UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 WASHINGTON,
D.C. 20549
 
 FORM
10-Q
 
 
 x
              QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE
 ACT OF
1934
 
 For the
quarterly period ended: June 30,
2008
 
 
  ̈
              TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE
 ACT OF
1934
 
 For the
transition period ended: ____________ to
____________
 
 Commission
File Number: 000-31929
 
 SONOMA
VALLEY BANCORP
 (Exact
name of registrant as specified in its charter)
 
 CALIFORNIA
              68-0454068(State
      of Incorporation)
              (I.R.S.
      Employer Identification No.)202
      West Napa Street Sonoma, California
              95476(Address
      of principal executive offices)
              (Zip
      Code)
 
 (707)
935-3200
 (Registrant's
telephone number, including area code)
 
 Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
 Yes   x                                           No    ̈
 
 Indicate
by a check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See the definitions of “large accelerated filer,” “large
accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.
 
 Large
accelerated filer     ̈                                                                                          
 Accelerated filer    ̈
 Non-accelerated
filer     x (Do not check if a
smaller reporting
company)           Smaller
reporting company    ̈
 
 Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act.
 
 Yes  ̈                                           No  x
 
 The
number of shares outstanding of the registrant's Common Stock, no par value, as
of August 1, 2008 was 2,288,709.
  
  
 INDEX
 
 Part
      I  Financial Information
              Page
      NumberItem
      1. Financial Statements (Unaudited):Consolidated Balance Sheets at June 30,
      2008, December 31, 2007 and June 30, 2007
              3Consolidated Statements of Operations
      for the three and six  months ended June 30, 2008 and
      2007
              4Consolidated Statements of Changes in
      Shareholders’ Equity for the six months ended June 30, 2008, and the
      years ended December 31, 2007 and 2006
              5Consolidated Statements of Cash Flows for
      the six months ended June 30, 2008 and 2007
              7Notes to Consolidated Financial
      Statements
              8Average Balances/Yields and Rates
      Paid for the six months ended June 30, 2008 and
    2007
              11Item
      2. Management's Discussion and Analysis
      of Financial Condition and Results of Operations
              12Average Balances/Yields and Rates
      Paid for the three months ended June 30, 2008 and
      2007
              23Item
      3. Quantitative and Qualitative
      Disclosure About Market Risk
              26Item
      4. Controls and
      Procedures
              26Part
      II  Other InformationItem
      1. Legal Proceedings
              27Item
      2. Unregistered Sales of Equity Securities
      and Use of Proceeds
              27Item
      3. Defaults Upon Senior
      Securities
              27Item
      4. Submission of Matters to a Vote of
      Security Holders
              28Item
      5. Other Information
              28Item
      6. Exhibits
              28Signatures
              29Certifications
 
  2
 
 Part
I
  Item
1.                      The information furnished in these
interim statements reflects all adjustments and accruals which are, in the
opinion of management, necessary for a fair statement of the results for such
periods.  The results of operations in the interim statements are not
necessarily indicative of the results that may be expected for the full
year.
 
 FINANCIAL
STATEMENTS
 SONOMA
VALLEY BANCORP AND SUBSIDIARY
 CONSOLIDATED BALANCE SHEETS
 June 30,
2008 (Unaudited), December 31, 2007 (Audited)
 and June
30, 2007 (Unaudited)
  June
      30,
                2008
              
              
              December
      31,
                2007
              
              
              June
      30,
                2007ASSETSCash
      and due from banks
              
              $
              6,794,689
              
              
              $
              6,268,091
              
              
              $
              6,749,796Interest-bearing
      due from banks
              
              
              8,850,264
              
              
              
              3,065,543
              
              
              
              180,935Total
      cash and cash equivalents
              
              
              15,644,953
              
              
              
              9,333,634
              
              
              
              6,930,731Investment
      securities available-for-sale at fair value
              
              
              2,040,691
              
              
              
              8,203,190
              
              
              
              11,078,887Investment
      securities held-to-maturity (fair value of $14,065,909, $14,754,249 and
      $15,784,619 respectively)
              
              
              13,964,670
              
              
              
              14,554,224
              
              
              
              15,875,285Loans
      and lease financing receivables, net
              
              
              252,291,863
              
              
              
              246,738,218
              
              
              
              233,667,597Premises
      and equipment, net
              
              
              794,674
              
              
              
              792,455
              
              
              
              839,234Accrued
      interest receivable
              
              
              1,674,077
              
              
              
              1,682,209
              
              
              
              1,718,246Other
      real estate owned
              
              
              320,416
              
              
              
              0
              
              
              
              0Cash
      surrender value of life insurance
              
              
              10,566,430
              
              
              
              10,354,153
              
              
              
              10,137,352Other
      assets
              
              
              5,979,727
              
              
              
              6,201,195
              
              
              
              5,323,639Total
      assets
              
              $
              303,277,501
              
              
              $
              297,859,278
              
              
              $
              285,570,971LIABILITIESNoninterest-bearing
      demand deposits
              
              $
              52,634,753
              
              
              $
              58,589,202
              
              
              $
              52,274,181Interest-bearing
      transaction deposits
              
              
              28,551,865
              
              
              
              30,135,049
              
              
              
              28,910,157Savings
      and money market deposits
              
              
              78,377,774
              
              
              
              73,528,081
              
              
              
              75,134,262Time
      deposits, $100,000 and over
              
              
              53,377,068
              
              
              
              44,160,741
              
              
              
              40,834,649Other
      time deposits
              
              
              31,659,159
              
              
              
              29,634,626
              
              
              
              29,448,446Total
      deposits
              
              
              244,600,619
              
              
              
              236,047,699
              
              
              
              226,601,695Other
      borrowings
              
              
              22,100,000
              
              
              
              27,500,000
              
              
              
              26,300,000Accrued
      interest payable and other liabilities
              
              
              6,501,169
              
              
              
              6,377,299
              
              
              
              5,761,494Total
      liabilities
              
              
              273,201,788
              
              
              
              269,924,998
              
              
              
              258,663,189SHAREHOLDERS'
      EQUITYCommon
      stock, no par value; 10,000,000 shares authorized; 2,288,709 shares at
      June 30, 2008, 2,242,809 shares at December 31, 2007 and 2,261,936 shares
      at June 30, 2007 issued and outstanding
              
              
              16,222,864
              
              
              
              15,578,903
              
              
              
              15,528,312Additional
      paid-in-capital
              
              
              2,640,657
              
              
              
              2,455,409
              
              
              
              2,472,873Retained
      earnings
              
              
              11,222,268
              
              
              
              9,934,967
              
              
              
              9,014,327Accumulated
      other comprehensive loss
              
              
              (10,076
              )
              
              
              (34,999
              )
              
              
              (107,730
              )Total
      shareholders' equity
              
              
              30,075,713
              
              
              
              27,934,280
              
              
              
              26,907,782Total
      liabilities and shareholders' equity
              
              $
              303,277,501
              
              
              $
              297,859,278
              
              
              $
              285,570,971
 
 The
accompanying notes are an integral part of these financial
statements.
  3
 SONOMA
VALLEY BANCORP AND SUBSIDIARY
 CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
  For
      the Three Months
              
              
              For
      the Six MonthsEnded
      June 30,
              
              
              Ended
      June 30,2008
              
              
              2007
              
              
              2008
              
              
              2007INTEREST
      INCOMELoans
      and leases
              
              $
              4,741,420
              
              
              $
              4,897,959
              
              
              $
              9,673,174
              
              
              $
              9,503,765Taxable
      securities
              
              
              17,041
              
              
              
              120,246
              
              
              
              68,967
              
              
              
              275,677Tax-exempt
      securities
              
              
              133,511
              
              
              
              154,670
              
              
              
              269,343
              
              
              
              308,250Federal
      funds sold and other
              
              
              4,519
              
              
              
              11,223
              
              
              
              32,440
              
              
              
              17,675Dividends
              
              
              25,980
              
              
              
              15,460
              
              
              
              49,847
              
              
              
              32,253Total
      interest income
              
              
              4,922,471
              
              
              
              5,199,558
              
              
              
              10,093,771
              
              
              
              10,137,620INTEREST
      EXPENSEInterest-bearing
      transaction deposits
              
              
              11,987
              
              
              
              12,558
              
              
              
              25,135
              
              
              
              24,275Savings
      and money market deposits
              
              
              348,222
              
              
              
              457,745
              
              
              
              764,114
              
              
              
              923,820Time
      deposits, $100,000 and over
              
              
              556,557
              
              
              
              466,664
              
              
              
              1,104,710
              
              
              
              910,299Other
      time deposits
              
              
              305,066
              
              
              
              326,342
              
              
              
              633,359
              
              
              
              621,704Other
      borrowings
              
              
              149,067
              
              
              
              296,348
              
              
              
              443,794
              
              
              
              542,486Total
      interest expense
              
              
              1,370,899
              
              
              
              1,559,657
              
              
              
              2,971,112
              
              
              
              3,022,584NET
      INTEREST INCOME
              
              
              3,551,572
              
              
              
              3,639,901
              
              
              
              7,122,659
              
              
              
              7,115,036Provision
      for loan and lease losses
              
              
              310,000
              
              
              
              290,000
              
              
              
              530,000
              
              
              
              425,000NET
      INTEREST INCOME AFTER
                PROVISION
      FOR LOAN AND
                LEASE
      LOSSES
              
              
              3,241,572
              
              
              
              3,349,901
              
              
              
              6,592,659
              
              
              
              6,690,036NON-INTEREST
      INCOME
              
              
              531,454
              
              
              
              579,330
              
              
              
              1,088,388
              
              
              
              1,129,118NON-INTEREST
      EXPENSESalaries
      and employee benefits
              
              
              1,387,178
              
              
              
              1,338,658
              
              
              
              2,815,470
              
              
              
              2,786,501Premises
      and equipment
              
              
              236,095
              
              
              
              242,074
              
              
              
              464,800
              
              
              
              486,555Other
              
              
              722,973
              
              
              
              692,964
              
              
              
              1,447,750
              
              
              
              1,198,951Total
      non-interest expense
              
              
              2,346,246
              
              
              
              2,273,696
              
              
              
              4,728,020
              
              
              
              4,472,007Income
      before provision for income taxes
              
              
              1,426,780
              
              
              
              1,655,535
              
              
              
              2,953,027
              
              
              
              3,347,147Provision
      for income taxes
              
              
              480,155
              
              
              
              582,377
              
              
              
              979,113
              
              
              
              1,258,091NET
      INCOME
              
              $
              946,625
              
              
              $
              1,073,158
              
              
              $
              1,973,914
              
              
              $
              2,089,056NET
      INCOME PER SHARE
              
              $
              .42
              
              
              $
              .48
              
              
              $
              .88
              
              
              $
              .93NET
      INCOME PER SHARE
                ASSUMING
      DILUTION
              
              $
              .41
              
              
              $
              .46
              
              
              $
              .86
              
              
              $
              .89
 
 The
accompanying notes are an integral part of these financial
statements.
 
