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: September 30,
2009
 
  ̈
                  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
                  
                   ̈
                  
                  (Do
      not check if a smaller reporting company)
                  
                  Smaller
      reporting company
                  x
 
 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 November 1, 2009 was 2,326,803.
  
  
 INDEX
 
 Part
      I  Financial Information
                  Page
      NumberItem
      1. Financial Statements (Unaudited):Consolidated Balance Sheets at September
      30, 2009, December 31, 2008 and September 30, 2008
                  3Consolidated Statements of Operations
      for the three and nine months ended September 30, 2009 and
      2008
                  4Consolidated Statements of Changes
      in Shareholders’ Equity for the nine months ended September 30, 2009,
      and the years ended December 31, 2008 and 2007
                  5Consolidated Statements of Cash Flows for
      the nine months ended September 30, 2009 and 2008
                  7Notes to Consolidated Financial
      Statements
                  8Item 2. Management's Discussion and
      Analysis of Financial Condition and Results of
    Operations
                  11Average Balances/Yields and Rates Paid for
      the nine months ended September 30, 2009 and 2008
                  13Average Balances/Yields and Rates Paid for
      the three months ended September 30, 2009 and
2008
                  28Item 3. Quantitative and Qualitative Disclosure
      About Market Risk
                  31Item 4. Controls and Procedures
                  31Part
      II  Other InformationItem 1. Legal Proceedings
                  32Item 1A. Risk Factors
                  32Item 2. Unregistered Sales of Equity Securities
      and Use of Proceeds
                  34Item 3. Defaults Upon Senior
      Securities
                  34Item 4. Submission of Matters to a Vote of
      Security Holders
                  34Item 5. Other Information
                  34Item 6. Exhibits
                  35Signatures
                  36Certifications
                  36
 
  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
 September
30, 2009 (Unaudited), December 31, 2008 (Audited)
 and
September 30, 2008 (Unaudited)
 September
      30,
                    2009
                  
                  
                  December
      31,
                    2008
                  
                  
                  September
      30,
                    2008ASSETSCash
      and due from banks
                  
                  $
                  4,590,608
                  
                  
                  $
                  6,302,692
                  
                  
                  $
                  6,891,263Interest-bearing
      due from banks
                  
                  
                  21,761,642
                  
                  
                  
                  11,930,363
                  
                  
                  
                  15,381,775Total
      cash and cash equivalents
                  
                  
                  26,352,250
                  
                  
                  
                  18,233,055
                  
                  
                  
                  22,273,038Investment
      securities available-for-sale at fair value
                  
                  
                  10,561,357
                  
                  
                  
                  6,578,924
                  
                  
                  
                  2,036,539Investment
      securities held-to-maturity (fair value of $13,849,348, $14,028,111 and
      $13,524,623 respectively)
                  
                  
                  13,396,977
                  
                  
                  
                  13,862,911
                  
                  
                  
                  13,382,308Loans
      and lease financing receivables, net
                  
                  
                  280,013,125
                  
                  
                  
                  262,376,784
                  
                  
                  
                  259,543,134Premises
      and equipment, net
                  
                  
                  614,696
                  
                  
                  
                  734,091
                  
                  
                  
                  786,261Accrued
      interest receivable
                  
                  
                  1,859,477
                  
                  
                  
                  1,678,547
                  
                  
                  
                  1,659,077Other
      real estate owned
                  
                  
                  478,610
                  
                  
                  
                  285,665
                  
                  
                  
                  320,416Cash
      surrender value of life insurance
                  
                  
                  11,058,594
                  
                  
                  
                  10,777,482
                  
                  
                  
                  10,673,741Other
      assets
                  
                  
                  9,828,242
                  
                  
                  
                  7,420,622
                  
                  
                  
                  6,774,039Total
      assets
                  
                  $
                  354,163,328
                  
                  
                  $
                  321,948,081
                  
                  
                  $
                  317,448,553LIABILITIESNoninterest-bearing
      demand deposits
                  
                  $
                  50,941,938
                  
                  
                  $
                  48,279,759
                  
                  
                  $
                  54,162,469Interest-bearing
      transaction deposits
                  
                  
                  32,471,725
                  
                  
                  
                  31,062,597
                  
                  
                  
                  28,306,822Savings
      and money market deposits
                  
                  
                  90,202,813
                  
                  
                  
                  88,317,397
                  
                  
                  
                  81,724,337Time
      deposits, $100,000 and over
                  
                  
                  79,077,355
                  
                  
                  
                  50,694,468
                  
                  
                  
                  51,394,535Other
      time deposits
                  
                  
                  36,365,253
                  
                  
                  
                  35,591,280
                  
                  
                  
                  31,767,944Total
      deposits
                  
                  
                  289,059,084
                  
                  
                  
                  253,945,501
                  
                  
                  
                  247,356,107Other
      borrowings
                  
                  
                  20,000,000
                  
                  
                  
                  30,000,000
                  
                  
                  
                  33,000,000Accrued
      interest payable and other liabilities
                  
                  
                  7,394,973
                  
                  
                  
                  7,142,484
                  
                  
                  
                  6,745,006Total
      liabilities
                  
                  
                  316,454,057
                  
                  
                  
                  291,087,985
                  
                  
                  
                  287,101,113SHAREHOLDERS'
      EQUITYPreferred
      stock, no par value; $1,000 per share liquidation
                    preference;
      2,000,000 shares authorized; 8,653 Series A and 433 Series B at September
      30, 2009 and none at December 31, 2008 and September 30, 2008 issued and
      outstanding
                  
                  
                  8,699,301
                  
                  
                  
                  0
                  
                  
                  
                  0Common
      stock, no par value; 10,000,000 shares authorized; 2,326,803 shares at
      September 30, 2009, 2,290,657 shares at December 31, 2008 and 2,288,709
      shares at September 30, 2008 issued and outstanding
                  
                  
                  16,852,765
                  
                  
                  
                  16,402,084
                  
                  
                  
                  16,385,614Additional
      paid-in-capital
                  
                  
                  2,579,498
                  
                  
                  
                  2,577,855
                  
                  
                  
                  2,520,540Retained
      earnings
                  
                  
                  9,556,837
                  
                  
                  
                  11,863,688
                  
                  
                  
                  11,451,730Accumulated
      other comprehensive income (loss)
                  
                  
                  20,870
                  
                  
                  
                  16,469
                  
                  
                  
                  (10,444
                  )Total
      shareholders' equity
                  
                  
                  37,709,271
                  
                  
                  
                  30,860,096
                  
                  
                  
                  30,347,440Total
      liabilities and shareholders' equity
                  
                  $
                  354,163,328
                  
                  
                  $
                  321,948,081
                  
                  
                  $
                  317,448,553
 
 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 Nine MonthsEnded
      September 30,
                  
                  
                  Ended
      September 30,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008INTEREST
      INCOMELoans
      and leases
                  
                  $
                  4,601,855
                  
                  
                  $
                  4,661,936
                  
                  
                  $
                  13,486,661
                  
                  
                  $
                  14,335,110Taxable securities
                  
                  
                  42,695
                  
                  
                  
                  14,473
                  
                  
                  
                  124,173
                  
                  
                  
                  83,440Tax-exempt securities
                  
                  
                  131,925
                  
                  
                  
                  129,822
                  
                  
                  
                  400,219
                  
                  
                  
                  399,165Federal funds sold and other
                  
                  
                  17,346
                  
                  
                  
                  6,029
                  
                  
                  
                  30,510
                  
                  
                  
                  38,469Dividends/CA Warrants
                  
                  
                  4,161
                  
                  
                  
                  24,377
                  
                  
                  
                  4,258
                  
                  
                  
                  74,224Total
      interest income
                  
                  
                  4,797,982
                  
                  
                  
                  4,836,637
                  
                  
                  
                  14,045,821
                  
                  
                  
                  14,930,408INTEREST
      EXPENSEInterest-bearing
      transaction deposits
                  
                  
                  13,631
                  
                  
                  
                  12,457
                  
                  
                  
                  31,061
                  
                  
                  
                  37,592Savings
      and money market deposits
                  
                  
                  199,734
                  
                  
                  
                  348,426
                  
                  
                  
                  649,318
                  
                  
                  
                  1,112,540Time
      deposits, $100,000 and over
                  
                  
                  395,921
                  
                  
                  
                  442,232
                  
                  
                  
                  1,151,891
                  
                  
                  
                  1,546,942Other
      time deposits
                  
                  
                  183,456
                  
                  
                  
                  252,826
                  
                  
                  
                  611,447
                  
                  
                  
                  886,185Other
      borrowings
                  
                  
                  187,324
                  
                  
                  
                  179,922
                  
                  
                  
                  600,669
                  
                  
                  
                  623,716Total
      interest expense
                  
                  
                  980,066
                  
                  
                  
                  1,235,863
                  
                  
                  
                  3,044,386
                  
                  
                  
                  4,206,975NET
      INTEREST INCOME
                  
                  
                  3,817,916
                  
                  
                  
                  3,600,774
                  
                  
                  
                  11,001,435
                  
                  
                  
                  10,723,433Provision
      for loan and lease losses
                  
                  
                  2,550,000
                  
                  
                  
                  300,000
                  
                  
                  
                  7,430,000
                  
                  
                  
                  830,000NET
      INTEREST INCOME AFTER
                    PROVISION
      FOR LOAN AND
                    LEASE
      LOSSES
                  
                  
                  1,267,916
                  
                  
                  
                  3,300,774
                  
                  
                  
                  3,571,435
                  
                  
                  
                  9,893,433NON-INTEREST
      INCOME
                  
                  
                  520,321
                  
                  
                  
                  528,883
                  
                  
                  
                  1,501,932
                  
                  
                  
                  1,617,271NON-INTEREST
      EXPENSESalaries
      and employee benefits
                  
                  
                  1,228,353
                  
                  
                  
                  1,414,357
                  
                  
                  
                  3,816,582
                  
                  
                  
                  4,229,827Premises
      and equipment
                  
                  
                  243,835
                  
                  
                  
                  233,897
                  
                  
                  
                  738,178
                  
                  
                  
                  698,697Other
                  
                  
                  1,108,153
                  
                  
                  
                  805,485
                  
                  
                  
                  3,239,432
                  
                  
                  
                  2,253,235Total
      non-interest expense
                  
                  
                  2,580,341
                  
                  
                  
                  2,453,739
                  
                  
                  
                  7,794,192
                  
                  
                  
                  7,181,759(Loss)Income
      before provision for income taxes
                  
                  
                  (792,104
                  )
                  
                  
                  1,375,918
                  
                  
                  
                  (2,720,825
                  )
                  
                  
                  4,328,945Provision
      for income taxes
                  
                  
                  (433,859
                  )
                  
                  
                  459,843
                  
                  
                  
                  (1,442,633
                  )
                  
                  
                  1,438,956NET
      (LOSS)INCOME
                  
                  $
                  (358,245
                  )
                  
                  $
                  916,075
                  
                  
                  $
                  (1,278,192
                  )
                  
                  $
                  2,889,989Preferred
      stock dividends and amortization of preferred stock
    discount
                  
                  
                  (136,935
                  )
                  
                  
                  0
                  
                  
                  
                  (334,513
                  )
                  
