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,
2008








 ̈
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE


ACT OF
1934





For the
transition period ended: ____________ to
____________





Commission
File Number: 000-31929





SONOMA
VALLEY BANCORP


(Exact
name of registrant as specified in its charter)





CALIFORNIA
            68-0454068(State
      of Incorporation)
            (I.R.S.
      Employer Identification No.)202
      West Napa Street Sonoma, California
            95476(Address
      of principal executive offices)
            (Zip
      Code)





(707)
935-3200


(Registrant's
telephone number, including area code)





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.


Yes   x                                           No    ̈





Indicate
by a check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See the definitions of “large accelerated filer,” “large
accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.





Large
accelerated
filer                 ̈                                                                                       
Accelerated filer    ̈


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





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).





Yes  ̈                                           No  x





The
number of shares outstanding of the registrant's Common Stock, no par value, as
of November 3, 2008 was 2,287,894.














INDEX





Part
      I  Financial Information
            Page
      NumberItem
      1. Financial Statements (Unaudited):Consolidated Balance Sheets at
      September 30, 2008, December 31, 2007 and September 30,
      2007
            3Consolidated Statements of Operations for
      the three and nine  months ended September 30, 2008 and
      2007
            4Consolidated Statements of Changes in
      Shareholders’ Equity for the nine months ended September 30, 2008,
      and the years ended December 31, 2007 and 2006
            5Consolidated Statements of Cash Flows for
      the nine months ended September 30, 2008 and 2007
            7Notes to Consolidated Financial
      Statements
            8Average Balances/Yields and Rates
      Paid for the nine months ended September 30, 2008 and
      2007
            11Item 1A. Risk Factors
            12Item 2. Management's Discussion and
      Analysis of Financial Condition and Results of
    Operations
            12Average Balances/Yields and Rates Paid for
      the three months ended September 30, 2008 and
2007
            26Item 3. Quantitative and Qualitative
      Disclosure About Market Risk
            28Item 4. Controls and
      Procedures
            29Part II  Other InformationItem 1. Legal Proceedings
            30Item 2. Unregistered Sales of Equity Securities
      and Use of Proceeds
            30Item 3. Defaults Upon Senior
      Securities
            30Item 4. Submission of Matters to a Vote of
      Security Holders
            30Item 5. Other Information
            30Item 6. Exhibits
            31Signatures
            32Certifications








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, 2008 (Unaudited), December 31, 2007 (Audited)


and
September 30, 2007 (Unaudited)


September
      30,
                  2008
                
                
                December
      31,
                  2007
                
                
                September
      30,
                  2007ASSETSCash
      and due from banks
                
                $
                6,891,263
                
                
                $
                6,268,091
                
                
                $
                7,078,751Interest-bearing
      due from banks
                
                
                15,381,775
                
                
                
                3,065,543
                
                
                
                1,533,209Total
      cash and cash equivalents
                
                
                22,273,038
                
                
                
                9,333,634
                
                
                
                8,611,960Investment
      securities available-for-sale at fair value
                
                
                2,036,539
                
                
                
                8,203,190
                
                
                
                10,156,112Investment
      securities held-to-maturity (fair value of $13,524,623, $14,754,249 and
      $15,782,933 respectively)
                
                
                13,382,308
                
                
                
                14,554,224
                
                
                
                15,686,806Loans
      and lease financing receivables, net
                
                
                259,543,134
                
                
                
                246,738,218
                
                
                
                245,084,808Premises
      and equipment, net
                
                
                786,261
                
                
                
                792,455
                
                
                
                828,243Accrued
      interest receivable
                
                
                1,659,077
                
                
                
                1,682,209
                
                
                
                1,818,770Other
      real estate owned
                
                
                320,416
                
                
                
                0
                
                
                
                0Cash
      surrender value of life insurance
                
                
                10,673,741
                
                
                
                10,354,153
                
                
                
                10,249,739Other
      assets
                
                
                6,774,039
                
                
                
                6,201,195
                
                
                
                5,887,051Total
      assets
                
                $
                317,448,553
                
                
                $
                297,859,278
                
                
                $
                298,323,489LIABILITIESNoninterest-bearing
      demand deposits
                
                $
                54,162,469
                
                
                $
                58,589,202
                
                
                $
                53,712,752Interest-bearing
      transaction deposits
                
                
                28,306,822
                
                
                
                30,135,049
                
                
                
                27,746,096Savings
      and money market deposits
                
                
                81,724,337
                
                
                
                73,528,081
                
                
                
                74,197,697Time
      deposits, $100,000 and over
                
                
                51,394,535
                
                
                
                44,160,741
                
                
                
                44,423,070Other
      time deposits
                
                
                31,767,944
                
                
                
                29,634,626
                
                
                
                28,856,247Total
      deposits
                
                
                247,356,107
                
                
                
                236,047,699
                
                
                
                228,935,862Other
      borrowings
                
                
                33,000,000
                
                
                
                27,500,000
                
                
                
                36,600,000Accrued
      interest payable and other liabilities
                
                
                6,745,006
                
                
                
                6,377,299
                
                
                
                6,069,273Total
      liabilities
                
                
                287,101,113
                
                
                
                269,924,998
                
                
                
                271,605,135SHAREHOLDERS'
      EQUITYCommon
      stock, no par value; 10,000,000 shares authorized; 2,288,709 shares at
      September 30, 2008, 2,242,809 shares at December 31, 2007 and 2,242,401
      shares at September 30, 2007 issued and outstanding
                
                
                16,385,614
                
                
                
                15,578,903
                
                
                
                15,563,152Additional
      paid-in-capital
                
                
                2,520,540
                
                
                
                2,455,409
                
                
                
                2,353,547Retained
      earnings
                
                
                11,451,730
                
                
                
                9,934,967
                
                
                
                8,864,479Accumulated
      other comprehensive loss
                
                
                (10,444
                )
                
                
                (34,999
                )
                
                
                (62,824
                )Total
      shareholders' equity
                
                
                30,347,440
                
                
                
                27,934,280
                
                
                
                26,718,354Total
      liabilities and shareholders' equity
                
                $
                317,448,553
                
                
                $
                297,859,278
                
                
                $
                298,323,489





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 30,2008
                
                
                2007
                
                
                2008
                
                
                2007INTEREST
      INCOMELoans
      and leases
                
                $
                4,661,936
                
                
                $
                5,005,194
                
                
                $
                14,335,110
                
                
                $
                14,508,959Taxable
      securities
                
                
                14,473
                
                
                
                98,603
                
                
                
                83,440
                
                
                
                374,280Tax-exempt securities
                
                
                129,822
                
                
                
                153,069
                
                
                
                399,165
                
                
                
                461,319Federal funds sold and other
                
                
                6,029
                
                
                
                4,325
                
                
                
                38,469
                
                
                
                22,000Dividends
                
                
                24,377
                
                
                
                18,176
                
                
                
                74,224
                
                
                
                50,429Total
      interest income
                
                
                4,836,637
                
                
                
                5,279,367
                
                
                
                14,930,408
                
                
                
                15,416,987INTEREST
      EXPENSEInterest-bearing
      transaction deposits
                
                
                12,457
                
                
                
                11,150
                
                
                
                37,592
                
                
                
                35,425Savings
      and money market deposits
                
                
                348,426
                
                
                
                484,318
                
                
                
                1,112,540
                
                
                
                1,408,138Time
      deposits, $100,000 and over
                
                
                442,232
                
                
                
                526,022
                
                
                
                1,546,942
                
                
                
                1,436,321Other
      time deposits
                
                
                252,826
                
                
                
                330,872
                
                
                
                886,185
                
                
                
                952,576Other
      borrowings
                
                
                179,922
                
                
                
                356,056
                
                
                
                623,716
                
                
                
                898,542Total
      interest expense
                
                
                1,235,863
                
                
                
                1,708,418
                
                
                
                4,206,975
                
                
                
                4,731,002NET
      INTEREST INCOME
                
                
                3,600,774
                
                
                
                3,570,949
                
                
                
                10,723,433
                
                
                
                10,685,985Provision
      for loan and lease losses
                
                
                300,000
                
                
                
                140,000
                
                
                
                830,000
                
                
                
                565,000NET
      INTEREST INCOME AFTER
                  PROVISION
      FOR LOAN AND
                  LEASE
      LOSSES
                
                
                3,300,774
                
                
                
                3,430,949
                
                
                
                9,893,433
                
                
                
                10,120,985NON-INTEREST
      INCOME
                
                
                528,883
                
                
                
                581,340
                
                
                
                1,617,271
                
                
                
                1,710,458NON-INTEREST
      EXPENSESalaries
      and employee benefits
                
                
                1,414,357
                
                
                
                1,387,070
                
                
                
                4,229,827
                
                
                
                4,173,571Premises
      and equipment
                
                
                233,897
                
                
                
                244,068
                
                
                
                698,697
                
                
                
                730,623Other
                
                
                805,485
                
                
                
                699,476
                
                
                
                2,253,235
                
                
                
                1,898,427Total
      non-interest expense
                
                
                2,453,739
                
                
                
                2,330,614
                
                
                
                7,181,759
                
                
                
                6,802,621Income
      before provision for income taxes
                
                
                1,375,918
                
                
                
                1,681,675
                
                
                
                4,328,945
                
                
                
                5,028,822Provision
      for income taxes
                
                
                459,843
                
                
                
                589,171
                
                
                
                1,438,956
                
                
                
                1,847,262NET
      INCOME
                
                $
                916,075
                
                
                $
                1,092,504
                
                
                $
                2,889,989
                
                
                $
                3,181,560NET
      INCOME PER SHARE
                
                $
                .41
                
                
                $
                .49
                
                
                $
                1.28
                
                
                $
                1.42NET
      INCOME PER SHARE
                  ASSUMING
      DILUTION
                
                $
                .40
                
                
                $
                .47
                
                
                $
                1.26
                
                
                $
                1.37





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, 2008 (Unaudited), and the years
ended


December
31, 2007 (Audited) and 2006 (Audited)


Comprehensive
                      
                      
                      Common
      Stock
                      
                      
                      Additional
      Paid-in
                      
                      
                      Retained
                      
                      
                      Accumulated
      Other ComprehensiveIncome
                      
                      
                      Shares
                      
                      
                      Amount
                      
                      
                      Capital
                      
                      
                      Earnings
                      
                      
                      Income(Loss)
                      
                      
                      TotalBALANCE
      AT JANUARY 1, 2006
                      
                      
                      
                      
                      
                      2,204,949
                      
                      
                      $
                      15,004,135
                      
                      
                      $
                      1,252,292
                      
                      
                      $
                      7,493,757
                      
                      
                      $
                      (310,391
                      )
                      
                      $
                      23,439,793Redemption
      and retirement  of stock
                      
                      
                      
                      
                      
                      (55,028
                      )
                      
                      
                      (410,308
                      )
                      
                      
                      
                      
                      
                      
                      (1,025,843
                      )
                      
                      
                      
                      
                      
                      
                      (1,436,151
                      )Stock
      options exercised and related tax benefits
                      
                      
                      
                      
                      
                      104,126
                      
                      
                      
                      885,729
                      
                      
                      
                      438,757
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      1,324,486Cash
      dividend of $.55 per share
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (1,252,957
                      )
                      
                      
                      
                      
                      
                      
                      (1,252,957
                      )Stock
      options vested
                      
                      
                      
                      
                      
                      29,000
                      
                      
                      
                      
                      
                      
                      
                      100,224
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      100,224Restricted
      stock vested
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      81,375
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      81,375Net
      income for the year
                      
                      $
                      3,991,759
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      3,991,759
                      
                      
                      
                      
                      
                      
                      
                      3,991,759Other
      comprehensive income, net of tax: Unrealized holding gains on securities
      available- for-sale arising during the year, net of taxes of
      $108,781
                      