 
 
 
 4
 SONOMA
VALLEY BANCORP AND SUBSIDIARY
 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS'
EQUITY
 For the
six months ended June 30, 2008 (Unaudited), and the years ended
 December
31, 2007 (Audited) and 2006 (Audited)
 Comprehensive
              
              
              Common
      Stock
              
              
              Additional
      Paid-in
              
              
              Retained
              
              
              Accumulated
      Other ComprehensiveIncome
              
              
              Shares
              
              
              Amount
              
              
              Capital
              
              
              Earnings
              
              
              Income(Loss)
              
              
              TotalBALANCE
      AT JANUARY 1, 2006
              
              
              
              
              
              2,204,949
              
              
              $
              15,004,135
              
              
              $
              1,252,292
              
              
              $
              7,493,757
              
              
              $
              (310,391
              )
              
              $
              23,439,793Redemption
      and retirement  of stock
              
              
              
              
              
              (55,028
              )
              
              
              (410,308
              )
              
              
              
              
              
              
              (1,025,843
              )
              
              
              
              
              
              
              (1,436,151
              )Stock
      options exercised and related tax benefits
              
              
              
              
              
              104,126
              
              
              
              885,729
              
              
              
              438,757
              
              
              
              
              
              
              
              
              
              
              
              1,324,486Cash
      dividend of $.55 per share
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (1,252,957
              )
              
              
              
              
              
              
              (1,252,957
              )Stock
      options vested
              
              
              
              
              
              29,000
              
              
              
              
              
              
              
              100,224
              
              
              
              
              
              
              
              
              
              
              
              100,224Restricted
      stock vested
              
              
              
              
              
              
              
              
              
              
              
              
              
              81,375
              
              
              
              
              
              
              
              
              
              
              
              81,375Net
      income for the year
              
              $
              3,991,759
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              3,991,759
              
              
              
              
              
              
              
              3,991,759Other
      comprehensive income, net of tax: Unrealized holding gains on securities
      available- for-sale arising during the year, net of taxes of
      $108,781
              
              
              155,542Other
      comprehensive income, net of taxes
              
              
              155,542
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              155,542
              
              
              
              155,542Total
      comprehensive income
              
              $
              4,147,301BALANCE
      AT  DECEMBER 31, 2006
              
              
              
              
              
              
              2,283,047
              
              
              
              15,479,556
              
              
              
              1,872,648
              
              
              
              9,206,716
              
              
              
              (154,849
              )
              
              
              26,404,071Redemption
      and retirement  of stock
              
              
              
              
              
              
              (100,415
              )
              
              
              (689,422
              )
              
              
              
              
              
              
              (2,243,816
              )
              
              
              
              
              
              
              (2,933,238
              )Stock
      options exercised and related tax benefits
              
              
              
              
              
              
              60,177
              
              
              
              626,019
              
              
              
              358,353
              
              
              
              
              
              
              
              
              
              
              
              984,372Cash
      dividend of $.60 per share
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (1,371,471
              )
              
              
              
              
              
              
              (1,371,471
              )Stock
      options vested
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              216,473
              
              
              
              
              
              
              
              
              
              
              
              216,473Restricted
      stock vested
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              162,750
              
              
              
              
              
              
              
              
              
              
              
              162,750Restricted
      stock vested and related tax benefit
              
              
              
              
              
              
              
              
              
              
              162,750
              
              
              
              (154,815
              )
              
              
              
              
              
              
              
              
              
              
              7,935Net
      income for the year
              
              $
              4,343,538
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              4,343,538
              
              
              
              
              
              
              
              4,343,538Other
      comprehensive  income, net of tax: Unrealized holding gains on
      securities available- for-sale arising during the year, net of taxes of
      $83,819
              
              
              119,850Other
      comprehensive  income, net of taxes
              
              
              119,850
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              119,850
              
              
              
              119,850Total
      comprehensive income
              
              $
              4,463,388
 5
  SONOMA
VALLEY BANCORP AND SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Continued)
 For the
six months ended June 30, 2008 (Unaudited), and the years ended
 December
31, 2007 (Audited) and 2006 (Audited)
 
 Comprehensive
              
              
              Common
      Stock
              
              
              Additional
      Paid-in
              
              
              Retained
              
              
              Accumulated
      Other ComprehensiveIncome
              
              
              Shares
              
              
              Amount
              
              
              Capital
              
              
              Earnings
              
              
              Income(Loss)
              
              
              TotalBALANCE
      AT DECEMBER 31, 2007
              
              
              
              
              
              2,242,809
              
              
              $
              15,578,903
              
              
              $
              2,455,409
              
              
              $
              9,934,967
              
              
              $
              (34,999
              )
              
              $
              27,934,280Redemption
      and retirement  of stockStock
      options exercised and related tax benefits
              
              
              
              
              
              45,900
              
              
              
              643,961
              
              
              
              72,313
              
              
              
              
              
              
              
              
              
              
              
              716,274Cash
      dividend of $.30 per share
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (686,613
              )
              
              
              
              
              
              
              (686,613
              )Stock
      options vested
              
              
              
              
              
              
              
              
              
              
              
              
              
              31,560
              
              
              
              
              
              
              
              
              
              
              
              31,560Restricted
      stock vested
              
              
              
              
              
              
              
              
              
              
              
              
              
              81,375
              
              
              
              
              
              
              
              
              
              
              
              81,375Net
      income for the year
              
              $
              1,973,914
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              1,973,914
              
              
              
              
              
              
              
              1,973,914Other
      comprehensive income,  net of tax:  Unrealized holding
      gains on securities available- for-sale arising during the year, net of
      taxes of $17,429
              
              
              24,923Other
      comprehensive income,  net of taxes
              
              
              24,923
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              24,923
              
              
              
              24,923Total
      comprehensive income
              
              $
              1,998,837BALANCE
      AT June 30, 2008
              
              
              
              
              
              
              2,288,709
              
              
              $
              16,222,864
              
              
              $
              2,640,657
              
              
              $
              11,222,268
              
              
              $
              (10,076
              )
              
              $
              30,075,713
  The
accompanying notes are an integral part of these financial
statements.
  6
  SONOMA
VALLEY BANCORP AND SUBSIDIARY
 CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
 For the
six months ended June 30, 2008 and 2007
 
 2008
              
              
              2007OPERATING
      ACTIVITIESNet
      income
              
              $
              1,973,914
              
              
              $
              2,089,056Adjustments
      to reconcile net income to net cash provided by operating
      activities:Provision
      for loan and lease losses
              
              
              530,000
              
              
              
              425,000Depreciation
              
              
              115,050
              
              
              
              126,514Amortization
      and other
              
              
              36,905
              
              
              
              27,498Stock
      options and restricted stock vested
              
              
              112,935
              
              
              
              272,992Net
      change in interest receivable
              
              
              8,132
              
              
              
              (46,628
              )Net
      change in cash surrender value of life insurance
              
              
              (212,277
              )
              
              
              (200,046
              )Net
      change in other assets
              
              
              362,752
              
              
              
              (112,636
              )Net
      change in interest payable and other liabilities
              
              
              123,870
              
              
              
              (120,954
              )NET
      CASH PROVIDED BY OPERATING ACTIVITIES
              
              
              3,051,281
              
              
              
              2,460,796INVESTING
      ACTIVITIESPurchases
      of securities held-to-maturity
              
              
              0
              
              
              
              (101,751
              )Purchases
      of securities available-for-sale
              
              
              (1,007,500
              )
              
              
              (4,195
              )Proceeds
      from maturing securities held-to-maturity
              
              
              560,000
              
              
              
              0Proceeds
      from maturing securities available-for-sale
              
              
              7,205,000
              
              
              
              10,000,000Net
      change in loans and leases
              
              
              (6,404,061
              )
              
              
              (17,761,907
              )Purchases
      of premises and equipment
              
              
              (117,269
              )
              
              
              (16,523
              )Purchases
      of life insurance
              
              
              0
              
              
              
              (350,000
              )NET
      CASH PROVIDED(USED) FOR INVESTING ACTIVITIES
              
              
              236,170
              
              
              
              (8,234,376
              )FINANCING
      ACTIVITIESNet
      change in demand, interest-bearing transaction and savings
      deposits
              
              
              (2,687,940
              )
              
              
              (4,751,579
              )Net
      change in time deposits
              
              
              11,240,860
              
              
              
              (1,414,141
              )Stock
      repurchases
              
              
              0
              
              
              
              (2,071,997
              )Cash
      dividend paid
              
              
              (686,613
              )
              
              
              (695,888
              )Net
      change in FHLB borrowings
              
              
              (5,400,000
              )
              
              
              13,700,000Stock
      options exercised
              
              
              557,561
              
              
              
              485,660NET
      CASH  PROVIDED BY FINANCING ACTIVITIES
              
              
              3,023,868
              
              
              
              5,252,055NET
      CHANGE IN CASH AND CASH EQUIVALENTS
              
              
              6,311,319
              
              
              
              (521,525
              )Cash
      and cash equivalents at beginning of period
              
              
              9,333,634
              
              
              
              7,452,256CASH
      AND CASH EQUIVALENTS AT END OF PERIOD
              
              $
              15,644,953
              
              
              $
              6,930,731SUPPLEMENTAL
      DISCLOSURES OF CASH FLOW INFORMATION:Cash
      paid during the year for:Interest
      expense
              
              $
              2,996,199
              
              
              $
              3,021,615Income
      taxes
              
              $
              682,156
              
              
              $
              765,000SUPPLEMENTAL
      DISCLOSURES OF NONCASH ACTIVITIES:Loans
      transferred to other real estate owned
              
              $
              320,416
              
              
              $
              0Net
      change in unrealized gains and losses on securities
              
              $
              42,352
              
              
              $
              80,072Net
      change in deferred income taxes on unrealized gains on
      securities
              
              $
              (17,429
              )
              
              $
              (32,953
              )
 
 The
accompanying notes are an integral part of these financial
statements.
  7
  SONOMA
VALLEY BANCORP AND SUBSIDIARY
 NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS
 June
30, 2008
 (Unaudited)
 Note
1:  Basis of Presentation
  In the
opinion of Management, the unaudited interim consolidated financial statements
contain all adjustments of a normal recurring nature, which are necessary to
present fairly the financial condition of Sonoma Valley Bancorp and our
wholly-owned subsidiary Sonoma Valley Bank (together, the "Company") at June 30,
2008 and results of operations for the six months then ended.
  Certain
information and footnote disclosures presented in our annual financial
statements are not included in these interim financial
statements.  Accordingly, the accompanying unaudited interim
consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in our 2007 Annual
Report on Form 10-K.  The results of operations for the three and six
months ended June 30, 2008 are not necessarily indicative of the operating
results through December 31, 2008.
  Note
2:  Consolidation
  The
consolidated financial statements include the accounts of Sonoma Valley Bancorp
and its wholly owned subsidiary, Sonoma Valley Bank.  All material
intercompany accounts and transactions have been eliminated in
consolidation.
  Note
3:  Commitments
  We had no
outstanding performance letters of credit at June 30, 2008 and June 30,
2007.
  Note
4:  Net Income Per Common Share
  Net
income per share is calculated by using the weighted average common shares
outstanding.  The weighted average number of common shares used in
computing the net income per common share for the period ending June 30, 2008
was 2,254,842 and for the period ending June 30, 2007 was
2,257,213.
  Net income per share
(diluted) is calculated by using the weighted average common shares (diluted)
outstanding.  The weighted average number of common shares (diluted)
used in computing the net income per common share (diluted) for the period
ending June 30, 2008 was 2,306,696 and for the period ending June 30, 2007 was
2,340,768.
  Note
5:  Stock Option Accounting
  We have a
stock-based employee and director compensation plan.  We adopted the
fair value recognition provisions of SFAS No. 123, Accounting
for Stock-Based Compensation,prospectively to all employee awards
granted, modified, or settled after January 1, 2003.Options
were granted in 2004, 2007 and 2008 under the fair value
method.  Awards under our plan generally vest over five
years.  Restricted stock was granted in July 2006 that vests over
three and five years beginning July 2007.  The cost related to
stock-based employee and director compensation is included in the determination
of net income for the periods ended June 30, 2008 and 2007.
  8
  Note
6:  Employee Benefit Plans
  We
provide retirement plans to our key officers and directors.  The plans
are unfunded and provide for payment to the officers and directors specified
amounts for specified periods after retirement.  The amount of pension
expense related to this plan, and the components of pension expense for the six
months ended June 30, 2008 and 2007 are as follows:
 
 Directors
              
              
              Officers2008
              
              
              2007
              
              
              2008
              
              
              2007Service
      cost
              
              $
              20,593
              
              
              $
              (100,949
              )
              
              $
              148,906
              
              
              $
              125,999Interest
      cost on projected benefit obligation
              
              
              14,597
              
              
              
              (59,336
              )
              
              
              138,551
              
              
              
              99,325Amortization
      of unrecognized liability at transition
              
              
              (5,107
              )
              
              
              31,855
              
              
              
              84,391
              
              
              
              40,299Net
      periodic pension cost recognized
              
              $
              30,083
              
              
              $
              (128,430
              )
              
              $
              371,848
              
              
              $
              265,623
 
 
 Note
7:  Fair Value Measurement
 
 Statement
of financial accounting standards (SFAS) No. 157 defines fair value, establishes
a framework for measuring fair value under generally accepted accounting
principals, and expands disclosures about fair value
measurement.  Effective January 1, 2008 the Company adopted SFAS No.
157, which enhances the disclosures about financial instruments carried at fair
value.  The adoption of SFAS No. 157 did not have an impact on the
company’s financial condition or results of operations.
 