                  
                  0NET
      (LOSS)INCOME AVAILABLE TO
                    COMMON
      SHAREHOLDERS
                  
                  
                  (495,180
                  )
                  
                  
                  916,075
                  
                  
                  
                  (1,612,705
                  )
                  
                  
                  2,889,989(LOSS)EARNINGS
      PER SHARE AVAILABLE TO COMMON SHAREHOLDERSBasic
                  
                  $
                  (0.22
                  )
                  
                  $
                  .41
                  
                  
                  $
                  (.70
                  )
                  
                  $
                  1.28Diluted
                  
                  $
                  (0.21
                  )
                  
                  $
                  .40
                  
                  
                  $
                  (.70
                  )
                  
                  $
                  1.26Dividends
      declared per common share
                  
                  $
                  .00
                  
                  
                  $
                  .00
                  
                  
                  $
                  .30
                  
                  
                  $
                  .60WEIGHTED
      AVERAGE NUMBER OF SHARES OUTSTANDINGBasic
                  
                  
                  2,302,269
                  
                  
                  
                  2,260,255
                  
                  
                  
                  2,302,269
                  
                  
                  
                  2,260,255Diluted
                  
                  
                  2,304,511
                  
                  
                  
                  2,294,794
                  
                  
                  
                  2,304,511
                  
                  
                  
                  2,294,794
 
 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 nine months ended September 30, 2009 (Unaudited), and the years
ended
 December
31, 2008 (Audited) and 2007 (Audited)
 Comprehensive
                                            
                                            Preferred
                                            
                                            Common
      Stock
                                            
                                            
                                            Additional
      Paid-in
                                            
                                            
                                            Retained
                                            
                                            
                                            Accumulated
      Other ComprehensiveIncome
                                            
                                            Stock
                                            
                                            Shares
                                            
                                            
                                            Amount
                                            
                                            
                                            Capital
                                            
                                            
                                            Earnings
                                            
                                            
                                            Income(Loss)
                                            
                                            
                                            TotalBALANCE
      AT JANUARY 1, 2007
                                            
                                            
                                            
                                            
                                            
                                            
                                            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 and related tax benefits
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            162,750
                                            
                                            
                                            
                                            7,935
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            170,685Net
      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 loss, net of taxes
                                            
                                            
                                            119,850
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            119,850
                                            
                                            
                                            
                                            119,850Total
      comprehensive income
                                            
                                            $
                                            4,463,388BALANCE
      AT   DECEMBER 31, 2007
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            2,242,809
                                            
                                            
                                            
                                            15,578,903
                                            
                                            
                                            
                                            2,455,409
                                            
                                            
                                            
                                            9,934,967
                                            
                                            
                                            
                                            (34,999
                                            )
                                            
                                            
                                            27,934,280Redemption
      and retirement  of stock
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (1,190
                                            )
                                            
                                            
                                            (8,526
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            (13,414
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            (21,940
                                            )Stock
      options exercised and related tax benefits
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            49,038
                                            
                                            
                                            
                                            668,957
                                            
                                            
                                            
                                            72,318
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            741,275Cash
      dividend of $.60 per share
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (1,373,226
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            (1,373,226
                                            )Stock
      options vested
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            64,805
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            64,805Restricted
      stock vested and related tax benefit
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            162,750
                                            
                                            
                                            
                                            (14,677
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            148,073Net
      income for the year
                                            
                                            $
                                            3,315,361
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            3,315,361
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            3,315,361Other
      comprehensive
                                              income, net of tax: Unrealized holding gains on securities available-
      for-sale arising during the year, net of taxes of $35,994
                                            
                                            
                                            51,468Other
      comprehensive
                                              loss, net of taxes
                                            
                                            
                                            51,468
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            51,468
                                            
                                            
                                            
                                            51,468Total
      comprehensive income
                                            
                                            $
                                            3,366,829
  5
 SONOMA
VALLEY BANCORP AND SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Continued)
 For
the nine months ended September 30, 2009 (Unaudited), and the years
ended
 December
31, 2008 (Audited) and 2007 (Audited)
 Comprehensive
                                            
                                            
                                            Preferred
                                            
                                            
                                            Common
      Stock
                                            
                                            
                                            Additional
      Paid-in
                                            
                                            
                                            Retained
                                            
                                            
                                            Accumulated
      Other ComprehensiveIncome
                                            
                                            
                                            Stock
                                            
                                            
                                            Shares
                                            
                                            
                                            Amount
                                            
                                            
                                            Capital
                                            
                                            
                                            Earnings
                                            
                                            
                                            Income(Loss)
                                            
                                            
                                            TotalBALANCE
      AT DECEMBER 31, 2008
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            2,290,657
                                            
                                            
                                            $
                                            16,402,084
                                            
                                            
                                            $
                                            2,577,855
                                            
                                            
                                            $
                                            11,863,688
                                            
                                            
                                            $
                                            16,469
                                            
                                            
                                            $
                                            30,860,096Issuance
      of preferred stock
                                            
                                            
                                            
                                            
                                            $
                                            8,653,000
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            8,653,000Dividends
      on preferred stock
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (288,212
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            (288,212
                                            )Amortization/
      Accretion of preferred stock,net
                                            
                                            
                                            
                                            
                                            
                                            46,301
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (46,301
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            0Stock
      options exercised and related tax benefits
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            36,146
                                            
                                            
                                            
                                            287,931
                                            
                                            
                                            
                                            38,618
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            326,549Cash
      dividend of $.30 per share
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (694,146
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            (694,146
                                            )Stock
      options vested
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            50,465
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            50,465Restricted
      stock vested
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            162,750
                                            
                                            
                                            
                                            (87,440
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            75,310Net loss
      for the year
                                            
                                            $
                                            (1,278,192
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (1,278,192
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            (1,278,192
                                            )Other
      comprehensive loss, net of tax: Unrealized holding loss on securities
      available- for-sale arising during the year, net of taxes of
      $3,078
                                            
                                            
                                            4,401Other
      comprehensive loss, net of taxes
                                            
                                            
                                            4,401
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            4,401
                                            
                                            
                                            
                                            4,401Total
      comprehensive income
                                            
                                            $
                                            (1,273,791
                                            )BALANCE
      AT September 30, 2009
                                            
                                            
                                            
                                            
                                            
                                            $
                                            8,699,301
                                            
                                            
                                            
                                            2,326,803
                                            
                                            
                                            $
                                            16,852,765
                                            
                                            
                                            $
                                            2,579,498
                                            
                                            
                                            $
                                            9,556,837
                                            
                                            
                                            $
                                            20,870
                                            
                                            
                                            $
                                            37,709,271
 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
nine months ended September 30, 2009 and 2008
 
 2009
              
              
              2008OPERATING
      ACTIVITIESNet
      (loss)income
              
              $
              (1,278,192
              )
              
              $
              2,889,989Adjustments
      to reconcile net income to net cash provided by operating
      activities:Provision
      for loan and lease losses
              
              
              7,430,000
              
              
              
              830,000Depreciation
              
              
              174,518
              
              
              
              172,946Amortization
      and other
              
              
              42,607
              
              
              
              55,799Stock-based
      compensation expense
              
              
              125,775
              
              
              
              155,568Provision
      for foreclosed real estate
              
              
              57,055
              
              
              
              0Net
      change in interest receivable
              
              
              (180,930
              )
              
              
              23,132Net
      change in cash surrender value of life insurance
              
              
              (281,112
              )
              
              
              (319,588
              )Net
      change in other assets
              
              
              (2,372,080
              )
              
              
              (431,303
              )Net
      change in interest payable and other liabilities
              
              
              (35,723
              )
              
              
              367,707NET
      CASH PROVIDED BY OPERATING ACTIVITIES
              
              
              3,681,918
              
              
              
              3,744,250INVESTING
      ACTIVITIESPurchases
      of securities available-for-sale
              
              
              (10,476,627
              )
              
              
              (1,008,605
              )Proceeds
      from maturing securities held-to-maturity
              
              
              425,000
              
              
              
              1,128,100Proceeds
      from maturing securities available-for-sale
              
              
              6,500,000
              
              
              
              7,205,000Net
      change in loans and leases
              
              
              (25,316,341
              )
              
              
              (13,955,332
              )Purchases
      of premises and equipment
              
              
              (55,123
              )
              
              
              (166,752
              )NET
      CASH USED FOR INVESTING ACTIVITIES
              
              
              (28,923,091
              )
              
              
              (6,797,589
              )FINANCING
      ACTIVITIESNet
      change in demand, interest-bearing transaction and savings
      deposits
              
              
              5,956,723
              
              
              
              1,941,296Net
      change in time deposits
              
              
              29,156,860
              
              
              
              9,367,112Proceeds
      from issuance of Preferred stock
              
              
              8,653,000
              
              
              
              0Cash
      dividend paid
              
              
              (694,146
              )
              
              
              (1,373,226
              )Proceeds
      from FHLB borrowings
              
              
              15,000,000
              
              
              
              25,000,000Repayments
      of FHLB borrowings
              
              
              (25,000,000
              )
              
              
              (19,500,000
              )Stock
      options exercised
              
              
              287,931
              
              
              
              557,561NET
      CASH  PROVIDED BY FINANCING ACTIVITIES
              
              
              33,360,368
              
              
              
              15,992,743NET
      CHANGE IN CASH AND CASH EQUIVALENTS
              
              
              8,119,195
              
              
              
              12,939,404Cash
      and cash equivalents at beginning of period
              
              
              18,233,055
              
              
              
              9,333,634CASH
      AND CASH EQUIVALENTS AT END OF PERIOD
              
              $
              26,352,250
              
              
              $
              22,273,038SUPPLEMENTAL
      DISCLOSURES OF CASH FLOW INFORMATION:Cash
      paid during the year for:Interest
      expense
              
              $
              3,049,185
              
              
              $
              4,253,548Income
      taxes
              
              $
              1,015,570
              
              
              $
              1,662,156SUPPLEMENTAL
      DISCLOSURES OF NONCASH ACTIVITIES:Loans
      transferred to other real estate owned
              
              $
              250,000
              
              
              $
              320,416Net
      change in unrealized gains and losses on securities
              
              $
              7,479
              
              
              $
              41,727Net
      change in deferred income taxes on unrealized gains on
      securities
              
              $
              (3,078
              )
              
              $
              (17,172
              )Accrued
      preferred stock dividends
              
              $
              (288,212
              )
              
              
              0Amortization/Accretion
      of preferred stock discount/premium, net
              
              $
              (46,301
              )
              
              
              0
 
 The
accompanying notes are an integral part of these financial
statements.
 
 
 
 
 7
 
 SONOMA
VALLEY BANCORP AND SUBSIDIARY
 NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS
 September
30, 2009
 (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 Subsidiary
(the "Company") at September 30, 2009 and results of operations for the nine
months then ended. Subsequent events were evaluated for these September 30, 2009
financial statements through November 12, 2009, the date that the financial
statements were issued.
 
 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 2008 Annual
Report on Form 10-K.  The results of operations for the nine months
ended September 30, 2009 are not necessarily indicative of the operating results
through December 31, 2009.
 
 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 September 30, 2009 and September
30, 2008.
 
 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 September 30,
2009 was 2,302,269 and for the period ending September 30, 2008 was
2,260,255.
 
 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 September 30, 2009 was 2,304,511 and for the period ending
September 30, 2008 was 2,294,794.
 
