##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q (Mark One) x
    
    Quarterly Report Under Section 13 or 15(d) of the Securities Exchange
Act of 1934For the
Quarterly Period Ended September 30, 2004oro
    
    Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934For the
Transition period
from  to
 Commission File Number: 000-50950 VALLEY BANCORP  Nevada
    
    88-0493760(State or Other Jurisdiction of Incorporation or Organization)
    
    (I.R.S. Employer I.D. Number)3500 W. Sahara Avenue, Las Vegas, NV
    
    89102(Address of Principal Executive Offices)
    
    (Zip Code)
 (702) 221-8600 
  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
    
    o
 Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act) Yes
    
    o
    
    No
    
    x
 Indicate the number of shares outstanding of each of the issuers classes of
common stock, as of the latest practicable date. Common Stock Issued and Outstanding: 2,789,228 shares as of October 31,
2004.




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VALLEY BANCORP Table of Contents PagePART I FINANCIAL INFORMATIONItem 1. Financial Statements-UnauditedConsolidated Balance Sheets at September 30, 2004 and December 31, 2003
    
    
    2Consolidated Statements of Income for the Three Months and Nine Months Ended September 30, 2004 and 2003
    
    
    3Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2004 and 2003
    
    
    4Notes to Consolidated Financial Statements
    
    
    5-8Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    9-19Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    19-21Item 4. Controls and Procedures
    
    
    21PART II OTHER INFORMATION
    
    
    22Item 1. Legal Proceedings
    
    
    22Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    22Item 3. Defaults Upon Senior Securities
    
    
    22Item 4. Submission of Matters to a Vote of Security Holders
    
    
    22Item 5. Other Information
    
    
    22Item 6. Exhibits
    
    
    22Signatures
    
    
    23EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32
  1




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##### Table of Contents



Part I. Financial Information 
 ITEM 1. FINANCIAL STATEMENTS Valley Bancorp And Subsidiary 
 Consolidated Balance Sheets (Unaudited)
 September 30,
    
    December 31,2004
    
    2003AssetsCash and due from banks
    
    $
    9,464,955
    
    
    $
    4,951,928Federal funds sold
    
    
    26,805,000
    
    
    
    8,875,000Cash and cash equivalents
    
    
    36,269,955
    
    
    
    13,826,928Interest-bearing deposits at other financial institutions
    
    
    9,503,168
    
    
    
    14,865,406Securities available for sale at fair value
    
    
    12,837,118
    
    
    
    19,006,189Loans, net of allowance for loan losses of $2,089,457 and $1,563,112, respectively
    
    
    186,524,631
    
    
    
    133,794,739Loans held for sale
    
    
    600,841
    
    
    
    Premises and equipment, net
    
    
    4,323,585
    
    
    
    4,456,897Other real estate owned
    
    
    
    
    
    
    228,173Accrued interest receivable
    
    
    642,096
    
    
    
    564,549Deferred taxes, net
    
    
    174,364
    
    
    
    23,551Other assets
    
    
    305,394
    
    
    
    149,618Total assets
    
    $
    251,181,152
    
    
    $
    186,916,050Liabilities and Stockholders EquityDeposits:Non-interest bearing demand
    
    $
    49,839,207
    
    
    $
    26,838,976Interest bearing:Demand
    
    
    72,688,226
    
    
    
    65,010,797Savings
    
    
    12,747,885
    
    
    
    9,556,595Time, $100,000 and over
    
    
    32,765,622
    
    
    
    26,516,444Other time
    
    
    46,375,795
    
    
    
    41,874,873Total deposits
    
    
    214,416,735
    
    
    
    169,797,685Accrued interest payable and other liabilities
    
    
    1,046,524
    
    
    
    615,431Long-term debt
    
    
    476,754
    
    
    
    505,447Total liabilities
    
    
    215,940,013
    
    
    
    170,918,563Commitments and contingencies (Note 5)Stockholders equity:Preferred stock, $1.00 par value, 500,000 shares authorized;
none issued or outstanding
    
    
    
    
    
    
    Common stock, $0.73 par value; 10,000,000 shares authorized and 2,789,228
shares issued and outstanding as of September 30, 2004; 2,750,000 shares
authorized and
1,725,478 shares issued and outstanding as of December 31, 2003
    
    
    2,036,136
    
    
    
    1,259,599Surplus
    
    
    29,591,190
    
    
    
    13,243,845Retained earnings
    
    
    3,668,045
    
    
    
    1,476,325Accumulated other comprehensive income (loss)
    
    
    (54,232
    )
    
    
    17,718Total stockholders equity
    
    
    35,241,139
    
    
    
    15,997,487Total liabilities and stockholders equity
    
    $
    251,181,152
    
    
    $
    186,916,050
 See Notes to Consolidated Financial Statements. 2




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##### Table of Contents



Valley Bancorp And Subsidiary 
 Consolidated Statements Of Income (Unaudited)
 Three Months Ended September 30,
    
    Nine Months Ended September 30,2004
    
    2003
    
    2004
    
    2003Interest income on:Loans, including fees
    
    $
    3,279,449
    
    
    $
    2,415,942
    
    
    $
    8,947,101
    
    
    $
    6,916,050Securities available for sale
    
    
    81,900
    
    
    
    63,448
    
    
    
    258,009
    
    
    
    137,412Federal funds sold and interest-bearing deposits at
other financial institutions
    
    
    112,688
    
    
    
    93,299
    
    
    
    330,387
    
    
    
    325,963Total interest income
    
    
    3,474,037
    
    
    
    2,572,689
    
    
    
    9,535,497
    
    
    
    7,379,425Interest expense on:Deposits
    
    
    662,783
    
    
    
    691,606
    
    
    
    1,955,327
    
    
    
    2,334,178Other borrowed funds
    
    
    7,080
    
    
    
    9,283
    
    
    
    26,354
    
    
    
    28,323Total interest expense
    
    
    669,863
    
    
    
    700,889
    
    
    
    1,981,681
    
    
    
    2,362,501Net interest income
    
    
    2,804,174
    
    
    
    1,871,800
    
    
    
    7,553,816
    
    
    
    5,016,924Provision for loan losses
    
    
    120,000
    
    
    
    113,000
    
    
    
    506,000
    
    
    
    305,668Net interest income after provision for
loan losses
    
    
    2,684,174
    
    
    
    1,758,800
    
    
    
    7,047,816
    
    
    
    4,711,256Other income:Service charges on deposit accounts
    
    
    63,311
    
    
    
    62,395
    
    
    
    204,152
    
    
    
    166,507Net gain (loss) on sale of available for sale securities
    
    
    (9,156
    )
    
    
    20,519
    
    
    
    (6,155
    )
    
    
    20,519Other
    
    
    8,760
    
    
    
    8,394
    
    
    
    26,505
    
    
    
    29,29362,915
    
    
    
    91,308
    
    
    
    224,502
    
    
    
    216,319Other expense:Salaries and employee benefits
    
    
    833,322
    
    
    
    642,621
    
    
    
    2,264,518
    
    
    
    1,872,826Equipment rentals, depreciation and maintenance
    
    
    58,802
    
    
    
    66,745
    
    
    
    180,526
    
    
    
    191,510Occupancy
    
    
    97,441
    
    
    
    96,315
    
    
    
    251,435
    
    
    
    258,964Data processing
    
    
    90,215
    
    
    
    82,522
    
    
    
    251,372
    
    
    
    233,088Legal, professional and consulting
    
    
    64,126
    
    
    
    94,054
    
    
    
    146,400
    
    
    
    255,807Advertising and public relations
    
    
    16,875
    
    
    
    26,745
    
    
    
    90,951
    
    
    