 In
general, fair values determined by:
 
 Level 1
inputs utilize quoted prices (unadjusted) in active markets for identical assets
or liabilities that the Company has the ability to
access.
  Level 2
inputs include quoted prices for similar assets and liabilities in active
markets, and inputs other than quoted prices that are observable for the asset
or liability, such as interest rates and yield curves that are observable at
commonly quoted intervals. Fair values determined by Level 2 inputs utilize
inputs other than quoted prices included in Level 1 that are observable for the
asset or liability, either directly or indirectly.
 
 Level 3
inputs are unobservable inputs for the asset or liability, and include
situations where there is little, if any market activity for the asset or
liability.
  9
 The
following table presents information about the Company’s assets and liabilities
measured at fair value on a recurring basis as of June 30, 2008, and indicate
the fair value hierarchy of the valuation techniques utilized by the Company to
determine such fair value.
 
 At
      June 30, 2008Total
              
              
              Level
      1
              
              
              Level
      2
              
              
              Level
      3Available-for-sale
      securities
              
              $
              2,040,691
              
              
              $
              24,132
              
              
              $
              2,019,559
              
              
              $
              0
 
 The
following methods were used to estimate the fair value of each class of
financial instrument above:
 
 Securities
available-for-sale –Securities classified as available-for-sale are
reported at fair value utilizing Level 1 inputs for equity securities and
Level 2 inputs for all other investment securities.  For equity
securities, the Company obtains the fair value measurements from NASDAQ and for
investment securities, the Company obtains fair value measurements from an
independent pricing service.  The fair value measurements consider
observable data that may include dealer quotes, market spreads, cash flows, the
U.S. Treasury yield curve, live trading levels, trade execution data, market
consensus prepayment speeds, credit information and the bond’s terms and
conditions among other things.
  The
Company may be required, from time to time, to measure certain assets at fair
value on a nonrecurring basis in accordance with U.S. generally accepted
accounting principles.  These include assets that are measured at the
lower of cost or market that were recognized at fair value below cost at the end
of the period.  Assets measured at fair value on a nonrecurring basis
are included in the table below.
 
 June
      30, 2008Total
              
              
              Level
      1
              
              
              Level
      2
              
              
              Level
      3Impaired
      Loans
              
              $
              8,011,180
              
              
              $
              0
              
              
              $
              8,011,180
              
              
              $
              0Other
      Real Estate Owned
              
              $
              320,416
              
              
              $
              0
              
              
              $
              320,416
              
              
              $
              0
 
 
 Impaired loans –The fair value of impaired loans and other real estate owned is estimated
using one of several methods, including collateral value, market value of
similar debt, enterprise value, liquidation value and discounted cash
flows.  Those impaired loans not requiring an allowance represent
loans for which the fair value of the expected repayments or collateral exceed
the recorded investments in such loans.  At June 30, 2008
substantially all of the total impaired loans were evaluated based on the fair
value of the collateral.  In accordance with SFAS 157, impaired loans
where an allowance is established based on the fair value of collateral require
classification in the fair value hierarchy.  When the fair value of
the collateral is based on an observable market price or a current appraised
value, the Company records the impaired loan as nonrecurring Level
2.  When an appraised value is not available or management determines
the fair value of the collateral is further impaired below the appraised value
and there is no observable market price, the Company records the impaired loan
as nonrecurring Level 3.
 
  
  10
 SONOMA
VALLEY BANCORP
 AVERAGE BALANCES/YIELDS AND RATES
PAID
 For the
six months ended June 30, 2008 and 2007
  2008
              
              
              2007ASSETS
              
              Average
                Balance
              
              
              Income/
                Expense
              
              
              Yield/
                Rate
              
              
              Average
                Balance
              
              
              Income/
                Expense
              
              
              Yield/
                RateInterest-earning
      assets:Loans(2):Commercial
              
              $
              177,123,126
              
              
              $
              6,722,176
              
              
              
              7.65
              %
              
              $
              152,697,374
              
              
              $
              6,268,267
              
              
              
              8.28
              %Consumer
              
              
              30,327,759
              
              
              
              1,117,588
              
              
              
              7.43
              %
              
              
              27,855,006
              
              
              
              1,271,970
              
              
              
              9.21
              %Real
      estate construction
              
              
              25,382,056
              
              
              
              1,043,029
              
              
              
              8.29
              %
              
              
              28,882,815
              
              
              
              1,251,468
              
              
              
              8.74
              %Real
      estate mortgage
              
              
              19,246,242
              
              
              
              729,477
              
              
              
              7.64
              %
              
              
              17,894,432
              
              
              
              647,950
              
              
              
              7.30
              %Tax
      exempt loans (1)
              
              
              2,209,027
              
              
              
              90,646
              
              
              
              8.27
              %
              
              
              2,313,765
              
              
              
              94,336
              
              
              
              8.22
              %Leases
              
              
              20,285
              
              
              
              1,078
              
              
              
              10.72
              %
              
              
              30,838
              
              
              
              1,849
              
              
              
              12.09
              %Unearned
      loan fees
              
              
              (355,290
              )
              
              
              
              
              
              
              
              
              
              
              (502,371
              )Total
      loans
              
              
              253,953,205
              
              
              
              9,703,994
              
              
              
              7.71
              %
              
              
              229,171,859
              
              
              
              9,535,840
              
              
              
              8.39
              %Investment
      securitiesAvailable
      for sale:Taxable
              
              
              4,091,751
              
              
              
              69,364
              
              
              
              3.42
              %
              
              
              15,478,259
              
              
              
              276,289
              
              
              
              3.60
              %Hold
      to maturity:Tax
      exempt (1)
              
              
              14,185,192
              
              
              
              408,095
              
              
              
              5.80
              %
              
              
              15,833,620
              
              
              
              467,044
              
              
              
              5.95
              %Total
      investment securities
              
              
              18,276,943
              
              
              
              477,459
              
              
              
              5.27
              %
              
              
              31,311,879
              
              
              
              743,333
              
              
              
              4.79
              %Federal
      funds sold
              
              
              85,714
              
              
              
              1,208
              
              
              
              2.84
              %
              
              
              135,359
              
              
              
              3,506
              
              
              
              5.22
              %FHLB
      stock
              
              
              1,750,802
              
              
              
              49,449
              
              
              
              5.70
              %
              
              
              1,323,471
              
              
              
              31,641
              
              
              
              4.82
              %Total
      due from banks/interest-bearing
              
              
              1,886,285
              
              
              
              31,233
              
              
              
              3.34
              %
              
              
              545,551
              
              
              
              14,169
              
              
              
              5.24
              %Total
      interest-earning assets
              
              $
              275,952,949
              
              
              $
              10,263,343
              
              
              
              7.50
              %
              
              $
              262,488,119
              
              
              $
              10,328,489
              
              
              
              7.93
              %Noninterest-bearing
      assets:Reserve
      for loan losses
              
              
              (3,803,245
              )
              
              
              
              
              
              
              
              
              
              
              (3,467,649
              )Cash
      and due from banks
              
              
              5,615,134
              
              
              
              
              
              
              
              
              
              
              
              5,700,009Premises
      and equipment
              
              
              811,432
              
              
              
              
              
              
              
              
              
              
              
              895,963Other
      real estate owned
              
              
              181,835
              
              
              
              
              
              
              
              
              
              
              
              0Other
      assets
              
              
              16,470,263
              
              
              
              
              
              
              
              
              
              
              
              15,355,485Total
      assets
              
              $
              295,228,368
              
              
              
              
              
              
              
              
              
              
              $
              280,971,927LIABILITIES
      AND SHAREHOLDERS' EQUITYInterest-bearing
      liabilities:Interest-
      bearing depositsInterest-bearing
      transaction
              
              $
              30,377,251
              
              
              $
              25,135
              
              
              
              0.17
              %
              
              $
              29,760,656
              
              
              $
              24,275
              
              
              
              0.16
              %Savings
      deposits
              
              
              76,444,146
              
              
              
              764,114
              
              
              
              2.02
              %
              
              
              76,461,162
              
              
              
              923,820
              
              
              
              2.44
              %Time
      deposits over $100,000
              
              
              50,854,046
              
              
              
              1,104,710
              
              
              
              4.38
              %
              
              
              39,265,155
              
              
              
              910,299
              
              
              
              4.68
              %Other
      time deposits
              
              
              30,969,274
              
              
              
              633,359
              
              
              
              4.12
              %
              
              
              28,294,316
              
              
              
              621,704
              
              
              
              4.43
              %Total
      interest-bearing deposits
              
              
              188,644,717
              
              
              
              2,527,318
              
              
              
              2.70
              %
              
              
              173,781,289
              
              
              
              2,480,098
              
              
              
              2.88
              %Other
      borrowings
              
              
              22,173,626
              
              
              
              443,794
              
              
              
              4.04
              %
              
              
              21,040,525
              
              
              
              542,486
              
              
              
              5.20
              %Total
      interest-bearing liabilities
              
              
              210,818,343
              
              
              $
              2,971,112
              
              
              
              2.84
              %
              
              
              194,821,814
              
              
              $
              3,022,584
              
              
              
              3.13
              %Non-interest-bearing
      liabilities:Non-interest-bearing
      demand deposits
              
              
              48,684,036
              
              
              
              
              
              
              
              
              
              
              
              53,384,933Other
      liabilities
              
              
              6,358,558
              
              
              
              
              
              
              
              
              
              
              
              5,599,916Shareholders'
      equity
              
              
              29,367,431
              
              
              
              
              
              
              
              
              
              
              
              27,165,264Total
      liabilities and shareholders' equity
              
              $
              295,228,368
              
              
              
              
              
              
              
              
              
              
              $
              280,971,927Interest
      rate spread
              
              
              
              
              
              
              
              
              
              
              4.66
              %
              
              
              
              
              
              
              
              
              
              
              4.80
              %Interest
      income
              
              
              
              
              
              $
              10,263,343
              
              
              
              7.50
              %
              
              
              
              
              
              $
              10,328,489
              
              
              
              7.93
              %Interest
      expense
              
              
              
              
              
              
              2,971,112
              
              
              
              2.17
              %
              
              
              
              
              
              
              3,022,584
              
              
              
              2.32
              %Net
      interest income/margin
              
              
              
              
              
              $
              7,292,231
              
              
              
              5.33
              %
              
              
              
              
              
              $
              7,305,905
              
              
              
              5.61
              %
  (1)  Fully
      tax equivalent adjustments are based on a federal income tax rate of 34%
      in 2008 and 2007.
 (2)  Non
      accrual loans have been included in loans for the purposes of the above
      presentation.  Loan fees of approximately $218,087 and $273,773
      for the six months ended June 30, 2008 and 2007, respectively, were
      amortized to the appropriate interest income
  categories.
 11
 Item 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
 Forward-Looking
Statements
 
 With the
exception of historical facts stated herein, the matters discussed in this Form
10-Q are “forward-looking” statements that involve risks and uncertainties that
could cause actual results to differ materially from projected
results.  Such “forward-looking” statements include, but are not
necessarily limited to statements regarding anticipated levels of future
revenues and earnings from the operation of Sonoma Valley Bancorp and its wholly
owned subsidiary, Sonoma Valley Bank (“Bank”), projected costs and expenses
related to operations of our liquidity, capital resources, and the availability
of future equity capital on commercially reasonable terms.  Factors
that could cause actual results to differ materially include, in addition to the
other factors discussed in our Form 10-K for the year ended December 31, 2007,
and subsequent periodic reports, the following; (i) increased competition from
other banks, savings and loan associations, thrift and loan associations,
finance companies, credit unions, offerors of money market funds, and other
financial institutions; (ii) the risks and uncertainties relating to general
economic and political conditions, both domestically and internationally,
including, but not limited to, inflation, or natural disasters affecting the
primary service area of our major industries; or (iii) changes in the laws and
regulations governing the Bank’s activities at either the state or federal
level.  Readers of this Form 10-Q are cautioned not to put undue
reliance on “forward-looking” statements which, by their nature, are uncertain
as reliable indicators of future performance.  We disclaim any
obligation to publicly update these “forward-looking” statements, whether as a
result of new information, future events, or otherwise.
 