 Note
5:  Stock Option Accounting
 
 We have a
stock-based employee and director compensation plan in which compensation cost
is recognized over the employee requisite service period, based on the fair
value of the award at grant date.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 September 30, 2009 and 2008.
 
 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 nine
months ended September 30, 2009 and 2008 are as follows:
 
 Directors
              
              
              Officers2009
              
              
              2008
              
              
              2009
              
              
              2008Service
      cost
              
              $
              45,229
              
              
              $
              30,525
              
              
              $
              81,008
              
              
              $
              223,760Interest
      cost on projected benefit obligation
              
              
              34,873
              
              
              
              21,639
              
              
              
              169,995
              
              
              
              208,199Amortization
      of unrecognized liability at transition
              
              
              (9,913
              )
              
              
              (7,570
              )
              
              
              17,777
              
              
              
              126,814Net
      periodic pension cost recognized
              
              $
              70,189
              
              
              $
              44,594
              
              
              $
              268,780
              
              
              $
              558,773
 
 
 Note
7:  Fair Value Measurement
 
 US GAAP
defines fair value, establishes a framework for measuring fair value under
generally accepted accounting principles, and expands disclosures about fair
value measurement. 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.
 
 The
following table presents information about the Company’s assets and liabilities
measured at fair value on a recurring basis as of September 30, 2009, and
indicate the fair value hierarchy of the valuation techniques utilized by the
Company to determine such fair value.
 
 At
      September 30, 2009Total
              
              
              Level
      1
              
              
              Level
      2
              
              
              Level
      3Available-for-sale
      securities
              
              $
              10,561,357
              
              
              $
              14,752
              
              
              $
              10,546,605
              
              
              $
              0
 
 
 9
 
 
 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.
 
 September
      30, 2009Total
              
              
              Level
      1
              
              
              Level
      2
              
              
              Level
      3Impaired
      Loans
              
              $
              48,469,544
              
              
              $
              0
              
              
              $
              29,363,436
              
              
              $
              19,106,108Other
      Real Estate Owned
              
              $
              478,610
              
              
              $
              0
              
              
              $
              478,610
              
              
              $
              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 or loans for which the impairment has
already been charged off.  At September 30, 2009 all of the total
impaired loans were evaluated based on the fair value of the collateral or
discounted cash flows.  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 the fair value of the
impaired loans is based on discounted cash flows, the Company records the
impaired loan as nonrecurring Level 3.
 
 Note 8
-  Stockholder’s Equity
 
 On
February 20, 2009, we completed the issuance of $8,653,000 of Series A preferred
stock and related warrant for Series B preferred stock under the U.S. Department
of Treasury’s Capital Purchase Program.  We issued 8,653 shares of
Series A preferred stock and a warrant to acquire 433 shares of Series B
preferred stock for the aggregate purchase price (collectively the “Preferred
Stock”). The warrant was exercised immediately and the 433 shares issued. The
Series A preferred stock has a cumulative dividend of 5% per annum for five
years and, unless redeemed, 9% thereafter.  The liquidation amount is
$1,000 per share.  The Series B preferred stock pays a dividend of
9%.  The Preferred Stock has no maturity date and ranks senior to the
Company’s common stock with respect to the payment of dividends and
distributions and amounts payable upon liquidation, dissolution and winding up
of the Company. The Preferred Stock is generally non-voting, other than class
voting on certain matters that could adversely affect the Preferred
Stock.
 
 Preferred
stock dividends, including accretion of the discount, were $334,513 for the nine
months ended September 30, 2009.
 
 10
 
 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, 2008,
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 Nine Month Periods
 Ended
September 30, 2009 and 2008
 
 Overview
 
 The
Company recorded a net loss of $1,278,192 for the nine months ended September
30, 2009. This represents a decline of $4.2 million from earnings of $2,889,989
during the period ended September 30, 2008. The decline in earnings relates to a
$6.6 million increase in the provision for loan losses, a $115,339 decline in
non-interest income and a $612,433 increase in non-interest expense, offset by
an increase in net interest income of $276,095 and a $2.88 million decline in
the provision for income taxes. The increase in the loan loss provision is a
result of year to date net charge offs of $6.5 million and in response to our
evaluation of the required level of the allowance for loan losses in the current
economic environment. Additionally, we have experienced a significant increase
in non-performing loans from $2.24 million at September 30, 2008 to $7.07
million at September 30, 2009. Non-performing loans at December 31, 2008 totaled
$6.53 million.
 
 Net
income (loss) allocable to common shareholders declined from net income of
$2,889,989 during the nine months ended September 30, 2008 to a net loss of
$1,612,705 or $(.70) per diluted share for the nine months ended September 30,
2009. This represents a decline of $4.5 million from earnings of $2,889,989 or
$1.26 per diluted share during the period ended September 30, 2008. Included in
the current year loss was the net income statement loss described above of
$1,278,192 plus $334,513 which represents dividends accrued and discount
amortized on preferred stock.
 
 11
 
 
 On
February 20, 2009 the Company entered into a Letter Agreement with the United
States Department of the Treasury, pursuant to which the Company issued and sold
(i) 8,653 shares of the Company’s Preferred Stock, Series and (ii) a warrant to
purchase 433 shares of the Company’s preferred stock, Series B for an aggregate
purchase price of $8,653,000 in cash. Of the $8,653,000, $6,000,000 was
transferred to the Bank as a capital infusion. The remainder has been
temporarily invested in excess reserves at the Federal Reserve Bank. These
funds also provide us with additional lending capacity and liquidity which we
can utilize to support our growth objectives and local economic
expansion
 
 Total
assets at September 30, 2009 were $354.2 million, an increase of $32.2 million
from the $321.9 million at December 31, 2008.  Cash and due from banks
increased by $8.1 million from $18.2 million at December 31, 2008 to $26.4
million at September 30, 2009 and investment securities increased by $3.52
million to $23.95 million at September 30, 2009.  Loans net of
unearned fees increased $18.6 million. Deposits increased by $35.11 million from
$253.95 million at December 31, 2008 to $289.06 million at September 30,
2009.  All categories of deposits showed increases with CD’s greater
that $100,000 growing 56% or $28.4 million from $50.69 million in December 2008
to $79.08 million as of September 30, 2009. This is a result of customers
placing deposits with the CDARS program for which we receive reciprocal
deposits. Total shareholders’ equity increased by $6.8 million from $30.9
million at December 31, 2008 to $37.7 million at September 30, 2009. This
increase is related to the issuance of $8.7 million in preferred stock offset by
our $1.6 million 2009 loss for the nine months ending September 30,
2009.
 
 Return
(loss) on average total assets on an annualized basis for the nine month period
was (0.50)% in 2009 and 1.30% in 2008 based on net income of
$1,278,192.  The decline in the return on assets is the result of the
$4.2 million decline in net income combined with growth of $43.8 million or
14.8% in average assets from $296.6 million as of September 30, 2008 to $340.4
million as of September 30, 2009.  Return (loss) on average
shareholders' equity on an annualized basis at the end of the third quarter
2009 and 2008 was (4.53)% and 12.99%, respectively.  The decline in
return (loss) on equity is the result of the decline in net income from $2.9
million in 2008 to a loss of $1.3 million in 2009. Additionally average equity
grew $8.0 million or 26.8% from $29.7 million as of September 30, 2008 to $37.7
million as of September 30, 2009.
 
 Section
404 of Sarbanes-Oxley Act of 2002 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,
2008.  Our external independent auditors are required to attest to and
report on management's assessment of internal control over financial reporting
beginning December 31, 2010.  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 13,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
($249,849 in 2009 and $251,756 in 2008, based on a 34% federal income tax
rate).
 
 The
slight increase in net interest income for the nine months ended September
30, 2009 (stated on a fully tax equivalent basis) is a result of the net effect
of an $886,494 decrease in interest income offset by a larger decrease in
interest expense of $1,162,589, showing a net increase of
$276,095.  As of September 30, 2008 the federal funds rate and Wall
Street Journal prime rate were 2% and 5%, respectively. Over the course of the
last year both rates have declined 175 basis points. At September 30, 2009 the
federal funds rate was 0.00% - 0.25% and the prime rate was 3.25%.
 
 
 12
 SONOMA
VALLEY BANCORP
 AVERAGE BALANCES/YIELDS AND RATES
PAID
 For the
nine months ended September 30, 2009 and 2008
 
 2009
              
              
              2008ASSETS
              
              Average
                Balance
              
              
              Income/
                Expense
              
              
              Yield/
                Rate
              
              
              Average
                Balance
              
              
              Income/
                Expense
              
              
              Yield/
                RateInterest-earning
      assets:Loans(2):Commercial
              
              $
              194,064,487
              
              
              $
              9,385,020
              
              
              
              6.47
              %
              
              $
              176,487,467
              
              
              $
              9,856,967
              
              
              
              7.47
              %Consumer
              
              
              37,687,842
              
              
              
              1,779,258
              
              
              
              6.31
              %
              
              
              31,149,537
              
              
              
              1,696,535
              
              
              
              7.28
              %Real
      estate construction
              
              
              26,795,185
              
              
              
              1,129,420
              
              
              
              5.64
              %
              
              
              26,852,216
              
              
              
              1,612,353
              
              
              
              8.03
              %Real
      estate mortgage
              
              
              21,533,527
              
              
              
              1,108,178
              
              
              
              6.88
              %
              
              
              19,430,397
              
              
              
              1,078,099
              
              
              
              7.42
              %Tax
      exempt loans (1)
              
              
              2,084,563
              
              
              
              128,461
              
              
              
              8.24
              %
              
              
              2,195,780
              
              
              
              135,664
              
              
              
              8.26
              %Leases
              
              
              11,560
              
              
              
              0
              
              
              
              0.00
              %
              
              
              19,673
              
              
              
              1,617
              
              
              
              10.99
              %Unearned
      loan fees
              
              
              (240,864
              )
              
              
              
              
              
              
              
              
              
              
              (328,825
              )Total
      loans
              
              
              281,936,300
              
              
              
              13,530,337
              
              
              
              6.42
              %
              
              
              255,806,245
              
              
              
              14,381,235
              
              
              
              7.52
              %Investment
      securitiesAvailable
      for sale:Taxable
              
              
              6,909,964
              
              
              
              127,594
              
              
              
              2.47
              %
              
              
              3,402,856
              
              
              
              83,917
              
              
              
              3.30
              %Hold
      to maturity:Tax
      exempt (1)
              
              
              13,660,263
              
              
              
              606,392
              
              
              
              5.94
              %
              
              
              14,006,800
              
              
              
              604,795
              
              
              
              5.77
              %Total
      investment securities
              
              
              20,570,227
              
              
              
              733,986
              
              
              
              4.77
              %
              
              
              17,409,656
              
              
              
              688,712
              
              
              
              5.29
              %CA
      Warrants
              
              
              30,823
              
              
              
              837
              
              
              
              3.63
              %
              
              
              0
              
              
              
              0
              
              
              
              0.00
              %Federal
      funds sold
              
              
              0
              
              
              
              0
              
              
              
              0.00
              %
              
              
              64,672
              
              
              
              1,284
              
              
              
              2.65
              %FHLB
      stock
              
              
              1,592,385
              
              
              
              0
              
              
              
