                                                                                          |       |   |   |   |   |
| *Executive  Officers and Directors:(5)*     |       |                                                                                          |       |   |   |   |   |
| * *                                    |       |                                                                                          |       |   |   |   |   |
| James L. Gilbert                            |       | 143,561                                                                                       |       | 2,500 |   | 1.91 | % |
|                                        |       |                                                                                          |       |   |   |   |   |
| Thomas A.  Haidlen                          |       | 191,380                                                                                       |       | 3,375 |   | 2.54 | % |
|                                        |       |                                                                                          |       |   |   |   |   |
| Michael Q. Jones                            |       | 11,520                                                                                        |       | 2,250 |   | 0.18 | % |
|                                        |       |                                                                                          |       |   |   |   |   |
| Arne J. Knudsen                             |       | 342,160                                                                                       |       | 0 |   | 4.47 | % |
|                                        |       |                                                                                          |       |   |   |   |   |
| Roger M. Schrimp                            |       | 198,065                                                                                       |       | — |   | 2.59 | % |
|                                        |       |                                                                                          |       |   |   |   |   |
| Danny L. Titus                              |       | 216,051                                                                                       |       | — |   | 2.82 | % |
|                                        |       |                                                                                          |       |   |   |   |   |
| Richard J.  Vaughan                         |       | 88,000                                                                                        |       | 16,875 |   | 1.37 | % |
|                                        |       |                                                                                          |       |   |   |   |   |
| Donald Barton                               |       | 10,000                                                                                        |       | 2,000 |   | 0.16 | % |
|                                        |       |                                                                                          |       |   |   |   |   |
| Ronald C. Martin  (6)                       |       | 169,100                                                                                       |       | 27,000 |   | 2.56 | % |
|                                        |       |                                                                                          |       |   |   |   |   |
| Christopher M.  Courtney                    |       | 47,871                                                                                        |       | 74,250 |   | 1.59 | % |
|                                        |       |                                                                                          |       |   |   |   |   |
| Richard A.  McCarty                         |       | 1,502                                                                                         |       | 55,028 |   | 0.74 | % |
|                                        |       |                                                                                          |       |   |   |   |   |
| All officers and  directors as a group (11) |       | 1,419,210                                                                                     |       | 183,278 |   | 20.92 | % |

 

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----

*(1) *Exceptas otherwise noted, may include shares held by such person’s spouse (exceptwhere legally separated) and minor children, and by any other relative of suchperson who has the same home; shares held in “street name” for the benefit ofsuch person; shares held by a family or living trust as to which such person isa trustee and primary beneficiary with sole voting and investment power (orshared power with a spouse); or shares held in an Individual Retirement Accountor pension plan as to which such person is the sole beneficiary.

 

*(2) *Consistsof shares which the applicable individual or group has the right to acquireupon the exercise of stock options which are vested or will vest within60 days of March 30, 2009 pursuant to the Company’s Stock Plans.

 

*(3) *Thispercentage is based on the total number of shares of our common stockoutstanding, plus the number of option shares which the applicable individualor group has the right to acquire upon the exercise of stock options which arevested or will vest within 60 days of March 30, 2009 pursuant to ourStock Plans.

 

*(4) *Theaddress for Patrick Hopper is 2624 Pebblegold Avenue, Henderson, Nevada 89074.

 

*(5) *Theaddress for all officers and directors is c/o Oak Valley Community Bank, 125North Third Avenue, Oakdale, California 95361.

 

*(6) *Excludethird party participant shares held by Mr. Martin in his capacity astrustee of the Company’s 401(k) plan.

 

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**ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.**

 

**Loans toDirectors and Officers in the Ordinary Course of Business**

 

The Bank offers loans todirectors, officers, and employees in the ordinary course of business onsubstantially the same terms, including interest rate and collateral, as thoseprevailing at the time for comparable loans with persons not related to thelender, and which do not involve more than the normal risk of collectibility orpresent other unfavorable features. All such loans were performing inaccordance with their terms as of the date of this registration statement.Federal regulations permit executive officers and directors to participate inloan programs that are available to other employees, so long as the director orexecutive officer is not given preferential treatment compared to otherparticipating employees.

 

Section 402 of theSarbanes-Oxley Act of 2002 generally prohibits a company from extending credit,arranging for the extension of credit or renewing an extension of credit in theform of a personal loan one of its officers or directors. There are severalexceptions to this general prohibition, including loans made by an FDIC insureddepository institution that is subject to the insider lending restrictions ofthe Federal Reserve Act. All loans to our directors and officers comply withthe Federal Reserve Act and the Federal Reserve Board’s Regulation O and,therefore, are excepted from the prohibitions of Section 402.

 

**DirectorRetirement Agreements; Bank-Owned Life Insurance Policies**

 

On August 21, 2001,the Board of Directors authorized the Bank to enter into Director Retirement Agreementswith each director.  The agreements are intended to encourage existingdirectors to remain directors of the Bank, assuring the Bank that it will havethe benefit of the directors’ experience and guidance in the years ahead.

 

For retirement after thelater of age 72 or five years of service, the Director Retirement Agreementsprovide an annual benefit during the director’s lifetime of $12,000 for 10years.  If a director retires or becomes disabled before the NormalRetirement Age, he will receive a lump-sum payment in an amount equal to theretirement liability balance accrued by the Bank at the time of earlyretirement or disability.

 

If a change in control ofthe Bank occurs (as defined in the Director Retirement Agreements) and adirector’s service terminates within 24 months after the change in control, thedirector will receive the retirement liability balance accrued by the Bankpayable to the director for retirement at age 72 or after five years ofservice.

 

In December of 2001,the Bank purchased insurance policies on the lives of its directors, paying thepremiums for these insurance policies with one lump-sum premium payment ofapproximately $1,045,000.  Although the Bank expects the policies on thedirectors’ lives to serve as a source of funds for benefits payable under theDirector Retirement Agreements, the contractual entitlements arising under theDirector Retirement Agreements are not funded and remain contractualliabilities of the Bank, payable upon each director’s termination of service.

 

The policy interests aredivided between the Bank and each director.  Under the Bank’s Split DollarAgreements and Split Dollar Policy endorsements with the directors, the Bank isentitled to any insurance policy death benefits remaining after payment to thedirector’s beneficiary.  The Bank expects to recover the premium in fullfrom its portion of the policies’ death benefits.

 

If a director isterminated for cause, the Bank will not pay any benefits under his DirectorRetirement Agreement.  For this purpose, the term “cause” means a director’sgross negligence or gross neglect of duties, fraud, disloyalty, dishonesty orwillful violation of law or significant bank policies in connection with thedirector’s service that results in an adverse effect on the Bank.

 

On August 21, 2001,the Board of Directors of the Bank adopted the Oak Valley Community BankSupplemental Life Insurance Plan which applies to Messrs. Martin, Courtneyand McCarty.  The Plan is intended to encourage these key employees of theBank to continue their employment with the Bank.  In December 2001, December 2002and January 2003, the Bank purchased single premium life insurancepolicies in the amounts of $951,000, $579,000 and $592,000, respectively, onthe life of each of the officers covered by the Plan.  Under the SplitDollar Life Insurance Agreements to be entered into by the Bank with each suchofficer in the Plan, the Bank is the owner of the policies and the partialbeneficiary in an amount equal to the cash surrender values of the policies.

 

**Compensationof Non-employee Directors**

 

Persons who are directorsand are not employees of the Company receive $2,000 per month.  There isno plan in place for compensation of persons who are directors who areemployees.  In addition, non-employee Directors of the Company wereeligible to participate in the Company’s incentive stock plan. However,there were no stock options granted to non-employee directors in fiscal year2007 or 2008.

 

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**DirectorCompensation Table**

 

The following tableprovides compensation information for the year ended December 31, 2008 foreach non-employee Director of the Company.  Information related to Messrs. Martinand Courtney’s compensation is detailed in the “Summary Compensation Table” setforth above.

 

**DIRECTORCOMPENSATION TABLE**

 
| **Name**            | ** ** | **Fees Earned or  Paid in Cash** | ** ** | **Stock Awards** | ** ** | **Option Awards** | ** ** | **Change in  Pension Value  and  Nonqualified  Deferred  Compensation  Earnings** | ** ** | **All Other  Compensation  (1)** | ** ** | **Total** | ** ** |
|---------------------|------------|------------------------------------------------------|------------|-----------------------|------------|------------------------|------------|---------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-----------|------------|
| Donald Barton       |       | $                                                    | 24,000     |                  | $          |                   |       | —                                                                                      |       | $                                     |       | $         | 1,301      |   | $ | 25,301 |   |
| James L. Gilbert    |       | $                                                    | 24,000     |                  | $          |                   |       | —                                                                                      |       | $                                     |       | $         | 5,293      |   | $ | 29,293 |   |
| Thomas A.  Haidlen  |       | $                                                    | 24,000     |                  | $          |                   |       | —                                                                                      |       | $                                     |       | $         | 4,022      |   | $ | 28,022 |   |
| Michael Q. Jones    |       | $                                                    | 24,000     |                  | $          |                   |       | —                                                                                      |       | $                                     |       | $         | 5,820      |   | $ | 29,820 |   |
| Arne J. Knudsen     |       | $                                                    | 24,000     |                  | $          |                   |       | —                                                                                      |       | $                                     |       | $         | 13,868     |   | $ | 37,868 |   |
| Roger M. Schrimp    |       | $                                                    | 24,000     |                  | $          |                   |       | —                                                                                      |       | $                                     |       | $         | 8,585      |   | $ | 32,585 |   |
| Danny L. Titus      |       | $                                                    | 24,000     |                  | $          |                   |       | —                                                                                      |       | $                                     |       | $         | 5,178      |   | $ | 29,178 |   |
| Richard J.  Vaughan |       | $                                                    | 24,000     |                  | $          |                   |       | —                                                                                      |       | $                                     |       | $         | 16,067     |   | $ | 40,067 |   |

 

----

*(1) *Representsamounts accrued under the Director Retirement Agreements between the Bank andeach Director.

 

**ITEM 14 — PRINCIPAL ACCOUNTING FEES AND SERVICES**

 

The following tablepresents fees for professional services rendered by Moss Adams LLP and billedto the Bank for the audit of the Bank’s annual financial statements for theyears ended December 31, 2008 and 2007, and fees for other services billedby Moss Adams LLP during those periods:

 
| **Fees**            | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------|------------|----------|------------|----------|------------|
| Audit Fees          |       | $        | 104,377    |     | $          | 67,500 |   |
| Audit-related  Fees |       | 40,000   |       | 2,961    |       |
| Tax Fees            |       | 12,278   |       | 11,650   |       |
| All other Fees      |       | 18,275   |       | 27,739   |       |
|                |       |     |       |     |       |
| Total               |       | $        | 174,930    |     | 72,914     |   |
|                     |            |          |            |          |            |  |  |

 

*AuditFees.*    Annual audit fees relate toservices rendered in connection with the audit of the annual financialstatements included in our annual report.

 

*Audit-RelatedFees.*    Audit-related services includefees for consultations concerning financial accounting and reporting matters.

 

*TaxFees.*    Tax services include fees fortax compliance, tax advice and tax planning.

 

*AllOther Fees.*    The increase in all otherfees is primarily attributable to tax advising work in the areas of enterprisezone and costs aggregation work.

 

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**PART IV**

** **

**ITEM 15 — EXHIBITS, FINANCIAL STATEMENT SCHEDULES**

** **

**(a) Financial Statements**

 

**Indexto Financial Statements**

 
| ** **                                                  | **PAGE**   |
|-------------------------------------------------------------|------------|
|                                                        |       |
| **Report of Independent Registered Public Accounting Firm** | F-2        |
|                                                        |       |
| **Financial  Statements**                                   | ** ** |
| Balance sheets                                              | F-3        |
| Statements of  earnings                                     | F-4        |
| Statements of shareholders’ equity                     | F-5        |
| Statements of cash flows                                    | F-6        |
|                                                        |       |
| Notes to financial statements                               | F-7        |

 

**(b) Exhibits**

** **

The warranties,representations and covenants contained in any of the agreements includedherein or which appear as exhibits hereto should not be relied upon by buyers,sellers or holders of the Company’s securities and are not intended aswarranties, representations or covenants to any individual or entity except asspecifically set forth in such agreement

 

**Indexto Exhibits**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                             |
|---------------------|------------|-----------------------------------------------------------------------------------------------------------------------------|
| 2.1                 |       | Agreement and Plan of  Merger between the Registrant, Interim Oak Valley Bancorp, Inc. and Oak  Valley Community Bank* |
|                |       |                                                                                                                        |
| 3.1                 |       | Articles of  Incorporation of Oak Valley Bancorp, Inc.*                                                                |
|                |       |                                                                                                                        |
| 3.2                 |       | First Amendment to  Articles of Incorporation of Oak Valley Bancorp, Inc.*                                             |
|                |       |                                                                                                                        |
| 3.3                 |       | Bylaws of Oak Valley  Bancorp, Inc.*                                                                                   |
|                |       |                                                                                                                        |
| 3.4                 |       | First Amended and  Restated Bylaws of Oak Valley Bancorp, Inc.**                                                       |
|                |       |                                                                                                                        |
| 3.5                 |       | Certificate of  Determination of Series A Preferred Stock of Oak Valley  Bancorp, Inc.**                          |
|                |       |                                                                                                                        |
| 3.6                 |       | Letter Agreement  between the United States Department of the Treasury and Oak Valley Bancorp  dated December 5, 2008**     |
|                |       |                                                                                                                        |
| 10.1                |       | Oak Valley Community  Bank 1998 Restated Stock Option Plan*                                                                 |
|                |       |                                                                                                                        |
| 10.2                |       | Oak Valley Community  Bank Form of Director Retirement Agreement*                                                      |
|                |       |                                                                                                                        |
| 10.3                |       | Oak Valley Community  Bank Form of Salary Continuation Agreement*                                                      |
|                |       |                                                                                                                        |
| 10.4                |       | Securities Purchase  Agreement between Oak Valley Bancorp and the U.S. Treasury effective  December 4, 2008**          |
|                |       |                                                                                                                        |
| 11                  |       | Statement Regarding  Computation of Net Earnings per Share                                                                  |

 

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| 14     |   | Code of Ethics                                                                                                                                                                              |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                        |
| 21     |   | Subsidiaries of the  Issuer*                                                                                                                                                                |
|   |   |                                                                                                                                                                                        |
| 23.1   |   | Consent of Independent  Registered Accounting Firm                                                                                                                                          |
|   |   |                                                                                                                                                                                        |
| 24     |   | Power of Attorney  (included on the signature page of this report)                                                                                                                     |
|   |   |                                                                                                                                                                                        |
| 31.01  |   | Certification of Chief  Executive Officer pursuant to Exchange Act Rules 13a-14(a) and  15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002     |
|   |   |                                                                                                                                                                                        |
| 31.02  |   | Certification of Chief  Financial Officer pursuant to Exchange Act Rules 13a-14(a) and  15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002     |
|   |   |                                                                                                                                                                                        |
| 32.01  |   | Certifications of Chief  Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |

 

----

* Incorporated byreference from the Form 10 filed on July 31, 2008

 

** Incorporated byreference from the Form 8-A filed on January 14, 2009

 

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**SIGNATURES**

** **

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, as amended, the registrant has duly caused this report to be signed onits behalf by the undersigned, thereunto duly authorized, in Oakdale,California on March 30, 2009.

 
|   | **OAK VALLEY BANCORP**   a California corporation |
|--------|--------------------------------------------------------|
|   |                                                   |   |
|   |                                                   |   |
|   | By:                                                    | /s/  RONALD  C. MARTIN |
|   |                                                   | Ronald C. Martin,*Chief Executive Officer* |
|        |                                                        |  |  |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant and in thecapacities and on the date indicated.