                      
                      155,542Other
      comprehensive income, net of taxes
                      
                      
                      155,542
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      155,542
                      
                      
                      
                      155,542Total
      comprehensive income
                      
                      $
                      4,147,301BALANCE
      AT  DECEMBER 31, 2006
                      
                      
                      
                      
                      
                      
                      2,283,047
                      
                      
                      
                      15,479,556
                      
                      
                      
                      1,872,648
                      
                      
                      
                      9,206,716
                      
                      
                      
                      (154,849
                      )
                      
                      
                      26,404,071Redemption
      and retirement  of stock
                      
                      
                      
                      
                      
                      
                      (100,415
                      )
                      
                      
                      (689,422
                      )
                      
                      
                      
                      
                      
                      
                      (2,243,816
                      )
                      
                      
                      
                      
                      
                      
                      (2,933,238
                      )Stock
      options exercised and related tax benefits
                      
                      
                      
                      
                      
                      
                      60,177
                      
                      
                      
                      626,019
                      
                      
                      
                      358,353
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      984,372Cash
      dividend of $.60 per share
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (1,371,471
                      )
                      
                      
                      
                      
                      
                      
                      (1,371,471
                      )Stock
      options vested
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      216,473
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      216,473Restricted
      stock vested
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      162,750
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      162,750Restricted
      stock vested and related tax benefit
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      162,750
                      
                      
                      
                      (154,815
                      )
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      7,935Net
      income for the year
                      
                      $
                      4,343,538
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      4,343,538
                      
                      
                      
                      
                      
                      
                      
                      4,343,538Other
      comprehensive  income, net of tax: Unrealized holding gains on
      securities available- for-sale arising during the year, net of taxes of
      $83,819
                      
                      
                      119,850Other
      comprehensive  income, net of taxes
                      
                      
                      119,850
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      119,850
                      
                      
                      
                      119,850Total
      comprehensive income
                      
                      $
                      4,463,388




5





SONOMA
VALLEY BANCORP AND SUBSIDIARY


CONSOLIDATED
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Continued)


For the
nine months ended September 30, 2008 (Unaudited), and the years
ended


December
31, 2007 (Audited) and 2006 (Audited)





Comprehensive
                
                
                Common
      Stock
                
                
                Additional
      Paid-in
                
                
                Retained
                
                
                Accumulated
      Other ComprehensiveIncome
                
                
                Shares
                
                
                Amount
                
                
                Capital
                
                
                Earnings
                
                
                Income(Loss)
                
                
                TotalBALANCE
      AT DECEMBER 31, 2007
                
                
                
                
                
                2,242,809
                
                
                $
                15,578,903
                
                
                $
                2,455,409
                
                
                $
                9,934,967
                
                
                $
                (34,999
                )
                
                $
                27,934,280Redemption
      and retirement  of stockStock
      options exercised and related tax benefits
                
                
                
                
                
                45,900
                
                
                
                643,961
                
                
                
                72,313
                
                
                
                
                
                
                
                
                
                
                
                716,274Cash
      dividend of $.60 per share
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (1,373,226
                )
                
                
                
                
                
                
                (1,373,226
                )Stock
      options granted
                
                
                
                
                
                
                
                
                
                
                
                
                
                48,182
                
                
                
                
                
                
                
                
                
                
                
                48,182Restricted
      stock granted
                
                
                
                
                
                
                
                
                
                
                
                
                
                122,063
                
                
                
                
                
                
                
                
                
                
                
                122,063Restricted
      stock vested and related tax benefit
                
                
                
                
                
                
                
                
                
                162,750
                
                
                
                (177,427
                )
                
                
                
                
                
                
                
                
                
                
                (14,677
                )Net
      income for the year
                
                $
                2,889,989
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                2,889,989
                
                
                
                
                
                
                
                2,889,989Other
      comprehensive income,  net of tax:  Unrealized holding
      gains on securities available- for-sale arising during the year, net of
      taxes of $17,172
                
                
                24,555Other
      comprehensive income,  net of taxes
                
                
                24,555
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                24,555
                
                
                
                24,555Total
      comprehensive income
                
                $
                2,914,544BALANCE
      AT September 30, 2008
                
                
                
                
                
                
                2,288,709
                
                
                $
                16,385,614
                
                
                $
                2,520,540
                
                
                $
                11,451,730
                
                
                $
                (10,444
                )
                
                $
                30,347,440




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, 2008 and 2007





2008
                
                
                2007OPERATING
      ACTIVITIESNet
      income
                
                $
                2,889,989
                
                
                $
                3,181,560Adjustments
      to reconcile net income to net cash provided by operating
      activities:Provision
      for loan and lease losses
                
                
                830,000
                
                
                
                565,000Depreciation
                
                
                172,946
                
                
                
                185,932Amortization
      and other
                
                
                55,799
                
                
                
                42,464Stock
      options and restricted stock vested
                
                
                155,568
                
                
                
                316,416Net
      change in interest receivable
                
                
                23,132
                
                
                
                (147,152
                )Net
      change in cash surrender value of life insurance
                
                
                (319,588
                )
                
                
                (312,433
                )Net
      change in other assets
                
                
                (431,303
                )
                
                
                (707,454
                )Net
      change in interest payable and other liabilities
                
                
                367,707
                
                
                
                186,825NET
      CASH PROVIDED BY OPERATING ACTIVITIES
                
                
                3,744,250
                
                
                
                3,311,158INVESTING
      ACTIVITIESPurchases
      of securities held-to-maturity
                
                
                0
                
                
                
                (101,751
                )Purchases
      of securities available-for-sale
                
                
                (1,008,605
                )
                
                
                (4,195
                )Proceeds
      from maturing securities held-to-maturity
                
                
                1,128,100
                
                
                
                172,600Proceeds
      from maturing securities available-for-sale
                
                
                7,205,000
                
                
                
                11,000,000Net
      change in loans and leases
                
                
                (13,955,332
                )
                
                
                (29,319,118
                )Purchases
      of premises and equipment
                
                
                (166,752
                )
                
                
                (64,950
                )Purchases
      of life insurance
                
                
                0
                
                
                
                (350,000
                )NET
      CASH USED FOR INVESTING ACTIVITIES
                
                
                (6,797,589
                )
                
                
                (18,667,414
                )FINANCING
      ACTIVITIESNet
      change in demand, interest-bearing transaction and savings
      deposits
                
                
                1,941,296
                
                
                
                (5,413,634
                )Net
      change in time deposits
                
                
                9,367,112
                
                
                
                1,582,081Stock
      repurchases
                
                
                0
                
                
                
                (2,812,426
                )Cash
      dividend paid
                
                
                (1,373,226
                )
                
                
                (1,371,471
                )Net
      change in FHLB borrowings
                
                
                5,500,000
                
                
                
                24,000,000Stock
      options exercised
                
                
                557,561
                
                
                
                531,410NET
      CASH  PROVIDED BY FINANCING ACTIVITIES
                
                
                15,992,743
                
                
                
                16,515,960NET
      CHANGE IN CASH AND CASH EQUIVALENTS
                
                
                12,939,404
                
                
                
                1,159,704Cash
      and cash equivalents at beginning of period
                
                
                9,333,634
                
                
                
                7,452,256CASH
      AND CASH EQUIVALENTS AT END OF PERIOD
                
                $
                22,273,038
                
                
                $
                8,611,960SUPPLEMENTAL
      DISCLOSURES OF CASH FLOW INFORMATION:Cash
      paid during the year for:Interest
      expense
                
                $
                4,253,548
                
                
                $
                4,731,002Income
      taxes
                
                $
                1,662,156
                
                
                $
                1,465,000SUPPLEMENTAL
      DISCLOSURES OF NONCASH ACTIVITIES:Loans
      transferred to other real estate owned
                
                $
                320,416
                
                
                $
                0Net
      change in unrealized gains and losses on securities
                
                $
                41,727
                
                
                $
                156,384Net
      change in deferred income taxes on unrealized gains on
      securities
                
                $
                (17,172
                )
                
                $
                (64,359
                )





The
accompanying notes are an integral part of these financial
statements.





7





SONOMA
VALLEY BANCORP AND SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


September
30, 2008


(Unaudited)




Note
1:  Basis of Presentation





In the
opinion of Management, the unaudited interim consolidated financial statements
contain all adjustments of a normal recurring nature, which are necessary to
present fairly the financial condition of Sonoma Valley Bancorp and our
wholly-owned subsidiary Sonoma Valley Bank (together, the "Company") at
September 30, 2008 and results of operations for the nine months then
ended.





Certain
information and footnote disclosures presented in our annual financial
statements are not included in these interim financial
statements.  Accordingly, the accompanying unaudited interim
consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in our 2007 Annual
Report on Form 10-K.  The results of operations for the three and nine
months ended September 30, 2008 are not necessarily indicative of the operating
results through December 31, 2008.





Note
2:  Consolidation





The
consolidated financial statements include the accounts of Sonoma Valley Bancorp
and its wholly owned subsidiary, Sonoma Valley Bank.  All material
intercompany accounts and transactions have been eliminated in
consolidation.





Note
3:  Commitments





We had no
outstanding performance letters of credit at September 30, 2008 and September
30, 2007.





Note
4:  Net Income Per Common Share





Net
income per share is calculated by using the weighted average common shares
outstanding.  The weighted average number of common shares used in
computing the net income per common share for the period ending September 30,
2008 was 2,260,255 and for the period ending September 30, 2007 was
2,248,162.





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, 2008 was 2,294,794 and for the period ending
September 30, 2007 was 2,329,678.





Note
5:  Stock Option Accounting





We have a
stock-based employee and director compensation plan.  We adopted the
fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based
Compensation,prospectively to all employee awards granted, modified, or
settled after January 1, 2003.Options
were granted in 2004, 2007 and 2008 under the fair value
method.  Awards under our plan generally vest over five
years.  Restricted stock was granted in July 2006 that vests over
three and five years beginning July 2007.  The cost related to
stock-based employee and director compensation is included in the determination
of net income for the periods ended September 30, 2008 and 2007.




8


Note
6:  Employee Benefit Plans





We
provide retirement plans to our key officers and directors.  The plans
are unfunded and provide for payment to the officers and directors specified
amounts for specified periods after retirement.  The amount of pension
expense related to this plan, and the components of pension expense for the nine
months ended September 30, 2008 and 2007 are as follows:





Directors
                
                
                Officers2008
                
                
                2007
                
                
                2008
                
                
                2007Service
      cost
                
                $
                30,525
                
                
                $
                (97,351
                )
                
                $
                223,760
                
                
                $
                191,508Interest
      cost on projected benefit obligation
                
                
                21,639
                
                
                
                (57,221
                )
                
                
                208,199
                
                
                
                150,966Amortization
      of unrecognized liability at transition
                
                
                (7,570
                )
                
                
                30,720
                
                
                
                126,814
                
                
                
                61,250Net
      periodic pension cost recognized
                
                $
                44,594
                
                
                $
                (123,852
                )
                
                $
                558,773
                
                
                $
                403,724








Note
7:  Fair Value Measurement





Statement
of financial accounting standards (SFAS) No. 157 defines fair value, establishes
a framework for measuring fair value under generally accepted accounting
principals, and expands disclosures about fair value
measurement.  Effective January 1, 2008 the Company adopted SFAS No.
157, which enhances the disclosures about financial instruments carried at fair
value.  The adoption of SFAS No. 157 did not have an impact on the
company’s financial condition or results of operations.





In
general, fair values determined by:





Level 1
inputs utilize quoted prices (unadjusted) in active markets for identical assets
or liabilities that the Company has the ability to access.





Level 2
inputs include quoted prices for similar assets and liabilities in active
markets, and inputs other than quoted prices that are observable for the asset
or liability, such as interest rates and yield curves that are observable at
commonly quoted intervals.  Fair values determined by Level 2 inputs
utilize inputs other than quoted prices included in Level 1 that are observable
for the asset or liability, either directly or indirectly.