    72,198Outside services
    
    
    68,518
    
    
    
    55,288
    
    
    
    184,439
    
    
    
    166,333Federal Reserve Bank & correspondent bank fees
    
    
    27,951
    
    
    
    17,958
    
    
    
    85,269
    
    
    
    54,477Telephone
    
    
    41,609
    
    
    
    31,271
    
    
    
    113,579
    
    
    
    88,224Office supplies & printing
    
    
    24,568
    
    
    
    31,043
    
    
    
    103,270
    
    
    
    97,077Director fees
    
    
    31,600
    
    
    
    22,775
    
    
    
    75,875
    
    
    
    69,025Other
    
    
    59,307
    
    
    
    56,344
    
    
    
    198,581
    
    
    
    153,8731,414,334
    
    
    
    1,223,681
    
    
    
    3,946,215
    
    
    
    3,513,402Income before income taxes
    
    
    1,332,755
    
    
    
    626,427
    
    
    
    3,326,103
    
    
    
    1,414,173Income tax expense
    
    
    454,116
    
    
    
    213,558
    
    
    
    1,134,383
    
    
    
    461,281Net income
    
    $
    878,639
    
    
    $
    412,869
    
    
    $
    2,191,720
    
    
    $
    952,892Comprehensive income
    
    $
    951,920
    
    
    $
    403,258
    
    
    $
    2,119,770
    
    
    $
    974,509Earnings per share:Basic
    
    $
    0.48
    
    
    $
    0.24
    
    
    $
    1.25
    
    
    $
    0.58Diluted
    
    $
    0.47
    
    
    $
    0.23
    
    
    $
    1.20
    
    
    $
    0.56
 See Notes to Consolidated Financial Statements. 3




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##### Table of Contents



Valley Bancorp And Subsidiary 
 Consolidated Statements Of Cash Flows (Unaudited)
 Nine Months Ended September 30,2004
    
    2003Cash Flows from Operating Activities:Net income
    
    $
    2,191,720
    
    
    $
    952,892Adjustments to reconcile net income to net cash provided by
operating activities:Depreciation of premises and equipment
    
    
    212,818
    
    
    
    222,563(Gain) loss on sale of other real estate owned
    
    
    7,547
    
    
    
    (Gain) loss on sale of securities available for sale
    
    
    6,155
    
    
    
    (20,519
    )Deferred taxes
    
    
    (113,748
    )
    
    
    17,122Tax benefit resulting from the exercise of nonqualified stock options
    
    
    
    
    
    
    23,715Net accretion/amortization of investment discount/premium
    
    
    (81,847
    )
    
    
    30,012Provision for loan losses
    
    
    506,000
    
    
    
    305,668(Increase) decrease in accrued interest receivable
    
    
    (77,547
    )
    
    
    (83,631
    )(Increase) decrease in other assets
    
    
    (155,776
    )
    
    
    131,557Increase in accrued interest payable and other liabilities
    
    
    431,093
    
    
    
    173,899Net cash provided by operating activities
    
    
    2,926,415
    
    
    
    1,753,278Cash Flows from Investing Activities:Net increase in loans
    
    
    (53,836,733
    )
    
    
    (17,210,908
    )Net (increase) decrease in interest bearing deposits at other financial institutions
    
    
    5,362,238
    
    
    
    (4,690,801
    )Purchase of securities available for sale
    
    
    (10,024,292
    )
    
    
    (15,026,775
    )Proceeds from the maturities of securities available for sale
    
    
    2,081,365
    
    
    
    1,000,000Proceeds from the sale of securities available for sale
    
    
    14,078,675
    
    
    
    5,047,320Proceed from the sale of other real estate
    
    
    220,626
    
    
    
    Purchase of premises and equipment
    
    
    (79,506
    )
    
    
    (62,450
    )Net cash used in investing activities
    
    
    (42,197,627
    )
    
    
    (30,943,614
    )Cash Flows from Financing Activities:Net increase in deposits
    
    
    44,619,050
    
    
    
    23,970,708Principal payments on notes payable
    
    
    (28,693
    )
    
    
    (26,724
    )Proceeds from issuance of common stock
    
    
    17,123,882
    
    
    
    3,048,340Proceeds from stock options exercised
    
    
    
    
    
    
    279,000Net cash provided by financing activities
    
    
    61,714,239
    
    
    
    27,271,324Increase (decrease) in cash and cash equivalents
    
    
    22,443,027
    
    
    
    (1,919,012
    )Cash and cash equivalents, beginning of period
    
    
    13,826,928
    
    
    
    22,760,187Cash and cash equivalents, end of period
    
    $
    36,269,955
    
    
    $
    20,841,175
 See Notes to Consolidated Financial Statements. 4




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##### Table of Contents



Valley Bancorp 
 Notes to Consolidated Financial Statements
  1. Nature of Business and Basis of Presentation Valley Bancorp is a bank holding company whose primary subsidiary, Valley Bank,
is a Nevada State chartered bank that provides a full range of banking services
to commercial and consumer customers through three branches located in Las
Vegas, Henderson and Pahrump, Nevada. These entities are collectively referred
to herein as the Company. The Companys business is concentrated in southern
Nevada and is subject to the general economic conditions of this area. Segment
information is not presented since all of the Companys revenues are
attributable to one operating segment. The accounting and reporting policies of the Company conform to accounting
principles generally accepted in the United States of America and general
industry practices. The preparation of financial statements requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosures of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from
those estimates. A material estimate that is particularly susceptible to
significant change in the near term relates to the determination of the
allowance for loan losses. The information as of and for the periods ended September 30, 2004 and 2003 has
not been audited and is presented in a condensed format which does not contain
all of the information and footnotes required by generally accepted accounting
principles for complete financial statements. The information furnished in
these interim statements reflects all adjustments that are, in the opinion of
management, necessary for a fair statement of the results for each respective
period presented. Such adjustments are of a recurring nature unless otherwise
disclosed. The results of operations for the nine months ended September 30,
2004 are not necessarily indicative of results to be anticipated for the full
year ending December 31, 2004. 2. Earnings Per Share Basic earnings per share represents income available to common stockholders
divided by the weighted-average number of common shares outstanding during the
period. Diluted earnings per share reflects additional common shares that would
have been outstanding if dilutive potential common shares had been issued, as
well as any adjustment to income that would result from assumed issuance.
Potential common shares that may be issued by the Company relate solely to
outstanding options, and are determined using the treasury stock method. Earnings per common share have been computed based on the following: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net income
    
    $
    878,639
    
    
    $
    412,869
    
    
    $
    2,191,720
    
    
    $
    952,892Less: Preferred stock dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income applicable to common stock
    
    $
    878,639
    
    
    $
    412,869
    
    
    $
    2,191,720
    
    
    $
    952,892Average number of common shares outstanding
    
    
    1,817,978
    
    
    
    1,722,243
    
    
    
    1,756,650
    
    
    
    1,637,600Effect of dilutive options
    
    
    70,358
    
    
    
    59,501
    
    
    
    63,120
    
    
    
    55,984Average number of common shares outstanding used to calculate
diluted earnings per common share
    
    
    1,888,336
    
    
    
    1,781,744
    
    
    
    1,819,770
    
    
    
    1,693,584Basic EPS
    
    $
    0.48
    
    
    $
    0.24
    
    
    $
    1.25
    
    
    $
    0.58Diluted EPS
    
    $
    0.47
    
    
    $
    0.23
    
    
    $
    1.20
    
    
    $
    0.56
 5




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3. Stock Options The Company has two stock-based compensation plans, which are described more
fully in Note 11 of the Companys December 31, 2003 annual report as filed in
the Form S-1 with the SEC. The Company accounts for those plans under the
recognition and measurement principles of APB Opinion No. 25, Accounting for
Stock Issued to Employees,and related interpretations. No stock-based employee
compensation cost is reflected in net income, as all options granted under
those plans had an exercise price equal to the estimated fair value of the
underlying common stock on the date of grant. The following table illustrates
the effect on net income and earnings per share if the Company had applied the
fair value recognition provisions of FASB Statement No. 123, Accounting for
Stock-Based Compensation,to stock-based employee compensation: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net Income As Reported
    