 

**POWEROF ATTORNEY**

 

KNOW ALL MEN BY THESEPRESENTS, that each of the undersigned officers and directors of the registranthereby constitutes and appoints Ronald C. Martin and Richard A. McCarty, andeach of them, as lawful attorney-in-fact and agent for each of the undersigned(with full power of substitution and resubstitution, for and in the name, placeand stead of each of the undersigned officers and directors), to sign and filewith the Securities and Exchange Commission under the Securities Exchange Actof 1934, as amended, any and all amendments, supplements and exhibits to thisreport and any and all other documents in connection therewith, hereby grantingunto said attorneys-in-fact, and each of them, full power and authority to doand perform each and every act and thing necessary or desirable to be done inorder to effectuate the same as fully and to all intents and purposes as eachof the undersigned might or could do if personally present, hereby ratifyingand confirming all that said attorneys-in-fact and agents, or any of them, orany of their substitutes, may do or cause to be done by virtue hereof.

 
| **Signature**                | ** ** | **Title**  | ** ** | **Date**             |
|------------------------------|------------|------------|------------|----------------------|
| ** **                   | ** ** | ** ** | ** ** | ** **           |
| /s/ DONALD  BARTON           |       | Director   |       | March 30,  2009 |
| Donald Barton                |       |       |       |                 |
|                         |       |       |       |                 |
|                         |       |       |       |                 |
| /s/ CHRISTOPHER  M. COURTNEY |       | Director   |       | March 30,  2009 |
| Christopher M.  Courtney     |       |       |       |                 |
|                         |       |       |       |                 |
|                         |       |       |       |                 |
| /s/ JAMES L.  GILBERT        |       | Director   |       | March 30,  2009 |
| James L. Gilbert             |       |       |       |                 |
|                         |       |       |       |                 |
|                         |       |       |       |                 |
| /s/ THOMAS A.  HAIDLEN       |       | Director   |       | March 30,  2009 |
| Thomas A.  Haidlen           |       |       |       |                 |
|                         |       |       |       |                 |
|                         |       |       |       |                 |
| /s/ MICHAEL Q.  JONES        |       | Director   |       | March 30,  2009 |
| Michael Q. Jones             |       |       |       |                 |
|                         |       |       |       |                 |
|                         |       |       |       |                 |
| /s/ ARNE J.  KNUDSEN         |       | Director   |       | March 30,  2009 |
| Arne J. Knudsen              |       |       |       |                 |
|                         |       |       |       |                 |
|                         |       |       |       |                 |
| /s/ RONALD C.  MARTIN        |       | Director   |       | March 30,  2009 |
| Ronald C. Martin             |       |       |       |                 |
|                         |       |       |       |                 |
|                         |       |       |       |                 |
| /s/ ROGER M.  SCHRIMP        |       | Director   |       | March 30,  2009 |
| Roger M. Schrimp             |       |       |       |                 |
|                         |       |       |       |                 |
|                         |       |       |       |                 |
| /s/ DANNY L.  TITUS          |       | Director   |       | March 30,  2009 |
| Danny L. Titus               |       |       |       |                 |
|                         |       |       |       |                 |
|                         |       |       |       |                 |
| /s/ RICHARD J.  VAUGHAN      |       | Director   |       | March 30,  2009 |
| Richard J.  Vaughan          |       |       |       |                 |

 

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**INDEX TOFINANCIAL STATEMENTS**

 
| ** **                                                   | **PAGE**   |
|--------------------------------------------------------------|------------|
|                                                         |       |
| **REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING  FIRM** | F-2        |
|                                                         |       |
| **FINANCIAL  STATEMENTS**                                    | ** ** |
| Balance  sheets                                              | F-3        |
| Statements of earnings                                       | F-4        |
| Statement of shareholders’ equity                       | F-5        |
| Statements of cash flows                                     | F-6        |
|                                                         |       |
| Notes to financial statements                                | F-7        |

 

F-1

----

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**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

 

Tothe Board of Directors and Stockholders

OakValley Bancorp

 

We have audited theaccompanying consolidated balance sheets of Oak Valley Bancorp and subsidiary(the “Company”) as of December 31, 2008 and 2007 and the relatedconsolidated statements of earnings, shareholders’ equity, and cash flows forthe years ended December 31, 2008 and 2007. These financial statements arethe responsibility of the Company’s management. Our responsibility is toexpress an opinion on these financial statements based on our audits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement. The Company is not required to have, nor were weengaged to perform, an audit of its internal control over financialreporting.  Our audits includedconsideration of internal control over financial reporting as a basis fordesigning audit procedures that are appropriate in the circumstances, but notfor the purpose of expressing an opinion on the effectiveness of the Company’sinternal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting  the amounts and disclosures in the financialstatements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, thefinancial statements referred to above present fairly, in all materialrespects, the financial position of Oak Valley Bancorp and subsidiary as of December 31,2008 and 2007, and the results of their operations and their cash flows for theyears ended December 31, 2008 and 2007 in conformity with accountingprinciples generally accepted in the United States of America.

 

As discussed in Notes 1and 16 to the consolidated financial statements, effective January 1,2008, the Company adopted Statement of Financial Accounting Standards(SFAS)  No. 157 “Fair ValueMeasurements” and Emerging Issues Task Force (EITF) 06-04 “Accounting forDeferred Compensation and Postretirement Benefit Aspects of Endorsement SplitDollar Life Insurance Arrangements.”

 

/s/ Moss Adams LLP

 

Stockton, California

March 31, 2009

 

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**OAKVALLEY BANCORP**

**BALANCESHEETS**

** **
| ** **                                                                                                                                                         | ** ** | **December 31,** | ** **  | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|-------------|-----------------------|------------|
| ** **                                                                                                                                                         | ** ** | **2008**              | ** **  | **2007**              | ** ** |
| **ASSETS**                                                                                                                                                         |       |                  |        |                  |       |
| Cash and due  from banks                                                                                                                                           |       | $                     | 9,072,860   |                  | $          | 10,397,951 |   |
| Federal funds  sold                                                                                                                                                |       | 765,000               |        | 3,805,000             |       |
| Cash and cash  equivalents                                                                                                                                         |       | 9,837,860             |        | 14,202,951            |       |
|                                                                                                                                                               |       |                  |        |                  |       |
| Securities  available for sale                                                                                                                                     |       | 41,448,877            |        | 33,372,624            |       |
| Loans, net of  allowance for loan loss of $5,569,496 in 2008 and $4,506,753 in 2007                                                                                |       | 421,572,911           |        | 382,264,026           |       |
| Bank premises  and equipment, net                                                                                                                                  |       | 11,093,967            |        | 10,108,620            |       |
| Other real  estate owned (OREO)                                                                                                                                    |       | 2,745,575             |        | —                |       |
| Accrued interest  and other assets                                                                                                                                 |       | 21,503,821            |        | 14,310,569            |       |
|                                                                                                                                                               |       |                  |        |                  |       |
|                                                                                                                                                               |       | $                     | 508,203,011 |                  | $          | 454,258,790 |   |
|                                                                                                                                                               |       |                  |        |                  |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                                     | ** ** | ** **            | ** **  | ** **            | ** ** |
|                                                                                                                                                               |       |                  |        |                  |       |
| Deposits                                                                                                                                                           |       | $                     | 378,248,467 |                  | $          | 377,347,776 |   |
| Accrued interest  and other liabilities                                                                                                                            |       | 2,968,465             |        | 3,549,624             |       |
| FHLB advances                                                                                                                                                      |       | 69,000,000            |        | 31,000,000            |       |
| Total  liabilities                                                                                                                                                 |       | 450,216,932           |        | 411,897,400           |       |
|                                                                                                                                                               |       |                  |        |                  |       |
| Shareholders’  equity                                                                                                                                         |       |                  |        |                  |       |
| Preferred stock,  no par value; $1,000 per share liquidation preference, 10,000,000 shares  authorized and 13,500 issued and outstanding at December 31, 2008 |       | 12,680,649            |        | —                |       |
| Common stock, no  par value; 10,000,000 shares authorized, 7,661,627 and 7,607,780 shares  issued and outstanding at December 31, 2008 and 2007, respectively |       | 23,863,331            |        | 22,843,171            |       |
| Additional  paid-in capital                                                                                                                                        |       | 1,925,224             |        | 1,748,380             |       |
| Retained  earnings                                                                                                                                                 |       | 19,226,645            |        | 17,723,646            |       |
| Accumulated  other comprehensive income, net of tax                                                                                                                |       | 290,230               |        | 46,193                |       |
|                                                                                                                                                               |       |                  |        |                  |       |
| Total  shareholders’ equity                                                                                                                                   |       | 57,986,079            |        | 42,361,390            |       |
|                                                                                                                                                               |       |                  |        |                  |       |
|                                                                                                                                                               |       | $                     | 508,203,011 |                  | $          | 454,258,790 |   |

 

*See accompanying notes*

 

F-3

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** OAKVALLEY BANCORP**

**STATEMENTSOF EARNINGS**

** **
| ** **                                           | ** ** | **YEAR ENDED DECEMBER 31,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                           | ** ** | **2008**                                   | ** ** | **2007** | ** ** |
| INTEREST INCOME                                      |       |                                       |       |   |   |
| Interest and  fees on loans                          |       | $                                          | 27,611,325 |   | $ | 30,132,688 |   |
| Interest on  securities available for sale           |       | 1,615,951                                  |       | 1,541,034 |   |
| Interest on  federal funds sold                      |       | 17,996                                     |       | 159,163 |   |
| Interest on  deposits with banks                     |       | 1,887                                      |       | 4,203 |   |
| Total interest  income                               |       | 29,247,159                                 |       | 31,837,088 |   |
|                                                 |       |                                       |       |   |   |
| INTEREST EXPENSE                                     |       |                                       |       |   |   |
| Deposits                                             |       | 7,240,037                                  |       | 11,227,565 |   |
| FHLB advances                                        |       | 1,484,525                                  |       | 1,730,636 |   |
| Federal funds  purchased                             |       | 7,748                                      |       | 48,286 |   |
| Total interest  expense                              |       | 8,732,310                                  |       | 13,006,487 |   |
|                                                 |       |                                       |       |   |   |
| Net interest  income                                 |       | 20,514,849                                 |       | 18,830,601 |   |
| PROVISION FOR  LOAN LOSSES                           |       | 2,188,139                                  |       | 555,000 |   |
|                                                 |       |                                       |       |   |   |
| Net interest  income after provision for loan losses |       | 18,326,710                                 |       | 18,275,601 |   |
|                                                 |       |                                       |       |   |   |
| NON-INTEREST  INCOME                                 |       |                                       |       |   |   |
| Service charges  on deposits                         |       | 1,299,014                                  |       | 1,090,125 |   |
| Earnings on cash  surrender value of life insurance  |       | 370,004                                    |       | 175,168 |   |
| Mortgage  commissions                                |       | 100,857                                    |       | 194,975 |   |
| Other                                                |       | 752,532                                    |       | 737,341 |   |
| Total  non-interest income                           |       | 2,522,407                                  |       | 2,197,609 |   |
|                                                 |       |                                       |       |   |   |
| NON-INTEREST  EXPENSE                                |       |                                       |       |   |   |
| Salaries and  employee benefits                      |       | 9,305,601                                  |       | 8,586,098 |   |
| Occupancy  expenses                                  |       | 2,694,684                                  |       | 2,222,541 |   |
| Data processing  fees                                |       | 764,792                                    |       | 541,556 |   |
| Telephone  expenses                                  |       | 295,466                                    |       | 253,500 |   |
| OREO expenses                                        |       | 1,553,881                                  |       | — |   |
| Other operating  expenses                            |       | 3,250,819                                  |       | 2,609,124 |   |
| Total  non-interest expense                          |       | 17,865,243                                 |       | 14,212,819 |   |
|                                                 |       |                                       |       |   |   |
| Earnings before  provision for income taxes          |       | 2,983,874                                  |       | 6,260,391 |   |
|                                                 |       |                                       |       |   |   |
| PROVISION FOR  INCOME TAXES                          |       | 822,045                                    |       | 2,335,270 |   |
| NET EARNINGS                                         |       | $                                          | 2,161,829  |   | $ | 3,925,121 |   |
|                                                 |       |                                       |       |   |   |
| Preferred stock  dividends and accretion             |       | 63,819                                     |       | — |   |
| NET INCOME  AVAILABLE TO COMMON SHAREHOLDERS         |       | $                                          | 2,098,010  |   | $ | 3,925,121 |   |
|                                                 |       |                                       |       |   |   |
| NET EARNINGS PER  COMMON SHARE                       |       | $                                          | 0.27       |   | $ | 0.53 |   |
|                                                 |       |                                       |       |   |   |
| NET EARNINGS PER  DILUTED COMMON SHARE               |       | $                                          | 0.27       |   | $ | 0.52 |   |

 

*Seeaccompanying notes*

 

F-4

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Tableof Contents

 

**OAKVALLEY BANCORP**

**STATEMENTOF SHAREHOLDERS’ EQUITY**

 
| ** **                                                                                        | ** ** | **YEARS ENDED DECEMBER 31, 2008 and 2007** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| ** **                                                                                        | ** ** | ** **                                                               | ** ** | ** ** | ** ** | ** ** | ** ** | **Additional** | ** ** | ** ** | ** ** | ** ** | ** ** | **Accumulated  Other** | ** ** | **Total** | ** ** |
| ** **                                                                                        | ** ** | **Common Stock**                                                    | ** ** | **Preferred** | ** ** | **Paid-in** | ** ** | **Retained** | ** ** | **Comprehensive** | ** ** | **Comprehensive** | ** ** | **Shareholders’** | ** ** |
| ** **                                                                                        | ** ** | **Shares**                                                               | ** ** | **Amount** | ** ** | **Stock** | ** ** | **Capital** | ** ** | **Earnings** | ** ** | **Income** | ** ** | **Income (Loss)** | ** ** | **Equity** | ** ** |
| ** **                                                                                        | ** ** | ** **                                                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balances,  January 1, 2007                                                                        |       | 7,103,243                                                                |       | $ | 17,648,475 |   | $ |     |   | $ | 1,502,004 |   | $ | 15,243,222 |   |   |   | $ | (204,772 | ) | $ | 34,188,929 |   |
| Stock offering                                                                                    |       | 456,431                                                                  |       | 5,020,739 |   |   |   |   |   |   |   |   |   |   |   | 5,020,739 |   |
| Stock offering  expense                                                                           |       |                                                                     |       | (25,000 | ) |   |   |   |   |   |   |   |   |   |   | (25,000 | ) |
| Stock options  exercised                                                                          |       | 48,106                                                                   |       | 198,957 |   |   |   |   |   |   |   |   |   |   |   | 198,957 |   |
| Tax benefit of  stock options exercised                                                           |       |                                                                     |       |   |   |   |   | 116,303 |   |   |   |   |   |   |   | 116,303 |   |
| Cash dividends  ($0.19 per share)                                                                 |       |                                                                     |       |   |   |   |   |   |   | (1,444,697 | ) |   |   |   |   | (1,444,697 | ) |
| Stock based  compensation                                                                         |       |                                                                     |       |   |   |   |   | 130,073 |   |   |   |   |   |   |   | 130,073 |   |
| Comprehensive  income                                                                             |       |                                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net changes in  unrealized gain on available-for-sale securities (net of income tax of  $163,169) |       |                                                                     |       |   |   |   |   |   |   |   |   | $ | 250,965 |   | 250,965 |   | 250,965 |   |
| Net earnings                                                                                      |       |                                                                     |       |   |   |   |   |   |   | 3,925,121 |   | 3,925,121 |   |   |   | 3,925,121 |   |
| Comprehensive  income                                                                             |       |                                                                     |       |   |   |   |   |   |   |   |   | $ | 4,176,086 |   |   |   |   |   |
| Balances,  December 31, 2007                                                                      |       | 7,607,780                                                                |       | $ | 22,843,171 |   | $ |     |   | $ | 1,748,380 |   | $ | 17,723,646 |   |   |   | $ | 46,193 |   | $ | 42,361,390 |   |
| Stock options  exercised                                                                          |       | 53,847                                                                   |       | 186,922 |   |   |   |   |   |   |   |   |   |   |   | 186,922 |   |
| Issuance of  Preferred Stock                                                                      |       |                                                                     |       |   |   | 12,666,762 |   |   |   |   |   |   |   |   |   | 12,666,762 |   |
| Issuance of TCPP  Warrants                                                                        |       |                                                                     |       | 833,238 |   |   |   |   |   |   |   |   |   |   |   | 833,238 |   |
| Preferred Stock  Amortization                                                                     |       |                                                                     |       |   |   | 13,887 |   |   |   | (13,887 | ) |   |   |   |   | — |   |
| Tax benefit of  stock options exercised                                                           |       |                                                                     |       |   |   |   |   | 54,195 |   |   |   |   |   |   |   | 54,195 |   |
| Cash dividends  ($0.075 per share)                                                                |       |                                                                     |       |   |   |   |   |   |   | (574,484 | ) |   |   |   |   | (574,484 | ) |
| Stock based  compensation                                                                         |       |                                                                     |       |   |   |   |   | 122,649 |   |   |   |   |   |   |   | 122,649 |   |
| Cumulative  effect of adopting EITF 06-04 (net of income tax of $49,383)                          |       |                                                                     |       |   |   |   |   |   |   | (70,459 | ) |   |   |   |   | (70,459 | ) |
| Comprehensive  income                                                                             |       |                                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net changes in  unrealized gain on available-for-sale securities (net of income tax of  $158,664) |       |                                                                     |       |   |   |   |   |   |   |   |   | 244,037 |   | 244,037 |   | 244,037 |   |
| Net earnings                                                                                      |       |                                                                     |       |   |   |   |   |   |   | 2,161,829 |   | 2,161,829 |   |   |   | 2,161,829 |   |
| Comprehensive  income                                                                             |       |                                                                     |       |   |   |   |   |   |   |   |   | $ | 2,405,866 |   |   |   |   |   |
| Balances,  December 31, 2008                                                                      |       | 7,661,627                                                                |       | $ | 23,863,331 |   | $ | 12,680,649 |   | $ | 1,925,224 |   | $ | 19,226,645 |   |   |   | $ | 290,230 |   | $ | 57,986,079 |   |