Level 3
inputs are unobservable inputs for the asset or liability, and include
situations where there is little, if any market activity for the asset or
liability.







9


The
following table presents information about the Company’s assets and liabilities
measured at fair value on a recurring basis as of September 30, 2008, and
indicate the fair value hierarchy of the valuation techniques utilized by the
Company to determine such fair value.





At
      September 30, 2008Total
                Level
      1
                Level
      2
                Level
      3Available-for-sale
      securities
                $2,036,539
                $24,182
                $2,012,357
                $0





The
following methods were used to estimate the fair value of each class of
financial instrument above:





Securities
available-for-sale –Securities classified as available-for-sale are
reported at fair value utilizing Level 1 inputs for equity securities and Level
2 inputs for all other investment securities.  For equity securities,
the Company obtains the fair value measurements from NASDAQ and for investment
securities, the Company obtains fair value measurements from an independent
pricing service.  The fair value measurements consider observable data
that may include dealer quotes, market spreads, cash flows, the U.S. Treasury
yield curve, live trading levels, trade execution data, market consensus
prepayment speeds, credit information and the bond’s terms and conditions among
other things.





The
Company may be required, from time to time, to measure certain assets at fair
value on a nonrecurring basis in accordance with U.S. generally accepted
accounting principles.  These include assets that are measured at the
lower of cost or market that were recognized at fair value below cost at the end
of the period.  Assets measured at fair value on a nonrecurring basis
are included in the table below.





September
      30, 2008Total
              Level
      1
              Level
      2
              Level
      3Impaired
      Loans
              $8,011,571
              $0
              $8,011,571
              $0Other
      Real Estate Owned
              $   320,416
              $0
              $   320,416
              $0








Impaired loans –The fair value of impaired loans and other real estate owned is estimated
using one of several methods, including collateral value, market value of
similar debt, enterprise value, liquidation value and discounted cash
flows.  Those impaired loans not requiring an allowance represent
loans for which the fair value of the expected repayments or collateral exceed
the recorded investments in such loans.  At September 30, 2008
substantially all of the total impaired loans were evaluated based on the fair
value of the collateral.  In accordance with SFAS 157, impaired loans
where an allowance is established based on the fair value of collateral require
classification in the fair value hierarchy.  When the fair value of
the collateral is based on an observable market price or a current appraised
value, the Company records the impaired loan as nonrecurring Level
2.  When an appraised value is not available or management determines
the fair value of the collateral is further impaired below the appraised value
and there is no observable market price, the Company records the impaired loan
as nonrecurring Level 3.




10


SONOMA
VALLEY BANCORP


AVERAGE BALANCES/YIELDS AND RATES
PAID


For the
nine months ended September 30, 2008 and 2007




2008
                
                
                2007ASSETS
                  Interest-earning
      assets:
                
                Average
                  Balance
                
                
                Income/
                  Expense
                
                
                Yield/
                  Rate
                
                
                Average
                  Balance
                
                
                Income/
                  Expense
                
                
                Yield/
                  RateLoans(2):Commercial
                
                $
                176,487,467
                
                
                $
                9,856,967
                
                
                
                7.47
                %
                
                $
                156,037,313
                
                
                $
                9,592,753
                
                
                
                8.22
                %Consumer
                
                
                31,149,537
                
                
                
                1,696,535
                
                
                
                7.28
                %
                
                
                27,943,321
                
                
                
                1,876,175
                
                
                
                8.98
                %Real
      estate construction
                
                
                26,852,216
                
                
                
                1,612,353
                
                
                
                8.03
                %
                
                
                29,431,614
                
                
                
                1,932,015
                
                
                
                8.78
                %Real
      estate mortgage
                
                
                19,430,397
                
                
                
                1,078,099
                
                
                
                7.42
                %
                
                
                18,355,761
                
                
                
                1,012,192
                
                
                
                7.37
                %Tax
      exempt loans (1)
                
                
                2,195,780
                
                
                
                135,664
                
                
                
                8.26
                %
                
                
                2,301,872
                
                
                
                141,568
                
                
                
                8.22
                %Leases
                
                
                19,673
                
                
                
                1,617
                
                
                
                10.99
                %
                
                
                28,730
                
                
                
                2,389
                
                
                
                11.12
                %Unearned
      loan fees
                
                
                (328,825
                )
                
                
                
                
                
                
                
                
                
                
                (490,907
                )Total
      loans
                
                
                255,806,245
                
                
                
                14,381,235
                
                
                
                7.52
                %
                
                
                233,607,704
                
                
                
                14,557,092
                
                
                
                8.33
                %Investment
      securitiesAvailable
      for sale:Taxable
                
                
                3,402,856
                
                
                
                83,917
                
                
                
                3.30
                %
                
                
                13,835,059
                
                
                
                375,102
                
                
                
                3.62
                %Hold
      to maturity:Tax
      exempt (1)
                
                
                14,006,800
                
                
                
                604,795
                
                
                
                5.77
                %
                
                
                15,812,132
                
                
                
                698,968
                
                
                
                5.91
                %Total
      investment securities
                
                
                17,409,656
                
                
                
                688,712
                
                
                
                5.29
                %
                
                
                29,647,191
                
                
                
                1,074,070
                
                
                
                4.84
                %Federal
      funds sold
                
                
                64,672
                
                
                
                1,284
                
                
                
                2.65
                %
                
                
                89,744
                
                
                
                3,506
                
                
                
                5.22
                %FHLB
      stock
                
                
                1,658,850
                
                
                
                73,747
                
                
                
                5.94
                %
                
                
                1,377,572
                
                
                
                49,607
                
                
                
                4.81
                %Total
      due from banks/interest-bearing
                
                
                2,266,925
                
                
                
                37,186
                
                
                
                2.19
                %
                
                
                496,545
                
                
                
                18,494
                
                
                
                4.98
                %Total
      interest-earning assets
                
                $
                277,206,348
                
                
                $
                15,182,164
                
                
                
                7.32
                %
                
                $
                265,218,756
                
                
                $
                15,702,769
                
                
                
                7.92
                %Noninterest-bearing
      assets:Reserve
      for loan losses
                
                
                (3,898,303
                )
                
                
                
                
                
                
                
                
                
                
                (3,568,169
                )Cash
      and due from banks
                
                
                5,579,748
                
                
                
                
                
                
                
                
                
                
                
                5,640,513Premises
      and equipment
                
                
                804,965
                
                
                
                
                
                
                
                
                
                
                
                879,316Other
      real estate owned
                
                
                228,366
                
                
                
                
                
                
                
                
                
                
                
                0Other
      assets
                
                
                16,650,308
                
                
                
                
                
                
                
                
                
                
                
                15,557,310Total
      assets
                
                $
                296,571,432
                
                
                
                
                
                
                
                
                
                
                $
                283,727,726LIABILITIES
      AND SHAREHOLDERS' EQUITYInterest-bearing
      liabilities:Interest-
      bearing depositsInterest-bearing
      transaction
                
                $
                30,176,377
                
                
                $
                37,592
                
                
                
                0.17
                %
                
                $
                28,968,957
                
                
                $
                35,425
                
                
                
                0.16
                %Savings
      deposits
                
                
                77,548,456
                
                
                
                1,112,540
                
                
                
                1.92
                %
                
                
                75,821,383
                
                
                
                1,408,138
                
                
                
                2.48
                %Time
      deposits over $100,000
                
                
                51,073,637
                
                
                
                1,546,942
                
                
                
                4.05
                %
                
                
                40,690,514
                
                
                
                1,436,321
                
                
                
                4.72
                %Other
      time deposits
                
                
                31,230,447
                
                
                
                886,185
                
                
                
                3.79
                %
                
                
                28,503,347
                
                
                
                952,576
                
                
                
                4.47
                %Total
      interest-bearing deposits
                
                
                190,028,917
                
                
                
                3,583,259
                
                
                
                2.52
                %
                
                
                173,984,201
                
                
                
                3,832,460
                
                
                
                2.95
                %Federal
      funds purchased
                
                
                156,934
                
                
                
                2,578
                
                
                
                2.20
                %
                
                
                0
                
                
                
                0
                
                
                
                0.00
                %Other
      borrowings
                
                
                20,617,153
                
                
                
                621,138
                
                
                
                4.03
                %
                
                
                23,368,077
                
                
                
                898,542
                
                
                
                5.14
                %Total
      interest-bearing liabilities
                
                
                210,803,004
                
                
                $
                4,206,975
                
                
                
                2.67
                %
                
                
                197,352,278
                
                
                $
                4,731,002
                
                
                
                3.21
                %Non-interest-bearing
      liabilities:Non-interest-bearing
      demand deposits
                
                
                49,487,970
                
                
                
                
                
                
                
                
                
                
                
                53,453,259Other
      liabilities
                
                
                6,559,041
                
                
                
                
                
                
                
                
                
                
                
                5,730,348Shareholders'
      equity
                
                
                29,721,417
                
                
                
                
                
                
                
                
                
                
                
                27,191,841Total
      liabilities and shareholders' equity
                
                $
                296,571,432
                
                
                
                
                
                
                
                
                
                
                $
                283,727,726Interest
      rate spread
                
                
                
                
                
                
                
                
                
                
                4.65
                %
                
                
                
                
                
                
                
                
                
                
                4.71
                %Interest
      income
                
                
                
                
                
                $
                15,182,164
                
                
                
                7.32
                %
                
                
                
                
                
                $
                15,702,769
                
                
                
                7.92
                %Interest
      expense
                
                
                
                
                
                
                4,206,975
                
                
                
                2.03
                %
                
                
                
                
                
                
                4,731,002
                
                
                
                2.38
                %Net
      interest income/margin
                
                
                
                
                
                $
                10,975,189
                
                
                
                5.29
                %
                
                
                
                
                
                $
                10,971,767
                
                
                
                5.54
                %





(1)  Fully
      tax equivalent adjustments are based on a federal income tax rate of 34%
      in 2008 and 2007.


(2)  Non
      accrual loans have been included in loans for the purposes of the above
      presentation.  Loan fees of approximately $291,943 and $395,580
      for the nine months ended September 30, 2008 and 2007, respectively, were
      amortized to the appropriate interest income
  categories.





11





Item
1A.  Risk Factors–Below are some suggested additional risk
factors you may consider including. Please review for
accuracy/applicability.





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.





Item
      2.MANAGEMENT'S DISCUSSIONAND ANALYSIS
      OF FINANCIAL CONDITION AND RESULTS OF
  OPERATIONS





Forward-Looking
Statements





With the
exception of historical facts stated herein, the matters discussed in this Form
10-Q are “forward-looking” statements that involve risks and uncertainties that
could cause actual results to differ materially from projected
results.  Such “forward-looking” statements include, but are not
necessarily limited to statements regarding anticipated levels of future
revenues and earnings from the operation of Sonoma Valley Bancorp and its wholly
owned subsidiary, Sonoma Valley Bank (“Bank”), projected costs and expenses
related to operations of our liquidity, capital resources, and the availability
of future equity capital on commercially reasonable terms.  Factors
that could cause actual results to differ materially include, in addition to the
other factors discussed in our Form 10-K for the year ended December 31, 2007,
and subsequent periodic reports, the following; (i) increased competition from
other banks, savings and loan associations, thrift and loan associations,
finance companies, credit unions, offerors of money market funds, and other
financial institutions; (ii) the risks and uncertainties relating to general
economic and political conditions, both domestically and internationally,
including, but not limited to, inflation, or natural disasters affecting the
primary service area of our major industries; or (iii) changes in the laws and
regulations governing the Bank’s activities at either the state or federal
level.  Readers of this Form 10-Q are cautioned not to put undue
reliance on “forward-looking” statements which, by their nature, are uncertain
as reliable indicators of future performance.  We disclaim any
obligation to publicly update these “forward-looking” statements, whether as a
result of new information, future events, or otherwise.