              0.00
              %
              
              
              1,658,850
              
              
              
              73,747
              
              
              
              5.94
              %Total
      due from banks/interest-bearing
              
              
              17,567,293
              
              
              
              30,510
              
              
              
              0.23
              %
              
              
              2,266,925
              
              
              
              37,186
              
              
              
              2.19
              %Total
      interest-earning assets
              
              
              321,697,028
              
              
              $
              14,295,670
              
              
              
              5.94
              %
              
              
              277,206,348
              
              
              $
              15,182,164
              
              
              
              7.32
              %Noninterest-bearing
      assets:Reserve
      for loan losses
              
              
              (6,334,435
              )
              
              
              
              
              
              
              
              
              
              
              (3,898,303
              )Cash
      and due from banks
              
              
              5,086,751
              
              
              
              
              
              
              
              
              
              
              
              5,579,748Premises
      and equipment
              
              
              683,916
              
              
              
              
              
              
              
              
              
              
              
              804,965Other
      real estate owned
              
              
              275,042
              
              
              
              
              
              
              
              
              
              
              
              228,366Other
      assets
              
              
              19,007,957
              
              
              
              
              
              
              
              
              
              
              
              16,650,308Total
      assets
              
              $
              340,416,259
              
              
              
              
              
              
              
              
              
              
              $
              296,571,432LIABILITIES
      AND SHAREHOLDERS' EQUITYInterest-bearing
      liabilities:Interest-
      bearing depositsInterest-bearing
      transaction
              
              $
              31,144,230
              
              
              $
              31,061
              
              
              
              0.13
              %
              
              $
              30,176,377
              
              
              $
              37,592
              
              
              
              0.17
              %Savings
      deposits
              
              
              90,803,579
              
              
              
              649,318
              
              
              
              0.96
              %
              
              
              77,548,456
              
              
              
              1,112,540
              
              
              
              1.92
              %Time
      deposits over $100,000
              
              
              60,603,767
              
              
              
              1,151,891
              
              
              
              2.54
              %
              
              
              51,073,637
              
              
              
              1,546,942
              
              
              
              4.05
              %Other
      time deposits
              
              
              36,781,942
              
              
              
              611,447
              
              
              
              2.22
              %
              
              
              31,230,447
              
              
              
              886,185
              
              
              
              3.79
              %Total
      interest-bearing deposits
              
              
              219,333,518
              
              
              
              2,443,717
              
              
              
              1.49
              %
              
              
              190,028,917
              
              
              
              3,583,259
              
              
              
              2.52
              %Federal
      funds purchased
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              156,934
              
              
              
              2,578
              
              
              
              2.20
              %Other
      borrowings
              
              
              26,835,897
              
              
              
              600,669
              
              
              
              2.99
              %
              
              
              20,617,153
              
              
              
              621,138
              
              
              
              4.03
              %Total
      interest-bearing liabilities
              
              
              246,169,415
              
              
              $
              3,044,386
              
              
              
              1.65
              %
              
              
              210,803,004
              
              
              $
              4,206,975
              
              
              
              2.67
              %Non-interest-bearing
      liabilities:Non-interest-bearing
      demand deposits
              
              
              49,012,034
              
              
              
              
              
              
              
              
              
              
              
              49,487,970Other
      liabilities
              
              
              7,538,196
              
              
              
              
              
              
              
              
              
              
              
              6,559,041Shareholders'
      equity
              
              
              37,696,614
              
              
              
              
              
              
              
              
              
              
              
              29,721,417Total
      liabilities and shareholders' equity
              
              $
              340,416,259
              
              
              
              
              
              
              
              
              
              
              $
              296,571,432Interest
      rate spread
              
              
              
              
              
              
              
              
              
              
              4.29
              %
              
              
              
              
              
              
              
              
              
              
              4.65
              %Interest
      income
              
              
              
              
              
              $
              14,295,670
              
              
              
              5.94
              %
              
              
              
              
              
              $
              15,182,164
              
              
              
              7.32
              %Interest
      expense
              
              
              
              
              
              
              3,044,386
              
              
              
              1.27
              %
              
              
              
              
              
              
              4,206,975
              
              
              
              2.03
              %Net
      interest income/margin
              
              
              
              
              
              $
              11,251,284
              
              
              
              4.67
              %
              
              
              
              
              
              $
              10,975,189
              
              
              
              5.29
              %
  (1)
              Fully
      tax equivalent adjustments are based on a federal income tax rate of 34%
      in 2009 and 2008.
 (2)
              Non
      accrual loans have been included in loans for the purposes of the above
      presentation.  Loan fees of approximately $194,649 and $291,943
      for the nine months ended September 30, 2009 and 2008, respectively, were
      amortized to the appropriate interest income
  categories.
  13
  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 2009, our net interest margin declined 62 basis points to
4.67%, from 5.29% for the same period in 2008.  The decline in the net
interest margin is a result of asset yields repricing downward more than the
yields on earning liabilities. Additionally, with the increase in non- accrual
loans, we have experienced the loss of earnings from those loans.
 
 Interest
Income
 
 As
previously stated, interest income (stated on a fully taxable equivalent basis)
declined by $886,494 to $14.3 million in the first nine months of 2009, a
5.84% decrease from the $15.2 million realized during the same period in
2008.
 
 The
$886,494 decrease was the result of the 138 basis point decrease in the yield on
earning assets to 5.94% for the nine months ended September 30, 2009 from
7.32% for the same period in 2008.  Average balances of
interest-bearing assets increased $44.5 million or 16.05% from $277.2 million as
of September 30, 2008 to $321.7 million as of September 30, 2009.
 
 The gain
in volume of average earning assets was responsible for a $1,334,468 increase in
interest income, and the decrease in interest rates contributed $2,220,962, for
a net decrease in interest income of $886,494.
 
 Interest
Expense
 
 Total
interest expense for the first nine months of 2009 decreased by $1,162,589
to $3.044 million from $4.207 million for the same period in
2008.  The average rate paid on all interest-bearing liabilities
decreased from 2.67% in the first nine months of 2008 to 1.65% in the same
period in 2009, a decrease of 102 basis points.  Average balances of
interest-bearing liabilities increased from $210.8 million to $246.2 million, a
$35.4 million or 16.8% increase in interest-bearing liabilities.
 
 The gain
in volume of average balances was responsible for a $508,369 increase in
interest expense and the lower interest rates paid were responsible for a
$1,670,957 decrease in interest expense for a net decrease of
$1,162,589.
 
 Individual
components of interest income and interest expense are provided in the table
“Average Balances/Yields and Rates Paid” on page 13.
 
 Provision
for Loan Losses
 
 The
allowance for loan losses is maintained at a level that management believes will
be adequate to absorb inherent losses on existing loans based on an evaluation
of the collectability of the loans and prior loan loss
experience.  The evaluations take into consideration such factors as
changes in the nature and volume of the portfolio, overall portfolio quality,
review of specific problem loans, and current economic conditions that may
affect the borrower’s ability to repay their loan.  The allowance for
loan losses is based on estimates, and ultimate losses may vary from the current
estimates.  These estimates are reviewed periodically and, as
adjustments become necessary, they are reported in earnings in the periods in
which they become known.
 
 14
 
 
 The
provision for loan losses is established by charges to earnings based on
management’s overall evaluation of the collectability of the loan
portfolio.  Based on this evaluation the provision for loan losses
charged to operations for the nine months ended September 30, 2009 increased to
$7.43 million compared to $830,000 for the same time period in 2008. This boost
is due to significant increases in both charge-offs and non-performing assets
and is reflective of adverse changes in the current banking and real estate
environments. Year to date net charge-offs increased from $395,746 at September
30, 2008 to $6.5 million at September 30, 2009. Non-performing assets from $2.24
million at September 30, 2008 to $7.07 million at September 30,
2009.
 
 As of
September 30, 2009, the non-performing assets to total loans ratio was 2.47%
compared to 0.84% for the same period of 2008. Non accrual loans were $6.6
million as of September 30, 2009 compared to $1.9 million as of September 30,
2008, an increase of $4.7 million. Loans charged-off were $6.5 million and
recoveries were $62,562 as of September 30, 2009 compared with $416,253 in
charge-offs and $20,507 in recoveries for the same period in 2008.
 
 The
increase in charge-offs in 2009 is a result of a material drop in real estate
values in the Bank’s lending area caused by a continuing
recession.  Additionally, present economic conditions have caused more
business failures and financial difficulty for borrowers causing them to become
delinquent and unable to pay back their loans. See pages 19 and 20 for a
discussion of the allowance for loan losses.
  Non-interest
Income
 
 Non-interest
income for the first nine months of $1.5 million decreased 7.1% or $115,339 over
the $1.6 million recorded in the comparable period in 2008.  Other fee
income has shown the largest decrease of $47,440 from $276,769 as of September
30, 2008 to $229,329 as of September 30, 2009, a decline of 17.1%.
 
 All other
non-interest income showed an 11.2%, or $37,954, decrease from $338,209 in 2008
to $300,255 in 2009.  This is a result of a decrease in the income
generated by bank owned life insurance policies.  Income on the
policies was $319,000 as of September 30, 2008 compared to $281,000 as of
September 30, 2009, a decrease of $38,000.  The earnings on the
policies have declined due to the consistently low market interest rates at this
time.
 
 Year-to-date
income from service charges on deposit accounts has declined 3.0%, or $29,945,
from $1,002,293 in 2008 to $972,348 in 2009.  We experienced a $54,439
decrease related to fee income charged for overdrafts and checks drawn against
insufficient funds.
 
 Non-Interest
Expense
 
 Total
non-interest expense grew $612,000, or 8.5%, to $7.8 million for the
first nine months of 2009 from $7.2 million in the comparable period in
2008.  Non-interest expense on an annualized basis represented 3.06%
of average total assets in 2009 compared with 3.24% in the comparable period in
2008.
 
 15
 
 Salaries
and benefits decreased $413,000, or 9.8%, from $4.2 million for the nine months
ended September 30, 2008 to $3.8 million for the nine months ended September 30,
2009.  Management tries to utilize efficiencies to stabilize the
growth in full-time equivalent employees. At September 30, 2009, total full time
equivalent employees were 54 compared to 55 as of September 30,
2008.  As of September 30, 2009, assets per employee were $6.6 million
compared with $5.8 million as of September 30, 2008.
 
 Expenses
related to premises and equipment increased 5.7% to $738,000 in 2009 from
$699,000 for the same period in 2008.  The $39,000 increase in expense
in 2009 is the result of increases in software expense of $24,068 or 51.8% from
$46,000 to $70,500 as of September 30, 2008 and 2009, respectively. This expense
is related to enhancements in our on-line consumer banking product and software
to allow greater efficiency in performing our work. Miscellaneous equipment
expense showed an increase of $7,000 from $7,000 as of September 30, 2008 to
$14,000 as of September 30, 2009 Lease expense increased for the first nine
months of 2009 to $300,000 from $294,000 for the same period of 2008, an
increase of 2.0% or $6,000.
 