 

*See accompanying notes*

 

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**OAKVALLEY BANCORP**

**STATEMENTSOF CASH FLOWS**

 
| ** **                                                                                | ** ** | **YEAR ENDED DECEMBER 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                | ** ** | **2008**                                   | ** ** | **2007** | ** ** |
|                                                                                      |       |                                       |       |   |   |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                    |       |                                       |       |   |   |
| Net earnings                                                                              |       | $                                          | 2,161,829  |   | $ | 3,925,121 |   |
| Adjustments to  reconcile net earnings to net cash from operating activities:             |       |                                       |       |   |   |
| Provision for  loan losses                                                                |       | 2,188,139                                  |       | 555,000 |   |
| Depreciation,  amortization and accretion, net                                            |       | 1,116,198                                  |       | 986,559 |   |
| Stock-based  compensation expense                                                         |       | 122,649                                    |       | 130,073 |   |
| Excess tax  benefits from stock-based payment arrangements                                |       | (54,195                                    | )          | (106,355 | ) |
| Loss (gain) on  sale of premises and equipment                                            |       | 1,434                                      |       | (14,400 | ) |
| (Increase)  decrease in accrued interest receivable                                       |       | (7,744                                     | )          | 7,062 |   |
| Decrease in  accrued interest payable and other liabilities                               |       | (701,001                                   | )          | (5,085,005 | ) |
| Increase in  other assets                                                                 |       | (2,500,595                                 | )          | (2,583,711 | ) |
| Net cash from  operating activities                                                       |       | 2,326,714                                  |       | (2,185,656 | ) |
|                                                                                      |       |                                       |       |   |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                    |       |                                       |       |   |   |
| Purchases of  securities available for sale                                               |       | (15,606,409                                | )          | (19,190,393 | ) |
| Proceeds from  maturities, calls, and principal paydowns of securities available for sale |       | 7,947,699                                  |       | 22,516,909 |   |
| Net increase in  loans                                                                    |       | (44,242,599                                | )          | (9,999,737 | ) |
| Purchase of BOLI  policies                                                                |       | (4,740,000                                 | )          | 0 |   |
| Proceeds from  sales of premises and equipment                                            |       | 0                                          |       | 14,400 |   |
| Net purchases of  premises and equipment                                                  |       | (2,117,820                                 | )          | (4,845,574 | ) |
| Net cash from  investing activities                                                       |       | (58,759,129                                | )          | (11,504,395 | ) |
|                                                                                      |       |                                       |       |   |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                    |       |                                       |       |   |   |
| FHLB advanced  funds                                                                      |       | 269,863,000                                |       | 62,869,400 |   |
| FHLB payments                                                                             |       | (231,863,000                               | )          | (65,469,400 | ) |
| Federal funds  advances                                                                   |       | 63,178,130                                 |       | 66,305,000 |   |
| Federal funds  payments                                                                   |       | (63,178,130                                | )          | (66,305,000 | ) |
| Proceeds from  sale of Preferred Stock                                                    |       | 13,500,000                                 |       | 0 |   |
| Dividends paid                                                                            |       | (574,484                                   | )          | (1,444,697 | ) |
| Net increase in  demand deposits and savings accounts                                     |       | 10,146,439                                 |       | 32,607,147 |   |
| Net decrease in  time deposits                                                            |       | (9,245,748                                 | )          | (33,789,676 | ) |
| Excess tax  benefits from stock-based payment arrangements                                |       | 54,195                                     |       | 106,355 |   |
| Proceeds from  sale of common stock and exercise of stock options                         |       | 186,922                                    |       | 5,194,696 |   |
| Net cash from  financing activities                                                       |       | 52,067,324                                 |       | 73,825 |   |
|                                                                                      |       |                                       |       |   |   |
| NET DECREASE IN  CASH AND CASH EQUIVALENTS                                                |       | (4,365,091                                 | )          | (13,616,226 | ) |
|                                                                                      |       |                                       |       |   |   |
| CASH AND CASH  EQUIVALENTS, beginning of period                                           |       | 14,202,951                                 |       | 27,819,177 |   |
|                                                                                      |       |                                       |       |   |   |
| CASH AND CASH  EQUIVALENTS, end of period                                                 |       | $                                          | 9,837,860  |   | $ | 14,202,951 |   |
|                                                                                      |       |                                       |       |   |   |
| SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION:                                       |       |                                       |       |   |   |
| Cash paid during  the year for:                                                           |       |                                       |       |   |   |
| Interest                                                                                  |       | $                                          | 9,785,838  |   | $ | 13,341,328 |   |
| Income taxes                                                                              |       | $                                          | 1,160,000  |   | $ | 2,461,000 |   |
|                                                                                      |       |                                       |       |   |   |
| NON-CASH  INVESTING ACTIVITIES:                                                           |       |                                       |       |   |   |
| Real estate  acquired through foreclosure                                                 |       | $                                          | 2,745,575  |   | $ | 0 |   |
| Net change in  unrealized gain/(loss) on available-for-sale securities                    |       | $                                          | 402,701    |   | $ | (414,134 | ) |
|                                                                                      |       |                                       |       |   |   |
| NON-CASH  FINANCING ACTIVITIES:                                                           |       |                                       |       |   |   |
| Tax benefit from  stock options exercised                                                 |       | $                                          | 54,195     |   | $ | 116,303 |   |
| Cumulative  effect of adopting EITF 06-04                                                 |       | $                                          | 119,842    |   | $ | 0 |   |
|                                                                                      |       |                                       |       |   |   |

 

*See accompanying notes*

 

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Tableof Contents

 

**OAKVALLEY BANCORP**

**NOTESTO FINANCIAL STATEMENTS**

 

**NOTE 1 —SUMMARY OF ACCOUNTING POLICIES**

 

**IntroductoryExplanation**

 

On July 3,2008 (the “Effective Date”), a bank holding company reorganization wascompleted whereby Oak Valley Bancorp (“Bancorp”) became the parent holdingcompany for Oak Valley Community Bank ( the “Bank”).  On theEffective Date, a tax-free exchange was completed whereby each outstandingshare of the Bank was converted into one share of Bancorp and the Bank becamethe sole wholly-owned subsidiary of the holding company. The informationcontained in the financial statements and accompanying footnotes for periodssubsequent to the reorganization relate to consolidated Oak Valley Bancorp.Periods prior to the reorganization relate to the Bank only. The information iscomparable for all periods as the sole subsidiary of Bancorp is the Bank.

 

The consolidated financialstatements include the accounts of Bancorp and its wholly-owned banksubsidiary. All material intercompany transactions have been eliminated. In theopinion of Management, the consolidated financial statements contain alladjustments necessary to present fairly the financial position, results ofoperations, changes in stockholders’ equity and cash flows.  Alladjustments are of a normal, recurring nature.

 

A summary of thesignificant accounting policies applied in the preparation of the accompanyingfinancial statements follows.

 

Oak Valley Community Bank(the “Bank”) is a California State chartered bank. The Bank was incorporatedunder the laws of the state of California on May 31, 1990, and beganoperations in Oakdale on May 28, 1991. The Bank operates branches inOakdale, Sonora, Bridgeport, Bishop, Mammoth Lakes, Modesto, Patterson,Turlock, Ripon, Stockton, and Escalon, California. The Bridgeport, MammothLakes, and Bishop branches operate as a separate division, Eastern SierraCommunity Bank. The Bank’s primary source of revenue is providing loans tocustomers who are predominantly middle-market businesses.

 

In preparing financialstatements in conformity with accounting principles generally accepted in theUnited States of America, management is required to make estimates andassumptions that affect the reported amounts of assets and liabilities and thedisclosure of contingent assets and liabilities at the date of the financialstatements and revenues and expenses during the reporting period. Actualresults could differ from those estimates.

 

**Changein accounting principle*—***During 2008 in conjunction with the Company’s filing of a Form 10registration statement with the SEC, the Company made a change in accountingprinciple and adopted Staff Accounting Bulletin (SAB) No. 108.  As aresult, the Company recorded adjustments to its deferred tax assets and alsorecorded a liability related to lease agreements that include fixed rentescalation clauses.

 

In accordance withStatement of Financial Accounting Standards (SFAS) No. 154, AccountingChanges and Error Corrections, the Company adjusted its financial statements toapply SAB No. 108 retrospectively.  As a result of the change inaccounting principle, the following adjustments to the financial statementswere made:

 

·      Accruedinterest and other assets decreased by $144,586 at December 31, 2007.

·      Otherliabilities increased by $134,030 at December 31, 2007.

·      Retainedearnings decreased by $278,616 at December 31, 2007.

·      Occupancyexpense increased $42,107 for the year ended December 31, 2007.

·      Incometax expense increased $1,270 for the year ended December 31, 2007.

·      Netincome decreased $43,227 and basic and diluted earnings per share decreased$.01 per share to $.53 and $.52 per share, respectively, for the year ended December 31,2007.

 

**Stockoffering —** During 2007 the Bank facilitated a stock offeringin an effort to raise additional capital. The stock was first offered toexisting shareholders between May 14, 2007 through June 15, 2007.Subsequently, the offering was extended to the public between June 16,2007 through July 16, 2007. Common stock of the Bank was offered at $11per share to all investors. As a result of the offering, the Bank raised$4,995,739 in capital, net of offering expenses of $25,000. Additionally,456,431 in additional common shares of the Bank were issued as a result of theoffering.

 

**Cash andcash equivalents —** The Bank has defined cash and cashequivalents to include cash, due from banks, certificates of deposit withmaturities of three months or less, and federal funds sold. Generally, federalfunds are sold for one-day periods. At times throughout the year, balances canexceed FDIC insurance limits.  Management believes the risk of loss isremote as these amounts are held by major financial institutions.

 

F-7

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**OAKVALLEY BANCORP**

**NOTES TOFINANCIAL STATEMENTS**

 

**NOTE 1 —SUMMARY OF ACCOUNTING POLICIES (CONTINUED)**

 

**Securitiesavailable for sale —** Available-for-sale securities consist ofbonds, notes, and debentures not classified as trading securities orheld-to-maturity securities. Available-for-sale securities with unrealizedholding gains and losses, net of tax, are reported as a net amount in aseparate component of shareholders’ equity, accumulated other comprehensiveincome, until realized. Gains and losses on the sale of available-for-sale securitiesare determined using the specific identification method. The amortization ofpremiums and accretion of discounts are recognized as adjustments to interestincome over the period to maturity.

 

Investments with fairvalues that are less than amortized cost are considered impaired. Impairmentmay result from either a decline in the financial condition of the issuingentity or, in the case of fixed interest rate investments, from rising interestrates. At each financial statement date, management assesses each investment todetermine if impaired investments are temporarily impaired or if the impairmentis other than temporary based on the positive and negative evidence available.Evidence evaluated includes, but is not limited to, industry analyst reports,credit market conditions, and interest rate trends. If negative evidenceoutweighs positive evidence that the carrying amount is recoverable within areasonable period of time, the impairment is deemed to be other than temporaryand the security is written down in the period in which such determination ismade.

 

**Otherreal estate owned** - Real estate properties acquired through,or in lieu of, loan foreclosure are to be sold and are initially recorded atthe lower of carrying amount of the loan or fair value of the property at thedate of foreclosure less selling costs. Subsequent to foreclosure, valuations are periodically performed and anysubject revisions in the estimate of fair value are reported as adjustment tothe carrying value of the real estate, provided the adjusted carrying amountdoes not exceed the original amount at foreclosure.  Revenues and expenses from operations andchanges in the valuation allowance are included in other operating expenses.  As of December 31, 2008, six loans withoutstanding balances of $2,745,575 were reclassified to other real estateowned.

 

**Loans and allowance for loanlosses**— Loans are reported at the principal amountoutstanding, net of unearned income, deferred loan fees, and the allowance forloan losses. Unearned discounts on installment loans are recognized as incomeover the terms of the loans. Interest on other loans is calculated by using thesimple interest method on the daily balance of the principal amountoutstanding.

 

Loan fees net of certaindirect costs of origination, which represent an adjustment to interest yield,are deferred and amortized over the contractual term of the loan.

 

Loans on which theaccrual of interest has been discontinued are designated as non-accrual loans.Accrual of interest on loans is discontinued either when reasonable doubtexists as to the full and timely collection of interest or principal or when aloan becomes contractually past due by ninety days or more with respect tointerest or principal. When a loan is placed on non-accrual status, allinterest previously accrued, but not collected, is reversed against currentperiod interest income. Income on such loans is then recognized only to theextent that cash is received and where the future collection of principal isprobable. Interest accruals are resumed on such loans only when they arebrought fully current with respect to interest and principal and when, in thejudgment of management, the loans are estimated to be fully collectible as toboth principal and interest.

 

The allowance for loanlosses is established through a provision for loan losses charged tooperations. Loans are charged against the allowance for loan losses whenmanagement believes that the collectability of the principal is unlikely.Subsequent recoveries of previously charged off amounts, if any, are creditedto the allowance.