 For
the Six Month Periods
 Ended
June 30, 2008 and 2007
  Overview
 
 We
reported net income of $1,973,914 for the six months ended June 30, 2008
compared with $2,089,056 for the six months ended June 30,
2007.   The $115,142 decrease in net income is largely
attributable to a decline in the net interest margin and an increase in
non-interest expense.  On a per share basis, net income equaled $.88
compared with $.93 per share during the same period in 2007.
 
 Return on
average total assets on an annualized basis for the six month period was
1.34% in 2008 and 1.50% in 2007.  The decline in the return on assets
is the result of the $115,142 decline in net income combined with growth of
$14.3 million (5.07%) in average assets from $281.0 million as of June 30, 2007
to $295.2 million as of June 30, 2008.  Return on average
shareholders' equity on an annualized basis at the end of the second
quarter 2008 and 2007 was 13.52% and 15.51%, respectively.  The lower
return on equity is the result of the decline in net income in 2007 from $2.1
million in 2007 to $2.0 million in 2008. Additionally average equity grew $2.2
million or 8.1% from $27.2 million as of June 30, 2007 to $29.4 million as of
June 30, 2008.
 
 At June
30, 2008, total assets were $303.3 million, a 1.82% increase over $297.9 million
as of December 31, 2007 and a 6.2% increase over $285.6 million as of June 30,
2007.  We showed loans of $256.3 million at June 30, 2008 compared
with $250.5 million and $237.4 million as of December 31, 2007 and June 30,
2007, increases of 2.32% and 7.96%, respectively.  Deposits increased
3.6% or $8.6 million from $236.0 million  as of December 31, 2007 and
increased $18.0 million or 7.9% from $226.6 as of June 30, 2007 to $244.6
million as of June 30, 2008.  The increase in deposits is a result of
growth in savings and CD’s.  The loan-to-deposit ratio decreased to
104.8% at June 30, 2008 from 106.1% at December 31, 2007 and increased from
104.7% at June 30, 2007.
 
 Totalshareholders’equity increased by $2,141,433or7.67% during the six months ended June 30,
2008.  At June 30,
2008, we reported net income of
$1,973,914.  In March, we paid out
$686,613for cash dividends declared in
February 2008.   In 2004, stock
options were granted to senior employees with a fifth of the options vesting
each year over a fiveyear period.  In
2008,12,450options vested which increased equity
by $2,282.    In July 2006,
26,000 restricted stock options were granted to senior employees with a fifth of
the options vesting each year over a fiveyear period and 3,000 restricted stock
options were granted to a senior employee with a third of the options vesting
over a threeyear period.  In
2008, equity was increased by $81,375to reflect the expense for these
options.In June 2007,
10,000 unqualified stock options were granted to a director with a fifth of the
options vesting each year over a five year period.Additionally, in December, 2007, 7,410
unqualified stock options were granted to two directors with one third vesting
immediately and two thirds vesting over a two year period. In 2008, equity has
been increased by $10,098 and $8,382, respectively, for these 2007 grants. In
January 2008, 10,000 incentive stock options were awarded to a senior employee
with a fifth of the options vesting each year over a five year period.
 12
 In 2008,
equity was increased by $6,832 year-to-date. In April 2008, 10,000 unqualified
stock options were granted to a director with a fifth of the options vesting
each year over a five year period. In 2008 equity was increased $3,966 for
these options. The net income figure of $1,973,914 reflects an expense for the
incentive stock options of $9,114, restricted stock options of $81,375, and the
unqualified stock options of $22,446; therefore, the net effect of the stock
option transactions relative to equity was zero.  Directors exercised
23,164 options which added $200,860 to the capital accounts.  The tax
benefit of these options was $158,714, which also increased
equity.  Officers exercised 22,736 options which added $356,700 to the
capital accounts. The net effect of this activity results in capital of
$30,075,713 as of June 30, 2008, compared to capital of $27,934,280 as of
December 31, 2007.
 Section
404 of Sarbanes-Oxley Act of 2002 (“Section 404”) requires the Securities and
Exchange Commission (“SEC”) to prescribe rules requiring the establishment,
maintenance and evaluation of an issuer’s internal control of financial
reporting.  We certified compliance for the year ended December 31,
2007.  Our external independent auditors are required to attest to and
report on management's assessment of internal control over financial reporting
beginning December 31, 2009.  Our management and staff worked
diligently evaluating and documenting the internal control systems in order to
allow our management to report on our internal control over financial
reporting.
 
 RESULTS
OF OPERATIONS
 
 Net
Interest Income
 
 Net
interest income is the difference between total interest income and total
interest expense.  Net interest income, adjusted to a fully taxable
equivalent basis, as shown on the table- Average Balances/Yields and Rates Paid,
on page 11,is higher
than net interest income on the statement of income because it reflects
adjustments applicable to tax-exempt income from certain securities and loans
($169,572 in 2008 and $190,869 in 2007, based on a 34% federal income tax
rate).
 
 The
slight decline in net interest income for the six months ended June 30,
2008 (stated on a fully taxable equivalent basis) is a result of the net effect
of a $65,146 decrease in interest income offset by a decrease in interest
expense of $51,472, showing a net decrease of $13,674.  As of June 30,
2007 the federal funds rate and Wall Street Journal prime rate were 5.25% and
8.25%, respectively. Over the course of the last year both rates have declined
325 basis points. At June 30, 2008 the federal funds rate was 2% and the prime
rate was 5%.
  Net
interest income (stated on a fully taxable equivalent basis) expressed as a
percentage of average earning assets, is referred to as net interest
margin.  In 2008, our net interest margin decreased 28 basis points to
5.33%, from 5.61% for the same period in 2007.  The slight decline in
the net interest margin is a result of loan rates repricing downward faster than
deposit rates.
  Interest
Income
 
 As
previously stated, interest income (stated on a fully taxable equivalent basis)
declined by $65,146 to $10.263 million in the first six months of 2008, a
0.63% decrease over the $10.328 million realized during the same period in
2007.
 
 The
$65,146 decrease was the result of the 43 basis point decrease in the yield
on earning assets to 7.50% for the six months ended June 30, 2008 from
7.93% for the same period in 2007.  Average balances of
interest-bearing assets increased $13.5 million or 5.1% from $262.5 million as
of June 30, 2007 to $276.0 million as of June 30, 2008.
 
 The gain
in volume of average earning assets was responsible for a $713,768 increase in
interest income, and the decrease in interest rates contributed $778,914, for a
net decrease in interest income of $65,146.
 
 Interest
Expense
 
 Total
interest expense for the first six months of 2008 decreased by $51,472
to $2.971 million from $3.023 million for the same period in
2007.  The average rate paid on all interest-bearing liabilities
decreased from 3.13% in the first six months of 2007 to 2.84% in the same period
in 2008, a decrease of 29 basis points.  Average balances of
interest-bearing liabilities increased from $194.8 million to $210.8 million, a
$16.0 million or 8.2% gain in interest-bearing liabilities.
 
 The gain
in volume of average balances was responsible for a $329,472 increase in
interest expense and the lower interest rates paid were responsible for a
$380,944 decrease in interest expense for a net decrease of
$51,472.
 13
 Individual
components of interest income and interest expense are provided in the
table-Average Balances/Yields and Rates Paid on page 11.
 
 Provision
for Loan Losses
 
 The
provision for loan losses charged to operations for the six months ended June
30, 2008 was $530,000 compared to $425,000 for the same time period in
2007.  The provision for loan losses charged to operations is based on
our monthly evaluation of the loan portfolio and the adequacy of the allowance
for loan losses in relation to total loans outstanding. We have continued to
experience loan growth during the first six months of 2008 and we anticipate
that loan growth will continue, requiring that additional provisions may need to
be made for loan losses.  Additionally, there are regulatory concerns
about concentrations of commercial real estate loans among many financial
institutions.  The Company does have a concentration of commercial
real estate loans and although the loans remain adequately collateralized,
management determined that it would be prudent to increase the
provision. Our analysis indicates a sufficient amount is being accrued to
cover any potential loan losses, but as loans continue to grow additional
provisions will be made to the allowance for loan losses as needed.
 
 The
economic climate causes some concern due to the uncertainties in the mortgage
market and the potential ramifications to the entire real estate
industry.  As of June 30, 2008, we showed non performing assets of
$933,387 compared to $1.2 million as of June 30, 2007. The non-performing assets
ratio (non-performing assets/total loans) was 0.36% as of June 30, 2008 compared
to 0.51% as of June 30, 2007. There have been $298,926 loans charged off and
recoveries were $15,196 as of June 30, 2008, compared with $14,856 in charge
offs and $8,424 in recoveries for the same period in 2007.
 
 Non-interest
Income
 
 Non-interest
income for the first six months of $1.088 million decreased 3.6% or $41,000 over
the $1.129 million recorded in the comparable period in 2007.  Of the
decrease, 92.4% was due to decreases in service charges on deposit
accounts.  Year-to-date income from service charges on deposit
accounts has declined 5.3%, or $38,000, from $714,000 in 2007 to $676,000
in 2008.  There was a decrease of $43,000 in income from overdrafts
and checks drawn against insufficient funds.
 
 Other fee
income has shown a decrease at June 30, 2008 of 7.9% or $16,000 from $203,000 as
of June 30, 2007 to $187,000 in 2008. The lower income is a result of a $14,000
decline in miscellaneous income, which declined from $18,000 as of June 30, 2007
to $4,000 for the same period of 2008, a decrease of 75.2%.  Also
contributing to the decrease was an $11,000, or 30.0%, decline in income
earned from loan referrals from $37,000 in 2007 to $26,000 in 2008.
 
 All other
non-interest income showed a 6.1%, or $13,000, increase from $212,000 in 2007 to
$225,000 in 2008.  This is largely a result of an increase in the
income generated by bank owned life insurance policies.  Income on the
policies was $200,000 as of June 30, 2007 compared to $212,000 as of June 30,
2008, an increase of $12,000.  The earnings on the policies will
increase as the balances increase and if market rates increase, the income
produced by these policies should also increase.
 
 Non-Interest
Expense
 
 Total
non-interest expense grew $256,000, or 5.7%, to $4.7 million for the
first six months of 2008 from  $4.5 million in the comparable
period in 2007.  Non-interest expense on an annualized basis
represented 3.22% of average total assets in 2008 compared with 3.21% in the
comparable period in 2007.
 
 Salaries
and benefits increased $29,000, or 1.0%, from $2.786 million for the six months
ended June 30, 2007 to $2.815 million for the six months ended June 30,
2008.  Management tries to utilize efficiencies to stabilize the
growth in full -time equivalent employees, although we have added employees to
better manage our loan operations and tighten standards. At June 30, 2008 total
full time equivalent employees were 54 compared to 49 as of June 30,
2007.  As of June 30, 2008, assets per employee were $5.6 million
compared with $5.8 million as of June 30, 2007.
 
 14
 Expenses
related to premises and equipment decreased 4.5% to $465,000 in 2008 from
$487,000 for the same period in 2007. The $22,000 decline in expense in 2008 is
the result of a 48.3%, or $18,000, decrease in expenses related to depreciation
of computers and other equipment from $37,000 in 2007 to $19,000 in 2008.
Software expenses declined $13,000, or 28.2%, from $46,000 as of June 30, 2007
to $33,000 as of June 30, 2008. In 2008 we received $7,500 in lease income on a
bank owned property.
 Other
operating expenses increased 20.8% to $1.4 million in 2008 from $1.2 million in
2007, an increase of $249,000. The increase is a result of lower expense for
director retirement due to adjustment credits of $155,693 made in 2007, while
2008 reflects the true expense of $31,000 for the quarter and expenses of
$101,000 related to outsourcing our IT (information technology) department.
Also, FDIC insurance expense has increased in 2008 by $59,000 from the
comparable period in 2007 because the FDIC has begun charging more for their
insurance in order to grow their fund.
 