    $
    878,639
    
    
    $
    412,869
    
    
    $
    2,191,720
    
    
    $
    952,892Deduct: Total Stock-Based Employee Compensation Expense
Determined Under Fair Value Based Method For All Awards,
Net Of Related Tax Effects
    
    
    (15,639
    )
    
    
    (40,869
    )
    
    
    (46,720
    )
    
    
    (121,892
    )Proforma net income
    
    $
    863,000
    
    
    $
    372,000
    
    
    $
    2,145,000
    
    
    $
    831,000Basic
earnings per share - As reported
    
    $
    0.48
    
    
    $
    0.24
    
    
    $
    1.25
    
    
    $
    0.58Basic
earnings per share - Pro forma
    
    $
    0.47
    
    
    $
    0.22
    
    
    $
    1.22
    
    
    $
    0.51Diluted
earnings per share - As reported
    
    $
    0.47
    
    
    $
    0.23
    
    
    $
    1.20
    
    
    $
    0.56Diluted
earnings per share - Pro forma
    
    $
    0.46
    
    
    $
    0.21
    
    
    $
    1.18
    
    
    $
    0.49
 4. Loans The composition of the Companys loan portfolio was as follows: At September 30,
    
    At December 31,2004
    
    2003Commercial, financial and industrial
    
    $
    33,514,967
    
    
    $
    24,899,966Real Estate:Commercial
    
    
    93,468,863
    
    
    
    65,793,033Construction, raw land and land development
    
    
    54,801,335
    
    
    
    39,769,746Residential
    
    
    6,142,664
    
    
    
    4,375,179Consumer
    
    
    1,474,421
    
    
    
    1,045,075189,402,250
    
    
    
    135,882,999Deduct:Unearned net loan fees
    
    
    (788,162
    )
    
    
    (525,148
    )Allowance for loan losses
    
    
    (2,089,457
    )
    
    
    (1,563,112
    )Net loans
    
    $
    186,524,631
    
    
    $
    133,794,739
 6




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##### Table of Contents



There were no impaired or nonaccrual loans as of September 30, 2004. Impaired
and nonaccrual loans were $2.3 million and $704,000 as of December 31, 2003,
respectively. Net charge-offs (recoveries) for the nine months ended September
30, 2004 and 2003 were $(20,000) and $93,000, respectively. 5. Commitments and Contingencies Contingencies In December 2003 the Company reached a settlement in connection with certain
loan losses it incurred during the year ended December 31, 2002. The Company
received $300,000 in January 2004. In addition, the terms of the settlement
provide for twelve quarterly payments of $20,000 starting April 2004, and a
fixed payment of $10,000 on April 1, 2007. The Company will recognize these
payments as recoveries to the allowance for loan losses as they are received. In the normal course of business, the Company is involved in various other
legal proceedings. In the opinion of management, any liability resulting from
such proceedings would not have a material adverse effect on the consolidated
financial statements. Financial instruments with off-balance-sheet risk The Company is party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments consist of commitments to extend credit. They
involve, to varying degrees, elements of credit risk in excess of the amounts
recognized in the balance sheets. The Companys exposure to credit loss in the event of nonperformance by the
other parties to the financial instruments for these commitments is represented
by the contractual amounts of those instruments. The Company uses the same
credit policies in making commitments and conditional obligations as it does
for on-balance-sheet instruments. A summary of the contract amount of the Companys exposure to off-balance-sheet
risk as of September 30, 2004 and December 31, 2003 is as follows: At September 30,
    
    At December 31,2004

    
    2003Commitments to extend credit, of which approximately
6% and 19% are unsecured at September 30, 2004
and December 31, 2003, respectively
    
    $
    48,427,000
    
    
    $
    29,754,000Standby letters of credit, of which approximately
15% and 0% are unsecured at September 30, 2004
and December 31, 2003, respectively
    
    
    1,639,000
    
    
    
    1,000,000$
    50,066,000
    
    
    $
    30,754,000
 Commitments to extend credit Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected
to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The Company evaluates each
customers creditworthiness on a case-by-case basis. The amount of collateral
obtained, if deemed necessary by the Company upon extension of credit, is based
on managements credit evaluation of the party. Collateral held varies, but
may include accounts receivable, inventory, property and equipment, residential
real estate and income-producing commercial properties. 7




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##### Table of Contents



Standby letters of credit Standby letters of credit are conditional commitments issued by the Company to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support public and private borrowing arrangements. The
credit risk involved in issuing letters of credit is essentially the same as
that involved in extending loan facilities to customers. Lease commitments In 2001, the Company entered into a non-cancelable operating lease with respect
to its Pahrump branch office, expiring in five years. The lease includes two
renewal option periods of five years each. The agreement requires monthly
rental payments of approximately $7,120 for the first year with an escalation
clause for subsequent years. At September 30, 2004, the future annual lease
payments due under this lease commitment totaled approximately $133,000. 6. Stockholders Equity During the three months ended September 30, 2004, the Company issued 1,063,750
shares (including the over-allotment option) of its $0.73 par value common
stock in an underwritten public offering at a price to the public of $18.00 per
share. The proceeds after discounts and commissions amounted to $18.0 million
and direct, incremental costs of issuance were approximately $860,000 which
resulted in an increase in stockholders equity of $17.1 million. 8




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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results
of Operations This Quarterly Report contains forward-looking statements within the meaning of
the federal securities laws. These statements are not historical facts, but
rather are statements based on the Companys current expectations regarding its
business strategies and their intended results and its future performance.
Forward-looking statements are preceded by terms such as expects, feels,
believes, anticipates, intends, and similar expressions. Forward-looking
statements are not guarantees of future performance. Numerous risks and
uncertainties could cause the Companys actual results, performance, and
achievements to be materially different from those expressed or implied by the
forward-looking statements. Factors that may cause or contribute to these
differences include, without limitation, general economic conditions, including
changes in market interest rates and changes in monetary and fiscal policies of
the federal government; changes in market conditions in the Companys principal
market area; adverse changes in the financial condition of the loan loss
reserves; competitive pressures on loan or deposit terms; legislative and
regulatory changes; and other factors disclosed periodically in the Companys
filings with the Securities and Exchange Commission. Because of the risks and
uncertainties inherent in forward-looking statements, readers are cautioned not
to place undue reliance on them, whether included in this report or made
elsewhere from time to time by the Company or on its behalf. The Company
assumes no obligation to update any forward-looking statements. Overview of Operating Results for the Three Months and Nine Months Ended
September 30, 2004 and September 30, 2003 Net income increased from $413,000 or $0.23 per diluted share for the quarter
ended September 30, 2003 to $879,000 or $0.47 per diluted share for the quarter
ended September 30, 2004. For the nine months ended September 30, 2004, net
income was $2.2 million or $1.20 per diluted share as compared to $953,000 or
$0.56 per diluted share for the same period in 2003. The increase in earnings
for both periods was due primarily to increases in loans outstanding and other
earning assets. These items are discussed in further detail below. Critical Accounting Policies The Companys consolidated financial statements are prepared in accordance with
generally accepted accounting principles. The financial information contained
within these statements is, to a significant extent, financial information that
is based on approximate measures of the financial effects of transactions and
events that have already occurred. Based on its consideration of accounting
policies that involve the most complex and subjective decisions and
assessments, management has identified the allowance for loan losses as its
most critical accounting policy. Allowance for Loan Loss Methodology.The Companys allowance for loan loss
methodology incorporates a variety of risk considerations, both quantitative
and qualitative in establishing an allowance for loan loss that management
believes is appropriate at each reporting date. Quantitative factors include
the Companys historical loss experience, peer group experience, delinquency
and charge-off trends, collateral values, changes in nonperforming loans, and
other factors. Quantitative factors also incorporate known information about
individual loans, including borrowers sensitivity to interest rate movements.
Qualitative factors include the general economic environment in markets,
including economic conditions and in particular, the state of certain
industries. Size and complexity of individual credits in relation to loan
structure, existing loan policies and pace of portfolio growth are other
qualitative factors that are considered in the methodology. Changes in the
factors themselves are driven by perceived risk in pools of homogenous loans
classified by collateral type, purpose, terms, etc. Management monitors local
trends and peer experiences to anticipate future delinquency potential on a
quarterly basis. Since the Company has neither extensive loss history with segregation nor a
large sample of loans from inception to charge off, the Company does not use
migration analysis to accurately anticipate future losses through that method.
The Company relies heavily on the statistics provided through the FDIC
regarding loss percentages experienced by banks in the Western United States to
establish potential risk based on collateral type securing each loan. As
additional comparison, the Company examines local peer group banks to determine
the nature and scope of their 9