12


For
the Nine Month Periods


Ended
September 30, 2008 and 2007





Overview





We
reported net income of $2,889,989 for the nine months ended September 30,
2008 compared with $3,181,560 for the nine months ended September 30,
2007.   The $291,571 decrease in net income is attributable
to a $265,000 increase in the provision for loan losses and $379,000 increase in
non interest expense.  On a per share basis, net income equaled $1.28
compared with $1.42 per share during the same period in 2007.





Return on
average total assets on an annualized basis for the nine month period was 1.30%
in 2008 and 1.50% in 2007.  The decline in the return on assets is the
result of the $291,571 decline in net income combined with growth of $12.8
million (4.53%) in average assets from $283.7 million as of September 30, 2007
to $296.6 million as of September 30, 2008.  Return on average
shareholders' equity on an annualized basis at the end of the third quarter
2008 and 2007 was 12.99% and 15.64%, respectively.  The lower return
on equity is the result of the decline in net income in 2008 from $3.2 million
in 2007 to $2.9 million in 2008. Additionally, average equity grew $2.5 million
or 9.3% from $27.2 million as of September 30, 2007 to $29.7 million as of
September 30, 2008 which also contributes to the lower return on
equity.





At
September 30, 2008, total assets were $317.4 million, a 6.58% increase over
$297.9 million as of December 31, 2007 and a 6.41% increase over $298.3 million
as of September 30, 2007.  We showed loans of $263.7 million at
September 30, 2008 compared with $250.5 million and $248.9 million as of
December 31, 2007 and September 30, 2007, increases of 5.29% and 5.95%,
respectively.  Deposits increased 4.79% or $11.3 million from $236.0
million as of December 31, 2007 and increased $18.4 million or 8.0% from $228.9
as of September 30, 2007 to $247.4 million as of September 30,
2008.  The increase in deposits is a result of growth in savings and
CD’s.  The loan-to-deposit ratio increased to 106.6% at September 30,
2008 from 106.1% at December 31, 2007 and decreased from 108.7% at September 30,
2007.





Totalshareholders’equity increased by$2,413,160 or 8.64%during theninemonths endedSeptember30, 2008.  AtSeptember30, 2008, we reported net income of$2,889,989.In February, 2008 and in August, 2008
we declared cash dividends which were paid out in March, 2008 and September,
2008, respectively.In each instance the amount of the
dividend paid was $686,613.In 2004, stock options were granted to
senior employees with a fifth of the options vesting each year over a
fiveyear period.  In
2008,12,450options vested which increased equity
by $2,282.The 2004 stock option grant is now
fully expensed and the options are all vested.In July 2006, 26,000 restricted stockawards were granted to senior employees with
a fifth of theawards vesting each year overa fiveyear period and 3,000 restricted stockawards were granted to a senior employee
with a third of theawards vesting over a threeyear period.  In
2008, equity was increased by$122,063to reflect the expense for theseawards.In June 2007, 10,000 unqualified stock
options were granted to a director with a fifth of the options vesting each year
over a five year period.Additionally, in December, 2007, 7,410 unqualified stock options were granted to
two directors with one third vesting immediately and two thirds vesting over a
two year period. In 2008, equity has been increased by $15,147 and $12,572,
respectively, for these 2007 grants. In January 2008, 10,000 incentive stock
options were awarded to a senior employee with a fifth of the options vesting
each year over a five year period. In 2008, equity was increased by $10,248
year-to-date. In April 2008, 10,000 unqualified stock options were granted to a
director with a fifth of the options vesting each year over a five year period.
In 2008 equity was increased $7,933 for these options. The net income figure of
$2,889,989 reflects an expense for the incentive stock options of $12,531,
restricted stock options of $122,063, and the nonqualified stock options of
$35,652; therefore, the net effect of the stock option transactions relative to
equity was zero.  Directors exercised 23,164 options which added
$200,860 to the capital accounts.  The tax benefit of these options
was $158,714, which also increased equity.  Officers exercised 22,736
options which added $356,700 to the capital accounts. The net effect of this
activity results in capital of $30,347,440 as of September 30, 2008, compared to
capital of $27,934,280 as of December 31, 2007.





13


Section
404 of Sarbanes-Oxley Act of 2002 (“Section 404”) requires the Securities and
Exchange Commission (“SEC”) to prescribe rules requiring the establishment,
maintenance and evaluation of an issuer’s internal control of financial
reporting.  We certified compliance for the year ended December 31,
2007.  Our external independent auditors are required to attest to and
report on management's assessment of internal control over financial reporting
beginning December 31, 2009.  Our management and staff worked
diligently evaluating and documenting the internal control systems in order to
allow our management to report on our internal control over financial
reporting.





RESULTS
OF OPERATIONS





Net
Interest Income





Net
interest income is the difference between total interest income and total
interest expense.  Net interest income, adjusted to a fully taxable
equivalent basis, as shown on the table- Average Balances/Yields and Rates Paid,
on page 11,is higher
than net interest income on the statement of income because it reflects
adjustments applicable to tax-exempt income from certain securities and loans
($251,756 in 2008 and $285,782 in 2007, based on a 34% federal income tax
rate).





The
slight increase in net interest income for the nine months ended September
30, 2008 (stated on a fully taxable equivalent basis) is a result of the net
effect of a $520,605 decrease in interest income offset by a slightly larger
decrease in interest expense of $524,027, showing a net increase of
$3,422.  As of September 30, 2007 the federal funds rate and Wall
Street Journal prime rate were 4.75% and 7.75%, respectively. Over the course of
the last year both rates have declined 275 basis points. At September 30, 2008
the federal funds rate was 2% and the prime rate was 5%.







Net
interest income (stated on a fully taxable equivalent basis) expressed as a
percentage of average earning assets, is referred to as net interest
margin.  In 2008, our net interest margin decreased 25 basis points to
5.29% from 5.54% for the same period in 2007.  The decline in the net
interest margin is a result of earning asset rates repricing downward faster
than rates on earning liabilities.




Interest
Income





As
previously stated, interest income (stated on a fully taxable equivalent basis)
declined by $520,605 to $15.2 million in the first nine months of 2008, a
3.32% decrease over the $15.7 million realized during the same period in
2007.





The
$520,605 decrease was the result of the 60 basis point decrease in the yield on
earning assets to 7.32% for the nine months ended September 30, 2008 from
7.92% for the same period in 2007.  Average balances of
interest-bearing assets increased $12.0 million or 4.5% from $265.2 million as
of September 30, 2007 to $277.2 million as of September 30, 2008.





The gain
in volume of average earning assets was responsible for a $920,058 increase in
interest income. The decline in interest rates was responsible for a
decrease of $1,440,663, for a net decrease in interest income of
$520,605.





14


Interest
Expense





Total
interest expense for the first nine months of 2008 decreased by
$524,027 to $4.2 million from $4.7 million for the same period in
2007.  The average rate paid on all interest-bearing liabilities
decreased from 3.21% in the first nine months of 2007 to 2.67% in the same
period in 2008, a decrease of 54 basis points.  Average balances of
interest-bearing liabilities increased from $197.4 million to $210.8 million, a
$13.4 million or 6.8% gain in interest-bearing liabilities.





The gain
in volume of average balances was responsible for a $337,854 increase in
interest expense and the lower interest rates paid were responsible for a
$861,881 decrease in interest expense for a net decrease of
$524,027.





Individual
components of interest income and interest expense are provided in the
table-Average Balances/Yields and Rates Paid on page 11.





Provision
for Loan Losses





The
provision for loan losses charged to operations for the nine months
ended September 30, 2008 was $830,000 compared to $565,000 for the same
time period in 2007.  The provision for loan losses charged to
operations is based on our monthly evaluation of the loan portfolio and the
adequacy of the allowance for loan losses in relation to total loans
outstanding. We have continued to experience loan growth during the first nine
months of 2008 and we anticipate that loan growth will continue, requiring that
additional provisions may need to be made for estimated loan
losses.  Additionally, the difficulties in the credit markets and the
economic situation have caused declines in the values in the real estate market
and job losses generating concern about the collateral pledged for many of our
loans and customers continuing ability to repay their loans. Due to the above,
management determined that it would be prudent to increase the
provision. Our analysis indicates a sufficient amount is being accrued to
cover any potential loan losses, but as loans continue to grow and the economic
outlook remains uncertain, additional provisions will be made to the allowance
for loan losses as needed.





The
economic climate causes concern due to the uncertainties in the mortgage
market and the potential ramifications to the entire real estate
industry.  As of September 30, 2008, we showed non performing assets
of $2.6 million compared to $1.2 million as of September 30, 2007. The
non-performing assets ratio (non-performing assets/total loans) was .97% as of
September 30, 2008 compared to 0.50% as of September 30, 2007. There have been
$416,253 loans charged off and recoveries were $20,507 as of September 30, 2008,
compared with $55,493 in charge offs and $14,066 in recoveries for the same
period in 2007.





Non-interest
Income





For the
first nine months of 2008 non-interest income was $1.617 million and decreased
5.4% or $93,000 compared to the $1.710 million recorded in the comparable
period in 2007.  Of the decrease, 65.2% was due to decreases in
service charge income on deposit accounts.  Year-to-date income from
service charges on deposit accounts has declined 5.7%, or $61,000, from
$1.06 million in 2007 to $1.00 million in 2008.  There was a decrease
of $72,000 in income from overdrafts and checks drawn against insufficient
funds.





Other fee
income declined 12.6% or $40,000 as of September 30, 2008 from $317,000 as of
September 30, 2007 to $277,000. The lower income was a result of lower loan
referral income, which was $62,000 as of September 30, 2007 compared to $35,000
in 2008, a decline of $27,000 or 43.8%. Also contributing to the decrease was a
$14,000 decline in miscellaneous income, which declined from $21,000 as of
September 30, 2007 to $7,000 for the same period of 2008, a decrease of
66.4%.





All other
non-interest income showed a 2.3%, or $7,500, increase from $330,700 in 2007 to
$338,200 in 2008.  This is largely a result of an increase in the
income generated by bank owned life insurance policies.  Income on the
policies was $312,000 as of September 30, 2007 compared to $319,000 as of
September 30, 2008, an increase of $7,000.  The earnings on the
policies will increase as the balances increase and if market rates increase,
the income produced by these policies should also increase.





15


Non-Interest
Expense





Total
non-interest expense grew $379,000, or 5.6%, to $7.2 million for the
first nine months of 2008 from  $6.8 million in the comparable
period in 2007.  Non-interest expense on an annualized basis
represented 3.24% of average total assets in 2008 compared with 3.21% in the
comparable period in 2007.





Salaries
and benefits increased $56,000, or 1.3%, from $4.174 million for the nine months
ended September 30, 2007 to $4.230 million for the nine months ended September
30, 2008.  In 2008 we added employees to our loan administration team
to better manage our loans and comply with new standards put in place by the
Federal Financial Institutions Examination Council (FFIEC). Also, we have added
a loan officer to better serve the customers. Additionally, we had additional
accrual expense for our Supplemental Executive Retirement Plan as we have a
senior executive retiring in early 2009.  At September 30, 2008 total
full time equivalent employees were 55 compared to 50 as of September
30, 2007.  As of September 30, 2008, assets per employee were $5.8
million compared with $6.0 million as of September 30,
2007.





Expenses
related to premises and equipment decreased 4.4% to $699,000 in 2008 from
$731,000 for the same period in 2007.  The $32,000 decline in expense
in 2008 is in large part the result of a 47.1%, or $25,000, decrease in expenses
related to depreciation of computers and other equipment from $53,000 in 2007 to
$28,000 in 2008. Also, software expense declined $23,000, or 33.1%, from $69,000
as of September 30, 2007 to $46,000 as of September 30, 2008. In 2008 we
received $11,250 in lease income on a bank owned property, a $10,000 increase
over 2007.