 

The allowance for loanlosses is evaluated on a regular basis by management and is based onmanagement’s periodic review of the collectability of the loans in light ofhistorical experience, the nature and volume of the loan portfolio, adversesituations that may affect the borrower’s ability to repay, estimated value ofany underlying collateral, and prevailing economic conditions. This evaluationis inherently subjective as it requires estimates that are susceptible tosignificant revision as more information becomes available.

 

F-8

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**OAK VALLEYBANCORP**

**NOTES TOFINANCIAL STATEMENTS**

 

**NOTE 1 —SUMMARY OF ACCOUNTING POLICIES (CONTINUED)**

 

The allowance consists ofspecific, general, and unallocated components. The specific component relatesto loans that are classified as impaired. Impaired loans, as defined, aremeasured based on the present value of expected future cash flows discounted atthe loan’s effective interest rate or the fair value of the collateral if theloan is collateral dependent. The general component relates to non-impaired loansand is based on historical loss experience adjusted for qualitative factors. Anunallocated component is maintained to cover uncertainties that could affectmanagement’s estimate of probable losses. The unallocated component of theallowance reflects the margin of imprecision inherent in the underlyingassumptions used in the methodologies for estimating specific and generallosses in the portfolio.

 

The Bank considers a loanimpaired when it is probable that all amounts of principal and interest due,according to the contractual terms of the loan agreement, will not becollected, which is the same criteria used for the transfer of loans tonon-accrual status. Interest income is recognized on impaired loans in the samemanner as non-accrual loans. Factors considered by management in determiningimpairment include payment status, collateral value, and the probability ofcollecting scheduled principal and interest payments when due. Loans thatexperience insignificant payment delays and payment shortfalls generally arenot classified as impaired. Management determines the significance of paymentdelays and payment shortfalls on a case-by-case basis, taking intoconsideration all of the circumstances surrounding the loan and the borrower,including the length of the delay, the reasons for the delay, the borrower’sprior payment record, and the amount of the shortfall in relation to theprincipal and interest owed.

 

The method forcalculating the allowance for off-balance-sheet is based on an allowancepercentage which is less than other outstanding loan types because they are ata lower risk level.  This allowance percentage is evaluated by managementperiodically and is applied to the total undisbursed loan commitment balance tocalculate the allowance for off-balance-sheet commitments.

 

**Premisesand equipment —** Premises and equipment are stated at costless accumulated depreciation and amortization. Depreciation and amortizationare provided for in amounts sufficient to relate the cost of depreciable assetsto operations over their estimated service lives using the straight-line basis.The estimated lives used in determining depreciation are:

 
| Building                |   | 31.5                   |   | years  |   |
|-------------------------|--------|------------------------|--------|--------|--------|
|                    |   |                   |   |   |   |
| Equipment               |   | 3 – 12            |   | years  |   |
|                    |   |                   |   |   |   |
| Furniture and  fixtures |   | 3 –   7 |   | years  |   |
|                    |   |                   |   |   |   |
| Leasehold  improvements |   | 5 – 15            |   | years  |   |
|                    |   |                   |   |   |   |
| Automobiles             |   | 3 –   5 |   | years  |   |

 

Leasehold improvementsare amortized over the lesser of the useful life of the asset or the remainingterm of the lease. The straight-line method of depreciation is followed for allassets for financial reporting purposes, but accelerated methods are used fortax purposes. Deferred income taxes have been provided for the resultingtemporary differences.

 

**Incometaxes —** Deferred income taxes are provided for the temporarydifferences between the financial reporting basis and the tax basis of theBank’s assets and liabilities. Deferred tax assets and liabilities arereflected at currently enacted income tax rates applicable to the period inwhich the deferred tax assets or liabilities are expected to be realized orsettled using the liability method. As changes in tax laws or rates areenacted, deferred tax assets and liabilities are adjusted through the provisionfor income taxes.

 

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**OAKVALLEY BANCORP**

**NOTES TOFINANCIAL STATEMENTS**

 

**NOTE 1 —SUMMARY OF ACCOUNTING POLICIES (CONTINUED)**

 

The Bank adopted theprovisions of FASB Interpretation No. 48,*Accounting for Uncertainty in Income Taxes*, on January 1, 2007.The Bank had no unrecognized tax benefits which would require an adjustment tothe January 1, 2007 beginning balance of retained earnings. The Bank hadno unrecognized tax benefits at January 1, 2007, December 31, 2007and 2008.

 

The Bank recognizesinterest accrued and penalties related to unrecognized tax benefits in taxexpense. During the years ended December 31, 2008 and 2007 the Bankrecognized no interest and penalties.

 

The Bank files income taxreturns in the U.S. federal jurisdiction, and various states. With fewexceptions, the Bank is no longer subject to U.S. federal or state/local incometax examinations by tax authorities for years before 2004.

 

**Transfersof financial assets —** Transfers of financial assets areaccounted for as sales when control over the assets has been surrendered.Control over transferred assets is deemed to be surrendered when:  (1) theassets have been isolated from the Bank, (2) the transferee obtains theright (free of conditions that contain it from taking advantage of that right)to pledge or exchange the transferred assets, and (3) the Bank does notmaintain effective control over the transferred assets through an agreement torepurchase them before their maturity.

 

**Advertisingcosts —** The Bank expenses marketing costs as they areincurred. Advertising expense was $126,000 and $119,000 for the years ended December 31,2008 and 2007, respectively.

 

**Comprehensive income — **Comprehensiveincome is comprised of net income and other comprehensive income. Othercomprehensive income includes items previously recorded directly to equity,such as unrealized gains and losses on securities available for sale.Comprehensive income is presented in the statement of shareholders’ equity. Forthe years ended December 31, 2008 and 2007, no amounts were reclassifiedout of comprehensive income into earnings.

 

**Investmentin limited partnership** —  During 2007 the Bank acquiredlimited interests in a private limited partnership that acquires affordablehousing properties in California that generate Low Income Housing Tax Creditsunder Section 42 of the Internal Revenue Code of 1986, as amended. The Bank’s limited partnership investment is accounted for under the equitymethod.  The Bank’s noninterest expense associated with the utilization ofthese tax credits for the year ended December 31, 2008 and 2007 was 62,932and $54,308, respectively.  The limited partnership investment is expectedto generate a total tax benefit of approximately $1.16 million over the life ofthe investment for the combination of the tax credits and deductions onnoninterest expense.  The tax credits expire between 2009 and 2022. In 2007, a tax benefit of $54,000 was utilized for income tax purposes and anestimated amount of $134,000 will be utilized in 2008.  The recordedinvestment in limited partnerships totaled $962,740 and $377,790 at December 31,2008 and 2007, respectively, and is reflected as a component of accruedinterest and other assets on the balance sheets.

 

**Stockbased compensation —**Statement of Financial AccountingStandards (“SFAS”) No. 123R,* Share Based Payments*, requires companies to recognize in the incomestatement the grant-date fair value of stock options and other equity-based formsof compensation issued to employees over the employees’ requisite serviceperiod (generally the vesting period). The bank uses the straight-line recognition of expenses for awards withgraded vesting.

 

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**OAKVALLEY BANCORP**

**NOTES TOFINANCIAL STATEMENTS**

 

**NOTE 1 —SUMMARY OF ACCOUNTING POLICIES (CONTINUED)**

 

The fair value of eachoption grant is estimated as of the grant date using an option-pricing modelwith the assumptions noted in the following table. The Bank utilizes a binomialpricing model for all grants. Expected volatility is based on the historicalvolatility of the price of the Bank’s stock. The Bank uses historical data toestimate option exercise and stock option forfeiture rates within the valuationmodel. The expected term of options granted for the binomial model is derivedfrom applying a historical suboptimal exercise factor to the contractual termof the grant. For binomial pricing, the risk-free rate for periods is equal tothe U.S. Treasury yield at the time of grant and commensurate with thecontractual term of the grant.

 

The fair value of eachoption is estimated on the date of grant using an options pricing model withthe following weighted average assumptions:

 
| ** **                         | ** ** | **YEAR ENDED DECEMBER 31,** | ** ** |
|------------------------------------|------------|--------------------------------------------|------------|
| ** **                         | ** ** | **2008**                                   | ** ** | **2007** | ** ** |
| Pricing model                      |       | Binomial                                   |       | Binomial |   |
| Dividend yield                     |       | 1.54%                                      |       | 1.73% |   |
| Expected  volatility               |       | 36.25%                                     |       | 36.33% |   |
| Risk-free  interest rate           |       | 4.22%                                      |       | 4.79% |   |
| Expected option  term              |       | 7.27 years                                 |       | 7.25 years |   |
| Stock-based  compensation recorded |       | $                                          | 122,649    |   | $ | 130,073 |   |
|                                    |            |                                            |            |  |  |  |  |

 

**Reclassifications**— Certain prior year amounts have been reclassified to conform to the currentyear presentation. There was no effect on net income or shareholders’ equity.

 

**RecentlyIssued Accounting Standards —** In September 2006, theFASB issued Statement of Financial Accounting Standards No. 157, “FairValue Measurements,” (“SFAS 157”) which is effective for fiscal yearsbeginning after November 15, 2007 and for interim periods within thoseyears. SFAS 157 defines fair value, establishes a framework for measuringfair value and expands the related disclosure requirements. This Statementapplies under other accounting pronouncements that require or permit fair valuemeasurements. The Statement indicates, among other things, that a fair valuemeasurement assumes that the transaction to sell an asset or transfer aliability occurs in the principal market for the asset or liability or, in theabsence of a principal market, the most advantageous market for the asset orliability. SFAS 157 defines fair value based upon an exit price model.Relative to SFAS 157, the FASB proposed FASB Staff Positions (FSP) 157-a,157-b, and 157-c. FSP 157-a amends SFAS 157 to exclude FinancialAccounting Standards No. 13, “Accounting for Leases,” and its relatedinterpretive accounting pronouncements that address leasing transactions, whileFSP 157-b delays the effective date of SFAS 157 for all nonfinancialassets and nonfinancial liabilities, except those that are recognized ordisclosed at fair value in the financial statements on a recurring basis. FSP157-c clarifies the principles in SFAS 157 on the fair value measurementof liabilities. Public comments on FSP 157-a and 157-b were due in January 2008,while public comments on FSP 157-c were due in February 2008.  The Company adopted this pronouncementeffective January 1, 2008 and has determined that this Standard has nothad a material impact on the Company’s financial position, results ofoperations or cash flows.

 

F-11

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Tableof Contents

 

**OAKVALLEY BANCORP**

**NOTES TOFINANCIAL STATEMENTS**

 

**NOTE 1 —SUMMARY OF ACCOUNTING POLICIES (CONTINUED)**

 

In February 2007,the FASB issued Statement of Financial Accounting Standards No. 159, “TheFair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”),which permits entities to choose to measure many financial instruments andcertain other items at fair value. The objective is to improve financialreporting by providing entities with the opportunity to mitigate volatility inreported earnings caused by measuring related assets and liabilities usingdifferent measurement techniques. SFAS 159 requires additional disclosuresrelated to the fair value measurements included in the entity’s financialstatements. This Statement is effective for financial statements issued forfiscal years beginning after November 15, 2007. Accordingly, the Companyadopted SFAS 159 in the first quarter of 2008.  The Company did not elect the fair valueoption for any of its financial assets or liabilities.

 

In December 2007,the FASB issued Statement of Financial Accounting Standards No. 141(revised 2007), “Business Combinations” (“SFAS 141(R)”), which replacesStatement of Financial Accounting Standards No. 141, “BusinessCombinations” (“SFAS 141”). SFAS 141(R) retains the underlyingconcepts of SFAS 141 in that all business combinations are still required to beaccounted for at fair value under the acquisition method of accounting but SFAS141(R) changed the method of applying the acquisition method in a numberof significant aspects. Acquisition costs will generally be expensed asincurred; noncontrolling interests will be valued at fair value at theacquisition date; in-process research and development will be recorded at fairvalue as an indefinite-lived intangible asset at the acquisition date;restructuring costs associated with a business combination will generally beexpensed subsequent to the acquisition date; and changes in deferred tax assetvaluation allowances and income tax uncertainties after the acquisition dategenerally will affect income tax expense. SFAS 141(R) is effective on aprospective basis for all business combinations for which the acquisition dateis on or after the beginning of the first annual period subsequent to December 15,2008, with the exception of the accounting for valuation allowances on deferredtaxes and acquired tax contingencies. SFAS 141(R) amends SFAS 109 suchthat adjustments made to valuation allowances on deferred taxes and acquiredtax contingencies associated with acquisitions that closed prior to theeffective date of SFAS 141(R) would also apply the provisions of SFAS141(R). Early adoption is not permitted.

 

In December 2007,the FASB issued Statement of Financial Accounting Standards No. 160, “NoncontrollingInterests in Consolidated Financial Statements—an amendment of ARB No. 51.”(“SFAS 160”). SFAS 160 is effective for fiscal years, and interim periodswithin those fiscal years, beginning on or after December 15, 2008, withearlier adoption prohibited. The Statement requires the recognition of anoncontrolling interest (minority interest) as equity in the consolidatedfinancial statements and separate from the parent’s equity. The amount of netincome attributable to the noncontrolling interest will be included inconsolidated net income on the face of the income statement. The Statement alsoamends certain of ARB No. 51’s consolidation procedures for consistencywith the requirements of SFAS 141(R). This Statement also includes expandeddisclosure requirements regarding the interests of the parent and itsnoncontrolling interest. The Company is currently evaluating the potentialimpact this Statement may have on the Company’s financial position, results ofoperations and cash flows, but does not believe the impact of the adoption willbe material.

 

FASB Emerging Issues TaskForce (“EITF”) Issue No. 06-4, “Accounting for Deferred Compensation andPostretirement Benefit Aspects of Endorsement Split Dollar Life InsuranceArrangements.”  EITF 06-4 requires the recognition of a liability andrelated compensation expense for bank owned life insurance policies with jointbeneficiary agreements that provide a benefit to an employee that extends topost-retirement periods.  Under EITF 06-4, life insurance policiespurchased for the purpose of providing such benefits do not effectively settlean entity’s obligation to the employee.  Accordingly, the entity mustrecognize a liability and related compensation expense during the employee’sactive service period based on the future cost of insurance to be incurredduring the employee’s retirement.  If the entity has agreed to provide theemployee with a death benefit, then the liability for the future death benefitshould be recognized by following the guidance in SFAS 106, “Employer’sAccounting for Postretirement Benefits Other Than Pensions.”  The Companyadopted this pronouncement effective January 1, 2008. The impact to theCompany’s financial position, results of operations and cash flows was notmaterial.

 

F-12

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Tableof Contents

 

**OAKVALLEY BANCORP**

**NOTES TOFINANCIAL STATEMENTS**

 

**NOTE 2 —CASH AND DUE FROM BANKS**

 

Cash and due from banksincludes balances with the Federal Reserve Bank and other correspondent banks.The Bank is required to maintain specified reserves by the Federal ReserveBank. The average reserve requirements are based on a percentage of the Bank’sdeposit liabilities. In addition, the Federal Reserve Bank requires the Bank tomaintain a certain minimum balance at all times.