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##### Table of Contents



losses to date. Finally, the Company closely examines each credit graded
Special Mention and below to individually assess the appropriate loan loss
reserve for that particular credit. The Company periodically reviews the assumptions and formulae by which
additions are made to the specific and general valuation allowances for losses
in an effort to refine such allowances in light of the current status of the
factors described above. As the Company adds new products and increase the diversity of our loan
portfolio, we will enhance our methodology accordingly. We may report a
materially different amount for the provision for loan losses in the statement
of income to change the allowance for loan losses if our assessment of the
above factors were different. Although the Company believes the levels of the allowance as of September 30,
2004 was adequate to absorb probable losses in the loan portfolio, a decline in
local economic conditions, or other factors, could result in increasing losses
that cannot be reasonably predicted at this time. Comparison of Financial Condition at September 30, 2004 and December 31, 2003 Total Assets. Total assets increased 34.4%, from $186.9 million at December 31,
2003 to $251.2 million at September 30, 2004. This overall increase reflects a
$52.7 million or 39.4% increase in net loans receivable and a $22.4 million or
162.3% increase in cash and cash equivalents. The increase in net loans
receivable is primarily due to a $36.3 million increase in commercial real
estate and commercial & industrial lending, an $11.2 million increase in
construction lending, and a $3.8 million increase in raw land lending. These
increases were partially offset by a $5.4 million decrease in interest-bearing
deposits at other financial institutions and a $6.2 million decrease in
available for sale investment securities. The decrease in investment securities
available for sale is primarily due to sales and calls of agency securities.
Federal funds sold increased $17.9 million from December 31, 2003 to September
30, 2004 due primarily to the net proceeds from the initial public offering
that was closed on September 28, 2004. These funds have been temporarily
invested in the overnight Federal funds pending redeployment elsewhere. The following table sets forth the composition of our loan portfolio by the
type of loan at the dates indicated: September 30, 2004
    
    December 31, 2003Amount
    
    Percent
    
    Amount
    
    Percent(Dollars in thousands)Construction and land development loans
    
    $
    32,571
    
    
    
    17.19
    %
    
    $
    21,324
    
    
    
    15.70
    %Raw land loans
    
    
    22,230
    
    
    
    11.74
    %
    
    
    18,446
    
    
    
    13.57
    %Commercial real estate loans (1)
    
    
    93,469
    
    
    
    49.35
    %
    
    
    65,793
    
    
    
    48.42
    %Commercial and industrial loans
    
    
    33,515
    
    
    
    17.70
    %
    
    
    24,900
    
    
    
    18.32
    %Other loans
    
    
    7,617
    
    
    
    4.02
    %
    
    
    5,420
    
    
    
    3.99
    %Total loans
    
    
    189,402
    
    
    
    100.00
    %
    
    
    135,883
    
    
    
    100.00
    %Allowance for loan losses
    
    
    (2,089
    )
    
    
    
    
    
    
    (1,563
    )Unearned net loan fees
    
    
    (788
    )
    
    
    
    
    
    
    (525
    )Net loans
    
    $
    186,525
    
    
    
    
    
    
    $
    133,795
    (1)
    
    Includes commercial real estate loans and commercial and industrial loans secured by real estate. 10




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##### Table of Contents



The following table sets forth the composition of the securities portfolio at
the periods indicated. The securities are shown at fair value and unrealized
gains and losses are excluded from earnings and are reported net of deferred
taxes in accumulated other comprehensive income as a component of stockholders
equity. September 30,
    
    December 31,2004
    
    2003(Dollars in thousands)US Government agency securities
    
    $
    11,920
    
    
    $
    19,006Mortgage backed securities
    
    
    917
    
    
    
    Total
    
    $
    12,837
    
    
    $
    19,006
 Deposits. Total deposits increased $44.6 million or 26.3%, from $169.8 million
at December 31, 2003 to $214.4 million at September 30, 2004.
Non-interest-bearing deposits increased $23.0 million or 85.7%, primarily due
to a $22.0 million or 88.0% increase in business demand deposit accounts.
Interest-bearing deposits increased $21.6 million or 15.1%, primarily due to a
$10.7 million or 15.6% increase in time deposits, a $5.2 million or 10.4%
increase in money market accounts, and a $3.2 million or 33.4% increase in
savings accounts. Transaction accounts, which include both interest-bearing and
non-interest-bearing accounts, increased $33.9 million, from $101.4 million at
December 31, 2003 to $135.3 million at September 30, 2004. The increase in
business demand deposits as well as overall increase in other non-time deposits
is due to increased business relationships and marketing efforts focused on
gaining and retaining core deposit accounts. The following table reflects deposit ending balances by category as of the
dates indicated. September 30, 2004
    
    December 31, 2003Percent
    
    
    
    
    
    Percentof
    
    
    
    
    
    ofAmount
    
    Deposits
    
    Amount
    
    Deposits(Dollars in thousands)Transaction accounts:Savings accounts
    
    $
    12,748
    
    
    
    5.95
    %
    
    $
    9,557
    
    
    
    5.63
    %Money market deposit accounts
    
    
    55,391
    
    
    
    25.83
    %
    
    
    50,194
    
    
    
    29.55
    %NOW accounts
    
    
    17,297
    
    
    
    8.07
    %
    
    
    14,817
    
    
    
    8.73
    %Noninterest-bearing demand
accounts
    
    
    49,839
    
    
    
    23.24
    %
    
    
    26,839
    
    
    
    15.81
    %Total transaction accounts
    
    
    135,275
    
    
    
    63.09
    %
    
    
    101,407
    
    
    
    59.72
    %Time Deposits:$100,000 and over
    
    
    32,766
    
    
    
    15.28
    %
    
    
    26,516
    
    
    
    15.62
    %Other time
    
    
    46,376
    
    
    
    21.63
    %
    
    
    41,875
    
    
    
    24.66
    %Total time deposits
    
    
    79,142
    
    
    
    36.91
    %
    
    
    68,391
    
    
    
    40.28
    %Total Deposits
    
    $
    214,417
    
    
    
    100.00
    %
    
    $
    169,798
    
    
    