 Provision
for Income Taxes
 
 The
provision for income taxes declined to an effective tax rate of 33.16% for the
first six months of 2008 compared with 37.59% for the same period of
2007.  The lower effective tax rate is a reflection of tax benefits
received for options exercised and tax credits resulting from the bank’s
investment in California affordable housing. Income taxes reported in the
financial statements include deferred taxes resulting from timing differences in
the recognition of items for tax and financial reporting purposes.
  BALANCE
SHEET ANALYSIS
 
 Investments
 
 Investment
securities were $16.0 million at June 30, 2008, a 29.7% decrease from the $22.8
million at December 31, 2007 and a 40.6% decrease from $27.0 million at June 30,
2007.  The decline in the portfolio is a result of strong loan demand
and the need to utilize maturing and called investments to fund
loans.  We will usually maintain an investment portfolio of securities
rated “A” or higher by Standard and Poor's and or Moody's Investors
Service.  Local tax-exempt bonds are occasionally purchased without an
“A” rating.
 
 Securities
are classified as held to maturity (HTM) if we have both the intent and the
ability to hold these securities to maturity.  As of June 30, 2008, we
had securities totaling $14.0 million with a market value of $14.1 million
categorized as HTM.  Decisions to acquire municipal securities, which
are generally placed in this category, are based on tax planning needs and
pledge requirements.
 
 Securities
are classified as available for sale (AFS) if we intend to hold these debt
securities for an indefinite period of time, but not necessarily to
maturity.  Investment securities which are categorized as AFS are
acquired as part of the overall asset and liability management function and
serve as a primary source of liquidity.  Decisions to acquire or
dispose of different investments are based on an assessment of various economic
and financial factors, including, but not limited to, interest rate risk,
liquidity and capital adequacy.  Securities held in the AFS
category  are recorded at market value, which was $2.0 million
compared to an amortized cost of $2.1 million as of June 30, 2008.
 
 There
were nineteen municipal securities of $5.4 million in the HTM portfolio that
were temporarily impaired as of June 30, 2008. There were no securities in a
continuous loss position for 12 months or more as of June 30, 2008. Most of the
securities that were impaired as of December 31, 2007 are in a gain position at
this time due to the decline in interest rates. The nineteen municipal
securities which are impaired as of June 30, 2008 show a loss of $40,433. It is
our intent to carry the securities to maturity date, at which time we will
receive face value for the securities at no loss.
 
 Although
the quoted market values fluctuate, investment securities are generally held to
maturity, and accordingly, gains and losses to the income statement are
recognized upon sale, or at such time as management determines that a permanent
decline in value exists.  In our opinion, there was no investment in
securities at June 30, 2008 that constituted a material credit risk to the
Company.  The lower market value to amortized costs was a result of
the increase in market interest rates and not an indication of lower credit
quality. At the present time there is some uncertainty in the market relative to
the companies insuring the municipal securities that we hold. We are monitoring
this situation very closely and believe that the municipalities will be able to
fulfill their obligations and there will be no need to rely on the insurance
companies for payment. If the insurance companies are down-graded it could lower
the rating on the securities and therefore affect the fair value.
 15
 Loans
 
 Loan
balances, net of deferred loan fees at June 30, 2008, were $256.3 million, an
increase of 2.3% or $5.8 million over December 31, 2007 and an increase of 8.0%
or $18.9 million over June 30, 2007. As of June 30, 2008, commercial loans were
69.3% of the portfolio and decreased $168,000, or 0.09%, from December 31, 2007
and increased 10.7% or $17.1 million over June 30, 2007.  Included in
Commercial loans are loans made for commercial purposes and secured by real
estate.
  Real
Estate Construction loans were $27.1 million as of June 30, 2008 and showed
growth of $1.4 million, or 5.3%, over December 31, 2007 and a decline of
11.2%, or $3.4 million, over June 30, 2007.  This decrease is a result
of draw down variances in construction loans.
 
 Real
Estate Mortgage loans and Consumer loans both showed growth over June 30, 2007of
1.4% and 17.1% or $269,000 and $4.7 million, respectively.  Real
Estate mortgages grew 7.4%, or $1.3 million, over December 31, 2007,
and Consumer loans grew 10.8%, or $3.1 million.
 
 Lease
Financing Receivables declined by 12.9% and 25.2% or $3,000 and $6,000, as of
December 31, 2007 and June 30, 2007, respectively.  Customer interest
in lease financing receivables has declined in our market and we do not
anticipate this to change in the foreseeable future.
  June
      30,
                2008
              
              
              Percentage
                of Total
              
              
              December
      31,
                2007
              
              
              Percentage
                of Total
              
              
              June
      30,
                2007
              
              
              Percentage
                of TotalCommercial
              
              $
              177,821,482
              
              
              
              69.3
              %
              
              $
              177,989,391
              
              
              
              70.9
              %
              
              $
              160,672,241
              
              
              
              67.5
              %Consumer
              
              
              32,308,374
              
              
              
              12.6
              %
              
              
              29,163,877
              
              
              
              11.6
              %
              
              
              27,579,460
              
              
              
              11.6
              %Real
      estate construction
              
              
              27,146,824
              
              
              
              10.6
              %
              
              
              25,772,958
              
              
              
              10.3
              %
              
              
              30,586,538
              
              
              
              12.9
              %Real
      estate mortgage
              
              
              19,265,303
              
              
              
              7.5
              %
              
              
              17,946,113
              
              
              
              7.2
              %
              
              
              18,996,051
              
              
              
              8.0
              %Leases
              
              
              18,876
              
              
              
              0.0
              %
              
              
              21,665
              
              
              
              0.0
              %
              
              
              25,228
              
              
              
              0.0
              %256,560,859
              
              
              
              100.0
              %
              
              
              250,894,004
              
              
              
              100.0
              %
              
              
              237,859,518
              
              
              
              100.0
              %Deferred
      loan fees and costs, net
              
              
              (299,509
              )
              
              
              
              
              
              
              (432,569
              )
              
              
              
              
              
              
              (496,381
              )Allowance
      for loan and lease losses
              
              
              (3,969,487
              )
              
              
              
              
              
              
              (3,723,217
              )
              
              
              
              
              
              
              (3,695,540
              )$
              252,291,863
              
              
              
              
              
              
              $
              246,738,218
              
              
              
              
              
              
              $
              233,667,597
 
 Risk
Elements
 
 The
majority of our loan activity is with customers located within
Sonoma County, California.  Approximately 91.3% of the total loan
portfolio is secured by real estate located in our service
area.  Significant concentrations of credit risk may exist if a number
of loan customers are engaged in similar activities and have similar economic
characteristics.  We believe we have policies in place to identify
problem loans and to monitor concentrations of credits.
 
 Based on
its risk management review and a review of its loan portfolio, management
believes that its allowance for loan losses for the quarter ending June 30, 2008
is sufficient to absorb losses inherent in the loan portfolio.  This
assessment is based upon the best available information and does involve
uncertainty and matters of judgment.  Accordingly, the adequacy of the
loan loss reserve cannot be determined with precision, but is subject to
periodic review, and could be susceptible to significant change in future
periods.
 
 Non-Performing
Assets
 
 Non-performing
assets consist of loans on non-accrual status, delinquent loans past due greater
that 90 days, restructured loans and other real estate owned, or
OREO.  Management classifies all loans as non-accrual loans when they
become more than 90 days past due as to principal or interest, or when the
timely collection of interest or principal becomes uncertain, if earlier, unless
they are adequately secured and in the process of collection.
 
 16
 A loan
remains in a non-accrual status until both principal and interest have been
current for six months and meet cash flow or collateral criteria, or when the
loan is determined to be uncollectible and is charged off against the allowance
for loan losses, or in the case of real estate loans, is transferred to other
real estate owned.  A loan is classified as a restructured loan when
the interest rate is reduced, when the term is extended beyond the original
maturity date, or other concessions are made, because of the inability of the
borrower to repay the loan under the original terms. OREO represents assets held
through loan foreclosure or recovery activities. As of June 30, 2008 we had
$320,000 classified as OREO compared to no OREO as of December 31, 2007 and June
30, 2007.
  There
were $314,000 non-accrual loans and no loans 90 days or more past due and still
accruing at June 30, 2008 down from $1.1 million non-accrual loans and no loans
90 days or more past due and still accruing at June 30, 2007.  There
was $60,000 in non-accrual loans 90 days or more past due at June 30, 2008 and
$937,000 loans in non-accrual status and 90 days or more past due as of June 30,
2007. Occasionally, we will have more loans in non-accrual status than are 90
days past due following the guidelines in the above paragraph or if management
determines the collection of principal or interest is unlikely.
 
 Allowance
for Loan Losses
 
 The
allowance for loan losses is maintained at a level considered adequate to
provide for losses that can be reasonably anticipated.  The allowance
is increased by provisions charged to operating expense and reduced by
charge-offs, net of recoveries.  The allowance is based on estimates,
and ultimate losses may vary from the current estimates.  These
estimates are reviewed monthly and, as adjustments become necessary, they are
reported in earnings in the periods in which they become known.
 
 The
review process is intended to identify loan customers who may be experiencing
financial difficulties.  In these circumstances, a specific reserve
allocation or charge-off may be recommended.  Other factors considered
by management in evaluating the adequacy of the allowance
include:  loan volume, historical net loan loss experience, the
condition of industries and geographic areas experiencing or expected to
experience economic adversities, credit evaluations and current economic
conditions.  The allowance for loan losses is not a precise amount,
but based on the factors above, represents management's best estimate of losses
that may be ultimately realized from the current loan portfolio.
 
 Worsening
conditions in certain economic sectors and geographic areas could adversely
affect the loan portfolio, necessitating larger provisions for loan losses than
currently estimated. However, as of June 30, 2008 we believe overall the
allowance for loan losses is adequate based on our analysis of conditions at
that time.
 
 At June
30, 2008, the allowance for loan losses was $4.0 million, or 1.55% of period end
loans, compared with $3.7 million, or 1.49%, at December 31, 2007 and $3.7
million, or 1.56%, at June 30, 2007.
 
 Net
charge-offs to average loans increased when compared with the prior
year.  We recorded net losses of $284,000 or 0.22% of average loans as
of June 30, 2008 compared to June 30, 2007, which showed net charge offs of
$6,000 or 0.01% of average loans.  The increase, although still low by
industry standards, reflects our attention and effort in managing and collecting
past due loans by encouraging the customer to bring them to a current status or
to pay them off and management’s desire to quickly charge off a loan when it is
determined to be uncollectible.  The prompt charge-off of loans
improves the quality of the loan portfolio.
 