 

**NOTE 3 —SECURITIES**

 

The amortized cost andestimated fair values of debt securities as of December 31, 2008, are asfollows:

 
| ** **                           | ** ** | **Amortized Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross Unrealized  Losses** | ** ** | **Estimated Fair  Market Value** | ** ** |
|--------------------------------------|------------|-------------------------|------------|------------------------------|------------|-----------------------------------|------------|--------------------------------------------|------------|
| ** **                           | ** ** | ** **              | ** ** | ** **                   | ** ** | ** **                        | ** ** | ** **                                 | ** ** |
| Available-for-sale  securities:      |       |                    |       |                         |       |                              |       |                                       |       |
| U.S. agencies                        |       | $                       | 25,540,641 |                         | $          | 609,957                           |       | $                                          | (65,680    | ) | $ | 26,084,918 |   |
| Collateralized  mortgage obligations |       | 3,438,998               |       | 54,471                       |       | (8,861                            | )          | 3,484,608                                  |       |
| Municipalities                       |       | 9,970,961               |       | 14,829                       |       | (83,567                           | )          | 9,902,223                                  |       |
| SBA Pools                            |       | 1,820,810               |       | —                       |       | (41,682                           | )          | 1,779,128                                  |       |
| Asset-Back  Security                 |       | 198,081                 |       | —                       |       | (81                               | )          | 198,000                                    |       |
|                                 |       | $                       | 40,969,491 |                         | $          | 679,257                           |       | $                                          | (199,871   | ) | $ | 41,448,877 |   |

 

The following tablesdetail the gross unrealized losses and fair values aggregated by investmentcategory and length of time that individual securities have been in acontinuous unrealized loss position at December 31, 2008.

 
| ** **                             | ** ** | **Less than 12 months** | ** ** | **12 months or more** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|-----------|------------|
| ** **                             | ** ** | ** **                             | ** ** | **Unrealized**                       | ** ** | **Fair**  | ** ** | **Unrealized** | ** ** | ** ** | ** ** | **Unrealized** | ** ** |
| **Description  of Securities**         | ** ** | **Fair  Value**                        | ** ** | **Loss**                             | ** ** | **Value** | ** ** | **Loss** | ** ** | **Fair  Value** | ** ** | **Loss** | ** ** |
|                                   |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| U.S. agencies                          |       | $                                      | 2,900,405  |                                 | $          | (13,962   | )          | $ | 3,067,267 |   | $ | (51,718 | ) | $ | 5,967,672 |   | $ | (65,680 | ) |
| Collateralized  mortgage obligations   |       | 618,552                                |       | (2,109                               | )          | 1,085,704 |       | (6,752 | ) | 1,704,256 |   | (8,861 | ) |
| Municipalities                         |       | 9,357,996                              |       | (83,567                              | )          | —    |       | — |   | 9,357,996 |   | (83,567 | ) |
| SBA Pools                              |       | —                                 |       | —                               |       | 1,626,502 |       | (41,682 | ) | 1,626,502 |   | (41,682 | ) |
| Asset Backed  Securities               |       | 198,000                                |       | (81                                  | )          | —    |       | — |   | 198,000 |   | (81 | ) |
| Total  temporarily impaired securities |       | $                                      | 13,074,953 |                                 | $          | (99,719   | )          | $ | 5,779,473 |   | $ | (100,152 | ) | $ | 18,854,426 |   | $ | (199,871 | ) |

 

F-13

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Tableof Contents

 

**OAKVALLEY BANCORP**

**NOTES TOFINANCIAL STATEMENTS**

 

**NOTE 3 —SECURITIES (CONTINUED)**

 

At December 31,2008, a total of four U.S. agencies, one collateralized mortgage obligationsand two SBA pools make up the total amount of securities in an unrealized lossposition for greater than 12 months. Management periodically evaluates eachavailable-for-sale investment security in an unrealized loss position todetermine if the impairment is temporary or other than temporary. Managementhas determined that no investment security is other than temporarily impaired.The unrealized losses are due solely to interest rate changes and the Bank hasthe ability and intent to hold all investment securities with identifiedimpairments resulting from interest rate changes to the earlier of theforecasted recovery or the maturity of the underlying investment security.

 

The amortized cost andestimated fair value of debt securities at December 31, 2008, bycontractual maturity or call date, are shown below. Expected maturities willdiffer from contractual maturities because borrowers may have the right to callor prepay obligations with or without call or prepayment penalties.

 
| ** **                              | ** ** | ** **    | ** ** | **Estimated** | ** ** |
|-----------------------------------------|------------|---------------|------------|---------------|------------|
| ** **                              | ** ** | **Amortized** | ** ** | **Fair**      | ** ** |
| ** **                              | ** ** | **Cost**      | ** ** | **Value**     | ** ** |
|                                    |       |          |       |          |       |
| Available-for-sale  securities:         |       |          |       |          |       |
| Due in one year  or less                |       | $             | 88,186     |          | $          | 88,575 |   |
| Due after one  year through five years  |       | 1,250,978     |       | 1,235,828     |       |
| Due after five  years through ten years |       | 4,238,046     |       | 4,218,813     |       |
| Due after ten  years                    |       | 35,392,281    |       | 35,905,661    |       |
|                                    |       | $             | 40,969,491 |          | $          | 41,448,877 |   |

 

The amortized cost andestimated fair values of debt securities as of December 31, 2007, are asfollows:

 
| ** **                           | ** ** | ** **    | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | **Estimated** | ** ** |
|--------------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|---------------|------------|
| ** **                           | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair**      | ** ** |
| ** **                           | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Value**     | ** ** |
|                                 |       |          |       |           |       |           |       |          |       |
| Available-for-sale  securities:      |       |          |       |           |       |           |       |          |       |
| U.S. agencies                        |       | $             | 24,874,744 |           | $          | 153,914        |       | $             | (66,313    | ) | $ | 24,962,345 |   |
| Collateralized  mortgage obligations |       | 4,024,103     |       | 7,014          |       | (69,967        | )          | 3,961,150     |       |
| Municipalities                       |       | 2,343,015     |       | 58,834         |       | (1,855         | )          | 2,399,994     |       |
| SBA Pools                            |       | 2,054,076     |       | —         |       | (4,941         | )          | 2,049,135     |       |
|                                 |       |          |       |           |       |           |       |          |       |
|                                 |       | $             | 33,295,938 |           | $          | 219,762        |       | $             | (143,076   | ) | $ | 33,372,624 |   |

 

The following tabledetails the gross unrealized losses and fair values aggregated by investmentcategory and length of time that individual securities have been in acontinuous unrealized loss position at December 31, 2007.

 
| ** **                              | ** ** | **Less than 12 months** | ** ** | **12 months or more** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|-----------|------------|
| ** **                              | ** ** | ** **                             | ** ** | **Unrealized**                       | ** ** | **Fair**  | ** ** | **Unrealized** | ** ** | ** ** | ** ** | **Unrealized** | ** ** |
| **Description of Securities** | ** ** | **Fair Value**                    | ** ** | **Loss**                             | ** ** | **Value** | ** ** | **Loss** | ** ** | **Fair Value** | ** ** | **Loss** | ** ** |
|                                    |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| U.S. agencies                           |       | $                                      | 1,564,653  |                                 | $          | (1,182    | )          | $ | 7,076,297 |   | $ | (65,131 | ) | $ | 8,640,950 |   | $ | (66,313 | ) |
| Collateralized  mortgage obligations    |       | 977,951                                |       | (6,821                               | )          | 2,241,900 |       | (63,146 | ) | $ | 3,219,851 |   | $ | (69,967 | ) |
| Municipalities                          |       | 304,611                                |       | (406                                 | )          | 259,621   |       | (1,449 | ) | $ | 564,232 |   | $ | (1,855 | ) |
| SBA Pools                               |       | 2,049,134                              |       | (4,941                               | )          | —    |       | — |   | $ | 2,049,134 |   | $ | (4,941 | ) |
| Total  temporarily impaired securities  |       | $                                      | 4,896,349  |                                 | $          | (13,350   | )          | $ | 9,577,818 |   | $ | (129,726 | ) | $ | 14,474,167 |   | $ | (143,076 | ) |

 

F-14

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Tableof Contents

 

**OAKVALLEY BANCORP**

**NOTES TOFINANCIAL STATEMENTS**

 

**NOTE 3 —SECURITIES (CONTINUED)**

 

At December 31,2007, a total of ten U.S. agencies, four collateralized mortgage obligations,three municipal securities, and two SBA pools make up the total amount ofsecurities in an unrealized loss position for greater than 12 months.Management periodically evaluates each available-for-sale investment securityin an unrealized loss position to determine if the impairment is temporary orother than temporary. Management has determined that no investment security isother than temporarily impaired. The unrealized losses are due solely tointerest rate changes and the Bank has the ability and intent to hold allinvestment securities with identified impairments resulting from interest ratechanges to the earlier of the forecasted recovery or the maturity of theunderlying investment security.

 

There were no realizedgains or losses on sales of available-for-sale securities during 2008 and 2007.There were no sales of available-for-sale securities during 2008 and 2007.

 

Securities carried at$30,117,814 and $28,930,614 at December 31, 2008 and 2007, respectively,were pledged to secure deposits of public funds.

 

**NOTE 4 —LOANS**

 

The Bank’s customers areprimarily located in Stanislaus, San Joaquin, Tuolumne, Inyo, and MonoCounties. Approximately 63% of the Bank’s loans are commercial real estateloans. Approximately 9% of the Bank’s loans are for general commercial usesincluding professional, retail, and small business. Additionally, 17% of theBank’s loans are for real estate construction for residential and commercialreal estate. The remaining 11% are in agriculture, residential real estate, andconsumer loans. Generally, real estate loans are collateralized by realproperty while commercial and other loans are collateralized by funds ondeposit, business, or personal assets. Repayment of loans is generally expectedfrom cash flows of the borrower. Pre-approved permanent financing generallypays off construction loans.

 

Loan totals were asfollows:

 
| ** **                            | ** ** | **DECEMBER 31,** | ** **  |
|---------------------------------------|------------|-----------------------|-------------|
| ** **                            | ** ** | **2008**              | ** **  | **2007** | ** ** |
| Loans                                 |       |                  |        |   |   |
| Commercial real  estate               |       | $                     | 268,741,826 |   | $ | 208,309,072 |   |
| Commercial                            |       | 37,302,286            |        | 45,496,794 |   |
| Real estate  construction             |       | 73,321,446            |        | 83,173,030 |   |
| Agriculture                           |       | 25,916,928            |        | 31,429,970 |   |
| Residential real  estate and consumer |       | 22,894,644            |        | 19,400,263 |   |
|                                  |       |                  |        |   |   |
| Total loans                           |       | 428,177,130           |        | 387,809,129 |   |
|                                  |       |                  |        |   |   |
| Less:                                 |       |                  |        |   |   |
| Deferred loan  fees and costs, net    |       | (1,034,723            | )           | (1,038,350 | ) |
| Allowance for  loan losses            |       | (5,569,496            | )           | (4,506,753 | ) |
|                                  |       |                  |        |   |   |
| Net loans                             |       | $                     | 421,572,911 |   | $ | 382,264,026 |   |

 

F-15

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Tableof Contents

 

**OAK VALLEY BANCORP**

**NOTES TO FINANCIAL STATEMENTS**

 

**NOTE 4 —LOANS (CONTINUED)**

 

Changes in the allowancefor loan losses were as follows:

 
| ** **                                                            | ** ** | **YEARS ENDED DECEMBER 31,** | ** ** |
|-----------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                            | ** ** | **2008**                                    | ** ** | **2007** | ** ** |
|                                                                  |       |                                        |       |   |   |
| Balance,  beginning of year                                           |       | $                                           | 4,506,753  |   | $ | 4,341,062 |   |
| Provision  charged to operations                                      |       | 2,188,139                                   |       | 555,000 |   |
| Loans charged  off                                                    |       | (1,114,534                                  | )          | (401,510 | ) |
| Loan recoveries                                                       |       | 4,745                                       |       | 4,275 |   |
| Reclassification  of reserve related to off-balance-sheet commitments |       | (15,608                                     | )          | 7,926 |   |
|                                                                  |       |                                        |       |   |   |
| Balance, end of  year                                                 |       | $                                           | 5,569,496  |   | $ | 4,506,753 |   |

 

Changes in the allowanceoff-balance-sheet commitments were as follows:

 
| ** **                                                   | ** ** | **YEARS ENDED DECEMBER 31,** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                   | ** ** | **2008**                                    | ** ** | **2007** | ** ** |
|                                                         |       |                                        |       |   |   |
| Balance,  beginning of year                                  |       | $                                           | 209,757    |   | $ | 217,683 |   |
| Reclassification  of reserves from allowance for loan losses |       | 15,608                                      |       | (7,926 | ) |
| Provision  Charged to Operations for Off Balance Sheet       |       | (50,034                                     | )          | — |   |
| Balance, end of  year                                        |       | $                                           | 175,331    |   | $ | 209,757 |   |

 

The method forcalculating the allowance for off-balance-sheet is based on an allowancepercentage which is less than other outstanding loan types because they are ata lower risk level.  This allowance percentage is evaluated by managementperiodically and is applied to the total undisbursed loan commitment balance tocalculate the allowance for off-balance-sheet commitments.

 

The total recordedinvestment in impaired loans at December 31, 2008, was $4,078,765. Theaverage recorded investment in impaired loans was $4,294,356 during 2008. Therecorded investment in impaired loans that have a specific reserve was$3,322,670 at December 31, 2008. The recorded investment in impaired loansthat did not have a specific reserve was $756,005 at December 31, 2008.The total specific reserve related to impaired loans and included in theallowance for loan losses was $768,719. No interest income was recognized onimpaired loans, while considered impaired during 2008. The total recordedinvestment in non-accrual loans was $4,078,765 at December 31, 2008. In addition, there was one real estate construction loan with a principalbalance of $643,000 that was past due greater than 90 days and still accruinginterest at December 31, 2008.

 

The total recordedinvestment in impaired loans at December 31, 2007, was $9,087,462. Theaverage recorded investment in impaired loans was $1,411,000 during 2007. Therecorded investment in impaired loans that have a specific reserve was $977,218at December 31, 2007. The recorded investment in impaired loans that didnot have a specific reserve was $8,110,244 at December 31, 2007. The totalspecific reserve related to impaired loans and included in the allowance forloan losses was $95,430. No interest income was recognized on impaired loans,while considered impaired during 2007. The total recorded investment innon-accrual loans was $9,087,462 at December 31, 2007.  In addition,there were no loans past due greater than 90 days and still accruing interestat December 31, 2007.

 

At December 31, 2008and 2007, loans carried at $274,578,420 and $261,861,840, respectively, werepledged as collateral on advances from the Federal Home Loan Bank.

 

F-16

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Tableof Contents

 

**OAKVALLEY BANCORP**

**NOTES TOFINANCIAL STATEMENTS**

 

**NOTE 5 —PREMISES AND EQUIPMENT**

 

Major classifications ofpremises and equipment are summarized as follows:

 
| ** **                                      | ** ** | **DECEMBER 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **2008**              | ** ** | **2007** | ** ** |
|                                            |       |                  |       |   |   |
| Land                                            |       | $                     | 4,023,703  |   | $ | 3,611,703 |   |
| Building                                        |       | 3,192,470             |       | 2,480,649 |   |
| Leasehold  improvements                         |       | 3,604,173             |       | 3,152,407 |   |
| Furniture,  fixtures, and equipment             |       | 5,909,567             |       | 5,606,695 |   |
|                                            |       |                  |       |   |   |
|                                            |       | 16,729,913            |       | 14,851,454 |   |
|                                            |       |                  |       |   |   |
| Less accumulated  depreciation and amortization |       | 5,635,946             |       | 4,742,834 |   |
|                                            |       |                  |       |   |   |
|                                            |       | $                     | 11,093,967 |   | $ | 10,108,620 |   |

 

Depreciation expense was$1,131,038 and $1,022,739 for the years ended 2008 and 2007, respectively.