    100.00
    %
 Stockholders Equity. Stockholders equity increased from $16.0 million at
December 31, 2003 to $35.2 million at September 30, 2004. This increase was
primarily due to the Company issuing common stock through its initial public
offering during the quarter ended September 30, 2004 for net proceeds of $17.1
million. Retained earnings also increased by $2.2 million resulting from net
income for the nine months ended September 30, 2004. 11




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##### Table of Contents



Non-Performing Assets. The Company had no non-performing assets at September
30, 2004. The allowance for loan losses increased $526,000 or 33.7%, from $1.6
million at December 31, 2003 to $2.1 million at September 30, 2004 primarily
due to the growth in loans. The allowance for loan losses reflected the
current risk in the loan portfolio and represented 1.11% of total loans. The following table sets forth information concerning the allocation of
allowance for loan losses by loan category at the dates, indicated. September 30, 2004
    
    December 31, 2003Percent of
    
    
    
    
    
    Percent ofLoans in
    
    
    
    
    
    Loans inEach
    
    
    
    
    
    EachCategory to
    
    
    
    
    
    Category toTotal
    
    
    
    
    
    TotalAmount
    
    Loans
    
    Amount
    
    Loans(Dollars in thousands)Construction and land development loans
    
    $
    541
    
    
    
    17.19
    %
    
    $
    503
    
    
    
    15.70
    %Raw land loans
    
    
    114
    
    
    
    11.74
    %
    
    
    46
    
    
    
    13.57
    %Commercial real estate loans (1)
    
    
    558
    
    
    
    49.35
    %
    
    
    548
    
    
    
    48.42
    %Commercial and industrial loans
    
    
    825
    
    
    
    17.70
    %
    
    
    443
    
    
    
    18.32
    %Other loans
    
    
    51
    
    
    
    4.02
    %
    
    
    23
    
    
    
    3.99
    %Total
    
    $
    2,089
    
    
    
    100.00
    %
    
    $
    1,563
    
    
    
    100.00
    %
  (1)
    
    Includes commercial real estate loans and commercial and industrial loans secured by real estate. Comparison of Operating Results for the Three Months and Nine Months Ended
September 30, 2004 and September 30, 2003. Net Income. Net income was $879,000 for the three months ended September 30,
2004 compared to $413,000 for the three months ended September 30, 2003. This
represents an increase of $466,000 or 112.8%. Diluted earnings per share
increased $0.24, from $0.23 for the three months ended September 30, 2003 to
$0.47 for the same period in 2004. Return on average assets increased from
0.94% for the three months ended September 30, 2003 to 1.51% for the same
period in 2004. Return on average equity also increased, from 10.73% for the
three months ended September 30, 2003 to 19.47% for the same period in 2004.
These increases are mainly attributable to an increase in interest income from
lending activity during the three months ended September 30, 2004 as compared
to the same period in 2003. The Company also had a decrease in cost of funds
during 2004 due to lower interest rates being paid on deposits. For the nine months ended September 30, 2004, net income was $2.2 million as
compared to $953,000 for the same period in 2003. This represents an increase
of $1.2 million or 130.0%. Diluted earnings per share increased $0.64, from
$0.56 for the nine months ended September 30, 2003 to $1.20 for the same period
in 2004. Return on average assets increased from 0.75% for the nine months
ended September 30, 2003 to 1.32% for the same period in 2004. Return on
average equity also increased, from 8.86% for the nine months ended September
30, 2003 to 16.82% for the same period in 2004. These increases are mainly
attributable to higher interest income on loans due to higher loan balances
outstanding during the first nine months of 2004 as compared to the same period
in 2003. The Company also had lower cost of funds on deposits during 2004
despite having higher deposit balances outstanding. Non-interest expense
increased $433,000 or 12.3% for the nine months ended September 30, 2004 as
compared to the comparable period in 2003. This non-interest expense variance
was due primarily to increased compensation and employee benefits costs. These
changes are discussed in more detail in the following sections. Net Interest Income. Net interest income increased $932,000 or 49.8%, from $1.9
million for the three months ended September 30, 2003 to $2.8 million for the
same period in 2004. The Company experienced increased volume in both average
interest-earning assets and average interest-bearing liabilities. Average
interest-earning assets increased $54.6 million or 32.8%, while average
interest-bearing liabilities increased $27.1 million or 19.3%. 12




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##### Table of Contents



Interest rate spread increased 0.51%, from 4.15% for the three months ended
September 30, 2003 to 4.66% for the same period in 2004. Net interest margin
increased 0.59%, from 4.46% for the three months ended September 30, 2003 to
5.05% for the same period in 2004. The ratio of average interest-earning
assets to average interest-bearing liabilities increased 13.3%, from 118.8% for
the three months ended September 30, 2003 to 132.1% for the same period in
2004. Net interest income increased $2.5 million or 50.6%, from $5.0 million for the
nine months ended September 30, 2003 to $7.6 million for the same period in
2004. Although there was, in general, an overall decline in both yields and
costs when comparing the nine months ended September 30, 2003 to the same
period ended September 30, 2004, the Company experienced increased volume in
both average interest-earning assets and average interest-bearing liabilities.
Average interest-earning assets increased $47.7 million or 29.5%, while average
interest-bearing liabilities increased $26.0 million or 18.9%. Interest rate
spread increased 0.65%, from 3.81% for the nine months ended September 30, 2003
to 4.46% for the same period in 2004. Net interest margin increased 0.67%, from
4.15% for the nine months ended September 30, 2003 to 4.82% for the same period
in 2004. The ratio of average interest-earning assets to average
interest-bearing liabilities increased 10.5%, from 117.4% for the nine months
ended September 30, 2003 to 127.9% for the same period in 2004. The following tables set forth, for the periods indicated, information
regarding (i) the total dollar amount of interest income from interest-earning
assets and the resultant average yields; (ii) the total dollar amount of
interest expense on interest-bearing liabilities and the resultant average
rate; (iii) net interest income; (iv) interest rate spread (the difference
between the average yield earned on our earning assets and the rate paid on
interest bearing liabilities); and (v) net interest margin. Three Months Ended September 30,2004
    
    2003Interest
    
    Average
    
    
    
    
    
    Interest
    
    AverageAverage
    
    Income/
    
    Yield/
    
    Average
    
    Income/
    
    Yield/Balance (1)
    
    Expense
    
    Cost (2)
    
    Balance (1)
    
    Expense
    
    Cost (2)(Dollars in thousands)AssetsEarning assets:Loans (3) (4) (5)
    
    $
    181,289
    
    
    $
    3,279
    
    
    
    7.20
    %
    
    $
    130,652
    
    
    $
    2,416
    
    
    
    7.34
    %Federal funds sold (6)
    
    
    17,274
    
    
    
    60
    
    
    
    1.38
    %
    
    
    13,678
    
    
    
    33
    
    
    
    0.96
    %Interest bearing deposits (6)
    
    
    9,705
    
    
    
    53
    
    
    
    2.17
    %
    
    
    11,353
    
    
    
    60
    
    
    
    2.10
    %Investment securities (6)
    
    
    12,761
    
    
    
    82
    
    
    
    2.56
    %
    
    
    10,756
    
    
    
    63
    

    
    
    2.32
    %Total earning assets and interest income
    
    
    221,029
    
    
    
    3,474
    
    
    
    6.25
    %
    
    
    166,439
    
    
    
    2,572
    
    
    
    6.13
    %Non-interest earning assets:Cash and due from banks
    
    
    8,218
    
    
    
    
    
    
    
    
    
    
    
    4,542Premises and equipment
    
    
    4,358
    
    
    
    
    
    
    
    
    
    
    
    4,528Other assets
    
    
    1,039
    
    
    
    
    
    
    
    
    
    
    