 17
 An
analysis of the changes in the allowance for loan losses, including charge-offs
and recoveries by loan categories, is presented below.
  For
      the Six
                Months
      Ended
                6/30/08
              
              
              For
      the Year
                Ended
                12/31/07
              
              
              For
      the Six
                Months
      Ended
                6/30/07Balance
      beginning of year
              
              $
              3,723,217
              
              
              $
              3,276,972
              
              
              $
              3,276,972Charge-offs:Commercial
              
              
              (116,144
              )
              
              
              (187,075
              )
              
              
              0Consumer
              
              
              (182,782
              )
              
              
              (63,901
              )
              
              
              (14,856
              )Total
      charge-offs
              
              
              (298,926
              )
              
              
              (250,976
              )
              
              
              (14,856
              )Recoveries:Commercial
              
              
              9,512
              
              
              
              16,315
              
              
              
              7,954Consumer
              
              
              5,684
              
              
              
              906
              
              
              
              470Total
      recoveries
              
              
              15,196
              
              
              
              17,221
              
              
              
              8,424Net
      recoveries (charge-offs)
              
              
              (283,730
              )
              
              
              (233,755
              )
              
              
              (6,432
              )Provision
      charged to operations
              
              
              530,000
              
              
              
              680,000
              
              
              
              425,000Balance
      end of period
              
              $
              3,969,487
              
              
              $
              3,723,217
              
              
              $
              3,695,540Ratio
      of net charge-offs annualized to average loans
              
              
              0.22
              %
              
              
              0.10
              %
              
              
              0.01
              %Balance
      in allowance as a percentage  of loans outstanding at period
      end
              
              
              1.55
              %
              
              
              1.49
              %
              
              
              1.56
              %
  Deposits
 
 A
comparative schedule of average deposit balances is presented in the table on
page 11;period end and
year-end deposit balances are presented in the following table.
  June
      30,
                2008
              
              
              Percentage
                of Total
              
              
              December
      31,
                2007
              
              
              Percentage
                of Total
              
              
              June
      30,
                2007
              
              
              Percentage
                of TotalInterest-bearing
      transaction deposits
              
              $
              28,551,865
              
              
              
              11.7
              %
              
              $
              30,135,049
              
              
              
              12.8
              %
              
              $
              28,910,157
              
              
              
              12.7
              %Savings
      deposits
              
              
              78,377,774
              
              
              
              32.1
              %
              
              
              73,528,081
              
              
              
              31.1
              %
              
              
              75,134,262
              
              
              
              33.2
              %Time
      deposits, $100,000 and over
              
              
              53,377,068
              
              
              
              21.8
              %
              
              
              44,160,741
              
              
              
              18.7
              %
              
              
              40,834,649
              
              
              
              18.0
              %Other
      time deposits
              
              
              31,659,159
              
              
              
              12.9
              %
              
              
              29,634,626
              
              
              
              12.6
              %
              
              
              29,448,446
              
              
              
              13.0
              %Total
      interest-bearing  deposits
              
              
              191,965,866
              
              
              
              78.5
              %
              
              
              177,458,497
              
              
              
              75.2
              %
              
              
              174,327,514
              
              
              
              76.9
              %Demand
      deposits
              
              
              52,634,753
              
              
              
              21,5
              %
              
              
              58,589,202
              
              
              
              24.8
              %
              
              
              52,274,181
              
              
              
              23.1
              %Total
      deposits
              
              $
              244,600,619
              
              
              
              100.0
              %
              
              $
              236,047,699
              
              
              
              100.0
              %
              
              $
              226,601,695
              
              
              
              100.0
              %
  
 Total
deposits increased by $8.6 million, or 3.6%, during the six months of 2008 to
$244.6 million from $236.0 million at December 31, 2007, and increased by 7.9%
from $226.6 million as of June 30, 2007.  Time deposits greater than
$100,000, savings deposits and other time deposits showed increases over
year-end 2007.  Time deposits greater than $100,000 showed strong
growth of 20.9%, or $9.2 million, and were $53.4 million as of June 30, 2008
compared to $44.2 million at year-end 2007.  Savings deposits of $78.4
million increased $4.8 million, or 6.6%, from $73.5 million at December 31,
2007.  Other time deposits showed growth of 6.8%, or $2.0 million, and
were $31.7 million as of June 30, 2008 compared to $29.6 million at December 31,
2007.
 
 18
 Both
non-interest bearing demand deposits and interest bearing checking show
decreases. Non-interest bearing demand declined $6.0 million, or 10.2%, from
$58.6 million as of  December 2007 to $52.6 million as of June 30,
2008.  Interest-bearing checking declined to $28.6 million, a 5.3%, or
$1.6 million decline from $30.1 million as of December 31, 2007. Customers have
been moving deposits to higher yielding accounts.
 
 Capital
 
 Our
subsidiary, Sonoma Valley Bank (the “Bank”) is subject to FDIC regulations
governing capital adequacy.  The FDIC has adopted risk-based capital
guidelines which establish a risk-adjusted ratio relating capital to different
categories of assets and off-balance sheet exposures.  Under the
current guidelines, as of June 30, 2008, the Bank was required to have minimum
Tier 1 and total risk-based capital ratios of 4% and 8%, respectively. To be
well capitalized under Prompt Corrective Action Provisions requires minimum Tier
1 and total risk-based capital ratios to be 6% and 10%,
respectively.
 
 The FDIC
has also adopted minimum leverage ratio guidelines for compliance by banking
organizations.  The guidelines require a minimum leverage ratio of 4%
of Tier 1 capital to total average assets.  Banks experiencing high
growth rates are expected to maintain capital positions well above the minimum
levels.  The leverage ratio, in conjunction with the risk-based
capital ratio, constitutes the basis for determining the capital adequacy of
banking organizations.
 
 Based on
the FDIC's guidelines, the Bank's total risk-based capital ratio at June 30,
2008 was 11.72% and its Tier 1 risk-based capital ratio was
10.46%.  The Bank's leverage ratio was 10.10%.  All the
ratios exceed the minimum guidelines of 8.00%, 4.00% and 4.00%,
respectively.  The Company’s total risk based capital, Tier 1 risk
based capital and leverage ratios at June 30, 2008, were 11.76%, 10.51% and
10.15%, respectively.
  In
February 2001, we approved a program to repurchase Sonoma Valley Bancorp stock
up to $1.0 million, and in August 2002 we approved the repurchase of an
additional $1.0 million of Sonoma Valley Bancorp stock.  As of
December 31, 2005, $1,580,162 had been repurchased and retired, net of options
which were exercised and then subsequently repurchased and
retired.  In February 2006 we approved the repurchase of 60,000 shares
of Sonoma Valley Bancorp stock, in October 2006 we approved an additional 60,000
shares of Sonoma Valley Bancorp stock and in July, 2007 we approved an
additional 60,000 shares of Sonoma Valley Bancorp stock.  During the
twelve months ended December 31, 2006, 55,028 shares were repurchased and
retired, of which 15,035 shares, or $364,729, were a part of the amount approved
in August 2002.   As of December 31, 2007, 100,415 shares had
been repurchased and retired.  As of June 30, 2008, no shares have
been repurchased and retired. Refer to pages 12 and 13, for a discussion of
the changes in capital and pages 5 and 6 for the table of Statement of
Changes in Shareholders’ Equity.
  We
believe that the Bank's current capital position, which exceeds guidelines
established by industry regulators, is adequate to support our
business.
  Off
Balance Sheet Commitments
 
 Our
off-balance sheet commitments consist of commitments to extend credit and
standby letters of credit.  These commitments are extended to
customers in the normal course of business.  Unfunded loan commitments
were $49.0 million at June 30, 2008 and $57.7 million at June 30, 2007.Standby
letters of credit outstanding were $118,000 at June 30, 2008 and $348,000 at
June 30, 2007.  We also have contractual obligations consisting of
operating leases for various facilities and payments to participants under our
supplemental executive retirement plan and deferred compensation
plan.
 
 19
 Liquidity
Management
 
 Our
liquidity is determined by the level of assets (such as cash, federal funds sold
and available-for-sale securities) that are readily convertible to cash to meet
customer withdrawal and borrowing needs.  Deposit growth also
contributes to our liquidity.  We review our liquidity position on a
regular basis to verify that it is adequate to meet projected loan funding and
potential withdrawal of deposits.  We have a comprehensive Asset and
Liability Policy which we use to monitor and determine adequate levels of
liquidity.  As of June 30, 2008, our primary liquidity ratio (adjusted
liquid assets to deposits and short term liabilities) was 5.84% compared to
6.32% as of June 30, 2007. Available liquidity which includes the ability
to borrow at the Federal Home Loan Bank was 42.5% as of June 30, 2008 and 39.9%
as of June 30, 2007.  Management expects that liquidity will remain
adequate throughout 2008, as deposit growth keeps pace with loan
growth.  Any excess funds will be invested in quality liquid assets,
such as U.S. Treasury and Agency securities.  Management believes that
the Company has adequate liquidity and capital resources to meet its short-term
and long-term commitments.
 
 Market
Risk Management
 
 Overview.  Market
risk is the risk of loss from adverse changes in market prices and
rates.  Our market risk arises primarily from interest rate risk
inherent in our loan and deposit functions.  The goal for managing the
assets and liabilities is to maximize shareholder value and earnings while
maintaining a high quality balance sheet without exposing us to undue interest
rate risk.  Our Board has overall responsibility for the interest rate
risk management policies.  The Bank has an Asset and Liability
Management Committee (ALCO) that establishes and monitors guidelines to control
the sensitivity of earnings to changes in interest rates.
 
 Asset/Liability
Management.  Activities involved in asset/liability management
include but are not limited to lending, accepting and placing deposits and
investing in securities.  Interest rate risk is the primary market
risk associated with asset/liability management.  Sensitivity of
earnings to interest rate changes arises when yields on assets change in a
different time period or in a different amount from that of interest costs on
liabilities.  To mitigate interest rate risk, the structure of the
balance sheet is managed with the goal that movements of interest rates on
assets and liabilities are correlated and contribute to earnings even in periods
of volatile interest rates.When interest
rates increase, the market value of securities held in the investment portfolio
declines.  Generally, this decline is offset by an increase in
earnings.  When interest rates decline, the market value of securities
increases while earnings decrease due to the Bank's asset sensitivity caused by
the variable rate loans.  Usually we are able to mitigate risks from
changes in interest rates with this balance sheet structure.  Since
January 1, 2008 the target Federal Funds rate has declined 225 basis points from
4.25% to 2.00%. This has caused an increase in the market value of our
investments. The asset/liability management policy sets limits on the acceptable
amount of variance in net interest margin and market value of equity under
changing interest environments.  The Bank uses simulation models to
forecast earnings, net interest margin and market value of equity.
  Simulation
of earnings is the primary tool used to measure the sensitivity of earnings to
interest rate changes. Using computer-modeling techniques, we are able to
estimate the potential impact of changing interest rates on
earnings.  A balance sheet forecast is prepared quarterly using inputs
of actual loans, securities and interest bearing liabilities (i.e.,
deposits/borrowings) positions as the beginning base.  The forecast
balance sheet is processed against five interest rate scenarios.  The
scenarios include 100 and 200 basis point rising rate forecasts, a flat rate
forecast and 100 and 200 basis point falling rate forecasts which take place
within a one year time frame.  The net interest income is measured
during the year assuming a gradual change in rates over the twelve-month
horizon.  Our 2008 net interest income, as forecast below, was modeled
utilizing a forecast balance sheet projected from June 30, 2008
balances.  The following table summarizes the effect on net interest
income (NII) of 100 and 200 basis point changes in interest rates as measured
against a constant rate (no change) scenario.
  Interest
Rate Risk Simulation of Net Interest Income as of June 30, 2008
 (dollars
in thousands)
 Variation
      from a constant rate scenario
              
              $
      Change in NII+200bp
              
              $
      (342)+100bp
              
              $
      (227)-100bp
              
              $
      (259)-200bp
              
              $
      (295)
  20
 The
simulations of earnings do not incorporate any management actions, which might
moderate the negative consequences of interest rate
deviations.  Therefore, they do not reflect likely actual results, but
serve as conservative estimates of interest rate risk.
 Since the
primary tool used by management to measure and manage interest rate exposure is
a simulation model, use of the model to perform simulations reflecting changes
in interest rates over a twelve month horizon enables management to develop and
initiate strategies for managing exposure to interest rate
risks.  Management believes that both individually and in the
aggregate its modeling assumptions are reasonable, but the complexity of the
simulation modeling process results in a sophisticated estimate, not an
absolutely precise calculation of exposure.
 
 Interest Rate Sensitivity
Analysis.  Interest rate sensitivity is a function of the
repricing characteristics of the portfolio of assets and
liabilities.  These repricing characteristics are the time frames
within which the interest-bearing assets and liabilities are subject to change
in interest rates either at replacement, repricing or
maturity.  Interest rate sensitivity management focuses on the
maturity of assets and liabilities and their repricing during periods of change
in market interest rates.  Interest rate sensitivity is measured as
the difference between the volumes of assets and liabilities in the current
portfolio that are subject to repricing at various time horizons.  The
differences are known as interest sensitivity gaps.
 