 Other
operating expense increased 43.8% to $3.2 million in 2009 from $2.3 million in
2008, an increase of $986,000. The increase is a result of a $494,000 increase
in insurance expense from $193,000 as of September 30, 2008 to $687,000 for the
period ending September 30, 2009. Of the $494,000 increase $491,000 was related
to the accrual for the FDIC assessment due to increases in premiums and a
special assessment from $114,000 for the nine months ended September 30, 2008 to
$605,000 as of September 30, 2009. Other categories of insurance showed
increases of $4,000 over prior year. There was a $351,256 increase in
professional fees from $823,000 as of September 30, 2008 to $1.2 million. This
is a result of increases in legal fees-corporate matters and legal fees-loan
collection expense of $94,000 and $83,000, respectively. Other areas of
professional fees showing increases are other professional fees which included
expenses relative to personnel salary and benefit consultant, outside marketing
assistance and information technology consultant expense, increase in Director
fees and retirement expenses, increase in accounting and tax expense and an
increase in other exam fees. Loan expense increased $177,000 from $29,000 as of
September 30, 2008 to $206,000.  We established a provision for
unfunded loan commitments, which created an expense in 2009 of $60,000, where in
the past this amount was included in the provision for loan losses. Other loan
expenses that have increased are expenses on foreclosed property, which reflects
costs associated with that property, as well as a write down to reflect the
market value of the property, higher appraisal expense due to the need to
re-evaluate non-accrual loans secured by real estate and increases in loan
collection expense.
 
 Provision
(Benefit) for Income Taxes
 
 The
Company recorded an income tax benefit of $1.4 million, or 53.02% of pre-tax
loss for the nine months ended September 30, 2009. This compares to income tax
expense of $1.4 million, or 33.24% of pre-tax income during the first nine
months of 2008. The percentage for 2009 exceeds the statutory rate due to
federal tax credits on California Affordable Housing Investments and tax exempt
income such as earnings on Bank owned life insurance and municipal loan and
investment income, which are in addition to the tax benefit generated as a
result of the net loss.
 
 16
 
 
 BALANCE
SHEET ANALYSIS
 
 Investments
 
 Investment
securities were $24.0 million at September 30, 2009, a 17.2% increase from the
$20.4 million at December 31, 2008 and a 55.4% increase from $15.4 million at
September 30, 2008.  The increase in the portfolio is a result of
Treasury and Agency purchases to pledge at the Federal Reserve Bank for discount
window borrowings, a contingent liquidity source for the Company.  We
will usually maintain an investment portfolio of securities rated “A” or higher
by Standard and Poor's or Moody's Investors Service.  Local tax-exempt
bonds are occasionally purchased without an “A” rating. In this uncertain time,
with the downgrades of the credit rating agencies, some bonds now have an
underlying rating of less than an “A” rating, although all except two have an
Investment Grade bond 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 September 30,
2009, we had securities totaling $13.4 million with a market value of $13.8
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 $10.6 million compared to an amortized
cost of $10.5 million as of September 30, 2009.
 
 There
were fifteen equity securities of $14,752 in the AFS portfolio and two
securities of $394,404 in the HTM portfolio that are temporarily impaired as of
September 30, 2009. Unrealized losses totaled $32,688 on equity securities and
$3,229 on municipal securities. Of the above, fourteen equity securities or
$11,617 in the AFS portfolio and both municipal securities in the HTM portfolio
that have been in a continuous loss position for 12 months or more as of
September 30, 2009.    The primary cause of the impairment
of this security is interest rate volatility due to market volatility and
downgrades of municipal insurers causing municipal securities to rely on the
underlying rating of the municipality which is typically lower than AAA
rated.  It is our intention to carry the securities to maturity date,
at which time we will receive face value for the securities at no loss. The
equity securities are minimal shares of local and peer group banks so that we
may better review their financial and compensation information.
 
 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 September 30, 2009 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.
 
 17
 
 Loans
 
 Loan
balances, net of deferred loan fees at September 30, 2009, were $286.0 million,
an increase of 7.0% or $18.6 million over December 31, 2008 and an increase of
8.5% or $22.3 million over September 30, 2008. As of September 30, 2009,
commercial loans were 70.8% of the portfolio and increased $19.7 million, or
10.8%, from December 31, 2008 and increased 14.0% or $25.0 million over
September 30, 2008.  Included in Commercial loans are loans made for
commercial purposes and secured by real estate.
 
 Real
Estate Mortgage loans were $23.8 million and showed growth over December 31,
2008 of 17.9% or $3.6 million and grew $3.8 million or 18.9% from $20.0 million
as of September 2008.
 
 Real
Estate Construction loans showing the largest decline were $24.3 million as of
September 30, 2009 and showed a decline of $3.7 million, or 13.1%, over December
31, 2008 and a decline of 25.2%, or $8.2 million, over September 30,
2008.
 
 Consumer
loans declined $664,000 (1.85%) to $35.2 million at September 30, 2009 from
$35.9 million as of December 31, 2008 and grew $1.4 million (4.26%) from
September 30, 2008.
 
 At
quarter end, overdrafts were $294,000, down $359,000 from $653,000 as of
December 31, 2008 and down $217,000 from $511,000 as of September 30,
2008.
 
 Lease
Financing Receivables are zero at September 30, 2009.  Customer
interest in lease financing receivables has declined in our market and we do not
anticipate this to change in the foreseeable future. We no longer offer this
product.
 
 September
      30,
                2009
              
              
              Percentage
                of Total
              
              
              December
      31,
                2008
              
              
              Percentage
                of Total
              
              
              September
      30,
                2008
              
              
              Percentage
                of TotalCommercial
              
              $
              202,704,435
              
              
              
              70.8
              %
              
              $
              182,975,920
              
              
              
              68.4
              %
              
              $
              177,735,467
              
              
              
              67.3
              %Consumer
              
              
              35,233,031
              
              
              
              12.3
              %
              
              
              35,896,690
              
              
              
              13.4
              %
              
              
              33,282,448
              
              
              
              12.6
              %Real
      estate construction
              
              
              24,259,429
              
              
              
              8.5
              %
              
              
              27,918,414
              
              
              
              10.4
              %
              
              
              32,419,685
              
              
              
              12.3
              %Real
      estate mortgage
              
              
              23,763,486
              
              
              
              8.3
              %
              
              
              20,163,163
              
              
              
              7.5
              %
              
              
              19,992,413
              
              
              
              7.6
              %Leases
              
              
              0
              
              
              
              0.0
              %
              
              
              17,634
              
              
              
              0.0
              %
              
              
              17,868
              
              
              
              0.0
              %Overdrafts
              
              
              294,385
              
              
              
              0.1
              %
              
              
              652,933
              
              
              
              0.2
              %
              
              
              510,966
              
              
              
              0.2
              %286,254,766
              
              
              
              100.0
              %
              
              
              267,624,754
              
              
              
              100.0
              %
              
              
              263,958,847
              
              
              
              100.0
              %Deferred
      loan fees and costs, net
              
              
              (249,749
              )
              
              
              
              
              
              
              (215,470
              )
              
              
              
              
              
              
              (258,242
              )Allowance
      for loan and lease losses
              
              
              (5,991,892
              )
              
              
              
              
              
              
              (5,032,500
              )
              
              
              
              
              
              
              (4,157,471
              )$
              280,013,125
              
              
              
              
              
              
              $
              262,376,784
              
              
              
              
              
              
              $
              259,543,134
 
 
 18
 
 
 Risk
Elements
 
 The
majority of our loan activity is with customers located within
Sonoma County, California.  Approximately 89.9% 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 as of September 30, 2009 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
than 90 days and other real estate owned (OREO).  Non-performing
assets for September 2009 totaled $7.1 million up from $2.2 million in September
2008. As of September 30, 2009 the non-performing assets to total loans ratio
was 2.47%, compared to 0.84% for the same period of 2008. It is important to
note that over 80% of the Bank’s non-performing assets are real estate secured
and have been written down to their current collateral value.
 
 Management
classifies loans as non-accrual loans when they become more than 90 days past
due, or when the timely collection of interest or principal becomes
uncertain.  A loan remains in a non-accrual status until both
principal and interest have been current for six months and meets cash flow or
collateral criteria. If the loan is determined to be uncollectible it is charged
off against the allowance for loan losses, or in the case of real estate loans,
is transferred to other real estate owned.
 
 There
were $6.6 million non-accrual loans at September 30, 2009, and there were no
delinquent loans past due 90 days or more and still accruing. As of September
30, 2008, there were $1.9 million non-accrual loans and there were no delinquent
loans past due 90 days or more and still accruing.  Of the $6.6
million non-accrual loans at September 30, 2009, $6.3 million were delinquent
loans past due 90 days or more compared to $1.5 million at September 30,
2008.
 
 OREO
represents assets held through loan foreclosure or recovery activities. As of
September 30, 2009, we had $478,610 classified as OREO compared to $285,665 as
of December 31, 2008 and $320,416 as of September 30, 2008.
 
 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.
 
 19
 
 In
keeping with the US generally accepted accounting principles a review process is
performed to identify loan customers who may be experiencing financial
difficulties.  Management reviews problem loans on a quarterly basis
and determines which loans are considered to be “Impaired Loans”. An appropriate
specific reserve is set aside for all loans graded substandard or worse and
greater than $400,000. The specific reserve is based upon either the estimated
future cash flows or the fair value of the collateral if a loan is collateral
dependent.  The Bank obtains updated appraisals, at least annually, on
all collateral dependent loans.  The impairment for collateral
dependent loans is then charged-off.  If no impairment is determined
(the value of the collateral exceeds the loan balance), then a reserve factor
for loan pools, as discussed below, will be assigned to that loan to cover any
costs associated with the liquidation of collateral.  All loans that
do not have a specific reserve are grouped together into pools based on similar
risk characteristics, including whether the loan is secured or
unsecured.   The specific loan pool is assigned an appropriate
reserve factor based upon management’s experience with losses in that risk
category and the Bank’s historical loss experience.  The total of
these loan pools is then adjusted for current conditions, based on several
qualitative factors (Q-Factors). These factors are as follows:
 
 1.
              
              Changes
      in lending policies and procedures, including changes in underwriting
      standards and collection, charge-off, and recovery practices not
      considered elsewhere in estimating credit losses.2.
              
              Changes
      in international, national, regional, and local economic and business
      conditions and developments that affect the collectability of the
      portfolio, including the condition of various market
    segments.3.
              
              Changes
      in the nature and volume of the portfolio and in the terms of
      loans.4.
              
              Changes
      in the experience, ability, and depth of lending management and other
      relevant staff.5.
              
              Changes
      in the volume of overdrafts, severity of past due loans, the volume of non
      accrual loans, the volume of unfunded loan commitments, and the volume and
      severity of adversely classified or graded loans.6.
              
              Changes
      in the quality of the Bank’s loans review system.7.
              
              The
      existence and effect of any concentrations of credit, and changes in the
      level of such concentrations.8.
              
              The
      effect of other external factors such as competition and legal and
      regulatory requirements on the level of estimated credit losses in the
      institution’s existing portfolio.
 
 
 The
allowance for loan losses is not a precise amount, but based on risk categories
assigned such as “watch”, “substandard”, or “doubtful” and the factors above,
represents management's best estimate of losses that may be ultimately realized
from the current loan portfolio.
 
 At
September 30, 2009, the allowance for loan losses was $6.0 million, or 2.10% of
period-end loans, compared with $5.0 million, or 1.88%, at December 31, 2008 and
$4.2 million, or 1.58%, at September 30, 2008. This boost is due to significant
increases in both charge-offs and non-performing assets and is reflective of the
current deteriorating banking and real estate environments.  The
increased reserve puts the Bank in a better position to deal with impaired
assets as they arise.
 