    899Allowance for credit losses
    
    
    (2,015
    )
    
    
    
    
    
    
    
    
    
    
    (1,352
    )Total assets
    
    $
    232,629
    
    
    
    
    
    
    
    
    
    
    $
    175,056Liabilities and Stockholders EquityInterest bearing liabilities:Interest bearing demand deposits
    
    $
    73,386
    
    
    $
    182
    
    
    
    0.99
    %
    
    $
    58,553
    
    
    $
    135
    
    
    
    0.91
    %Savings deposits
    
    
    12,156
    
    
    
    15
    
    
    
    0.49
    %
    
    
    8,551
    
    
    
    12
    
    
    
    0.56
    %Time deposits $100,000 or more
    
    
    31,405
    
    
    
    172
    
    
    
    2.18
    %
    
    
    29,314
    
    
    
    211
    
    
    
    2.86
    %Other time deposits
    
    
    49,835
    
    
    
    294
    
    
    
    2.35
    %
    
    
    43,216
    
    
    
    333
    
    
    
    3.06
    %Short-term borrowings
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Long-term borrowings
    
    
    483
    
    
    
    7
    
    
    
    5.77
    %
    
    
    520
    
    
    
    9
    
    
    
    6.87
    %Total interest bearing liabilities
    
    
    167,265
    
    
    
    670
    
    
    
    1.59
    %
    
    
    140,154
    
    
    
    700
    
    
    
    1.98
    %Noninterest-bearing liabilities:Demand deposits
    
    
    46,489
    
    
    
    
    
    
    
    
    
    
    
    18,763Other liabilities
    
    
    816
    
    
    
    
    
    
    
    
    
    
    
    743Stockholders equity
    
    
    18,059
    
    
    
    
    
    
    
    
    
    
    
    15,396Total liabilities and stockholders equity
    
    $
    232,629
    
    
    
    
    
    
    
    
    
    
    $
    175,056Net Interest Spread (7)
    
    
    
    
    
    
    
    
    
    
    4.66
    %
    
    
    
    
    
    
    
    
    
    
    4.15
    %Net interest income/margin (8)
    
    
    
    
    
    $
    2,804
    
    
    
    5.05
    %
    
    
    
    
    
    $
    1,872
    
    
    
    4.46
    %
 13




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##### Table of Contents



Nine Months Ended September 30,2004
    
    2003Interest
    
    Average
    
    
    
    
    
    Interest
    
    AverageAverage
    
    Income/
    
    Yield/
    
    Average
    
    Income/
    
    Yield/Balance (1)
    
    Expense
    
    Cost (2)
    
    Balance (1)
    
    Expense
    
    Cost (2)(Dollars in thousands)AssetsEarning assets:Loans (3) (4) (5)
    
    $
    166,350
    
    
    $
    8,947
    
    
    
    7.18
    %
    
    $
    123,111
    
    
    $
    6,916
    
    
    
    7.51
    %Federal funds sold (6)
    
    
    16,460
    
    
    
    138
    
    
    
    1.12
    %
    
    
    19,315
    
    
    
    164
    
    
    
    1.14
    %Interest bearing deposits (6)
    
    
    12,444
    
    
    
    193
    
    
    
    2.07
    %
    
    
    10,361
    
    
    
    162
    
    
    
    2.09
    %Investment securities (6)
    
    
    14,166
    
    
    
    258
    
    
    
    2.43
    %
    
    
    8,928
    
    
    
    137
    
    
    
    2.05
    %Total earning assets and interest income
    
    
    209,420
    
    
    
    9,536
    
    
    
    6.08
    %
    
    
    161,715
    
    
    
    7,379
    
    
    
    6.10
    %Non-interest earning assets:Cash and due from banks
    
    
    7,684
    
    
    
    
    
    
    
    
    
    
    
    4,362Premises and equipment
    
    
    4,392
    
    
    
    
    
    
    
    
    
    
    
    4,581Other assets
    
    
    1,058
    
    
    
    
    
    
    
    
    
    
    
    1,009Allowance for credit losses
    
    
    (1,925
    )
    
    
    
    
    
    
    
    
    
    
    (1,312
    )Total assets
    
    $
    220,629
    
    
    
    
    
    
    
    
    
    
    $
    170,355Liabilities and Stockholders EquityInterest bearing liabilities:Interest bearing demand deposits
    
    $
    69,417
    
    
    $
    457
    
    
    
    0.88
    %
    
    $
    53,684
    
    
    $
    490
    
    
    
    1.22
    %Savings deposits
    
    
    11,159
    
    
    
    41
    
    
    
    0.49
    %
    
    
    8,216
    
    
    
    59
    
    
    
    0.96
    %Time deposits $100,000 or more
    
    
    31,960
    
    
    
    536
    
    
    
    2.24
    %
    
    
    30,108
    
    
    
    684
    
    
    
    3.04
    %Other time deposits
    
    
    50,590
    
    
    
    921
    
    
    
    2.43
    %
    
    
    45,189
    
    
    
    1,101
    
    
    
    3.26
    %Short-term borrowings
    
    
    102
    
    
    
    1
    
    
    
    1.31
    %
    
    
    
    
    
    
    
    
    
    
    Long-term borrowings
    
    
    492
    
    
    
    26
    
    
    
    7.06
    %
    
    
    529
    
    
    
    28
    
    
    
    7.08
    %Total interest bearing liabilities
    
    
    163,720
    
    
    
    1,982
    
    
    
    1.62
    %
    
    
    137,726
    
    
    
    2,362
    
    
    
    2.29
    %Noninterest-bearing liabilities:Demand deposits
    
    
    38,716
    
    
    
    
    
    
    
    
    
    
    
    17,589Other liabilities
    
    
    822
    
    
    
    
    
    
    
    
    
    
    
    693Stockholders equity
    
    
    17,371
    
    
    
    
    
    
    
    
    
    
    
    14,347Total liabilities and stockholders equity
    
    $
    220,629
    
    
    
    
    
    
    
    
    
    
    $
    170,355Net Interest Spread (7)
    
    
    
    
    
    
    
    
    
    
    4.46
    %
    
    
    
    
    
    
    
    
    
    
    3.81
    %Net interest income/margin (8)
    
    
    
    
    
    $
    7,554
    
    
    
    4.82
    %
    
    
    
    
    
    $
    5,017
    
    
    
    4.15
    %
   (1)
    
    Average balances are obtained from the best available daily or monthly data.(2)
    
    Annualized.(3)
    
    Loans are gross of allowance for credit losses but after unearned fees.(4)
    
    Non-accruing loans are included in the average balances.(5)
    
    Loan fees of $82,000, $66,000, $319,000 and $197,000 for the three months and nine months ended September 30, 2004 and 2003.(6)
    
    All investments are taxable.(7)
    
    Represents the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities(8)
    
    Net interest margin represents net interest income as a percentage of average interest-earning assets. Interest Income. For the three months ended September 30, 2004, interest income
increased $902,000 or 35.1%, primarily due to an increase of $863,000 or 35.7%
in loan interest income as compared to the same period in 2003. This increase
is the result of an increase of $50.6 million or 38.8% in average loans
receivable. The average yield on these loans decreased, from 7.34% for the
three months ended September 30, 2003 to 7.20% for the same period in 2004.
Interest income on all other investments increased by $39,000 or 25.0%. The
average yield for these investments increased 0.22%, from 1.73% for the three
months ended September 30, 2003 to 1.95% for the same period in 2004. This
increase is the result of rising rate environment during 2004. For the nine months ended September 30, 2004, interest income increased $2.2
million or 29.2%, primarily due to an increase of $2.0 million or 29.4% in loan
interest income as compared to the same period in 2003. This increase is the
result of an increase of $43.2 million or 35.1% in average loans receivable.
The average yield on these loans decreased, from 7.51% for the nine months
ended September 30, 2003 to 7.18% for the same period in 2004. 14