Other
operating expenses increased 18.7% to $2.253 million in 2008 from $1.898 million
in 2007, an increase of $355,000. All categories of all other non interest
expense show increases except for our data processing, item processing and ATM
processing expense, which showed a decline of $12,000 or 2.92% over 2007. The
largest increase was in the area of FDIC and other insurances, with FDIC
insurance increasing $94,000 or 475% from 2007. We anticipate our FDIC premiums
will continue to increase to replenish the Bank Insurance Fund. We showed
increases in professional fee expense of $79,000 or 10.6% from $744,000 in 2007
to $823,000 in 2008. The majority of this increase is a result of lower expense
for director retirement due to adjustment credits of $155,693 made in 2007,
while 2008 reflects the true expense of $45,000 year to date. Other operating
expense shows an increase of $65,000 or 24.4% over 2007 from $266,000 as of
September 30, 2007 to $331,000 as of September 30, 2008. In 2007 we purchased a
California Affordable Housing investment which began amortizing in 2008. Our
expense year to date is $57,000. We do receive tax credits to lower our taxes
with this investment. Also contributing to the growth in all other non interest
expense are increases in advertising/marketing, stationary and supplies, loan
expense, operational losses and telephone and postage expense.





Provision
for Income Taxes





The
provision for income taxes declined to an effective tax rate of 33.24% for the
first nine months of 2008 compared with 36.73% for the same period of
2007.  The lower effective tax rate is a reflection of tax benefits
received for options exercised and tax credits resulting from the bank’s
investment in California affordable housing. Income taxes reported in the
financial statements include deferred taxes resulting from timing differences in
the recognition of items for tax and financial reporting purposes.




BALANCE
SHEET ANALYSIS





Investments





Investment
securities were $15.4 million at September 30, 2008, a 32.2% decrease from the
$22.8 million at December 31, 2007 and a 40.3% decrease from $25.8 million at
September 30, 2007.  The decline in the portfolio is a result of
strong loan demand and the need to utilize maturing and called investments to
fund loans.  We will usually maintain an investment portfolio of
securities rated “A” or higher by Standard and Poor's and or Moody's Investors
Service.  Local tax-exempt bonds are occasionally purchased without an
“A” rating.





16


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,
2008, we had securities totaling $13.4 million with a market value of $13.5
million categorized as HTM.  Decisions to acquire municipal
securities, which are generally placed in this category, are based on tax
planning needs and pledge requirements.




Securities
are classified as available for sale (AFS) if we intend to hold these debt
securities for an indefinite period of time, but not necessarily to
maturity.  Investment securities which are categorized as AFS are
acquired as part of the overall asset and liability management function and
serve as a primary source of liquidity.  Decisions to acquire or
dispose of different investments are based on an assessment of various economic
and financial factors, including, but not limited to, interest rate risk,
liquidity and capital adequacy.  Securities held in the AFS category
are recorded at market value, which was $2.0 million compared to an amortized
cost of $2.0 million as of September 30, 2008.





There
were eleven municipal securities of $2.3 million in the HTM portfolio that were
temporarily impaired as of September 30, 2008. There were no securities in a
continuous loss position for 12 months or more as of September 30, 2008. Most of
the securities that were impaired as of December 31, 2007 are in a gain position
at this time due to the decline in interest rates. The eleven municipal
securities which are impaired as of September 30, 2008 show  a loss of
$30,404. It is our intent to carry the securities to maturity date, at which
time we will receive face value for the securities at no loss.





Although
the quoted market values fluctuate, investment securities are generally held to
maturity, and accordingly, gains and losses to the income statement are
recognized upon sale, or at such time as management determines that a permanent
decline in value exists.  In our opinion, there was no investment in
securities at September 30, 2008 that constituted a material credit risk to the
Company. The lower market value to amortized cost is a result of downgrades to
the bond insuring companies. There continues to be some uncertainty in the
market relative to the companies insuring the municipal securities that we hold.
We are monitoring this situation very closely. Additionally, we monitor the
underlying ratings of the municipalities who have issued the bonds and believe
they will be able to fulfill their obligations and there will be no need to rely
on the insurance companies for payment. When the insurance companies are
down-graded it results in lower ratings on the securities and therefore affects
their fair value.





Loans





Loan
balances, net of deferred loan fees at September 30, 2008, were $263.7 million,
an increase of 5.3% or $13.2 million over December 31, 2007 and an increase of
6.0% or $14.8 million over September 30, 2007. Real Estate Construction loans
were $32.4 million or 12.3% of the portfolio as of September 30, 2008 and showed
growth of $6.6 million, or 25.8%, over December 31, 2007 and a decline
of 2.0%, or $650,000, over September 30, 2007. The increase and decrease are
representative of the life cycle of construction loans with incremental draws to
cover construction and pay offs when the construction is complete.





Consumer
loans and real estate mortgage loans both showed growth over December 31, 2007
of 15.9% and 11.4% or $4.6 million and $2.0 million, respectively. Consumer
loans grew 19.3% or $5.5 million over September 30, 2007, while real estate
mortgages declined 3.3% or $680,000.





As of
September 30, 2008, commercial loans were 67.3% of the portfolio and decreased
$254,000, or 0.14%, from December 31, 2007 and increased 6.3% or $10.5 million
over September 30, 2007.  Included in Commercial loans are loans made
for commercial purposes and secured by real estate.





17


Lease
Financing Receivables declined by 17.5% and 23.8% or $4,000 and $6,000, as of
December 31, 2007 and September 30, 2007, respectively.  Customer
interest in lease financing receivables has declined in our market and we do not
anticipate this to change in the foreseeable future.





September
      30,
                  2008
                
                
                Percentage
                  of Total
                
                
                December
      31,
                  2007
                
                
                Percentage
                  of Total
                
                
                September
      30,
                  2007
                
                
                Percentage
                  of TotalCommercial
                
                $
                177,735,467
                
                
                
                67.3
                %
                
                $
                177,989,391
                
                
                
                70.9
                %
                
                $
                167,252,231
                
                
                
                67.1
                %Consumer
                
                
                33,793,414
                
                
                
                12.8
                %
                
                
                29,163,877
                
                
                
                11.6
                %
                
                
                28,323,568
                
                
                
                11.4
                %Real
      estate construction
                
                
                32,419,685
                
                
                
                12.3
                %
                
                
                25,772,958
                
                
                
                10.3
                %
                
                
                33,071,124
                
                
                
                13.2
                %Real
      estate mortgage
                
                
                19,992,413
                
                
                
                7.6
                %
                
                
                17,946,113
                
                
                
                7.2
                %
                
                
                20,672,173
                
                
                
                8.3
                %Leases
                
                
                17,868
                
                
                
                0.0
                %
                
                
                21,665
                
                
                
                0.0
                %
                
                
                23,446
                
                
                
                0.0
                %263,958,847
                
                
                
                100.0
                %
                
                
                250,894,004
                
                
                
                100.0
                %
                
                
                249,342,542
                
                
                
                100.0
                %Deferred
      loan fees and costs, net
                
                
                (258,242
                )
                
                
                
                
                
                
                (432,569
                )
                
                
                
                
                
                
                (457,639
                )Allowance
      for loan and lease losses
                
                
                (4,157,471
                )
                
                
                
                
                
                
                (3,723,217
                )
                
                
                
                
                
                
                (3,800,095
                )$
                259,543,134
                
                
                
                
                
                
                $
                246,738,218
                
                
                
                
                
                
                $
                245,084,808


Risk
Elements
 
 The
majority of our loan activity is with customers located within
Sonoma County, California.  Approximately 89.8% of the total loan
portfolio is secured by real estate located in our service
area.  Significant concentrations of credit risk may exist if a number
of loan customers are engaged in similar activities and have similar economic
characteristics.  We believe we have policies in place to identify
problem loans and to monitor concentrations of credits.
 
 Based on
its risk management review and a review of its loan portfolio, management
believes that its allowance for loan losses for the quarter ending September 30,
2008 is sufficient to absorb losses inherent in the loan
portfolio.  This assessment is based upon the best available
information and does involve uncertainty and matters of
judgment.  Accordingly, the adequacy of the loan loss reserve cannot
be determined with precision, but is subject to periodic review, and could be
susceptible to significant change in future periods.


18


Non-Performing
Assets





Non-performing
assets consist of loans on non-accrual status, delinquent loans past due greater
that 90 days, restructured loans and other real estate owned, or
OREO.  Management classifies all loans as non-accrual loans when they
become more than 90 days past due as to principal or interest, or when the
timely collection of interest or principal becomes uncertain, if earlier, unless
they are adequately secured and in the process of collection.





A loan
remains in a non-accrual status until both principal and interest have been
current for nine months and meet cash flow or collateral criteria, or when the
loan is determined to be uncollectible and is charged off against the allowance
for loan losses, or in the case of real estate loans, is transferred to other
real estate owned.  A loan is classified as a restructured loan when
the interest rate is reduced, when the term is extended beyond the original
maturity date, or other concessions are made, because of the inability of the
borrower to repay the loan under the original terms. As of September 30, 2008
there were $915,000 in restructured loans and as of September 30, 2007 there
were $508,000 in restructured loans, of these amounts $590,000 and $252,000,
respectively, are included in non-accrual loans discussed below. OREO represents
assets held through loan foreclosure or recovery activities. As of September 30,
2008 we had $320,000 classified as OREO compared to no OREO as of December 31,
2007 and September 30, 2007.





There
were $1.9 million non-accrual loans and no loans 90 days or more past due and
still accruing at September 30, 2008 up from $927,000 million non-accrual loans
and no loans 90 days or more past due and still accruing at September 30, 2007,
except for overdrafts of $63,000, which accrue $5.00 a day per overdrawn
account. There were no overdrafts 90 days or more at September 30,
2008.  There were $1.5 million in non-accrual loans 90 days or more
past due at September 30, 2008 and $662,000 loans in non-accrual status and 90
days or more past due as of September 30, 2007. Occasionally, we will have more
loans in non-accrual status than are 90 days past due following the guidelines
in the above paragraph or if management determines the collection of principal
or interest is unlikely.





Allowance
for Loan Losses





The
allowance for loan losses is maintained at a level considered adequate to
provide for losses that can be reasonably anticipated.  The allowance
is increased by provisions charged to operating expense and reduced by
charge-offs, net of recoveries.  The allowance is based on estimates,
and ultimate losses may vary from the current estimates.  These
estimates are reviewed monthly and, as adjustments become necessary, they are
reported in earnings in the periods in which they become known.





The
review process is intended to identify loan customers who may be experiencing
financial difficulties.  In these circumstances, a specific reserve
allocation or charge-off may be recommended.  Other factors considered
by management in evaluating the adequacy of the allowance
include:  loan volume, historical net loan loss experience, the
condition of industries and geographic areas experiencing or expected to
experience economic adversities, credit evaluations and current economic
conditions.  The allowance for loan losses is not a precise amount,
but based on the factors above, represents management's best estimate of losses
that may be ultimately realized from the current loan portfolio.





19


Worsening
conditions in certain economic sectors and geographic areas could adversely
affect the loan portfolio, necessitating larger provisions for loan losses than
currently estimated. However, as of September 30, 2008 we believe overall the
allowance for loan losses is adequate based on our analysis of conditions at
that time.





At
September 30, 2008, the allowance for loan losses was $4.2 million, or 1.58% of
period end loans, compared with $3.7 million, or 1.49%, at December 31, 2007 and
$3.8 million, or 1.53%, at September 30, 2007.





Net
charge-offs to average loans increased when compared with the prior
year.  We recorded net losses of $396,000 or 0.21% of average loans as
of September 30, 2008 compared to September 30, 2007, which showed net charge
offs of $42,000 or 0.02% of average loans.  The increase, although
still low by industry standards, reflects our attention and effort in managing
and collecting past due loans by encouraging the customer to bring them to a
current status or to pay them off and management’s desire to quickly charge off
a loan when it is determined to be uncollectible.  The prompt
charge-off of loans improves the quality of the overall loan
portfolio.