 Net
charge-offs to average loans increased when compared to the prior
year.  We recorded net charge-offs of $6.5 million as of September 30,
2009 compared to $396,000 as of September 30, 2008.  In accordance with
SFAS No.114 accounting standards, the Bank charges off estimated losses on
collateral dependent loans.   The Bank’s year to date net charge
offs of $6.5 million is largely due to the Bank’s recognition of estimated
losses caused by deterioration of real estate collateral values in the Bank’s
lending area.  One large lending relationship, secured by a commercial
construction project and a separate land development project, accounts for over
half of the Bank’s year to date net charge offs.
 
 20
 An
analysis of the changes in the allowance for loan losses, including charge-offs
and recoveries by loan categories, is presented below.
 
 
 For
      the Nine
                Months
      Ended
                9/30/09
              
              
              For
      the Year
                Ended
                12/31/08
              
              
              For
      the Nine
                Months
      Ended
                9/30/08Balance
      beginning of year
              
              $
              5,032,500
              
              
              $
              3,723,217
              
              
              $
              3,723,217Charge-offs:Commercial
              
              
              (3,894,084
              )
              
              
              (519,318
              )
              
              
              (120,120
              )Consumer
              
              
              (798,711
              )
              
              
              (449,556
              )
              
              
              (236,931
              )Real
      Estate Construction
              
              
              (1,351,016
              )
              
              
              0
              
              
              
              0Real
      Estate Mortgage
              
              
              (383,513
              )
              
              
              (28,400
              )
              
              
              (28,400
              )Leases
              
              
              (17,634
              )
              
              
              0
              
              
              
              0Overdrafts
              
              
              (88,212
              )
              
              
              (30,802
              )
              
              
              (30,802
              )Total
      charge-offs
              
              
              (6,533,170
              )
              
              
              (1,028,076
              )
              
              
              (416,253
              )Recoveries:Commercial
              
              
              56,329
              
              
              
              218,812
              
              
              
              13,443Consumer
              
              
              5,219
              
              
              
              1,691
              
              
              
              1,508Overdrafts
              
              
              1,014
              
              
              
              6,856
              
              
              
              5,556Total
      recoveries
              
              
              62,562
              
              
              
              227,359
              
              
              
              20,507Net
      recoveries (charge-offs)
              
              
              (6,470,608
              )
              
              
              (800,717
              )
              
              
              (395,746
              )Provision
      charged to operations
              
              
              7,430,000
              
              
              
              2,110,000
              
              
              
              830,000Balance
      end of period
              
              $
              5,991,892
              
              
              $
              5,032,500
              
              
              $
              4,157,471Ratio
      of net charge-offs annualized to average loans
              
              
              3.07
              %
              
              
              0.31
              %
              
              
              0.21
              %Balance
      in allowance as a percentage  of loans outstanding at period
      end
              
              
              2.10
              %
              
              
              1.88
              %
              
              
              1.58
              %
 
 Worsening
conditions in the general economy and real estate markets will likely continue
to adversely affect the loan portfolio, which could necessitate additional
provisions for loan losses, particularly on collateral dependent loans as the
bank continues to obtain updated appraisals.  As consumer spending and
personal cash flow weakens, there is increased risk associated with borrowers of
all types.  Although some believe the economy has begun to stabilize,
default rates and the unemployment rate continue to increase.  This is
usually an indicator that we can expect more foreclosures in the foreseeable
future.  Additionally, the drastic change in the availability of
credit during 2008 and continuing into 2009 has negatively impacted real estate
asset values, which serve as collateral to the majority of the Bank’s
loans.  This is especially true of loans secured by commercial real
estate for which the Bank has a significant concentration.  These
loans will continue to be carefully evaluated, on an on-going basis, for signs
of deterioration.
 
 As of
September 30, 2009, we believe the overall allowance for loan losses is adequate
based on our analysis of conditions at that time.
 
 
 21
 
 Deposits
 
 A
comparative schedule of average deposit balances is presented in the table on
page 13;period-end and
year-end deposit balances are presented in the following table.
 
 
 September
      30,
                2009
              
              
              Percentage
      of Total
              
              
              December
      31,
                2008
              
              
              Percentageof Total
              
              
              September
      30,
                2008
              
              
              Percentage
      of TotalInterest-bearing
      transaction deposits
              
              $
              32,471,725
              
              
              
              11.2
              %
              
              $
              31,062,597
              
              
              
              12.2
              %
              
              $
              28,306,822
              
              
              
              11.5
              %Savings
      deposits
              
              
              90,202,813
              
              
              
              31.2
              %
              
              
              88,317,397
              
              
              
              34.8
              %
              
              
              81,724,337
              
              
              
              33.0
              %Time
      deposits, $100,000 and over
              
              
              79,077,355
              
              
              
              27.4
              %
              
              
              50,694,468
              
              
              
              20.0
              %
              
              
              51,394,535
              
              
              
              20.8
              %Other
      time deposits
              
              
              36,365,253
              
              
              
              12.6
              %
              
              
              35,591,280
              
              
              
              14.0
              %
              
              
              31,767,944
              
              
              
              12.8
              %Total
      interest-bearing  deposits
              
              
              238,117,146
              
              
              
              82.4
              %
              
              
              205,665,742
              
              
              
              81.0
              %
              
              
              193,193,638
              
              
              
              78.1
              %Demand
      deposits
              
              
              50,941,938
              
              
              
              17.6
              %
              
              
              48,279,759
              
              
              
              19.0
              %
              
              
              54,162,469
              
              
              
              21,9
              %Total
      deposits
              
              $
              289,059,084
              
              
              
              100.0
              %
              
              $
              253,945,501
              
              
              
              100.0
              %
              
              $
              247,356,107
              
              
              
              100.0
              %
 
 
 Total
deposits increased by $35.1 million, or 13.8%, during the nine months of 2009 to
$289.1 million from $253.9 million at December 31, 2008, and increased by 16.9%
from $247.4 million as of September 30, 2008.  All categories of
deposits showed growth with time deposits greater that $100,000 showing the most
significant growth of 56.0% or $28.4 million from $50.7 million as of December
31, 2008 to $79.1 million at September 30, 2009. This growth is largely through
reciprocal CDARS deposits where our depositors spread deposits among other
financial institutions through the CDARS programs in order to realize FDIC
coverage of their deposits and we in turn accept deposits equal to the amount
sent to CDARS. Additionally, many of our depositors are taking advantage of the
higher $250,000 FDIC coverage now offered.
 
 Non
interest bearing demand also showed deposit growth of $2.6 million (5.5%) to
$50.9 million as of September 30, 2009 from $48.3 at December 31, 2008. Savings,
interest bearing checking and other time deposits also showed growth of $1.9
million, $1.4 million and $776,000 to $90.2 million, $32.5 million and $36.4
million, respectively.
 
 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 September 30, 2009, 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.
 
 22
 
 Based on
the FDIC's guidelines, the Bank's total risk-based capital ratio at September
30, 2009 was 12.14% and its Tier 1 risk-based capital ratio was
10.88%.  The Bank's leverage ratio was 9.11%.  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 September 30, 2009, were 12.76%, 11.50% and
9.64%, respectively.
 
 On
February 20, 2009, we completed the issuance of $8,653,000 of Series A preferred
stock and related warrant for Series B preferred stock under the U.S. Department
of Treasury’s Capital Purchase Program.  We issued 8,653 shares of
Series A preferred stock and a warrant to acquire 433 shares of Series B
preferred stock for the aggregate purchase price (collectively the “Preferred
Stock”). The warrant was exercised immediately and the 433 shares issued. The
Series A preferred stock has a cumulative dividend of 5% per annum for five
years and, unless redeemed, 9% thereafter.  The liquidation amount is
$1,000 per share.  The Series B preferred stock pays a dividend of
9%.  The Preferred Stock has no maturity date and ranks senior to the
Company’s common stock with respect to the payment of dividends and
distributions and amounts payable upon liquidation, dissolution and winding up
of the Company. The Preferred Stock is generally non-voting, other than class
voting on certain matters that could adversely affect the Preferred
Stock.
 
 The
Agreement contains limitations on certain actions of the Company, including, but
not limited to, payment of dividends, redemptions and acquisitions of Company
equity securities, and compensation of senior executive officers.
 
 In
February 2001, we approved a program to repurchase and retire Sonoma Valley
Bancorp stock. Effective February 20, 2009 the repurchase program has been
suspended pending the repayment of the Preferred Stock.
 
 In
September 2009, the shareholders were notified that the Board of Directors had
made a strategic decision to suspend its cash dividend program until further
notice.
 
 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 $40.2 million at September 30, 2009 and $46.6 million at September 30,
2008.Standby
letters of credit outstanding were $123,000 at September 30, 2009 and $118,000
at September 30, 2008.  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.
 
 23
 
 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 September 30, 2009, our primary liquidity ratio
(adjusted liquid assets to deposits and short term liabilities) was 10.44% of
assets compared to 7.67% as of September 30, 2008. Available liquidity,
which includes the ability to borrow at the Federal Home Loan Bank, was 27.3% of
assets as of September 30, 2009 and 37.9% as of September 30,
2008.  Management expects that liquidity will remain adequate
throughout 2009, as deposit growth keeps pace with loan growth.  Any
excess funds will be invested in quality liquid assets, such as excess reserves
with the Federal Reserve Bank or 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.  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.
 
 24
 
 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 a flat rate forecast, 100, 200 and 300 basis point rising rate
forecasts and a 25 basis point declining rate forecast which take place within a
one year time frame.  Normally we forecast a 100, 200, and 300 basis
point declining rate forecast, but since the target Fed Funds is currently 0 –
25 basis points we feel we cannot forecast a declining rate scenario of more
than 25 basis points. The net interest income is measured during the year
assuming a gradual change in rates over the twelve-month horizon.  Our
2009 net interest income, as forecast below, was modeled utilizing a forecast
balance sheet projected from September 30, 2009 balances.  The
following table summarizes the effect on net interest income (NII) of 100, 200
and 300 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 September 30,
2009
 (dollars
in thousands)
 
 Variation
      from a constant rate scenario
              
              
              $
      Change in NII+300bp
              
              
              $
              1,347+200bp
              
              
              $
              764+100bp
              
              
              $
              302-25bp
              
              
              $
              (53)
 
 The
simulations of earnings do not incorporate any management actions. 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.
 
 25
 
 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.  However, because the
Company’s asset rates change more than deposit rates, the Company’s interest
income will change more than the cost of funds when rates change. Its net
interest margin should therefore increase somewhat when rates increase and
shrink somewhat when rates fall. 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 $76.3 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 September 30, 2009 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 $175.6 million in
fixed rate assets over 12 months, shown in the table below, $15.3 million are
long term assets over five years.  This $15.3 million compares
favorably to the $89.0 million in demand and core deposits and
equity.
 