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##### Table of Contents



Interest income on all other investments increased by $126,000 or 27.2%. The
average yield for these investments increased 0.23%, from 1.60% for the nine
months ended September 30, 2003 to 1.83% for the same period in 2004. Interest Expense. For the three months ended September 30, 2004, total interest
expense decreased $30,000 or 4.3% as compared to the same period last year.
This decrease is primarily due to a decrease in the average cost of deposits,
which declined from 1.96% for the three months ended September 30, 2003 to
1.57% for the same period in 2004. Average deposits increased $27.1 million or
19.4%, from $139.6 million for the three months ended September 30, 2003 to
$166.8 million for the same period in 2004. The total cost of funds decreased
0.39%, from 1.98% for the three months ended September 30, 2003 to 1.59% for
the same period in 2004. For the nine months ended September 30, 2004, total interest expense decreased
$380,000 or 16.1% as compared to the same period last year. This decrease is
primarily due to a decrease in the average cost of deposits, which declined
from 2.27% for the nine months ended September 30, 2003 to 1.60% for the same
period in 2004. Average deposits increased $26.0 million or 18.8%, from $137.2
million for the nine months ended September 30, 2003 to $163.2 million for the
same period in 2004. The total cost of funds decreased 0.67%, from 2.29% for
the nine months ended September 30, 2003 to 1.62% for the same period in 2004. Provision for Loan Losses. The provision for loan losses totaled $120,000 for
the three months ended September 30, 2004 as compared to $113,000 for the same
period ended September 30, 2003. This $7,000 increase is primarily due to the
increase in the balance of the loan portfolio. Net recoveries increased
$25,000, from $4,000 for the quarter ended September 30, 2003 to $29,000 for
the same period in 2004. Management feels that their evaluations and
estimations were reasonable for determining the provision, and the allowance
for loan losses is deemed to be adequate as of September 30, 2004. However, a
decline in economic conditions or other factors beyond managements control
could significantly alter the amount of losses the Company recognizes in the
future. The provision for loan losses totaled $506,000 for the nine months ended
September 30, 2004 compared to $306,000 for the same period in 2003. This
$200,000 or 65.5% increase is primarily due to an increase in the amount of the
loan portfolio. Net charge-offs declined $113,000, from $93,000 for the nine
months ended September 30, 2003 to net recoveries of $20,000 for the same
period 2004. The following table sets forth the activity in allowance for loan losses for
the periods indicated. At or For the
    
    At or For theThree Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(Dollars in thousands)Balance at the beginning of period
    
    $
    1,940
    
    
    $
    1,318
    
    
    $
    1,563
    
    
    $
    1,222Charge-offs:Construction and land development loans
    
    
    
    
    
    
    
    
    
    
    (169
    )
    
    
    Raw land loans
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Commercial real estate loans (1)
    
    
    
    
    
    
    
    
    
    
    (150
    )
    
    
    Commercial and industrial loans
    
    
    
    
    
    
    
    
    
    
    (100
    )
    
    
    (95
    )Other loans
    
    
    
    
    
    
    (3
    )
    
    
    (8
    )
    
    
    (7
    )Total charge-offs
    
    
    
    
    
    
    (3
    )
    
    
    (427
    )
    
    
    (102
    )Recoveries:Construction and land development loans
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Raw land loans
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Commercial real estate loans (1)
    
    
    
    
    
    
    
    
    
    
    2
    
    
    
    Commercial and industrial loans
    
    
    20
    
    
    
    7
    
    
    
    436
    
    
    
    9Other loans
    
    
    9
    
    
    
    
    
    
    
    9
    
    
    
    Total recoveries
    
    
    29
    
    
    
    7
    
    
    
    447
    
    
    
    9
 15




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##### Table of Contents



At or For the
    
    At or For theThree Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(Dollars in thousands)Net (charge-offs)/recoveries
    
    
    29
    
    
    
    4
    
    
    
    20
    
    
    
    (93
    )Additions charge to operations
    
    
    120
    
    
    
    113
    
    
    
    506
    
    
    
    306Balance at end of period
    
    $
    2,089
    
    
    $
    1,435
    
    
    $
    2,089
    
    
    $
    1,435Allowance for loan losses as a percent of total loans
    
    
    1.11
    %
    
    
    1.09
    %
    
    
    1.11
    %
    
    
    1.09
    %Ratio of net charge-offs/(recoveries) to average loans -
annualized
    
    
    (0.06
    )%
    
    
    (0.01
    )%
    
    
    (0.02
    )%
    
    
    0.10
    %
  (1)
    
    Includes commercial real estate loans and commercial and industrial loans secured by real estate. Non-Interest Income. Non-interest income was $63,000 for the three months ended
September 30, 2004, as compared to $91,000 for the same period in 2003. The
decrease of $28,000 was due to a loss on the sale of securities of $9,000 in
the third quarter of 2004 while there was a gain on the sale of securities of
$20,000 in the third quarter of 2003. Non-interest income increased by $9,000
for the nine months ended September 30, 2004 to $225,000 as compared to
$216,000 for the same period last year, due primarily to increase in service
fee income. The following table sets forth information regarding noninterest income for the
periods shown. Noninterest IncomeFor the Three Months
    
    For the Nine MonthsEnded September 30,
    
    Ended September 30,2004
    
    2003
    
    2004
    
    2003(Dollars in thousands)Banking and service charge fees
    
    $
    63
    
    
    $
    63
    

    
    $
    204
    
    
    $
    167Gain (loss) on sale of securities
    
    
    (9
    )
    
    
    20
    
    
    
    (6
    )
    
    
    20Other income
    
    
    9
    
    
    
    8
    
    
    
    27
    
    
    
    29Total noninterest income
    
    $
    63
    
    
    $
    91
    
    
    $
    225
    
    
    $
    216
 Non-Interest Expense. Non-interest expense increased $191,000 or 15.6%, from
$1.2 million for the three months ended September 30, 2003 to $1.4 million for
the same period in 2004. The increase was primarily a result of increased
compensation and employee benefits costs due to increasing staff levels and
higher group insurance premiums. For the three months ended September 30,
2004, non-interest expense as a percentage of average earning assets on
annualized basis was 2.56% as compared to 2.94% for the same period in 2003.
The Company also achieved an Efficiency Ratio of 49.2% for three months ended
September 30, 2004 as compared to 63.0% for the same period in 2003. Non-interest expense increased $433,000 or 12.3%, from $3.5 million for the
nine months ended September 30, 2003 to $3.9 million for the same period in
2004. This $433,000 variance was due mainly to increased compensation and
employee benefits costs associated with new hires, annual salary adjustments
for existing personnel, as well as higher group insurance premiums. Salaries
and employee benefits expenses totaled $2.3 million for the nine months ended
September 30, 2004 as compared to $1.9 million for the same period in 2003.
Total number of full-time equivalent employees increased to 47 as of September
30, 2004 as compared to 42 as of September 30, 2003. Legal and professional
expense decreased $110,000 for the nine months ended September 30, 2004 to
$146,000 as compared to $256,000 for the comparable period in 2003. This
decrease was due primarily to lower legal fees associated with a loan
foreclosure and the equipment lease agreement lawsuit which were both settled
in the last quarter of 2003. For the nine months ended September 30, 2004,
non-interest expense as a percentage of average earning assets on annualized
basis was 2.51% as compared to 2.90% for the same period in 2003. The Company
also achieved an Efficiency Ratio of 50.7% for nine months ended September 30,
2004 as compared to 67.4% for the same period in 2003. The following table sets forth information regarding noninterest expenses for
the periods shown. 16