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
                    9/30/08
                  
                  
                  For
      the Year
                    Ended
                    12/31/07
                  
                  
                  For
      the Nine
                    Months
      Ended
                    9/30/07Balance
      beginning of year
                  
                  $
                  3,723,217
                  
                  
                  $
                  3,276,972
                  
                  
                  $
                  3,276,972Charge-offs:Commercial
                  
                  
                  (120,120
                  )
                  
                  
                  (187,075
                  )
                  
                  
                  0Consumer
                  
                  
                  (296,133
                  )
                  
                  
                  (63,901
                  )
                  
                  
                  (55,943
                  )Total
      charge-offs
                  
                  
                  (416,253
                  )
                  
                  
                  (250,976
                  )
                  
                  
                  (55,943
                  )Recoveries:Commercial
                  
                  
                  13,443
                  
                  
                  
                  16,315
                  
                  
                  
                  13,546Consumer
                  
                  
                  7,064
                  
                  
                  
                  906
                  
                  
                  
                  520Total
      recoveries
                  
                  
                  20,507
                  
                  
                  
                  17,221
                  
                  
                  
                  14,066Net
      recoveries (charge-offs)
                  
                  
                  (395,746
                  )
                  
                  
                  (233,755
                  )
                  
                  
                  (41,877
                  )Provision
      charged to operations
                  
                  
                  830,000
                  
                  
                  
                  680,000
                  
                  
                  
                  565,000Balance
      end of period
                  
                  $
                  4,157,471
                  
                  
                  $
                  3,723,217
                  
                  
                  $
                  3,800,095Ratio
      of net charge-offs annualized to average loans
                  
                  
                  0.21
                  %
                  
                  
                  0.10
                  %
                  
                  
                  0.01
                  %Balance
      in allowance as a percentage  of loans outstanding at period
      end
                  
                  
                  1.58
                  %
                  
                  
                  1.49
                  %
                  
                  
                  1.53
                  %





20


Deposits





A
comparative schedule of average deposit balances is presented in the table on
page 11;period end and
year-end deposit balances are presented in the following table.








September
      30,
                  2008
                
                
                Percentage
      of Total
                
                
                December
      31,
                  2007
                
                
                Percentage of Total
                
                
                September
      30,
                  2007
                
                
                Percentage
      of TotalInterest-bearing
      transaction deposits
                
                $
                28,306,822
                
                
                
                11.5
                %
                
                $
                30,135,049
                
                
                
                12.8
                %
                
                $
                27,746,096
                
                
                
                12.1
                %Savings
      deposits
                
                
                81,724,337
                
                
                
                33.0
                %
                
                
                73,528,081
                
                
                
                31.1
                %
                
                
                74,197,697
                
                
                
                32.4
                %Time
      deposits, $100,000 and over
                
                
                51,394,535
                
                
                
                20.8
                %
                
                
                44,160,741
                
                
                
                18.7
                %
                
                
                44,423,070
                
                
                
                19.4
                %Other
      time deposits
                
                
                31,767,944
                
                
                
                12.8
                %
                
                
                29,634,626
                
                
                
                12.6
                %
                
                
                28,856,247
                
                
                
                12.6
                %Total
      interest-bearing  deposits
                
                
                193,193,638
                
                
                
                78.1
                %
                
                
                177,458,497
                
                
                
                75.2
                %
                
                
                175,223,110
                
                
                
                76.5
                %Demand
      deposits
                
                
                54,162,469
                
                
                
                21,9
                %
                
                
                58,589,202
                
                
                
                24.8
                %
                
                
                53,712,752
                
                
                
                23.5
                %Total
      deposits
                
                $
                247,356,107
                
                
                
                100.0
                %
                
                $
                236,047,699
                
                
                
                100.0
                %
                
                $
                228,935,862
                
                
                
                100.0
                %








Total
deposits increased by $11.3 million, or 4.8%, during the nine months of 2008 to
$247.4 million from $236.0 million at December 31, 2007, and increased by $18.4
million or 8.0 % from $228.9 million as of September 30, 2007.  Time
deposits greater than $100,000, savings deposits and other time deposits showed
increases over year-end 2007.  Time deposits greater than $100,000
showed strong growth of 16.4%, or $7.2 million, and were $51.4 million as of
September 30, 2008 compared to $44.2 million at year-end
2007.  Savings deposits of $81.7 million increased $8.2 million, or
11.1%, from $73.5 million at December 31, 2007.  Other time deposits
showed growth of 7.2%, or $2.1 million, and were $31.8 million as of September
30, 2008 compared to $29.6 million at December 31, 2007.





Both
non-interest bearing demand deposits and interest bearing checking show
decreases. Non-interest bearing demand declined $4.4 million, or 7.6%, from
$58.6 million as of December 2007 to $54.2 million as of September 30,
2008.  Interest-bearing checking declined to $28.3 million, a 6.1%, or
$1.8 million decline from $30.1 million as of December 31, 2007. As rates have
been declining, customers have been moving deposits to higher yielding
accounts.





Capital





Our
subsidiary, Sonoma Valley Bank (the “Bank”) is subject to FDIC regulations
governing capital adequacy.  The FDIC has adopted risk-based capital
guidelines which establish a risk-adjusted ratio relating capital to different
categories of assets and off-balance sheet exposures.  Under the
current guidelines, as of September 30, 2008, the Bank was required to have
minimum Tier 1 and total risk-based capital ratios of 4% and 8%, respectively.
To be well capitalized under Prompt Corrective Action Provisions requires
minimum Tier 1 and total risk-based capital ratios to be 6% and 10%,
respectively.





21


The FDIC
has also adopted minimum leverage ratio guidelines for compliance by banking
organizations.  The guidelines require a minimum leverage ratio of 4%
of Tier 1 capital to total average assets.  Banks experiencing high
growth rates are expected to maintain capital positions well above the minimum
levels.  The leverage ratio, in conjunction with the risk-based
capital ratio, constitutes the basis for determining the capital adequacy of
banking organizations.





Based on
the FDIC's guidelines, the Bank's total risk-based capital ratio at September
30, 2008 was 11.40% and its Tier 1 risk-based capital ratio was
10.15%.  The Bank's leverage ratio was 9.81%.  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, 2008, were 11.45%, 10.20% and
9.86%, respectively.





In
February 2001, we approved a program to repurchase Sonoma Valley Bancorp stock
up to $1.0 million, and in August 2002 we approved the repurchase of an
additional $1.0 million of Sonoma Valley Bancorp stock.  As of
December 31, 2005, $1,580,162 had been repurchased and retired, net of options
which were exercised and then subsequently repurchased and
retired.  In February 2006 we approved the repurchase of 60,000 shares
of Sonoma Valley Bancorp stock, in October 2006 we approved an additional 60,000
shares of Sonoma Valley Bancorp stock and in July, 2007 we approved an
additional 60,000 shares of Sonoma Valley Bancorp stock.  During the
twelve months ended December 31, 2006, 55,028 shares were repurchased and
retired, of which 15,035 shares, or $364,729, were a part of the amount approved
in August 2002.   As of December 31, 2007, 100,415 shares had
been repurchased and retired.  As of September 30, 2008, no shares
have been repurchased and retired. Refer to page 13, for a discussion of the
changes in capital and pages 5 and 6 for the table of Statement of
Changes in Shareholders’ Equity.




We
believe that the Bank's current capital position, which exceeds guidelines
established by industry regulators, is adequate to support our
business.





Off
Balance Sheet Commitments





Our
off-balance sheet commitments consist of commitments to extend credit and
standby letters of credit.  These commitments are extended to
customers in the normal course of business.  Unfunded  loan
commitments were $46.6 million at September 30, 2008 and $52.2 million at
September 30, 2007.Standby
letters of credit outstanding were $118,000 at September 30, 2008 and $348,000
at September 30, 2007.  We also have contractual obligations
consisting of operating leases for various facilities and payments to
participants under our supplemental executive retirement plan and deferred
compensation plan. We
believe our available liquidity is sufficient to accommodate existing contingent
obligations listed above.





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, 2008, our primary liquidity ratio
(adjusted liquid assets to deposits and short term liabilities) was 7.67%
compared to 6.30% as of September 30, 2007. Available liquidity, which
includes the ability to borrow at the Federal Home Loan Bank, was 37.9% as of
September 30, 2008 and 36.5% as of September 30, 2007.  Management
expects that liquidity will remain adequate throughout 2008, as deposit growth
keeps pace with loan growth.  Any excess funds will be invested in
quality liquid assets, such as U.S. Treasury and Agency
securities.  Management believes that the Company has adequate
liquidity and capital resources to meet its short-term and long-term
commitments.





22


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.  Since January 1, 2008  the target
Federal Funds rate has declined 225 basis points from 4.25% to 2.00%. This has
caused an increase in the market value of our investments. The asset/liability
management policy sets limits on the acceptable amount of variance in net
interest margin and market value of equity under changing interest
environments.  The Bank uses simulation models to forecast earnings,
net interest margin and market value of equity.





Simulation
of earnings is the primary tool used to measure the sensitivity of earnings to
interest rate changes. Using computer-modeling techniques, we are able to
estimate the potential impact of changing interest rates on
earnings.  A balance sheet forecast is prepared quarterly using inputs
of actual loans, securities and interest bearing liabilities (i.e.,
deposits/borrowings) positions as the beginning base.  The forecast
balance sheet is processed against five interest rate scenarios.  The
scenarios include 100 and 200 basis point rising rate forecasts, a flat rate
forecast and 100 and 200 basis point falling rate forecasts which take place
within a one year time frame.  The net interest income is measured
during the year assuming a gradual change in rates over the twelve-month
horizon.  Our 2008 net interest income, as forecast below, was modeled
utilizing a forecast balance sheet projected from September 30, 2008
balances.  The following table summarizes the effect on net interest
income (NII) of 100 and 200 basis point changes in interest rates as measured
against a constant rate (no change) scenario.





Interest
Rate Risk Simulation of Net Interest Income as of September 30,
2008


(dollars
in thousands)





Variation
      from a constant rate scenario
                $
      Change in NII+200bp
                $     95+100bp
                $   (19)-100bp
                $
      (495)-150bp
                $
      (623)





The
simulations of earnings do not incorporate any management actions, which might
moderate the negative consequences of interest rate
deviations.  Therefore, they do not reflect likely actual results, but
serve as conservative estimates of interest rate risk.





23


Since the
primary tool used by management to measure and manage interest rate exposure is
a simulation model, use of the model to perform simulations reflecting changes
in interest rates over a twelve month horizon enables management to develop and
initiate strategies for managing exposure to interest rate
risks.  Management believes that both individually and in the
aggregate its modeling assumptions are reasonable, but the complexity of the
simulation modeling process results in a sophisticated estimate, not an
absolutely precise calculation of exposure.





Interest Rate Sensitivity
Analysis.  Interest rate sensitivity is a function of the
repricing characteristics of the portfolio of assets and
liabilities.  These repricing characteristics are the time frames
within which the interest-bearing assets and liabilities are subject to change
in interest rates either at replacement, repricing or
maturity.  Interest rate sensitivity management focuses on the
maturity of assets and liabilities and their repricing during periods of change
in market interest rates.  Interest rate sensitivity is measured as
the difference between the volumes of assets and liabilities in the current
portfolio that are subject to repricing at various time horizons.  The
differences are known as interest sensitivity gaps.