 

**NOTE 6 —ACCRUED INTEREST AND OTHER ASSETS**

 

Other assets aresummarized as follows:

 
| ** **                                 | ** ** | **DECEMBER 31,** | ** ** |
|--------------------------------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **2008**              | ** ** | **2007** | ** ** |
|                                       |       |                  |       |   |   |
| Interest income  receivable on loans       |       | $                     | 1,676,613  |   | $ | 1,693,677 |   |
| Interest income  receivable on investments |       | 209,746               |       | 184,940 |   |
| Net deferred tax  asset                    |       | 2,554,700             |       | 2,237,414 |   |
| Federal Reserve  Bank stock                |       | 750,550               |       | 669,500 |   |
| Federal Home  Loan Bank stock              |       | 3,803,700             |       | 2,283,300 |   |
| Cash surrender  value of life insurance    |       | 9,859,234             |       | 4,749,230 |   |
| Investment in  limited partnership         |       | 845,500               |       | 323,482 |   |
| Prepaid expenses  and other                |       | 1,803,778             |       | 2,169,026 |   |
|                                       |       |                  |       |   |   |
|                                       |       | $                     | 21,503,821 |   | $ | 14,310,569 |   |

 

F-17

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Tableof Contents

 

**OAKVALLEY BANCORP**

**NOTES TOFINANCIAL STATEMENTS**

 

**NOTE 7 —DEPOSITS**

 

Deposit totals were asfollows:

 
| ** **                     | ** ** | **DECEMBER 31,** | ** **  |
|--------------------------------|------------|-----------------------|-------------|
| ** **                     | ** ** | **2008**              | ** **  | **2007** | ** ** |
|                           |       |                  |        |   |   |
| Demand                         |       | $                     | 64,276,737  |   | $ | 68,150,833 |   |
| NOW accounts                   |       | 53,485,103            |        | 54,496,524 |   |
| Money market  deposit accounts |       | 157,351,888           |        | 138,413,815 |   |
| Savings                        |       | 12,532,242            |        | 16,438,359 |   |
| Time, under  $100,000          |       | 46,562,563            |        | 42,227,602 |   |
| Time, $100,000  and over       |       | 44,039,934            |        | 57,620,643 |   |
|                           |       |                  |        |   |   |
| Total deposits                 |       | $                     | 378,248,467 |   | $ | 377,347,776 |   |

 

Certificates of depositissued and their remaining maturities at December 31, 2008, are asfollows:

 
| **Year ending December 31,** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|------------|------------|
| 2009                                        |       | $          | 71,681,711 |   |
| 2010                                        |       | 18,098,971 |       |
| 2011                                        |       | 509,194    |       |
| 2012                                        |       | 300,971    |       |
| 2013                                        |       | 11,650     |       |
|                                        |       | $          | 90,602,497 |   |

 

**NOTE 8 —FHLB ADVANCES**

 

At December 31,2008, the Bank had advances from the Federal Home Loan Bank (“FHLB”) totaling$69,000,000. Of the total advances outstanding, $34,500,000 represents termadvances due in 2009, $18,500,000 represents term advances due in 2010, and$16,000,000 represents overnight open advances. The weighted average interestrate on these advances was 1.51% and interest payments are due monthly. Unusedand available advances totaled $38,130,625 at December 31, 2008. Loans carried at $274,578,420 at December 31, 2008, were pledged ascollateral on advances from the Federal Home Loan Bank.

 

At December 31,2007, the Bank had advances from the Federal Home Loan Bank (“FHLB”) totaling$31,000,000. Of the total advances outstanding, $10,000,000 represents termadvances due in 2008, $3,000,000 represents term advances due in 2009, and$18,000,000 represents overnight open advances. The weighted average interestrate on these advances was 4.69% and interest payments are due monthly. Unusedand available advances totaled $67,740,720 at December 31, 2007. Loans carried at $261,861,840 at December 31, 2007, were pledged ascollateral on advances from the Federal Home Loan Bank.

 

F-18

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Tableof Contents

 

**OAKVALLEY BANCORP**

**NOTES TOFINANCIAL STATEMENTS**

 

**NOTE 9 —INTEREST ON DEPOSITS**

 

Interest on deposits wascomprised of the following:

 
| ** **                         | ** ** | **YEARS ENDED DECEMBER 31,** | ** ** |
|------------------------------------|------------|---------------------------------------------|------------|
| ** **                         | ** ** | **2008**                                    | ** ** | **2007** | ** ** |
|                               |       |                                        |       |   |   |
| Savings and  other deposits        |       | $                                           | 4,210,099  |   | $ | 5,636,857 |   |
| Time deposits of  $100,000 or more |       | 1,578,851                                   |       | 3,457,958 |   |
| Other time  deposits               |       | 1,451,088                                   |       | 2,132,750 |   |
|                               |       |                                        |       |   |   |
|                               |       | $                                           | 7,240,037  |   | $ | 11,227,565 |   |

 

**NOTE 10 —INCOME TAXES**

 

The provision for incometaxes consists of the following:

 
| ** ** | ** ** | **YEARS ENDED DECEMBER 31,** | ** ** |
|------------|------------|---------------------------------------------|------------|
| ** ** | ** ** | **2008**                                    | ** ** | **2007** | ** ** | **2006** | ** ** |
|       |       |                                        |       |   |   |   |   |
| Current    |       |                                        |       |   |   |   |   |
| Federal    |       | $                                           | 802,797    |   | $ | 1,739,000 |   | $ | 2,089,500 |   |
| State      |       | 141,878                                     |       | 530,000 |   | 718,000 |   |
|       |       |                                        |       |   |   |   |   |
|       |       | 944,675                                     |       | 2,269,000 |   | 2,807,500 |   |
| Deferred   |       |                                        |       |   |   |   |   |
| Federal    |       | (8,812                                      | )          | 65,970 |   | (285,325 | ) |
| State      |       | (113,818                                    | )          | 300 |   | (42,000 | ) |
|       |       |                                        |       |   |   |   |   |
|       |       | (122,630                                    | )          | 66,270 |   | (327,325 | ) |
|       |       |                                        |       |   |   |   |   |
|       |       | $                                           | 822,045    |   | $ | 2,335,270 |   | $ | 2,480,175 |   |

 

F-19

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Tableof Contents

 

**OAKVALLEY BANCORP**

**NOTES TOFINANCIAL STATEMENTS**

 

**NOTE 10- INCOME TAXES (CONTINUED)**

 

The components of theBank’s deferred tax assets and liabilities (included in accrued interest andother assets on the balance sheet), is shown below:

 
| ** **                                        | ** ** | **DECEMBER 31,** | ** ** |
|---------------------------------------------------|------------|-----------------------|------------|
| ** **                                        | ** ** | **2008**              | ** ** | **2007** | ** ** |
|                                              |       |                  |       |   |   |
| Deferred tax  assets:                             |       |                  |       |   |   |
| Deferred loan  fees                               |       | $                     | 200        |   | $ | 400 |   |
| Allowance for  loan losses                        |       | 1,813,000             |       | 1,910,000 |   |
| State income tax                                  |       | 76,800                |       | 200,000 |   |
| Accrued bonus                                     |       | 7,800                 |       |   |   |
| Accrued vacation                                  |       | 35,000                |       | 31,000 |   |
| Accrued salary  continuation liability            |       | 372,000               |       | 280,000 |   |
| Deferred  compensation                            |       | 58,000                |       |   |   |
| Split Dollar  Life Insurance                      |       | 128,000               |       | 108,000 |   |
| EITF 06-04                                        |       | 49,000                |       | — |   |
| Nonaccrual loans                                  |       | 56,000                |       | 113,000 |   |
| OREO expenses                                     |       | 517,000               |       | — |   |
| Holding company  organization fees                |       | 58,000                |       | — |   |
| Unrealized loss  on securities available for sale |       | —                |       | 13,000 |   |
|                                              |       | 3,170,800             |       | 2,658,000 |   |
| Deferred tax  liabilities:                        |       |                  |       |   |   |
| Prepaid expenses                                  |       | (170,000              | )          | (51,000 | ) |
| FHLB dividends                                    |       | (217,000              | )          | (167,000 | ) |
| Accumulated  depreciation                         |       | (191,000              | )          | (58,000 | ) |
| Deferred rent                                     |       | (145,000              | )          | — |   |
| Stock Options                                     |       | (50,000               | )          | 2,600 |   |
| Investment in  limited partnership                |       | (800                  | )          | — |   |
| Unrealized loss  on securities available for sale |       | (185,000              | )          | — |   |
|                                              |       | (958,800              | )          | (276,000 | ) |
|                                              |       |                  |       |   |   |
| Net deferred  income tax asset                    |       | $                     | 2,212,000  |   | $ | 2,382,000 |   |

 

Management has assessedthe realizability of deferred tax assets and believes it is more likely thannot that all deferred tax assets will be realized in the normal course ofoperations. Accordingly, these assets have not been reduced by a valuationallowance.

 

F-20

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Tableof Contents

 

**OAKVALLEY BANCORP**

**NOTES TOFINANCIAL STATEMENTS**

 

**NOTE 10- INCOME TAXES (CONTINUED)**

 

Theeffective tax rate for 2008 and 2007 differs from the current Federal statutoryincome tax rate as follows:

 
| ** **                                             | ** ** | **YEARS ENDED DECEMBER 31,** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                             | ** ** | **2008**                                    | ** ** | **2007** | ** ** |
|                                                   |       |                                        |       |   |   |
| Federal  statutory income tax rate                     |       | 34.0                                        | %          | 34.0 | % |
| State taxes, net  of federal tax benefit               |       | 7.2                                         | %          | 7.2 | % |
| Tax exempt  interest on municipal securities and loans |       | (1.1                                        | )%         | (1.0 | )% |
| Taxe exempt  earnings on bank owned life insurance     |       | (5.1                                        | )%         | (1.1 | )% |
| Stock based  compensation                              |       | 1.6                                         | %          | 0.8 | % |
| Low income  housing tax credit                         |       | (3.6                                        | )%         | 0.0 | % |
| California  enterprise zone tax credits and deductions |       | (4.7                                        | )%         | (1.1 | )% |
| Other                                                  |       | (0.8                                        | )%         | (1.5 | )% |
| Effective tax  rate                                    |       | 27.5                                        | %          | 37.3 | % |

 

Bancorp files aconsolidated return in the U.S. Federal tax jurisdiction and a combined reportin the State of California tax jurisdiction.  Prior to the formationof Bancorp in 2007, the Bank filed in the U.S. Federal and Californiajurisdictions on a stand-alone basis.  None of the entities aresubject to examination by taxing authorities for years before 2005 for U.S.Federal or for years before 2004 for California.

 

We adopted theprovisions of FASB Interpretation (“FIN”) No. 48, Accounting forUncertainty in Income Taxes, on January 1, 2007.  No adjustmentswere identified for unrecognized tax benefits that required an adjustment tothe January 1, 2007 beginning tax reserve.  We had no taxreserve for uncertain tax positions at December 31, 2008.  We donot anticipate providing a reserve for uncertain tax positions in the nexttwelve months.  We have elected to record interest and penaltiesrelated to unrecognized tax benefits in tax expense.  During theyears ended December 31, 2008 and 2007, neither the Bank nor Bancorp hadan accrual for interest and penalties associated with uncertain tax positions.

 

**NOTE 11 —STOCK OPTION PLAN**

 

During 1991 the Bank’sBoard of Directors approved a fixed stock option plan (the “Plan”) under whichincentive and non-qualified stock options may be granted to key employees anddirectors, respectively, to purchase up to thirty-five percent of theauthorized and un-issued common stock of the Bank at a price equal to the fairmarket value on the date of grant. The Plan provides that the options are exercisablein equal increments over a five-year period from the date of grant or over anyother schedule approved by the Board of Directors. All incentive stock optionsexpire no later than ten years from the date of grant. The Plan wasratified by the shareholders at the Bank’s annual meeting in April 1992.

 

A summary of the statusof the Bank’s fixed stock option plan and changes during the year are presentedbelow.

 
| ** **                        | ** ** | **DECEMBER 31, 2008** | ** ** |
|-----------------------------------|------------|---------------------------------|------------|
| ** **                        | ** ** | ** **                      | ** ** | **Weighted-** | ** ** |
| ** **                        | ** ** | ** **                      | ** ** | **Average** | ** ** |
| ** **                        | ** ** | ** **                      | ** ** | **Exercise** | ** ** |
| ** **                        | ** ** | **Shares**                      | ** ** | **Price** | ** ** |
|                              |       |                            |       |   |   |
| Outstanding at  beginning of year |       | 506,564                         |       | $ | 6.96 |   |
| Granted                           |       | 10,000                          |       | $ | 10.81 |   |
| Exercised                         |       | (53,847                         | )          | $ | 3.47 |   |
| Forfeited                         |       | (42,262                         | )          | $ | 12.16 |   |
|                              |       |                            |       |   |   |
| Outstanding at  end of year       |       | 420,455                         |       | $ | 6.97 |   |

 

F-21

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Tableof Contents

 

**OAKVALLEY BANCORP**

**NOTES TOFINANCIAL STATEMENTS**

 

**NOTE 11 —STOCK OPTION PLAN**

 
| ** **                                                      | ** ** | **DECEMBER 31,** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                      | ** ** | **2008**              | ** ** | **2007** | ** ** |
|                                                            |       |                  |       |   |   |
| Weighted-average  fair value of options granted during the year |       | $                     | 4.16       |   | $ | 4.18 |   |
|                                                            |       |                  |       |   |   |
| Intrinsic value  of options exercised                           |       | $                     | 1700,008   |   | $ | 314,048 |   |
|                                                            |       |                  |       |   |   |
| Options  exercisable at year end:                               |       | 343,005               |       | 357,913 |   |
|                                                            |       |                  |       |   |   |
| Weighted average  exercise price                                |       | $                     | 6.23       |   | $ | 5.52 |   |
| Intrinsic value                                                 |       | 412,074               |       | 1,155,012 |   |
| Weighted average  remaining contractual life                    |       | 3.93 years            |       | 4.36 years |   |
|                                                            |       |                  |       |   |   |
| Options  outstanding at year end:                               |       | 420,455               |       | 506,564 |   |
|                                                            |       |                  |       |   |   |
| Weighted average  exercise price                                |       | $                     | 6.97       |   | $ | 6.96 |   |
| Intrinsic value                                                 |       | 412,074               |       | 1,210,741 |   |
| Weighted average  remaining contractual life                    |       | 4.43 years            |       | 5.22 years |   |

 

Tax benefits totaling$1,600 were recorded in the statement of earnings during 2008 related to thevesting of non-qualified stock options. As of December 31, 2008, there was$157,958 of total unrecognized compensation cost related to non-vested stockoptions which is expected to be recognized over a weighted-average period of2.56 years.

 

For the year ended December 31,2008, the Bank received $186,922 from the exercise of stock options andreceived income tax benefits of $54,195 related to the exercise ofnon-qualified employee stock options and disqualifying dispositions in theexercise of incentive stock options.

 

F-22

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Tableof Contents

 

**OAKVALLEY BANCORP**

**NOTES TOFINANCIAL STATEMENTS**

 

**NOTE12 — TREASURY CAPITAL PURCHASE PROGRAM**

 

In response to thestresses in the credit markets and to protect and recapitalize the U.S.financial system, on October 3, 2008, the Emergency Economic StabilizationAct of 2008 (“EESA”) was signed into law.  EESA includes the TreasuryCapital Purchase Program (the “TCPP”), which was intended to inject liquidityinto, and stabilize the financial industry.  On December 1,2008, we received preliminary approval from the United States Department of theTreasury (the “U.S. Treasury”) to participate in the TCPP.  On December 5,the Bank issued to the U.S. Treasury 13,500 shares of senior preferred stockwith a zero par value and a $1,000 per share liquidation preference, along withwarrants to purchase 350,346 shares of common stock at a per share exerciseprice of $5.78, in exchange for aggregate consideration of $13.5 million.  Dividendswill be payable quarterly in arrears on February 15, May 15, August 15and November 15 of each year with a 5% coupon dividend rate for the firstfive years and 9% thereafter. If dividends on the senior preferred shares arenot paid in full for six dividend periods, the U.S. Treasury will have theright to elect two directors to our board until full dividends have been paidfor four consecutive dividend periods. The attached warrants are immediatelyexercisable and expire 10 years after the issuance date. We must comply withrestrictions on executive compensation during the period that the U.S. Treasuryholds an equity position in us through the TCPP.  Under the AmericanRecovery and Reinvestment Act of 2009, we may elect to repurchase the preferredstock at the original purchase price plus accrued but unpaid dividends.