 SEPTEMBER
      30, 2009
                (dollars
      in thousands)
              
              Immediate
                Reprice
              
              
              Up
      to 3
                Months
              
              
              4
      to 6
                Months
              
              
              7
      to 12
                Months
              
              
              Over
      12
                Months
              
              
              TotalFFS
      + overnight IBB
              
              $
              21,762
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              21,762Securities
      + Other IBB
              
              
              0
              
              
              $
              985
              
              
              $
              421
              
              
              $
              843
              
              
              $
              21,709
              
              
              
              23,958Loans
              
              
              52,384
              
              
              
              11,886
              
              
              
              21,635
              
              
              
              40,179
              
              
              
              153,929
              
              
              
              280,013Total
      RSA
              
              $
              74,146
              
              
              $
              12,871
              
              
              $
              22,056
              
              
              $
              41,022
              
              
              $
              175,638
              
              
              $
              325,733MMDA/NOW/SAV
              
              $
              122,674
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              122,674CD’s
      <$100k
              
              
              0
              
              
              $
              10,298
              
              
              $
              10,465
              
              
              $
              10,465
              
              
              $
              5,138
              
              
              
              36,366CD’s
      >$100k
              
              
              0
              
              
              
              23,944
              
              
              
              34,856
              
              
              
              8,714
              
              
              
              11,564
              
              
              
              79,078Borrowings
              
              
              0
              
              
              
              0
              
              
              
              0
              
              
              
              5,000
              
              
              
              15,000
              
              
              
              20,000Total
      RSL
              
              $
              122,674
              
              
              $
              34,242
              
              
              $
              45,321
              
              
              $
              24,179
              
              
              $
              31,702
              
              
              $
              258,118GAP
              
              $
              (45,528
              )
              
              $
              (21,371
              )
              
              $
              (23,265
              )
              
              $
              16,843
              
              
              $
              143,936
              
              
              $
              67,615Cumulative
              
              $
              (45,528
              )
              
              $
              (69,899
              )
              
              $
              (93,164
              )
              
              $
              (76,321
              )
              
              $
              67,615%
      Assets
              
              
              -13.7
              %
              
              
              -19.8
              %
              
              
              -26.3
              %
              
              
              -21.6
              %
              
              
              19.1
              %
 
 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.
 
 26
 
 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 17 for discussion of investments).  The portfolio should
decline in value $478,000 for a 1% increase in rates.  The current
gain in the portfolio is $488,000 which means for a 1% interest rate shock the
gain would be $10,000. 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).
 
 27
 SONOMA
VALLEY BANCORP
 AVERAGE BALANCES/YIELDS AND RATES
PAID
 For the
three months ended September 30, 2009 and 2008
 
 2009
              
              
              2008ASSETS
              
              Average
                Balance
              
              
              Income/
                Expense
              
              
              Yield/
                Rate
              
              
              Average
                Balance
              
              
              Income/
                Expense
              
              
              Yield/
                RateInterest-earning
      assets:Loans(2):Commercial
              
              $
              201,902,807
              
              
              $
              3,230,649
              
              
              
              6.35
              %
              
              $
              175,215,278
              
              
              $
              3,134,791
              
              
              
              7.10
              %Consumer
              
              
              36,505,309
              
              
              
              580,864
              
              
              
              6.31
              %
              
              
              32,782,080
              
              
              
              578,947
              
              
              
              7.01
              %Real
      estate construction
              
              
              25,120,500
              
              
              
              340,972
              
              
              
              5.39
              %
              
              
              29,788,071
              
              
              
              569,324
              
              
              
              7.58
              %Real
      estate mortgage
              
              
              23,670,818
              
              
              
              421,179
              
              
              
              7.06
              %
              
              
              19,796,888
              
              
              
              348,622
              
              
              
              6.99
              %Tax
      exempt loans (1)
              
              
              2,055,303
              
              
              
              42,714
              
              
              
              8.25
              %
              
              
              2,168,815
              
              
              
              45,018
              
              
              
              8.24
              %Leases
              
              
              0
              
              
              
              0
              
              
              
              0.00
              %
              
              
              18,459
              
              
              
              539
              
              
              
              11.58
              %Unearned
      loan fees
              
              
              (253,498
              )
              
              
              
              
              
              
              
              
              
              
              (276,328
              )Total
      loans
              
              
              289,001,239
              
              
              
              4,616,378
              
              
              
              6.34
              %
              
              
              259,493,263
              
              
              
              4,677,241
              
              
              
              7.15
              %Investment
      securitiesAvailable
      for sale:Taxable
              
              
              8,672,875
              
              
              
              46,019
              
              
              
              2.11
              %
              
              
              2,040,040
              
              
              
              14,553
              
              
              
              2.83
              %Hold
      to maturity:Tax
      exempt (1)
              
              
              13,461,701
              
              
              
              199,884
              
              
              
              5.89
              %
              
              
              13,651,033
              
              
              
              196,700
              
              
              
              5.72
              %Total
      investment securities
              
              
              22,134,578
              
              
              
              245,903
              
              
              
              4.41
              %
              
              
              15,691,073
              
              
              
              211,253
              
              
              
              5.34
              %CA
      Warrants
              
              
              91,706
              
              
              
              837
              
              
              
              3.62
              %
              
              
              0
              
              
              
              0
              
              
              
              0.00
              %Federal
      funds sold
              
              
              0
              
              
              
              0
              
              
              
              0.00
              %
              
              
              23,555
              
              
              
              76
              
              
              
              1.28
              %FHLB
      stock
              
              
              1,645,000
              
              
              
              0
              
              
              
              0.00
              %
              
              
              1,477,089
              
              
              
              24,298
              
              
              
              6.53
              %Total
      due from banks/interest-bearing
              
              
              31,791,398
              
              
              
              17,346
              
              
              
              0.22
              %
              
              
              3,055,401
              
              
              
              5,953
              
              
              
              .77
              %Total
      interest-earning assets
              
              
              344,663,919
              
              
              $
              4,880,464
              
              
              
              5.62
              %
              
              
              279,740,381
              
              
              $
              4,918,821
              
              
              
              6.98
              %Noninterest-bearing
      assets:Reserve
      for loan losses
              
              
              (8,615,790
              )
              
              
              
              
              
              
              
              
              
              
              (4,087,362
              )Cash
      and due from banks
              
              
              5,090,475
              
              
              
              
              
              
              
              
              
              
              
              5,510,959Premises
      and equipment
              
              
              646,315
              
              
              
              
              
              
              
              
              
              
              
              792,107Other
      real estate owned
              
              
              297,832
              
              
              
              
              
              
              
              
              
              
              
              320,416Other
      assets
              
              
              20,113,662
              
              
              
              
              
              
              
              
              
              
              
              17,010,745Total
      assets
              
              $
              362,196,413
              
              
              
              
              
              
              
              
              
              
              $
              299,287,246LIABILITIES
      AND SHAREHOLDERS' EQUITYInterest-bearing
      liabilities:Interest-
      bearing depositsInterest-bearing
      transaction
              
              $
              33,855,559
              
              
              $
              13,631
              
              
              
              0.16
              %
              
              $
              29,773,852
              
              
              $
              12,457
              
              
              
              0.17
              %Savings
      deposits
              
              
              93,034,074
              
              
              
              199,734
              
              
              
              0.85
              %
              
              
              79,737,471
              
              
              
              348,426
              
              
              
              1.73
              %Time
      deposits over $100,000
              
              
              70,166,186
              
              
              
              395,921
              
              
              
              2.24
              %
              
              
              51,496,000
              
              
              
              442,232
              
              
              
              3.41
              %Other
      time deposits
              
              
              39,354,763
              
              
              
              183,456
              
              
              
              1.85
              %
              
              
              31,748,081
              
              
              
              252,826
              
              
              
              3.16
              %Total
      interest-bearing deposits
              
              
              236,410,582
              
              
              
              792,742
              
              
              
              1.33
              %
              
              
              192,755,404
              
              
              
              1,055,941
              
              
              
              2.17
              %Federal
      funds purchased
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              539,674
              
              
              
              2,578
              
              
              
              1.90
              %Other
      borrowings
              
              
              29,428,315
              
              
              
              187,324
              
              
              
              2.53
              %
              
              
              17,524,412
              
              
              
              177,344
              
              
              
              4.01
              %Total
      interest-bearing liabilities
              
              
              265,838,897
              
              
              $
              980,066
              
              
              
              1.46
              %
              
              
              210,819,490
              
              
              $
              1,235,863
              
              
              
              2.33
              %Non-interest-bearing
      liabilities:Non-interest-bearing
      demand deposits
              
              
              50,148,413
              
              
              
              
              
              
              
              
              
              
              
              51,086,420Other
      liabilities
              
              
              7,588,031
              
              
              
              
              
              
              
              
              
              
              
              6,960,284Shareholders'
      equity
              
              
              38,621,072
              
              
              
              
              
              
              
              
              
              
              
              30,421,052Total
      liabilities and shareholders' equity
              
              $
              362,196,413
              
              
              
              
              
              
              
              
              
              
              $
              299,287,246Interest
      rate spread
              
              
              
              
              
              
              
              
              
              
              4.16
              %
              
              
              
              
              
              
              
              
              
              
              4.65
              %Interest
      income
              
              
              
              
              
              $
              4,880,464
              
              
              
              5.62
              %
              
              
              
              
              
              $
              4,918,821
              
              
              
              6.98
              %Interest
      expense
              
              
              
              
              
              
              980,066
              
              
              
              1.13
              %
              
              
              
              
              
              
              1,235,863
              
              
              
              1.75
              %Net
      interest income/margin
              
              
              
              
              
              $
              3,900,398
              
              
              
              4.49
              %
              
              
              
              
              
              $
              3,682,958
              
              
              
              5.23
              %
 
 (1)
              Fully
      tax equivalent adjustments are based on a federal income tax rate of 34%
      in 2009 and 2008.
 (2)
              Non
      accrual loans have been included in loans for the purposes of the above
      presentation.  Loan fees of approximately $58,683 and $73,855
      for the three months ended September 30, 2009 and 2008, respectively, were
      amortized to the appropriate interest income
  categories.
  28
 For the Three Month Periods
 Ended
September 30, 2009 and 2008
 
 Overview
 
 We
reported a net loss of $358,245 for the third quarter of 2009. This represents a
decline of $1.3 million from earnings of $916,075 during the same period ended
September 30, 2008.   The decline in earnings is a result of a $2.25
million increase in the provision for loan losses, $127,000 increase in non
interest expense, a $9,000 decline in non interest income offset by a $217,000
increase in net interest income and an $894,000 decline in the provision for
income tax.
 
 Net
income (loss) allocable to common shareholders declined from net income of
$916,075 during the three months ended September 30, 2008 to a net loss of
$495,180 during the same period 2009. Included in the current year loss was the
net loss of $358,245 and $136,935 which represents dividends accrued and
discount amortized on preferred stock.  On a per share basis, net loss
for the three months ended September 30, 2009 equaled ($0.21) per diluted share
compared with net income of $0.40 per diluted share during the same period in
2008. See page 4 for the comparative detail.
 
 Return
(loss) on average total assets on an annualized basis for the three months ended
September 30, 2009 and 2008 was (.40%) and 1.22%,
respectively.  Return (loss) on average shareholders' equity on an
annualized basis for the three months ended September 30, 2009 and 2008 was
(3.71%) and 12.05%, respectively.  The decrease in the return on
equity is a result of the decline in earnings and the increase in average equity
when comparing the third quarter of 2009 to 2008.
 