A
positive cumulative gap may be equated to an asset sensitive
position.  An asset sensitive position in a rising interest rate
environment will cause a bank's interest rate margin to expand.  This
results as floating or variable rate loans reprice more rapidly than fixed rate
certificates of deposit that reprice as they mature over
time.  Conversely, a declining interest rate environment will cause
the opposite effect.  A negative cumulative gap may be equated to a
liability sensitive position.  A liability sensitive position in a
rising interest rate environment will cause a bank's interest rate margin to
contract, while a declining interest rate environment will have the opposite
effect. The  table on the previous page shows net interest income
declining both when rates increase and when rates decline.  Although
we are usually asset sensitive which would cause the Bank’s net interest margin
to expand, the negative change in net interest income shows both in a rising and
declining rate environment.  The decline in the rising rate
environment is a result of management’s conservative evaluation of the pressure
to increase rates on deposits, which temporarily causes the decline in the net
interest margin.





The
following table sets forth the dollar amounts of maturing and/or repricing
assets and liabilities for various periods. This does not include the impact of
prepayments or other forms of convexity caused by changing interest
rates.  Historically, this has been immaterial and estimates for them
are not included.





We have
more liabilities than assets repricing during the next year. Usually because our
asset rates change more than deposit rates, our interest income will change more
than the cost of funds when rates change.  For the current quarter, we
are making a more conservative assumption.  Historically, we have been
able to raise or lower deposit rates with a delay to loan rate changes, however
market demands are creating pressure to raise interest rates on
deposits.  Therefore, for a period of time, we have chosen to use the
simulation to forecast deposits rates rising quite rapidly in a rising rate
environment and we are unable to lower deposit rates in a falling rate
environment.  This causes the net interest margin to shrink and net
interest income to decline in both a rising and falling rate
environment.  The table below indicates that we are liability
sensitive for the first six months. During the seven to twelve month period, we
show more assets than liabilities repriceable in the seven to twelve month
category.  Still at the end of the twelve month cycle, the rate
sensitive gap shows $46.4 million more in liabilities than assets
repricing.





24


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, 2008 for our interest-bearing assets and
interest-bearing liabilities, and our interest rate sensitivity gap as a
percentage of total interest-earning assets.  Of the $121.7 million in
fixed rate assets over 12 months, shown in the table below, $29.9 million are
long term assets over five years.  This $29.9 million compares
favorably to the $84.3 million in demand and core deposits and
equity.








SEPTEMBER
      30, 2008
                    (dollars
      in thousands)
                  
                  Immediate
                    Reprice
                  
                  
                  Up
      to 3
                    Months
                  
                  
                  4
      to 6
                    Months
                  
                  
                  7
      to 12
                    Months
                  
                  
                  Over
      12
                    Months
                  
                  
                  TotalFFS
      + overnight IBB
                  
                  $
                  15,382
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  15,382Securities
      + Other IBB
                  
                  
                  0
                  
                  
                  $
                  1,001
                  
                  
                  $
                  460
                  
                  
                  $
                  920
                  
                  
                  $
                  13,038
                  
                  
                  
                  15,419Loans
                  
                  
                  62,916
                  
                  
                  
                  11,363
                  
                  
                  
                  26,822
                  
                  
                  
                  49,813
                  
                  
                  
                  108,629
                  
                  
                  
                  259,543Total
      RSA
                  
                  $
                  78,298
                  
                  
                  $
                  12,364
                  
                  
                  $
                  27,282
                  
                  
                  $
                  50,733
                  
                  
                  $
                  121,667
                  
                  
                  $
                  290,344MMDA/NOW/SAV
                  
                  $
                  110,031
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  110,031CD’s
      <$100k
                  
                  
                  0
                  
                  
                  $
                  12,712
                  
                  
                  $
                  8,242
                  
                  
                  $
                  8,242
                  
                  
                  $
                  2,572
                  
                  
                  
                  31,768CD’s
      >$100k
                  
                  
                  0
                  
                  
                  
                  24,837
                  
                  
                  
                  18,440
                  
                  
                  
                  4,610
                  
                  
                  
                  3,508
                  
                  
                  
                  51,395Borrowings
                  
                  
                  3,000
                  
                  
                  
                  0
                  
                  
                  
                  10,000
                  
                  
                  
                  15,000
                  
                  
                  
                  5,000
                  
                  
                  
                  33,000Total
      RSL
                  
                  $
                  113,031
                  
                  
                  $
                  37,549
                  
                  
                  $
                  36,682
                  
                  
                  $
                  27,852
                  
                  
                  $
                  11,080
                  
                  
                  $
                  226,194GAP
                  
                  $
                  (34,733
                  )
                  
                  $
                  (25,185
                  )
                  
                  $
                  (9,400
                  )
                  
                  $
                  22,881
                  
                  
                  $
                  110,587
                  
                  
                  $
                  64,150Cumulative
                  
                  $
                  (34,733
                  )
                  
                  $
                  (59,918
                  )
                  
                  $
                  (69,318
                  )
                  
                  $
                  (46,437
                  )
                  
                  $
                  64,150%
      Assets
                  
                  
                  -11.0
                  %
                  
                  
                  -18.9
                  %
                  
                  
                  -21.9
                  %
                  
                  
                  -14.7
                  %
                  
                  
                  20.2
                  %







Market risk in
securities.  Market risk in securities shows the amount of gain
or loss (before tax) in the securities portfolio.  Portfolio volume,
sector distribution, duration, and quality all affect market valuation. The
adjusted equity ratio is tier 1 capital adjustedfor the market gain or
loss less and any applicable tax effect divided by average total assets for
leverage capital purposes for the most recent quarter.  The ratio is
designed to show tier 1 capital if the securities portfolio had to be liquidated
and all gains and losses recognized.  If the ratio remains strong
after a +2% or +3% rate shock, market risk is reasonable in relation to the
level of capital.  A bank has flexibility and strength when the
securities portfolio can be liquidated for liquidity purposes without affecting
capital adequacy.





The Bank
has only moderate market risk in investments because the average maturity in the
portfolio is not very long, except for municipals, which are held to maturity
(see page 16 for discussion of investments).  The portfolio should
decline in value only about 1.6% or $371,000 for a 1% increase in
rates.  The gain in value if rates fall would be somewhat less,
because there are some callable bonds.  Marking-to-market available
for sale securities when rates change would add only modest volatility to a
strong level of equity.  This market risk acts to offset the interest
rate risk (i.e. if rates decline and NIM is squeezed, there would be a
concurrent gain in the value of securities).





25


SONOMA
VALLEY BANCORP


AVERAGE BALANCES/YIELDS AND RATES PAID


For the
three months ended September 30, 2008 and 2007




2008
                
                
                2007ASSETS
                  Interest-earning
      assets:
                
                Average
                  Balance
                
                
                Income/
                  Expense
                
                
                Yield/
                  Rate
                
                
                Average
                  Balance
                
                
                Income/
                  Expense
                
                
                Yield/
                  RateLoans(2):Commercial
                
                $
                175,215,278
                
                
                $
                3,134,791
                
                
                
                7.10
                %
                
                $
                162,612,801
                
                
                $
                3,324,486
                
                
                
                8.11
                %Consumer
                
                
                32,782,080
                
                
                
                578,947
                
                
                
                7.01
                %
                
                
                28,119,644
                
                
                
                604,205
                
                
                
                8.52
                %Real
      estate construction
                
                
                29,788,071
                
                
                
                569,324
                
                
                
                7.58
                %
                
                
                30,537,890
                
                
                
                680,547
                
                
                
                8.84
                %Real
      estate mortgage
                
                
                19,796,888
                
                
                
                348,622
                
                
                
                6.99
                %
                
                
                19,269,345
                
                
                
                364,242
                
                
                
                7.50
                %Tax
      exempt loans (1)
                
                
                2,168,815
                
                
                
                45,018
                
                
                
                8.24
                %
                
                
                2,277,726
                
                
                
                47,232
                
                
                
                8.23
                %Leases
                
                
                18,459
                
                
                
                539
                
                
                
                11.58
                %
                
                
                24,574
                
                
                
                540
                
                
                
                8.72
                %Unearned
      loan fees
                
                
                (276,328
                )
                
                
                
                
                
                
                
                
                
                
                (468,206
                )Total
      loans
                
                
                259,493,263
                
                
                
                4,677,241
                
                
                
                7.15
                %
                
                
                242,373,774
                
                
                
                5,021,252
                
                
                
                8.22
                %Investment
      securitiesAvailable
      for sale:Taxable
                
                
                2,040,040
                
                
                
                14,553
                
                
                
                2.83
                %
                
                
                10,597,367
                
                
                
                98,813
                
                
                
                3.70
                %Hold
      to maturity:Tax
      exempt (1)
                
                
                13,651,033
                
                
                
                196,700
                
                
                
                5.72
                %
                
                
                15,769,055
                
                
                
                231,924
                
                
                
                5.84
                %Total
      investment securities
                
                
                15,691,073
                
                
                
                211,253
                
                
                
                5.34
                %
                
                
                26,366,422
                
                
                
                330,737
                
                
                
                4.98
                %Federal
      funds sold
                
                
                23,555
                
                
                
                76
                
                
                
                1.28
                %
                
                
                0
                
                
                
                0
                
                
                
                0.00
                %FHLB
      stock
                
                
                1,477,089
                
                
                
                24,298
                
                
                
                6.53
                %
                
                
                1,484,729
                
                
                
                17,966
                
                
                
                4.80
                %Total
      due from banks/interest-bearing
                
                
                3,055,401
                
                
                
                5,953
                
                
                
                .77
                %
                
                
                402,608
                
                
                
                4,325
                
                
                
                4.26
                %Total
      interest-earning assets
                
                $
                279,740,381
                
                
                $
                4,918,821
                
                
                
                6.98
                %
                
                $
                270,627,533
                
                
                $
                5,374,280
                
                
                
                7.88
                %Noninterest-bearing
      assets:Reserve
      for loan losses
                
                
                (4,087,362
                )
                
                
                
                
                
                
                
                
                
                
                (3,766,517
                )Cash
      and due from banks
                
                
                5,510,959
                
                
                
                
                
                
                
                
                
                
                
                5,525,097Premises
      and equipment
                
                
                792,107
                
                
                
                
                
                
                
                
                
                
                
                846,480Other
      real estate owned
                
                
                320,416
                
                
                
                
                
                
                
                
                
                
                
                0Other
      assets
                
                
                17,010,745
                
                
                
                
                
                
                
                
                
                
                
                15,955,967Total
      assets
                
                $
                299,287,246
                
                
                
                
                
                
                
                
                
                
                $
                289,188,560LIABILITIES
      AND SHAREHOLDERS' EQUITYInterest-bearing
      liabilities:Interest-
      bearing depositsInterest-bearing
      transaction
                
                $
                29,773,852
                
                
                $
                12,457
                
                
                
                0.17
                %
                
                $
                27,409,466
                
                
                $
                11,150
                
                
                
                0.16
                %Savings
      deposits
                
                
                79,737,471
                
                
                
                348,426
                
                
                
                1.73
                %
                
                
                74,566,298
                
                
                
                484,318
                
                
                
                2.58
                %Time
      deposits over $100,000
                
                
                51,496,000
                
                
                
                442,232
                
                
                
                3.41
                %
                
                
                43,504,451
                
                
                
                526,022
                
                
                
                4.80
                %Other
      time deposits
                
                
                31,748,081
                
                
                
                252,826
                
                
                
                3.16
                %
                
                
                28,914,266
                
                
                
                330,872
                
                
                
                4.54
                %Total
      interest-bearing deposits
                
                
                192,755,404
                
                
                
                1,055,941
                
                
                
                2.17
                %
                
                
                174,394,481
                
                
                
                1,352,362
                
                
                
                3.08
                %Federal
      funds purchased
                
                
                539,674
                
                
                
                2,578
                
                
                
                1.90
                %
                
                
                0
                
                
                
                0
                
                
                
                0.00
                %Other
      borrowings
                
                
                17,524,412
                
                
                
                177,344
                
                
                
                4.01
                %
                
                
                27,968,387
                
                
                
                356,056
                
                
                
                5.05
                %Total
      interest-bearing liabilities
                
                
                210,819,490
                
                
                $
                1,235,863
                
                
                
                2.33
                %
                
                
                202,362,868
                
                
                $
                1,708,418
                
                
                
                3.35
                %Non-interest-bearing
      liabilities:Non-interest-bearing
      demand deposits
                
                
                51,086,420
                
                
                
                
                
                
                
                
                
                
                
                53,594,997Other
      liabilities
                
                
                6,960,284
                
                
                
                
                
                
                
                
                
                
                
                5,988,389Shareholders'
      equity
                
                
                30,421,052
                
                
                
                
                
                
                
                
                
                
                
                27,242,306Total
      liabilities and shareholders' equity
                
                $
                299,287,246
                
                
                
                
                
                
                
                
                
                
                $
                289,188,560Interest
      rate spread
                
                
                
                
                
                
                
                
                
                
                4.65
                %
                
                
                
                
                
                
                
                
                
                
                4.53
                %Interest
      income
                
                
                
                
                
                $
                4,918,821
                
                
                
                6.98
                %
                
                
                
                
                
                $
                5,374,280
                
                
                
                7.88
                %Interest
      expense
                
                
                
                
                
                
                1,235,863
                
                
                
                1.75
                %
                
                
                
                
                
                
                1,708,418
                
                
                
                2.50
                %Net
      interest income/margin
                
                
                
                
                
                $
                3,682,958
                
                
                
                5.23
                %
                
                
                
                
                
                $
                3,665,862
                
                
                
                5.38
                %





(1)
            Fully
      tax equivalent adjustments are based on a federal income tax rate of 34%
      in 2008 and 2007.