 

The proceeds of$13.5 million were allocated between the preferred stock and the warrants with$12.7 million allocated to preferred stock and $833 thousand allocated to thewarrants, based on their relative fair value at the time of issuance. The fairvalue of the preferred stock was estimated using discounted cash flows with adiscount rate of 9%. The fair value of the warrants was estimated using theBinomial option pricing model with the following assumptions: 1) risk-freeinterest rate of 2.66% (the Treasury 10-year yield rate as of warrant issuancedate); 2) estimated life of ten years (contractual term of the warrants); 3)volatility of 37.4%; and 4) dividend yield of 1.67%. The discount on thepreferred stock (i.e., difference between the initial carrying amount and theliquidation amount) is amortized over the five-year period preceding the 9%perpetual dividend, using effective yield method.

 

**NOTE 13 —EARNINGS PER SHARE**

 

The Bank computesearnings per share (“EPS”) in accordance with SFAS No. 128,*Earnings per Share.* SFAS No. 128requires the presentation of basic EPS, which does not consider the effect ofcommon stock equivalents and diluted EPS, which considers all dilutive commonstock equivalents.

 
| ** **                                                              | ** ** | **YEAR ENDED DECEMBER 31, 2008** | ** ** |
|-------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                              | ** ** | **Income**                                           | ** ** | **Shares** | ** ** | **Per-Share** | ** ** |
| ** **                                                              | ** ** | **(Numerator)**                                      | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** |
|                                                                    |       |                                                 |       |   |   |   |   |
| Net earnings                                                            |       | $                                                    | 2,161,829  |   |   |   |   |   |
|                                                                    |       |                                                 |       |   |   |   |   |
| Basic EPS:                                                              |       |                                                 |       |   |   |   |   |
| Net earnings  available to common shareholders                          |       | $                                                    | 2,098,010  |   | 7,642,775 |   | $ | 0.27 |   |
|                                                                    |       |                                                 |       |   |   |   |   |
| Effect of  dilutive securities:                                         |       |                                                 |       |   |   |   |   |
| Stock options                                                           |       | —                                               |       | 91,106 |   |   |   |
| Warrants                                                                |       | —                                               |       | 4,723 |   |   |   |
| Total dilutive  shares                                                  |       |                                                 |       | 95,829 |   |   |   |
|                                                                    |       |                                                 |       |   |   |   |   |
| Diluted EPS:                                                            |       |                                                 |       |   |   |   |   |
| Net earnings  available to common shareholders plus assumed conversions |       | $                                                    | 2,098,010  |   | 7,738,604 |   | $ | 0.27 |   |

 

Options to purchase254,875 shares of common stock in prices ranging from $7.20 to $15.67 wereoutstanding during 2008. They were not included in the computation of dilutedEPS because the options’ exercise price was greater than the average marketprice of the common shares. These options begin to expire in 2015.

 

F-23

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Tableof Contents

 

**OAKVALLEY BANCORP**

**NOTES TOFINANCIAL STATEMENTS**

 

**NOTE 13 —EARNINGS PER SHARE (CONTINUED)**

 
| ** **                                                              | ** ** | **YEAR ENDED DECEMBER 31, 2007** | ** ** |
|-------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                              | ** ** | **Income**                                           | ** ** | **Shares** | ** ** | **Per-Share** | ** ** |
| ** **                                                              | ** ** | **(Numerator)**                                      | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** |
|                                                                    |       |                                                 |       |   |   |   |   |
| Net earnings                                                            |       | $                                                    | 3,925,121  |   |   |   |   |   |
|                                                                    |       |                                                 |       |   |   |   |   |
| Basic EPS:                                                              |       |                                                 |       |   |   |   |   |
| Net earnings  available to common shareholders                          |       | $                                                    | 3,925,121  |   | 7,364,681 |   | $ | 0.53 |   |
|                                                                    |       |                                                 |       |   |   |   |   |
| Effect of  dilutive securities:                                         |       |                                                 |       |   |   |   |   |
| Stock options                                                           |       | —                                               |       | 159,824 |   |   |   |
|                                                                    |       |                                                 |       |   |   |   |   |
| Diluted EPS:                                                            |       |                                                 |       |   |   |   |   |
| Net earnings  available to common shareholders plus assumed conversions |       | $                                                    | 3,925,121  |   | 7,524,505 |   | $ | 0.52 |   |

 

Options to purchase104,750 shares of common stock in prices ranging from $10.85 to $15.67 wereoutstanding during 2007. They were not included in the computation of dilutedEPS because the options’ exercise price was greater than the average marketprice of the common shares. These options begin to expire in 2015.

 

F-24

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Tableof Contents

 

**OAKVALLEY BANCORP**

**NOTES TOFINANCIAL STATEMENTS**

 

**NOTE 14 —COMMITMENTS AND CONTINGENCIES**

 

The Bank is obligated forrental payments under certain operating lease agreements, some of which containrenewal options and escalation clauses that provide for increased rentals.Total rental expense for the years ended December 31, 2008 and 2007, was$904,800 and $669,054, respectively.

 

At December 31, 2008the future minimum commitments under these operating leases are as follows:

 
| **Year ending December 31,** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|------------|------------|
| 2009                                        |       | $          | 802,804    |   |
| 2010                                        |       | 793,216    |       |
| 2011                                        |       | 751,314    |       |
| 2012                                        |       | 780,793    |       |
| 2013                                        |       | 814,136    |       |
| Thereafter                                  |       | 3,950,322  |       |
|                                        |       | $          | 7,892,585  |   |

 

The Bank is a party tofinancial instruments with off-balance-sheet risk in the normal course ofbusiness to meet the financing needs of its customers. These financialinstruments include commitments to extend credit in the form of loans orthrough standby letters of credit. These instruments involve, to varyingdegrees, elements of credit and interest-rate risk in excess of the amountrecognized in the balance sheet. The contract amounts of those instrumentsreflect the extent of involvement the Bank has in particular classes offinancial instruments.

 

The Bank’s exposure tocredit loss in the event of non-performance by the other party to the financialinstrument for commitments to extend credit and standby letters of credit isrepresented by the contractual amount of those instruments. The Bank uses thesame credit policies in making commitments and conditional obligations as itdoes for on-balance-sheet instruments.

 

Financial instrumentswhose contract amounts represent credit risk:

 
| ** **                    | ** ** | **Contract** | ** ** |
|-------------------------------|------------|--------------|------------|
| ** **                    | ** ** | **Amount**   | ** ** |
|                          |       |         |       |
| Undisbursed loan  commitments |       | $            | 47,726,630 |   |
| Checking reserve              |       | 1,276,002    |       |
| Equity lines                  |       | 10,543,892   |       |
| Standby letters  of credit    |       | 3,528,566    |       |
|                          |       | $            | 63,075,090 |   |

 

Commitments to extendcredit are agreements to lend to a customer as long as there is no violation ofany condition established in the contract. Commitments generally have fixedexpiration dates or other termination clauses and may require payment of a fee.Since many of the commitments are expected to expire without being drawn upon,the total commitment amounts do not necessarily represent future cash requirements.The Bank evaluates each customer’s creditworthiness on a case-by-case basis.The amount of collateral obtained, if deemed necessary by the Bank uponextension of credit, is based on management’s credit evaluation. Collateralheld varies but may include accounts receivable, inventory, property, plant,and equipment, and income-producing commercial properties.

 

Standby letters of creditare conditional commitments issued by the Bank to guarantee the performance ofa customer to a third party. The credit risk involved in issuing letters ofcredit is essentially the same as that involved in extending loan facilities tocustomers.

 

F-25

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Tableof Contents

 

**OAKVALLEY BANCORP**

**NOTES TOFINANCIAL STATEMENTS**

 

**NOTE 15 —FINANCIAL INSTRUMENTS**

 

**Fairvalues of financial instruments —** The financial statementsinclude various estimated fair value information as of December 31, 2008and 2007. Such information, which pertains to the Bank’s financial instruments,does not purport to represent the aggregate net fair value of the Bank.Further, the fair value estimates are based on various assumptions,methodologies, and subjective considerations, which vary widely among differentfinancial institutions and which are subject to change. The following methodsand assumptions are used by the Bank.

 

*Cashand cash equivalents* — The carrying amounts of cash and cashequivalents approximate their fair value.

 

*Securities(including mortgage-backed securities)* — Fair values forsecurities are based on quoted market prices, where available. If quoted marketprices are not available, fair values are based on quoted market prices ofcomparable instruments.

 

*Loansreceivable* — For variable-rate loans that reprice frequentlyand have no significant change in credit risk, fair values are based oncarrying values. The fair values for other loans (e.g., real estateconstruction and mortgage, commercial, and installment loans) are estimatedusing discounted cash flow analyses, using interest rates currently beingoffered for loans with similar terms to borrowers of similar credit quality.

 

*Depositliabilities* — The fair values estimated for demand deposits(interest and non-interest checking, passbook savings, and certain types ofmoney market accounts) are, by definition, equal to the amount payable ondemand at the reporting date (i.e. their carrying amounts). The carryingamounts for variable-rate, fixed-term money market accounts and certificates ofdeposit approximate their fair values at the reporting date. Fair values forfixed-rate certificates of deposit are estimated using a discounted cash flowcalculation that applies interest rates currently being offered on certificatesto a schedule of the aggregate expected monthly maturities on time deposits.

 

*FederalHome Loan Bank (FHLB) advances* — Rates currently available tothe Bank for borrowings with similar terms and remaining maturities are used toestimate the fair value of the existing debt.

 

*Accruedinterest* — The carrying amounts of accrued interestapproximate their fair value.

 

*Off-balance-sheetinstruments* — Fair values for the Bank’s off-balance-sheetlending commitments are based on fees currently charged to enter into similaragreements, taking into account the remaining terms of the agreements and thecredit standing of the counterparties.

 

The estimated fair valuesof the Bank’s financial instruments at December 31, 2008 are as follows:

 
| ** **                                   | ** ** | ** **   | ** ** | **Estimated** | ** ** |
|----------------------------------------------|------------|--------------|------------|---------------|------------|
| ** **                                   | ** ** | **Carrying** | ** ** | **Fair**      | ** ** |
| ** **                                   | ** ** | **Amount**   | ** ** | **Value**     | ** ** |
| **Financial  assets:**                       |       |         |       |          |       |
|                                         |       |         |       |          |       |
| Cash and cash  equivalents                   |       | $            | 9,837,860  |          | $          | 9,837,860 |   |
| Securities  available for sale               |       | 41,448,877   |       | 41,448,877    |       |
| Loans                                        |       | 428,177,130  |       | 429,344,847   |       |
| Accrued interest  receivable                 |       | 1,886,359    |       | 1,886,359     |       |
|                                         |       |         |       |          |       |
| **Financial  liabilities:**                  |       |         |       |          |       |
|                                         |       |         |       |          |       |
| Deposits                                     |       | (378,248,467 | )          | (378,041,128  | )          |
| FHLB advance                                 |       | (69,000,000  | )          | (69,103,323   | )          |
| Accrued interest  payable                    |       | (763,117     | )          | (763,117      | )          |
|                                         |       |         |       |          |       |
| **Off-balance-sheet  assets (liabilities):** |       |         |       |          |       |
|                                         |       |         |       |          |       |
| Commitments and  standby letters of credit   |       |         |       | (3,528,566    | )          |
|                                              |            |              |            |               |            |  |  |

 

F-26

----

Tableof Contents

 

**OAKVALLEY BANCORP**

**NOTES TOFINANCIAL STATEMENTS**

 

**NOTE 15 —FINANCIAL INSTRUMENTS (Continued)**

 

The estimated fair valuesof the Bank’s financial instruments at December 31, 2007 were as follows:

 
| ** **                                   | ** ** | ** **   | ** ** | **Estimated** | ** ** |
|----------------------------------------------|------------|--------------|------------|---------------|------------|
| ** **                                   | ** ** | **Carrying** | ** ** | **Fair**      | ** ** |
| ** **                                   | ** ** | **Amount**   | ** ** | **Value**     | ** ** |
| **Financial  assets:**                       |       |         |       |          |       |
|                                         |       |         |       |          |       |
| Cash and cash equivalents                    |       | $            | 14,202,951 |          | $          | 14,202,951 |   |
| Securities  available for sale               |       | 33,372,624   |       | 33,372,624    |       |
| Loans                                        |       | 387,809,129  |       | 394,349,356   |       |
| Accrued interest  receivable                 |       | 1,878,617    |       | 1,878,617     |       |
|                                         |       |         |       |          |       |
| **Financial  liabilities:**                  |       |         |       |          |       |
|                                         |       |         |       |          |       |
| Deposits                                     |       | (377,347,776 | )          | (377,536,730  | )          |
| FHLB advance                                 |       | (31,000,000  | )          | (31,080,813   | )          |
| Accrued interest  payable                    |       | (1,816,645   | )          | (1,816,645    | )          |
|                                         |       |         |       |          |       |
| **Off-balance-sheet  assets (liabilities):** |       |         |       |          |       |
|                                         |       |         |       |          |       |
| Commitments and  standby letters of credit   |       |         |       | (814,000      | )          |
|                                              |            |              |            |               |            |  |  |

 

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**OAKVALLEY BANCORP**

**NOTES TOFINANCIAL STATEMENTS**

 

**NOTE16****-****FAIR VALUE MEASUREMENTS**

 

SFAS No. 157, FairValue Measurements, which the Company adopted effective January 1, 2008,defines fair value, establishes a framework for measuring fair value,establishes a three-level valuation hierarchy for disclosure of fair valuemeasurement and enhances disclosure requirements for fair value measurements.The valuation hierarchy is based upon the transparency of inputs to thevaluation of an asset or liability as of the measurement date. The three levelsare defined as follow:

 

Level 1:  Inputs to the valuation methodology arequoted prices (unadjusted) for identical assets or liabilities in activemarkets.

Level 2:  Inputs to the valuation methodology includequoted prices for similar assets and liabilities in active markets and inputsthat are observable for the asset or liability, either directly or indirectly,for substantially the full term of the financial instrument.

Level 3:  Inputs to the valuation methodology areunobservable and significant to the fair value measurement.

 

In certain cases, theinputs used to measure fair value may fall into different levels of the fairvalue hierarchy.  In such cases, thelevel in the fair value hierarchy within which the fair value measurement inits entirety falls has been determined based on the lowest level input that issignificant to the fair value measurement in its entirety.  The Company’s assessment of the significanceof a particular input to the fair value measurement in its entirety requiresjudgment, and considers factors specific to the asset or liability.