 A
positive cumulative gap may be equated to an asset sensitive
position.  An asset sensitive position in a rising interest rate
environment will cause a bank's interest rate margin to expand.  This
results as floating or variable rate loans reprice more rapidly than fixed rate
certificates of deposit that reprice as they mature over
time.  Conversely, a declining interest rate environment will cause
the opposite effect.  A negative cumulative gap may be equated to a
liability sensitive position.  A liability sensitive position in a
rising interest rate environment will cause a bank's interest rate margin to
contract, while a declining interest rate environment will have the opposite
effect.  The table above shows net interest income declining both when
rates increase and when rates decline.  Although we are usually asset
sensitive which would cause the Bank’s net interest margin to expand, the
negative change in net interest income shows both in a rising and declining rate
environment.  The decline in the rising rate environment is a result
of management’s conservative evaluation of the pressure to increase rates on
deposits, which temporarily causes the decline in the net interest
margin.
 
 The
following table sets forth the dollar amounts of maturing and/or repricing
assets and liabilities for various periods. This does not include the impact of
prepayments or other forms of convexity caused by changing interest
rates.  Historically, this has been immaterial and estimates for them
are not included.
  We have
more liabilities than assets repricing during the next year. Usually because our
asset rates change more than deposit rates, our interest income will change more
than the cost of funds when rates change.  For the current quarter, we
are making a more conservative assumption.  Historically, we have been
able to raise or lower deposit rates with a delay to loan rate changes, however
market demands are creating pressure to raise interest rates on
deposits.  Therefore, for a period of time, we have chosen to use the
simulation to forecast deposits rates rising quite rapidly in a rising rate
environment and we are unable to lower deposit rates in a falling rate
environment.  This causes the net interest margin to shrink and net
interest income to decline in both a rising and falling rate
environment.  The table below indicates that we are liability
sensitive for the first six months. During the seven to twelve month period, we
show more assets than liabilities repriceable in the seven to twelve month
category.  Still at the end of the twelve month cycle, the rate
sensitive gap shows $55.4 million more in liabilities than assets
repricing.
 
 We
control long term interest rate risk by keeping long term fixed rate assets
(longer than 5 years) less than long term fixed rate funding, primarily demand
deposit accounts and capital. The following table sets forth cumulative maturity
distributions as of June 30, 2008 for our interest-bearing assets and
interest-bearing liabilities, and our interest rate sensitivity gap as a
percentage of total interest-earning assets.  Of the $122.8 million in
fixed rate assets over 12 months, shown in the table below, $33.3 million are
long term assets over five years.  This $33.3 million compares
favorably to the $82.4 million in demand and core deposits and
equity.
 
 21
 
 JUNE
      30, 2008
                (dollars
      in thousands)
              
              Immediate
                Reprice
              
              
              Up
      to 3
                Months
              
              
              4
      to 6
                Months
              
              
              7
      to 12
                Months
              
              
              Over
      12
                Months
              
              
              TotalFFS
      + overnight IBB
              
              $
              8,850
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              8,850Securities
      + Other IBB
              
              
              0
              
              
              $
              203
              
              
              $
              425
              
              
              $
              849
              
              
              $
              14,528
              
              
              
              16,005Loans
              
              
              52,841
              
              
              
              9,185
              
              
              
              28,652
              
              
              
              53,337
              
              
              
              108,277
              
              
              
              252,292Total
      RSA
              
              $
              61,691
              
              
              $
              9,388
              
              
              $
              29,077
              
              
              $
              54,186
              
              
              $
              122,805
              
              
              $
              277,147MMDA/NOW/SAV
              
              $
              106,930
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              106,930CD’s
      <$100k
              
              
              0
              
              
              $
              12,679
              
              
              $
              8,679
              
              
              $
              8,679
              
              
              $
              1,623
              
              
              
              31,660CD’s
      >$100k
              
              
              0
              
              
              
              23,746
              
              
              
              21,564
              
              
              
              5,391
              
              
              
              2,676
              
              
              
              53,377Borrowings
              
              
              12,100
              
              
              
              0
              
              
              
              5,000
              
              
              
              5,000
              
              
              
              0
              
              
              
              22,100Total
      RSL
              
              $
              119,030
              
              
              $
              36,425
              
              
              $
              35,243
              
              
              $
              19,070
              
              
              $
              4,299
              
              
              $
              214,067GAP
              
              $
              (57,339
              )
              
              $
              (27,037
              )
              
              $
              (6,166
              )
              
              $
              35,116
              
              
              $
              118,506
              
              
              $
              63,080Cumulative
              
              $
              (57,339
              )
              
              $
              (84,376
              )
              
              $
              (90,542
              )
              
              $
              (55,426
              )
              
              $
              63,080%
      Assets
              
              
              -18.9
              %
              
              
              -27.9
              %
              
              
              -29.9
              %
              
              
              -18.3
              %
              
              
              20.8
              %
 
 
 Market risk in
securities.  Market risk in securities shows the amount of gain
or loss (before tax) in the securities portfolio.  Portfolio volume,
sector distribution, duration, and quality all affect market
valuation.  The adjusted equity ratio is tier 1 capital adjustedfor the market gain or
loss less and any applicable tax effect divided by average total assets for
leverage capital purposes for the most recent quarter.  The ratio is
designed to show tier 1 capital if the securities portfolio had to be liquidated
and all gains and losses recognized.  If the ratio remains strong
after a +2% or +3% rate shock, market risk is reasonable in relation to the
level of capital.  A bank has flexibility and strength when the
securities portfolio can be liquidated for liquidity purposes without affecting
capital adequacy.
 
 The Bank
has only moderate market risk in investments because the average maturity in the
portfolio is not very long, except for municipals, which are held to maturity
(see page 15 for discussion of investments).  The portfolio should
decline in value only about 2.1% or $427,000 for a 1% increase in
rates.  The gain in value if rates fall would be somewhat less,
because there are some callable bonds.  Marking-to-market available
for sale securities when rates change would add only modest volatility to a
strong level of equity.  This market risk acts to offset the interest
rate risk (i.e. if rates decline and NIM is squeezed, there would be a
concurrent gain in the value of securities).
  22
 SONOMA
VALLEY BANCORP
 AVERAGE
BALANCES/YIELDS AND RATES PAID
 For the three months ended June 30, 2008 and
2007
  2008
              
              
              2007ASSETS
              
              Average
                Balance
              
              
              Income/
                Expense
              
              
              Yield/
                Rate
              
              
              Average
                Balance
              
              
              Income/
                Expense
              
              
              Yield/
                RateInterest-earning
      assets:Loans(2):Commercial
              
              $
              174,519,779
              
              
              $
              3,247,445
              
              
              
              7.46
              %
              
              $
              155,574,054
              
              
              $
              3,260,133
              
              
              
              8.41
              %Consumer
              
              
              31,115,190
              
              
              
              557,789
              
              
              
              7.19
              %
              
              
              28,321,532
              
              
              
              633,930
              
              
              
              8.98
              %Real
      estate construction
              
              
              26,464,118
              
              
              
              530,080
              
              
              
              8.03
              %
              
              
              28,692,885
              
              
              
              627,768
              
              
              
              8.78
              %Real
      estate mortgage
              
              
              19,932,255
              
              
              
              375,654
              
              
              
              7.56
              %
              
              
              18,650,647
              
              
              
              344,049
              
              
              
              7.40
              %Tax
      exempt loans (1)
              
              
              2,209,027
              
              
              
              45,323
              
              
              
              8.23
              %
              
              
              2,313,765
              
              
              
              47,428
              
              
              
              8.22
              %Leases
              
              
              19,592
              
              
              
              539
              
              
              
              11.03
              %
              
              
              27,492
              
              
              
              777
              
              
              
              11.34
              %Unearned
      loan fees
              
              
              (316,684
              )
              
              
              
              
              
              
              
              
              
              
              (484,261
              )Total
      loans
              
              
              253,943,277
              
              
              
              4,756,830
              
              
              
              7.51
              %
              
              
              233,096,114
              
              
              
              4,914,085
              
              
              
              8.46
              %Investment
      securitiesAvailable
      for sale:Taxable
              
              
              2,353,859
              
              
              
              17,249
              
              
              
              2.94
              %
              
              
              13,401,504
              
              
              
              120,705
              
              
              
              3.61
              %Hold
      to maturity:Tax
      exempt (1)
              
              
              13,978,828
              
              
              
              202,289
              
              
              
              5.80
              %
              
              
              15,867,865
              
              
              
              234,346
              
              
              
              5.92
              %Total
      investment securities
              
              
              16,332,687
              
              
              
              219,538
              
              
              
              5.39
              %
              
              
              29,269,369
              
              
              
              355,051
              
              
              
              4.87
              %Federal
      funds sold
              
              
              0
              
              
              
              0
              
              
              
              0.00
              %
              
              
              272,222
              
              
              
              3,506
              
              
              
              5.17
              %FHLB
      stock
              
              
              1,691,808
              
              
              
              25,771
              
              
              
              6.07
              %
              
              
              1,401,649
              
              
              
              15,001
              
              
              
              4.29
              %Total
      due from banks/interest-bearing
              
              
              1,181,983
              
              
              
              4,520
              
              
              
              1.53
              %
              
              
              590,421
              
              
              
              7,718
              
              
              
              5.24
              %Total
      interest-earning assets
              
              $
              273,149,755
              
              
              $
              5,006,659
              
              
              
              7.35
              %
              
              $
              264,629,775
              
              
              $
              5,295,361
              
              
              
              8.03
              %Noninterest-bearing
      assets:Reserve
      for loan losses
              
              
              (3,852,604
              )
              
              
              
              
              
              
              
              
              
              
              (3,579,757
              )Cash
      and due from banks
              
              
              5,544,487
              
              
              
              
              
              
              
              
              
              
              
              5,640,402Premises
      and equipment
              
              
              805,735
              
              
              
              
              
              
              
              
              
              
              
              866,702Other
      real estate owned
              
              
              324,989
              
              
              
              
              
              
              
              
              
              
              
              0Other
      assets
              
              
              16,498,534
              
              
              
              
              
              
              
              
              
              
              
              15,524,645Total
      assets
              
              $
              292,470,896
              
              
              
              
              
              
              
              
              
              
              $
              283,081,767LIABILITIES
      AND SHAREHOLDERS' EQUITYInterest-bearing
      liabilities:Interest-
      bearing depositsInterest-bearing
      transaction
              
              $
              28,985,448
              
              
              $
              11,987
              
              
              
              0.17
              %
              
              $
              30,458,049
              
              
              $
              12,558
              
              
              
              0.17
              %Savings
      deposits
              
              
              77,675,134
              
              
              
              348,222
              
              
              
              1.80
              %
              
              
              74,677,354
              
              
              
              457,745
              
              
              
              2.46
              %Time
      deposits over $100,000
              
              
              54,340,915
              
              
              
              556,557
              
              
              
              4.11
              %
              
              
              39,793,806
              
              
              
              466,664
              
              
              
              4.70
              %Other
      time deposits
              
              
              31,751,693
              
              
              
              305,066
              
              
              
              3.85
              %
              
              
              28,886,134
              
              
              
              326,342
              
              
              
              4.53
              %Total
      interest-bearing deposits
              
              
              192,753,190
              
              
              
              1,221,832
              
              
              
              2.54
              %
              
              
              173,815,343
              
              
              
              1,263,309
              
              
              
              2.92
              %Other
      borrowings
              
              
              14,550,108
              
              
              
              149,067
              
              
              
              4.11
              %
              
              
              23,006,846
              
              
              
              296,348
              
              
              
              5.17
              %Total
      interest-bearing liabilities
              
              
              207,303,298
              
              
              $
              1,370,899
              
              
              
              2.65
              %
              
              
              196,822,189
              
              
              $
              1,559,657
              
              
              
              3.18
              %Non-interest-bearing
      liabilities:Non-interest-bearing
      demand deposits
              
              
              48,993,400
              
              
              
              
              
              
              
              
              
              
              
              53,637,882Other
      liabilities
              
              
              6,424,493
              
              
              
              
              
              
              
              
              
              
              
              5,595,587Shareholders'
      equity
              
              
              29,749,705
              
              
              
              
              
              
              
              
              
              
              
              27,026,109Total
      liabilities and shareholders' equity
              
              $
              292,470,896
              
              
              
              
              
              
              
              
              
              
              $
              283,081,767Interest
      rate spread
              
              
              
              
              
              
              
              
              
              
              4.70
              %
              
              
              
              
              
              
              
              
              
              
              4.85
              %Interest
      income
              
              
              
              
              
              $
              5,006,659
              
              
              
              7.35
              %
              
              
              
              
              
              $
              5,295,361
              
              
              
              8.03
              %Interest
      expense
              
              
              
              
              
              
              1,370,899
              
              
              
              2.01
              %
              
              
              
              
              
              
              1,559,657
              
              
              
              2.36
              %Net
      interest income/margin
              
              
              
              
              
              $
              3,635,760
              
              
              
              5.34
              %
              
              
              
              
              
              $
              3,735,704
              
              
              
              5.67
              %
 
 (1)
              Fully
      tax equivalent adjustments are based on a federal income tax rate of 34%
      in 2008 and 2007.
 (2)
              Non
      accrual loans have been included in loans for the purposes of the above
      presentation.  Loan fees of approximately $97,765 and $121,065
      for the three months ended June 30, 2008 and 2007, respectively, were
      amortized to the appropriate interest income
  categories.
 23
  For
the Three Month Periods
 Ended
June 30, 2008 and 2007
 
 Overview
  We
reported net income of $946,625 for the second quarter of 2008 compared with
$1,073,158 for the second quarter of 2007.  On a per share basis, net
income for the three months ended June 30, 2008 equaled $0.42 per share compared
with $0.48 per share during the same period in 2007, see page 4 for the
comparative detail.
 