(2)
            Non
      accrual loans have been included in loans for the purposes of the above
      presentation.  Loan fees of approximately $73,855 and $121,807
      for the three months ended September 30, 2008 and 2007, respectively, were
      amortized to the appropriate interest income
  categories.





26





For
      the Three Month Periods


Ended
September 30, 2008 and 2007





Overview





We
reported net income of $916,075 for the third quarter of 2008 compared with
$1,092,504 for the third quarter of 2007.  On a per share basis, net
income for the three months ended September 30, 2008 equaled $0.41 per share
compared with $0.49 per share during the same period in 2007, see page 4
for the comparative detail.





Return on
average total assets on an annualized basis for the three months ended September
30, 2008 and 2007 was 1.22% and 1.51%, respectively.  Return on
average shareholders' equity on an annualized basis for the three months ended
September 30, 2008 and 2007 was 12.05% and 16.04%, respectively. The
decrease in the return on equity is a result of the decline in earnings and the
increase in average equity experienced in the third quarter of 2008 when
compared to 2007.  Net income showed a decrease of 16.1%, or $176,429,
from $1,092,504 to $916,075 as of September 30, 2007 and 2008,
respectively.





RESULTS
OF OPERATIONS





Net
Interest Income





Net
interest income, adjusted to a fully taxable equivalent basis, increased
slightly by $17,000 to $3.683 million for the three months ended September 30,
2008 from $3.666 million for the same period of 2007.  Net interest
income on a fully taxable equivalent basis, as shown on the table -Average
Balances/Yields and Rates Paid on page 26, 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 ($82,184 in 2008 and $94,913
in 2007, based on a 34% federal income tax rate).





Net
interest income (stated on a fully taxable equivalent basis) expressed as a
percentage of average earning  assets, is referred to as net interest
margin.  Our net interest margin for the third quarter of
2008 decreased 15 basis points to 5.23% from 5.38% for the quarter
ended September 30, 2007.  The slight decrease in net interest
margin is a result of the net effect of a $455,000 decrease in interest income
offset by a slightly larger decrease in interest expense of $472,000, showing a
net increase of $17,000.  For the three months ended September 30,
2008, the yield on average earning assets has decreased 90 basis points, while
the yield on interest bearing liabilities decreased 102 basis points from 3.35%
for the three months of 2007 to 2.33% for the three months period ended
September 30, 2008.  The Federal Reserve Bank has continued to lower
rates.  As of September 30, 2008 the federal funds rate was 2% and the
prime rate was 5% down approximately 300 basis points on average from the same
time last year.





Interest
Income





Interest
income for the three months ended September 30, 2008 decreased by $455,000
to $4.9 million, an 8.5% decrease over the $5.4 million realized during the
same period in 2007.  The gain in volume of average balances was
responsible for a $214,000 increase in interest income and a
$669,000 decrease in income was related to lower interest rates, resulting
in a net decline in interest income of $455,000.





Interest
Expense





Total
interest expense for the three months ended September 30, 2008 decreased by
$473,000 to $1.2 million compared with $1.7 million in the same period of
2007.  The average rate paid on all interest-bearing liabilities for
the third quarter of 2008 decreased 102 basis points to 2.33% from
3.35% in the third quarter of 2007, and average balances for the third quarter
of 2008 increased to $210.8 million from $202.4 million in the same period of
2007, a 4.2% gain.





The gain
in volume of average balances accounted for a $11,000 increase in interest
expense while a decline of $484,000 was related to lower interest rates paid,
resulting in a $473,000 decrease in interest expense for the third
quarter of 2008.





Individual
components of interest income and interest expense are provided in the table -
Average Balances/Yields and Rates Paid on page 26.





27


Provision
for Loan Losses





The
provision for loan losses was $300,000 during the third quarter of 2008 compared
to the $140,000 provision for the third quarter of 2007.  The increase
in the provision is the result of managements' evaluation and assessment of the
loan portfolio in light of current economic conditions.  In addition,
the Company has continued to experience growth in loan volume.





Non-interest
Income





Non-interest
income of $529,000 for the third quarter of 2008 represented a decrease of
$52,000, or 9.0%, from the $581,000 for the comparable period in
2007.  Contributing to this variance was a decline in service charges
on deposit accounts which decreased $23,000, or 6.6%, from $349,000 for the
quarter ended September 2007 to $326,000 for the quarter ended September
2008.  Loan referral income is down 64.1%, or $16,000, from $37,000
for the third quarter 2007 to $9,000 for the same period in
2008.  Credit card merchant fees also declined $10,000, or 18.5%, from
$51,000 at September 30, 2007 to $42,000 at September 30, 2008.





Non-interest
Expense





For the
third quarter of 2008, non-interest expense was $2.45 million compared with
$2.33 million for the same period in 2007, representing an increase of $123,000,
or 5.3%.  Contributing to the increase in non-interest expense was
salaries and benefits expense of $1.414 million which increased $27,000 or 2.0%
compared with $1.387 million for the three months ended September 30,
2007.  At September 30, 2008 and September 30, 2007, total full-time
equivalent employees were 55 and 50, respectively.





The
expenses for premises and equipment declined 4.2% from $244,000 for the third
quarter of 2007 to $234,000 in 2008.  The $10,000 decrease in expense
in 2008 is a result of computer and equipment being fully
depreciated.





Other
non-interest expenses for the three months ended September 30, 2008 increased
15.2%, or $106,000, to $805,000 compared to $699,000 for the same period of
2007.  The increase is a result of increases in FDIC and other
insurance which increased $37,000 from $35,000 to $71,000 for third quarters
2007 and 2008, respectively. The 2008 increase in FDIC Insurance is responsible
for this increase. Expense for professional fees increased $36,000 or 12.4% from
$288,000 for third quarter 2007 to $324,000 for third quarter 2008. Advertising
and marketing expenses increased 44.3% from $64,000 the three months ended
September 2007 to $93,000 for the same period in 2008. The additional
expenditure helped reinforce our presence in the community during these troubled
economic times.





Provision
for Income Taxes





The
provision for income taxes decreased to an effective tax rate of 33.4% in the
third quarter of 2008 compared with 35.0% for the comparable period in
2007.  The lower effective tax rate is a reflection of tax credits
resulting from the Company’s investment in California affordable
housing.  Income taxes reported in the financial statement include
deferred taxes resulting from timing differences in the recognition of items for
tax and financial reporting purposes.





Item
      3.
            QUANTITATIVE AND QUALITATIVE DISCLOSUREABOUT MARKET RISK





Information
regarding Quantitative and Qualitative Disclosures about Market Risk appears on
page 23 through 25 under the caption “Management's Discussion and Analysis of
Financial Condition and Results of Operations -B Market Risk
Management” and is incorporated herein by reference.





28


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, 2008, there have been no changes in our internal
control over financial reporting, or to our knowledge, in other factors, that
have materially affected or, are reasonably likely to materially affect our
internal controls over financial reporting.





29


Part II





Item
1.                                      LEGAL PROCEEDINGS





From time
to time we may be a party to legal proceedings arising in the ordinary course of
business.  We are not currently a party to, nor are any of our
properties the subject of, any material pending legal proceedings.





Item
2.                                      UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF
PROCEEDS





The
following chart summarizes our repurchases of common shares as part of our
publicly announced repurchase plan.





(a)
              (b)
              (c)
              (d)Period
              Total
      Number of
                Shares
      (or Units)
                Purchased
              Average
      Price paid
                per
      Share (or Unit)
              Total
      Number of
                Shares
      (or Units)
                Purchased
      as Part
                of
      Publicly
                Announced
      Plans or
                Programs
              Maximum
      Number (or Approximate Dollar Value) of Shares (or Units) that May Yet be
      Purchased Under the Plans or Programs (1)  (2)Month
      #1:
                7/1/08-
      7/31/08
              0
              $.00
              0
              39,592Month
      #2:
                8/1/08-
      8/31/08
              0
              $.00
              0
              39,592Month
      #3:
                9/1/08–
      9/30/08
              0
              $.00
              0
              39,592Total
              0
              $.00
              0
              39,592





(1)
            On
      January 17, 2001 a repurchase program was approved up to
      $1,000,000.  On August 21, 2002 an additional $1,000,000 was
      approved. The program has no expiration
date.


(2)
            On
      February 15, 2006, 60,000 shares were approved for repurchase and on
      October 18, 2006 an additional 60,000 shares were approved for repurchase
      and on July 18, 2007, an additional 60,000 share were approved for
      repurchase.  The repurcash approved has no expiration
      date.





Item
3.                                      DEFAULTS UPON SENIOR SECURITIES





None





Item
4.                                      SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS





None





Item
5.                                      OTHER INFORMATION




The
Company previously entered into severance agreements with its
executive officers. The agreements include provisions for severance payments in
certain circumstances including change of control of the Company. The severance
agreements have been revised and amended to comply with Section 409A of the
Internal Revenue Code.  The Board of Directors of the Company considers
these agreements to provide the named executive officers with the ability to
make appropriate, informed decisions on strategy and direction of the Company
that may adversely impact their particular positions, but nevertheless are
appropriate for the Company and its shareholders. Our Board believes that
companies should provide reasonable severance benefits to employees, recognizing
that it may be difficult for them to find comparable employment within a short
period of time and that severance arrangements may be necessary to attract
highly qualified officers in a competitive hiring
environment.




Under
the severance agreements, in general, in the event the executive is
terminated without cause the executive is entitled to a severance payment equal
one
year of base salary for the Chief Financial Officer and the Chief Operating
Officer and two years of base salary for the Chief Executive Officer and the
President and Chief Administrative Officer.The form of severance
agreement is attached to this report as an Exhibit, and the terms and conditions
incorporated herein. The foregoing statements are not intended to be a complete
description of all terms and conditions.


30





Item
6.                                      EXHIBITS





Exhibits








10.13
              Sonoma
      Valley Bank Severance Agreement for Executive Officers [Form
  of]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
      Act32
              Certification
      of CEO and CFO pursuant to Section 906 of the Sarbanes-Oxley
  Act





31





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
      5, 2008
              
              /s/
      Mel Switzer, Jr.Mel
      Switzer, Jr.President
      and Chief Executive Officer(Principal
      Executive Officer)Date:
              November
      5, 2008
              
              /s/
      Mary Dieter SmithMary
      Dieter SmithExecutive
      Vice President and Chief Financial Officer(Principal
      Financial Officer and Principal Accounting Officer)










32