 

Assets and liabilitiesmeasured at fair value on a recurring and non-recurring basis are summarizedbelow:

 
| ** **                                                 | ** ** | **Fair Value Measurements at December 31, 2008 Using** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **December 31,  2008**                                                               | ** ** | **Quoted Prices  in Active  Markets for  Identical Assets  (Level 1)** | ** ** | **Significant  Other  Observable  Inputs  (Level 2)** | ** ** | **Significant  Unobservable  Inputs  (Level 3)** | ** ** |
|                                                       |       |                                                                                      |       |   |   |   |   |   |   |
| Assets and  liabilities measured on a recurring basis:     |       |                                                                                      |       |   |   |   |   |   |   |
| Available-for-sale  securities                             |       | $                                                                                         | 41,448,877 |   | $ |   |   | $ | 41,448,877 |   | $ | — |   |
|                                                       |       |                                                                                      |       |   |   |   |   |   |   |
| Assets and  liabilities measured on a non-recurring basis: |       |                                                                                      |       |   |   |   |   |   |   |
| Impaired Loans                                             |       | $                                                                                         | 3,309,956  |   | $ | — |   | $ | — |   | $ | 3,309,956 |   |

 

The fair value ofsecurities available for sale equals quoted market price, if available.  If quoted market prices are not available,fair value is determined using quoted market prices for similarsecurities.  Changes in fair market valueare recorded in other comprehensive income net of tax.  SFAS No. 157 applies to loans measuredfor impairment using the practical expedients permitted by SFAS No. 114,Accounting by Creditors for Impairment of a Loan, including impaired loansmeasured at an observable market price (if available), or at the fair value ofthe loan’s collateral (if the loan is collateral dependent). Fair value of theloan’s collateral, when the loan is dependent on collateral, is determined byappraisals or independent valuation which is then adjusted for the cost relatedto liquidation of the collateral. At December 31, 2008, impaired loans hada principal balance of $4,078,675, with a valuation allowance of $768,719.  Upon being classified as impaired, chargeoffs were taken to reduce the balance of each loan to an estimate of thecollateral fair market value less cost to dispose. This estimate was a level 3valuation.  There was no direct impact on the income statement.  Thecharge-offs were recorded as a debit to the allowance for loan losses.

 

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** **

**OAKVALLEY BANCORP**

**NOTES TOFINANCIAL STATEMENTS**

 

**NOTE 17 —RELATED PARTY TRANSACTIONS**

 

The Bank, in the normalcourse of business, makes loans and receives deposits from its directors,officers, principal shareholders, and their associates. In management’sopinion, these transactions are on substantially the same terms as comparabletransactions with other customers of the Bank. Loans to directors, officers,shareholders, and affiliates are summarized below:

 
| ** **                                       | ** ** | **YEARS ENDED DECEMBER 31,** | ** ** |
|--------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                       | ** ** | **2008**                                    | ** ** | **2007** | ** ** |
|                                             |       |                                        |       |   |   |
| Aggregate amount  outstanding, beginning of year |       | $                                           | 5,785,792  |   | $ | 7,307,946 |   |
| New loans or  advances during year               |       | 4,068,823                                   |       | 2,793,291 |   |
| Repayments  during year                          |       | (370,907                                    | )          | (4,315,445 | ) |
|                                             |       |                                        |       |   |   |
| Aggregate amount  outstanding, end of year       |       | $                                           | 9,483,708  |   | $ | 5,785,792 |   |

 

Related party depositstotaled $9,518,344 and $9,367,808 at December 31, 2008 and 2007,respectively.

 

**NOTE 18 —PROFIT SHARING PLAN**

 

The profit sharing planto which both the Bank and eligible employees contribute was established in1995. Bank contributions are voluntary and at the discretion of the Board ofDirectors. Contributions were approximately $296,000 and $326,000 for 2008 and2007, respectively.

 

**NOTE 19 —RESTRICTIONS ON RETAINED EARNINGS**

 

Under current CaliforniaState banking laws, the Bank may not pay cash dividends in an amount thatexceeds the lesser of retained earnings of the Bank or the Bank’s net earningsfor its last three fiscal years (less the amount of any distributions toshareholders made during that period). If the above requirements are not met, cashdividends may only be paid with the prior approval of the Commissioner of theDepartment of Financial Institutions, in an amount not exceeding the Bank’s netearnings for its last fiscal year or the amount of its net earnings for itscurrent fiscal year. Accordingly, the future payment of cash dividends willdepend on the Bank’s earnings and its ability to meet its capital requirements.

 

**NOTE 20 —OTHER POST-RETIREMENT BENEFIT PLANS**

 

The Bank has awardedcertain officers a salary continuation plan (the “Plan”). Under the Plan, theparticipants will be provided with a fixed annual retirement benefit for 20years after retirement. The Bank is also responsible for certain pre-retirementdeath benefits under the Plan. In connection with the implementation of thePlan, the Bank purchased single premium life insurance policies on the life ofeach of the officers covered under the Plan. The Bank is the owner and partialbeneficiary of these life insurance policies. The assets of the Plan, underInternal Revenue Service regulations, are owned by the Bank and are availableto satisfy the Bank’s general creditors.

 

During December 2001the Bank awarded its directors a director retirement plan (“DRP”). Under theDRP, the participants will be provided with a fixed annual retirement benefitfor ten years after retirement. The Bank is also responsible for certainpre-retirement death benefits under the DRP. In connection with theimplementation of the DRP, the Bank purchased single premium life insurancepolicies on the life of each director covered under the DRP. The Bank is theowner and partial beneficiary of these life insurance policies. The assets ofthe DRP, under Internal Revenue Service regulations, are the property of theBank and are available to satisfy the Bank’s general creditors.

 

Future compensation underboth plans is earned for services rendered through retirement. The Bank accruesfor the salary continuation liability based on anticipated years of service andvesting schedules provided under the plans. The Bank’s current benefitliability is determined based on vesting and the present value of the benefitsat a corresponding discount rate. The discount rate used is an equivalent ratefor investment-grade bonds with lives matching those of the service periodsremaining for the salary continuation contracts, which average approximately20 years. At December 31, 2008 and 2007, $903,657 and $680,844,respectively, has been accrued to date, based on a discounted cash flow using adiscount rate of 6%, and is included in other liabilities.

 

The Bank entered intosplit-dollar life insurance agreements with certain officers. In connectionwith the implementation of the split-dollar agreements, the Bank purchasedsingle premium life insurance policies on the life of each of the officerscovered by the split-dollar life insurance agreements. The Bank is the owner ofthe policies and the partial beneficiary in an amount equal to the cash 

 

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surrender value of thepolicies.

 

The combined cashsurrender value of all Bank-owned life insurance policies was $9,859,234 and$4,749,230 at December 31, 2008 and 2007, respectively. The cash surrendervalue of the life insurance policies is included in other assets (Note 6).

 

**NOTE 21 —REGULATORY MATTERS**

 

The Bank is subject tovarious regulatory capital requirements administered by federal and statebanking agencies. Failure to meet minimum capital requirements can initiatecertain mandatory — and possibly additional discretionary — actions byregulators that, if undertaken, could have a direct material effect on the Bank’sfinancial statements. Under capital adequacy guidelines and the regulatoryframework for prompt corrective action, the Bank must meet specific capitalguidelines that involve quantitative measures of the Bank’s assets,liabilities, and certain off-balance-sheet items as calculated under regulatoryaccounting practices. The Bank’s capital amounts and classifications are alsosubject to qualitative judgments by the regulators about components, riskweightings, and other factors.

 

Quantitative measuresestablished by regulation to ensure capital adequacy require the Bank tomaintain minimum amounts and ratios (set forth in the table on the next page)of total and Tier I capital (as defined in the regulations) torisk-weighted assets (as defined), and of Tier I capital (as defined) toaverage assets (as defined). Management believes, as of December 31, 2008,that the Bank meets all capital adequacy requirements to which it is subject.

 

As of December 31,2008, the most recent notification from the Federal Reserve Bank categorizedthe Bank as well capitalized under the regulatory framework for promptcorrective action. To be categorized as well capitalized, the Bank mustmaintain minimum total risk-based, Tier I risk-based, and Tier Ileverage ratios as set forth in the following table. There are no conditions orevents since notification that management believes have changed the Bank’scategory.

 

The Bank’s actual capitalamounts and ratios at December 31, 2008 and 2007, are presented in thefollowing table.

 
| ** **                                 | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **To be well**   | ** ** |
|--------------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                 | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **capitalized under** | ** ** |
| ** **                                 | ** ** | ** ** | ** ** | ** **                 | ** ** | **For capital**       | ** ** | **prompt corrective** | ** ** |
| ** **                                 | ** ** | **Actual** | ** ** | **adequacy purposes** | ** ** | **action provisions** | ** ** |
| ** **                                 | ** ** | **Amount** | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio** | ** ** |
| **Capital  ratios for Bank:**              |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| As of  December 31, 2008              |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Total capital  (to Risk- Weighted Assets)  |       | $          | 63,379,000 |                       | 13.3       | %                          | $          | 38,206,000                 |       | >8.0                    | %          | $ | 47,758,000 |   | >10.0 | % |
| Tier I capital  (to Risk- Weighted Assets) |       | $          | 57,635,000 |                       | 12.1       | %                          | $          | 19,103,000                 |       | >4.0                    | %          | $ | 28,655,000 |   | >6.0 | % |
| Tier I capital  (to Average Assets)        |       | $          | 57,635,000 |                       | 11.8       | %                          | $          | 19,593,000                 |       | >4.0                    | %          | $ | 24,492,000 |   | >5.0 | % |
|                                       |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| As of  December 31, 2007:             |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Total capital  (to Risk- Weighted Assets)  |       | $          | 47,311,000 |                       | 11.1       | %                          | $          | 33,994,000                 |       | >8.0                    | %          | $ | 42,493,000 |   | >10.0 | % |
| Tier I capital  (to Risk- Weighted Assets) |       | $          | 42,594,000 |                       | 10.0       | %                          | $          | 16,997,000                 |       | >4.0                    | %          | $ | 24,686,000 |   | >6.0 | % |
| Tier I capital  (to Average Assets)        |       | $          | 42,594,000 |                       | 9.4        | %                          | $          | 18,092,000                 |       | >4.0                    | %          | $ | 21,831,000 |   | >5.0 | % |
|                                       |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| **Capital  ratios for Bancorp:**           |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| As of  December 31, 2008              |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Total capital  (to Risk- Weighted Assets)  |       | $          | 63,440,000 |                       | 13.3       | %                          | $          | 38,211,000                 |       | >8.0                    | %          | N/A |   | N/A |   |
| Tier I capital  (to Risk- Weighted Assets) |       | $          | 57,696,000 |                       | 12.1       | %                          | $          | 19,106,000                 |       | >4.0                    | %          | N/A |   | N/A |   |
| Tier I capital  (to Average Assets)        |       | $          | 57,696,000 |                       | 11.8       | %                          | $          | 19,594,000                 |       | >4.0                    | %          | N/A |   | N/A |   |

 

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**OAKVALLEY BANCORP**

**NOTES TOFINANCIAL STATEMENTS**

 

**22.  PARENT ONLY CONDENSED FINANCIAL STATEMENTS**

 

**CONDENSEDBALANCE SHEET**

 
| ** **                                                                                                                                                            | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                            | ** ** | **2008**              | ** ** |
| **ASSETS**                                                                                                                                                            | ** ** | ** **            | ** ** |
|                                                                                                                                                                  |       |                  |       |
| Investment in  bank subsidiary                                                                                                                                        |       | $                     | 57,925,039 |   |
| Other assets                                                                                                                                                          |       | 61,040                |       |
|                                                                                                                                                                  |       |                  |       |
| Total Assets                                                                                                                                                          |       | $                     | 57,986,079 |   |
|                                                                                                                                                                  |       |                  |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                                        | ** ** | ** **            | ** ** |
|                                                                                                                                                                  |       |                  |       |
| Total  liabilities                                                                                                                                                    |       | —                |       |
|                                                                                                                                                                  |       |                  |       |
| Shareholders’  equity                                                                                                                                            |       |                  |       |
| Preferred stock,  no par value; 10,000,000 shares authorized and 13,500 issued and outstanding  at December 31, 2008                                             |       | 12,680,649            |       |
| Common stock, no  par value; 10,000,000 shares authorized and 7,661,627 and 7,103,243 shares  issued and outstanding at December 31, 2008 and 2007, respectively |       | 23,863,331            |       |
| Additional  paid-in capital                                                                                                                                           |       | 1,925,224             |       |
| Retained  earnings                                                                                                                                                    |       | 19,226,645            |       |
| Accumulated  other comprehensive income, net of tax                                                                                                                   |       | 290,230               |       |
|                                                                                                                                                                  |       |                  |       |
| Total  shareholders’ equity                                                                                                                                      |       | 57,986,079            |       |
|                                                                                                                                                                  |       |                  |       |
| Total  liabilities and shareholders’ equity                                                                                                                      |       | $                     | 57,986,079 |   |

 

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**OAKVALLEY BANCORP**

**NOTES TOFINANCIAL STATEMENTS**

 

**22.  PARENT ONLY CONDENSED FINANCIAL STATEMENTS(CONTINUED)**

 

**CONDENSEDSTATEMENT OF EARNINGS**

** **
| ** **                                                  | ** ** | **Year Ended**   | ** ** |
|-------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                  | ** ** | **December 31,** | ** ** |
| ** **                                                  | ** ** | **2008**              | ** ** |
|                                                        |       |                  |       |
| INCOME                                                      |       |                  |       |
| Dividends  declared by subsidiary                           |       | 711,929               |       |
| Total income                                                |       | 711,929               |       |
|                                                        |       |                  |       |
| EXPENSES                                                    |       |                  |       |
| Audit expense                                               |       | 15,000                |       |
| Legal expense                                               |       | 128,320               |       |
| Other operating  expenses                                   |       | 5,000                 |       |
| Total  non-interest expense                                 |       | 148,320               |       |
|                                                        |       |                  |       |
| Income before  equity in undistributed income of subsidiary |       | 563,609               |       |
|                                                        |       |                  |       |
| Equity in undistributed  net income of subsidiary           |       | 1,537,180             |       |
| Income before  income tax benefit                           |       | 2,100,789             |       |
|                                                        |       |                  |       |
| Income tax  benefit                                         |       | 61,040                |       |
|                                                        |       |                  |       |
| Net Income                                                  |       | $                     | 2,161,829  |   |
|                                                        |       |                  |       |
| Preferred Stock  dividends and accretion                    |       | 63,819                |       |
|                                                        |       |                  |       |
| Net income  available to common shareholders                |       | $                     | 2,098,010  |   |

 

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**OAKVALLEY BANCORP**

**NOTES TOFINANCIAL STATEMENTS**

 

**22.  PARENT ONLY CONDENSED FINANCIAL STATEMENTS(CONTINUED)**

 

**CONDENSEDSTATEMENT OF CASHFLOWS**

** **
| ** **                                                                    | ** ** | **YEAR ENDED  DECEMBER 31,** | ** ** |
|-------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                    | ** ** | **2008**                               | ** ** |
|                                                                          |       |                                   |       |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                        |       |                                   |       |
| Net earnings                                                                  |       | $                                      | 2,161,829  |   |
| Adjustments to  reconcile net earnings to net cash from operating activities: |       |                                   |       |
| Undistributed  net income of subsidiary                                       |       | (1,537,179                             | )          |
| Increase in  other assets                                                     |       | (61,040                                | )          |
| Net cash from  operating activities                                           |       | 563,610                                |       |
|                                                                          |       |                                   |       |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                        |       |                                   |       |
| Proceeds from  sale of Preferred Stock                                        |       | 13,500,000                             |       |
| Capital infusion  into bank subsidiary                                        |       | (13,500,000                            | )          |
| Dividends paid                                                                |       | (574,484                               | )          |
| Proceeds from  sale of common stock and exercise of stock options             |       | 10,874                                 |       |
| Net cash from  financing activities                                           |       | (563,610                               | )          |
|                                                                          |       |                                   |       |
| NET DECREASE IN  CASH AND CASH EQUIVALENTS                                    |       | —                                 |       |
|                                                                          |       |                                   |       |
| CASH AND CASH  EQUIVALENTS, beginning of period                               |       | —                                 |       |
|                                                                          |       |                                   |       |
| CASH AND CASH  EQUIVALENTS, end of period                                     |       | $                                      | —     |   |

 

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