 RESULTS
OF OPERATIONS
 
 Net
Interest Income
 
 Net
interest income, adjusted to a fully taxable equivalent basis, increased by
$217,000 to $3.9 million for the three months ended September 30, 2009, from
$3.7 million during the comparable period of 2008.  Net interest
income on a fully taxable equivalent basis, as shown on the table “Average
Balances/Yields and Rates Paid” on page 28, 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 ($82,482 in 2009 and $82,184
in 2008, 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 third quarter of 2009
decreased 74 basis points to 4.49% from 5.23% for the quarter ended September
30, 2008.  The decrease in net interest margin is the result of the
yield on earning assets declining faster than the yield on earning
liabilities.  For the three months ended September 30, 2009, the yield
on average earning assets has decreased 136 basis points, while the yield on
interest-bearing liabilities decreased 87 basis points from 2.33% for the three
months of 2008 to 1.46% for the three month period ended September 30,
2009.  The Federal Reserve Bank has continued to lower
rates.  As of September 30, 2009 the federal funds rate was 0.00% -
0.25% and the prime rate was 3.25% compared to the fed funds rate of 2.00% and
prime lending rate of 5.00% as of September 30, 2008.
 
 29
 
 Interest
Income
 
 Interest
income, adjusted to a fully taxable equivalent basis, for the three months ended
September 30, 2009 decreased by $38,000 to $4.88 million, a 0.78% decrease over
the $4.92 million realized during the same period in 2008.  The gain
in volume of average balances was responsible for a $538,000 increase in
interest income and a $576,000 decrease in income was related to lower interest
rates, resulting in a net decline in interest income of $38,000.
 
 Interest
Expense
 
 Total
interest expense for the three months ended September 30, 2009 decreased by
$256,000 to $980,000 compared with $1.2 million in the same period of
2008.  The average rate paid on all interest-bearing liabilities for
the third quarter of 2009 decreased 87 basis points to 1.46% from 2.33% in
the third quarter of 2008. Average interest-earning liabilities for the third
quarter of 2009 increased to $265.8 million from $210.8 million in the same
period of 2008, a 26.1% gain.
 
 The gain
in volume of average balances accounted for a $247,000 increase in interest
expense while a decline of $503,000 was related to lower interest rates paid,
resulting in a $256,000 decrease in interest expense for the third quarter of
2009.
 
 Individual
components of interest income and interest expense are provided in the table
“Average Balances/Yields and Rates Paid” on page 28.
 
 Provision
for Loan Losses
 
 The
provision for loan losses was $2.55 million during the third quarter of 2009
compared to the $300,000 provision for the third quarter of
2008.  This increase is primarily due to net charge offs during the
quarter of $5.2 million and a significant increase in non performing assets. The
Company continues to accrue based on the assessment of the loan portfolio in
light of current economic conditions and the continuing decline in real estate
values in the bank’s lending area.
 
 Non-interest
Income
 
 Non-interest
income of $520,000 for the third quarter of 2009 represented a decrease of
$9,000, or 1.62%, from the $529,000 for the comparable period in
2008.  Contributing to this variance was a decline in income generated
by bank-owned life insurance policies. Income on the policies was $96,000 for
the quarter ending September 30, 2009 compared to $107,000 for the same period
in 2008.
 
 Non-interest
Expense
 
 For the
third quarter of 2009, non-interest expense was $2.58 million compared with
$2.45 million for the same period in 2008, representing an increase of $127,000,
or 5.2%.The largest increase was in the area of other non interest expense which
increased $303,000 (37.6%) from $805,000 as of September 30, 2008 to $1.1
million as of September 30, 2009.  The largest increase in other
non-interest expense was in the accrual for FDIC insurance and a special
assessment from $42,000 for the three months ended September 30, 2008 to
$180,000 for the same period ended September 30, 2009, an increase of $138,000.
Professional fee expense increased $110,000, or 33.8% from $324,000 for the
three months ended September 30, 2008 to $434,000 for the same period in 2009.
This is a result of increases in consulting fees and legal fees for loan
collections of $42,000 and $35,000, respectively.
 
 30
 
 Salaries
and benefits expense decreased $186,000, or 13.2% for the three months ended
September 30, 2009 from $1.41 million to $1.23 million. At September 30, 2009
and September 2008, total full-time equivalent employees were 54 and 55,
respectively.
 
 The
expenses for premises and equipment increased 4.2% from $234,000 for the third
quarter of 2008 to $244,000 in 2009.  The $10,000 increase in expense
in 2009 is a result of increased building lease expense and additional software
costs.
 
 Provision
(Benefit) for Income Taxes
 
 The
Company recorded an income tax benefit of $433,859, or 54.8% of pre-tax loss for
the quarter ended September 30, 2009. This compares to income tax expense of
$459,843, or 33.4% of pre-tax income for the comparable quarter of 2008. The
percentage for 2009 exceeds the statutory rate due to federal tax credits on
California Affordable Housing Investments and tax exempt income such as earnings
on Bank owned life insurance and municipal loan and investment income which are
in addition to the tax benefit generated as a result of the net
loss.
 
 Item 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURE
ABOUT MARKET RISK
 
 
 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 September 30, 2009, 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.
 
 31
 
 Part
II
 
 Item 1.  LEGAL PROCEEDINGS
  From time
to time we are involved in litigation incidental to the conduct of our
business.  While the outcome of lawsuits and other proceedings against us
cannot be predicted with certainty, in the opinion of management, individually,
or in the aggregate, no such lawsuits are expected to have a material effect on
our financial position or results of operations.
 
 Item 1A. RISK FACTORS
 
 The risks
identified in the Annual Report on Form 10-K for the year ended December 31,
2008, have not changed in any material respect, except that additional risk
factors are added at the end of the list of risk factors under Item 1A to read
in its entirety as follows:
 
 If
Economic Conditions Deteriorate, Our Results of Operations and Financial
Condition could be Adversely Impacted.
 
 Our
financial results may be adversely affected by changes in prevailing economic
conditions, including decreases in real estate values, changes in interest rates
which may cause a decrease in interest rate spreads, adverse employment
conditions, the monetary and fiscal policies of the federal government and other
significant external events, including credit availability from correspondent
banks. Adverse changes in the economy may also have a negative effect of the
ability of borrowers to make timely repayments of their loans, which could have
an adverse impact on earnings.
 
 Our Securities Portfolio may be
Negatively Impacted by Fluctuations in Market Value.
 
 Our
securities portfolio may be impacted by fluctuations in market value,
potentially reducing accumulated other comprehensive income and/or earnings.
Fluctuations in market value may be caused by decreases in interest rates, lower
market prices for securities and lower investor demand. Our securities portfolio
is evaluated for other-than-temporary impairment on at least a quarterly basis.
If this evaluation shows an impairment to cash flow connected with one or more
securities, a potential loss to earnings may occur.
 
 Current
levels of market volatility are unprecedented.
 
 The
market for certain investment securities has become highly volatile or inactive,
and may not stabilize or resume in the near term. This volatility can result in
significant fluctuations in the prices of those securities, which may affect the
Company’s results of operations.
 
 Our
business has been and may continue to be adversely affected by current
conditions in the financial markets and economic conditions
generally.
 
 The
global and U.S. economies are experiencing significantly reduced business
activity and consumer spending as a result of, among other factors, disruptions
in the capital and credit markets during the past year. Dramatic declines in the
housing market during the past year, with falling home prices and increasing
foreclosures and unemployment, have resulted in significant write-downs of asset
values by financial institutions, including government-sponsored entities and
major commercial and investment banks.
 
 32
 
 A
sustained weakness or weakening in business and economic conditions generally or
specifically in the principal markets in which we do business could have one or
more of the following adverse effects on our business:
 
 •
              a
      decrease in the demand for loans or other products and services offered by
      us;
 
 •
              a
      decrease in the value of our loans or other assets secured by consumer or
      commercial real estate;
 
 •
              a
      decrease to deposit balances due to overall reductions in the accounts of
      customers;
 
 •
              an
      impairment of certain intangible assets or investment
      securities;
 
 •
              an
      increase in the number of borrowers who become delinquent, file for
      protection under bankruptcy laws or default on their loans or other
      obligations to us. An increase in the number of delinquencies,
      bankruptcies or defaults could result in a higher level of nonperforming
      assets, net charge-offs and provision for credit
  losses.
 
 Additional requirements under our
regulatory framework, especially those imposed under the American Recovery and
Reinvestment Act of 2009 ("ARRA"), the Emergency Economic Stabilization Act of
2008 ("EESA") or other legislation intended to strengthen the U.S. financial
system, could adversely affect us.
 
 Recent
government efforts to strengthen the U.S. financial system, including the
implementation of ARRA, EESA, the FDIC’s Temporary Liquidity Guaranty Program
(“TLGP”) and special assessments imposed by the FDIC, subject participants to
additional regulatory fees and requirements, including corporate governance
requirements, executive compensation restrictions, restrictions on declaring or
paying dividends, restrictions on share repurchases, limits on executive
compensation tax deductions and prohibitions against golden parachute payments.
These requirements, and any other requirements that may be subsequently imposed,
may have a material and adverse affect on our business, financial condition, and
results of operations.
 
 If
we are unable to redeem the Series A Preferred Stock within five years, the cost
of this capital to us will increase substantially.
 
 If we are
unable to redeem the Series A Preferred Stock prior to February 20, 2014, the
cost of the Series A Preferred Stock will increase substantially on that date,
from 5.0% per annum to 9.0% per annum. Depending on our financial condition at
the time, this increase in the annual dividend rate on the Series A Preferred
Stock could have a material negative effect on our liquidity.
 
 33
 
 Certain
restrictions will affect our ability to declare or pay dividends and repurchase
our shares as a result of our decision to participate in the Treasury’s Capital
Purchase program (the “CPP”).
 
 As a
result of our participation in the CPP, our ability to declare or pay dividends
on any of our common stock has been limited. Specifically, we are not able to
declare dividend payments on our common, junior preferred or pari passu
preferred stock if we are in arrears on the dividends on our Preferred
Stock.
 
 Further,
we are not permitted to increase dividends on our common stock without the
Treasury’s approval until the third anniversary of the investment unless the
Preferred Stock has been redeemed or transferred. In addition, our ability to
repurchase our shares has been restricted. The Treasury’s consent generally will
be required for us to make any stock repurchases until the tenth anniversary of
the investment by the Treasury unless the Preferred Stock has been redeemed or
transferred.
 
 Item 2.  UNREGISTERED SALES OF EQUITY
SECURITIES AND USE OF PROCEEDS
 
 None
 
 Item 3.  DEFAULTS UPON SENIOR
SECURITIES
 
 None
 
 Item 4.  SUBMISSION OF MATTERS TO A VOTE OF
SECURTIY HOLDERS
 
 None
 
 Item 5.  OTHER INFORMATION
 
 None
 
 34
 
 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
 
 35
 
 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:
              November
      12, 2009
              
              /s/Sean
      C. CuttingSean
      C. CuttingPresident
      and Chief Executive Officer(Principal
      Executive Officer)Date:
              November
      12, 2009
              
              /s/Mary
      Dieter SmithMary
      Dieter SmithExecutive
      Vice President and Chief Financial Officer(Principal
      Financial Officer and Principal Accounting Officer)
 
 36