 Return on
average total assets on an annualized basis for the three months ended June 30,
2008 and 2007 was 1.29% and 1.52%, respectively.  Return on average
shareholders' equity on an annualized basis for the three months ended June 30,
2008 and 2007 was 12.7% and 15.9%, respectively.  The decrease in the
return on equity is a result of the decline in earnings and the increase in
average equity experienced in the second quarter of 2008 when compared to
2007.  Net income showed a decrease of 11.8%, or $126,533, from
$1,073,158 to $946,625 as of June 30, 2007 and 2008, respectively.
 
 RESULTS
OF OPERATIONS
 
 Net
Interest Income
 
 Net
interest income, adjusted to a fully taxable equivalent basis, decreased by
$100,000 to $3.6 million for the three months ended June 30, 2008, from $3.7
million during the comparable period of 2007.  Net interest income on
a fully taxable equivalent basis, as shown on the table -Average Balances/Yields
and Rates Paid on page 23, is higher than net interest income on the
statements of income because it reflects adjustments applicable to tax-exempt
income from certain securities and loans ($84,000 in 2008 and $96,000 in 2007,
based on a 34% federal income tax rate).
 
 Net
interest income (stated on a fully taxable equivalent basis) expressed as a
percentage of average earning assets, is referred to as net interest
margin.  Our net interest margin for the second quarter of
2008 decreased 33 basis points to 5.34% from 5.67% for the quarter ended
June 30, 2007.  The decrease in net interest margin is the result of
yields on earning assets declining faster than the yields on earning
liabilities.  For the three months ended June 30, 2008, the yield on
average earning assets has decreased 68 basis points, while the yield on
interest bearing liabilities decreased 53 basis points from 3.18% for the three
months of 2007 to 2.65% for the three months period ended June 30,
2008.  The Federal Reserve Bank has continued to lower
rates.  As of June 30, 2008 the federal funds rate was 2% and the
prime rate was 5% down 325 basis points from the same time last
year.
 
 Interest
Income
 
 Interest
income for the three months ended June 30, 2008 decreased by $289,000 to
$5.0 million, a 5.5% decrease over the $5.3 million realized during the same
period in 2007.  The gain in volume of average balances was
responsible for a $278,000 increase in interest income and a $567,000 decrease
in income was related to lower interest rates, resulting in a net decline in
interest income of $289,000.
  Interest
Expense
 
 Total
interest expense for the three months ended June 30, 2008 decreased by
$189,000 to $1.4 million compared with $1.6 million in the same period of
2007.  The average rate paid on all interest-bearing liabilities for
the second quarter of 2008 decreased 53 basis points to 2.65% from
3.18% in the second quarter of 2007, and average balances for the second quarter
of 2008 increased to $207.3 million from $196.8 million in the same period of
2007, a 5.3% gain.
 
 The gain
in volume of average balances accounted for a $103,000 increase in interest
expense while a decline of $292,000 was related to lower interest rates paid,
resulting in a $189,000 decrease in interest expense for the second quarter of
2008.
 
 Individual
components of interest income and interest expense are provided in the table -
Average Balances/Yields and Rates Paid on page 23.
 
 24
 Provision
for Loan Losses
 
 The
provision for loan losses was $310,000 during the second quarter of 2008
compared to the $290,000 provision for the second quarter of
2007.  The increase in the provision is the result of managements'
evaluation and assessment of the loan portfolio in light of current economic
conditions.  In addition, the Company has continued to experience
growth in loan volume.
 
 Non-interest
Income
 
 Non-interest
income of $531,000 for the second quarter of 2008 represented a decrease of
$48,000, or 8.3%, from the $579,000 for the comparable period in
2007.  Contributing to this variance was a decline in service charges
on deposit accounts which decreased $25,000, or 7.2%, from 353,000 for the
quarter ended June 2007 to 328,000 for the quarter ended June
2008.  Loan referral income is down 69.5%, or $18,000, from this time
last year.  Miscellaneous income also declined $9,000, or 79.3%, from
$11,000 at June 30, 2007 to $2,000 at June 30, 2008.
 
 Non-interest
Expense
 
 For the
second quarter of 2008, non-interest expense was $2.34 million compared with
$2.27 million for the same period in 2007, representing an increase of $73,000,
or 3.2%.  The largest increase in non-interest expense was salaries
and benefits expense of $1.387 million which increased $48,000 or 3.6% compared
with 1.339 million for the three months ended June 30, 2007.  At June
30, 2008 and June 30, 2007, total full-time equivalent employees were 54 and 49,
respectively.
 
 The
expenses for premises and equipment declined 2.5% from $242,000 for the second
quarter of 2007 to $236,000 in 2008.  The $6,000 decrease in expense
in 2008 is a result of computer and equipment being fully
depreciated.
 
 Other
non-interest expenses for the three months ended June 30, 2008 increased 4.3%,
or $30,000, to $723,000 compared to $693,000 for the same period of
2007.  The increase is a result of increases in expense in technology,
other professional expense, and postage.  Also contributing to the
increase was FDIC insurance costs.  The increase in technology and
other professional allows us to maintain strong network security and provides
back up expertise for network administration.
  Provision
for Income Taxes
 
 The
provision for income taxes decreased to an effective tax rate of 33.7% in the
second quarter of 2008 compared with 35.2% for the comparable period in
2007.  The lower effective tax rate is a reflection of tax benefits
received for options exercised as well as credits resulting from the Company’s
investment in California affordable housing.  Income taxes reported in
the financial statement include deferred taxes resulting from timing differences
in the recognition of items for tax and financial reporting purposes.
 
 25
 Item
3.  QUANTITATIVE AND QUALITATIVE DISCLOSURE
ABOUT MARKET RISK
  Information
regarding Quantitative and Qualitative Disclosures about Market Risk appears on
page 20 through 22 under the caption “Management's Discussion and Analysis of
Financial Condition and Results of Operations -B
Market Risk Management” and is incorporated herein by reference.
  Item
4.  CONTROLS AND
PROCEDURES
 
 Disclosure
Controls and Procedures
 
 Disclosure
controls and procedures are designed with the objective of ensuring that
information required to be disclosed in reports filed by the Company under the
Exchange Act, such as this Quarterly Report, is recorded, processed, summarized
and reported within the time periods specified in the rules and forms of the
Securities and Exchange Commission. Disclosure controls and procedures are also
designed with the objective of ensuring that such information is accumulated and
communicated to management, including the Chief Executive Officer and the Chief
Financial Officer, as appropriate to allow timely decisions regarding required
disclosure.
  Evaluation
of Disclosure Controls and Procedures
  The
Company carried out an evaluation, under the supervision and with the
participation of management, including the Chief Executive Officer and the Chief
Financial Officer, about the effectiveness of disclosure controls and procedures
pursuant to Exchange Act Rule 13a-15(e). Based upon that evaluation, the Chief
Executive Officer and the Chief Financial Officer concluded that the disclosure
controls and procedures, as of the end of the period covered by this Form 10-Q,
are effective in alerting them to material information required to be included
in this Form 10-Q.
  Changes
in Internal Control over Financial Reporting
 
 During
the quarter ended June 30, 2008, there have been no changes in our internal
control over financial reporting, or to our knowledge, in other factors, that
have materially affected or, are reasonably likely to materially affect our
internal controls over financial reporting.
 
  26
  Part
II
 
 Item
1.                LEGAL PROCEEDINGS
 
 From time
to time we may be a party to legal proceedings arising in the ordinary course of
business.  We are not currently a party to, nor are any of our
properties the subject of, any material pending legal proceedings.
 
 Item
2.                UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS
 
 The
following chart summarizes our repurchases of common shares as part of our
publicly announced repurchase plan.
 
 (a)
              (b)
              (c)
              (d)Period
              Total
      Number of
                Shares
      (or Units)
                Purchased
              Average
      Price paid
                per
      Share (or Unit)
              Total
      Number of
                Shares
      (or Units)
                Purchased
      as Part
                of
      Publicly
                Announced
      Plans or
                Programs
              Maximum
      Number (or Approximate Dollar Value) of Shares (or Units) that May Yet be
      Purchased Under the Plans or Programs
                (1)  (2)Month
      #1:
                4/1/08-
      4/30/08
              0
              $.00
              0
              39,592Month
      #2:
                5/1/08-
      5/31/08
              0
              $.00
              0
              39,592Month
      #3:
                6/1/08–
      6/30/08
              0
              $.00
              0
              39,592Total
              0
              $.00
              0
              39,592
 
 (1)
              On
      January 17, 2001 a repurchase program was approved up to
      $1,000,000.  On August 21, 2002 an additional $1,000,000 was
      approved.  No expiration.
 (2)
              On
      February 15, 2006, 60,000 shares were approved for repurchase and on
      October 18, 2006 an additional 60,000 shares were approved for repurchase
      and on July 18, 2007, an additional 60,000 share were approved for
      repurchase.  No
expiration.
 
 Item
3                 
DEFAULTS UPON SENIOR
SECURITIES
  None
 
  27
 Item 4.                
SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS
 The
Company held the annual meeting of shareholders on June 3, 2008.  The
proposals and the outcomes from
the voting
are set forth below.
  Proposal
Number 1:  Election of Directors: and
  Nominees
              Shares
      Voted For
              Shares
      Withholding Authority/Voted AgainstSuzanne
      Brangham
              1,734,126
              133,472Dale
      T. Downing
              1,739,020
              128,579Robert
      B. Hitchcock
              1,740,950
              126,648Robert
      J. Nicholas
              1,738,098
              129,500Valerie
      Pistole
              1,737,964
              129,635Mel
      Switzer, Jr.
              1,739,884
              127,714
 
 
 Proposal
      Number 2:
              Ratification
      of Richardson and Co. as the independent auditors for the Company for the
      fiscal year 2008.
 
 Total
      shares Voted
              For
              Against
              Abstain/Broker
      Non-Votes1,746,796
              100,990
              19,811
 
 
 
 Item
5.                 OTHER INFORMATION
 
 None
 
 Item
6.                   EXHIBITS
 
 Exhibits
 
 31.1
              Certification
      of Principal Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act
 31.2
              Certification
      of Principal Financial Officer and Principal Accounting
      Officer  pursuant to Section 302 of the Sarbanes-Oxley
      Act
 32          Certification
of CEO and CFO pursuant to Section 906 of the Sarbanes-Oxley
Act
  28
  SIGNATURES
 
 Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
 
 
 SONOMA
      VALLEY BANCORP(Registrant)Date:
              August
      13, 2008
              
              /s/Mel
      Switzer, Jr.Mel
      Switzer, Jr.President
      and Chief Executive Officer(Principal
      Executive Officer)Date:
              August 13,
      2008
              
              /s/Mary
      Dieter SmithMary
      Dieter SmithExecutive
      Vice President and Chief Financial Officer(Principal
      Financial Officer and Principal Accounting Officer)
  29