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##### Table of Contents



Noninterest ExpenseFor the Three Months
    
    For the Nine MonthsEnded September 30,
    
    Ended September 30,2004
    
    2003
    
    2004
    
    2003(Dollars in thousands)Salaries and employee benefits
    
    $
    833
    
    
    $
    643
    
    
    $
    2,265
    
    
    $
    1,873Occupancy and equipment
    
    
    156
    
    
    
    163
    
    
    
    432
    
    
    
    451Data processing
    
    
    90
    
    
    
    82
    
    
    
    251
    
    
    
    233Legal, professional and consulting
    
    
    64
    
    
    
    94
    
    
    
    146
    
    
    
    256Advertising and public relations
    
    
    17
    
    
    
    27
    
    

    
    91
    
    
    
    72Outside services
    
    
    68
    
    
    
    55
    
    
    
    184
    
    
    
    166Federal Reserve Bank & correspondent bank fees
    
    
    28
    
    
    
    18
    
    
    
    85
    
    
    
    54Telephone
    
    
    42
    
    
    
    31
    
    
    
    114
    
    
    
    88Office supplies & printing
    
    
    25
    
    
    
    31
    
    
    
    103
    
    
    
    97Director fees
    
    
    32
    
    
    
    23
    
    
    
    76
    
    
    
    69Other
    
    
    59
    
    
    
    56
    
    
    
    199
    
    
    
    154Total noninterest expense
    
    $
    1,414
    
    
    $
    1,223
    
    
    $
    3,946
    
    
    $
    3,513As a % of
average earning assets - annualized
    
    
    2.56
    %
    
    
    2.94
    %
    
    
    2.51
    %
    
    
    2.90
    %Efficiency Ratio (1)
    
    
    49.17
    %
    
    
    62.98
    %
    
    
    50.69
    %
    
    
    67.39
    %Average earning assets
    
    $
    221,029
    
    
    $
    166,439
    
    
    $
    209,420
    
    
    $
    161,715
  (1)
    
    Efficiency ratio represents noninterest expenses, excluding loan loss provision, as a percentage of
the aggregate of net interest income and noninterest income, excluding gains on sales of securities. Liquidity and Capital Resources The Companys primary sources of funds are customer deposits, proceeds from
loan principal and interest payments, sale of loans, and maturing securities.
While maturities and scheduled amortization of loans are a predictable source
of funds, deposit flows and loans prepayments are influenced greatly by general
interest rates, other economic conditions, and competition. The Company
generally maintains sufficient cash and short-term investments to meet
short-term liquidity needs. At September 30, 2004, cash and cash equivalents
totaled $36.3 million or 14.5% of total assets, and investment securities
available for sale totaled $12.8 million. The Companys liquidity is comprised of three primary classifications: cash
flows from or used in operating activities; cash flows from or used in
investing activities; and cash flows provided by or used in financing
activities. Net cash provided by or used in operating activities has consisted
primarily of net income adjusted for certain non-cash income and expense items
such as the loan loss provision, investment and other amortizations and
depreciation. For the nine months ended September 30, 2004 net cash provided by
operating activities was $2.9 million, compared to net cash provided by
operating activities of $1.7 million for the same period of 2003. This variance
from the prior period was due primarily to an increase in net income. The Companys primary investing activities are the origination of real estate,
commercial and consumer loans and purchase and sale of securities and
interest-bearing deposits at other financial institutions. For the nine months
ended September 30, 2004, total net loans increased by $52.7 million or 39.4%.
Investment securities and interest-bearing deposits decreased to $22.3 million
at September 30, 2004 from $33.9 million at December 31, 2003. Net cash used in all investing activities was $42.2 million and $30.9 million
for the nine months ended September 30, 2004 and 2003, respectively. At
September 30, 2004 the Company had outstanding loan commitments of $48.4
million and outstanding letters of credit of $1.6 million. The Company
anticipates that it will have sufficient funds available to meet current loan
commitments. Net cash provided by financing activities has been impacted significantly by
increases in deposit levels and the initial public offering of the Companys
common stock. During the nine months ended September 30, 2004, total 17




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##### Table of Contents



deposits increased by $44.6 million. The net proceeds from the issuance of
common stock during the nine months ended September 30, 2004 also provided
additional $17.1 million cash. Capital adequacy refers to the level of capital required to sustain asset
growth over time and to absorb losses. The Companys objective is to maintain
a level of capitalization that is sufficient to take advantage of profitable
growth opportunities while meeting regulatory requirements. This is achieved by
improving profitability through effectively allocating resources to more
profitable businesses, improving asset quality, strengthening service quality,
and streamlining costs. As of September 30, 2004, the Company and the Banks regulatory capital ratios
were in excess of all applicable regulatory requirements. The following tables
reflect the Companys and the Banks actual levels of regulatory capital as of
September 30, 2004 and the applicable minimum regulatory capital requirements
as well as the regulatory capital requirements that apply to be deemed well
capitalized pursuant to the prompt corrective action requirements. Companys Capital Ratios At September 30, 2004For capitalActual
    
    adequacy purposes
    
    To be well capitalizedAmount
    
    Ratio
    
    Amount
    
    Ratio
    
    Amount
    
    Ratio(Dollars in thousands)Tier 1 leverage capital to average assets (1)
    
    
    35,295
    
    
    
    15.17
    %
    
    
    9,305
    
    
    
    4.00
    %
    
    
    11,631
    
    
    
    5.00
    %Tier 1 capital to risk weighted assets (1)
    
    
    35,295
    
    
    
    16.77
    %
    
    
    8,433
    
    
    
    4.00
    %
    
    
    12,649
    
    
    
    6.00
    %Total capital to risk weighted assets (1)
    
    
    37,384
    
    
    
    17.76
    %
    
    
    16,865
    
    
    
    8.00
    %
    
    
    21,082
    
    
    
    10.00
    %
    (1)
    
    Tier 1 leverage (or core) capital ratio is
computed as a percentage of average total assets of
$232.6 million.
Risk-based capital ratios are computed as a percentage of risk-weighted assets of $210.5 million.(2)
    
    See Supervision and Regulation - Capital
Adequacy - Prompt Corrective Action. Banks Capital Ratios At September 30, 2004To be well capitalizedFor capital
    
    under prompt correctiveActual
    
    adequacy purposes
    
    action provisions (2)Amount
    
    Ratio
    
    Amount
    
    Ratio
    
    Amount
    
    Ratio(Dollars in thousands)Tier 1 leverage capital to average assets (1)
    
    
    33,226
    
    
    
    14.29
    %
    
    
    9,298
    
    
    
    4.00
    %
    
    
    11,623
    
    
    
    5.00
    %Tier 1 capital to risk weighted assets (1)
    
    
    33,226
    
    
    
    15.81
    %
    
    
    8,407
    
    
    
    4.00
    %
    
    
    12,610
    
    
    
    6.00
    %Total capital to risk weighted assets (1)
    
    
    35,315
    
    
    
    16.81
    %
    
    
    16,813
    
    
    
    8.00
    %
    
    
    21,017
    
    
    
    10.00
    %
    (1)
    
    Tier 1 leverage (or core) capital ratio is computed as a percentage of average total assets of $232.5 million.
Risk-based capital ratios are computed as a percentage of risk-weighted assets of $210.1 million.(2)
    
    See Supervision and Regulation - Capital
Adequacy - Prompt Corrective Action. At September 30, 2004, the Company had off-balance sheet loan commitments of
approximately $50.0 million. Of this amount, the unused portion of lines of
credit extended by the Company was approximately $48.4 million and $1.6 million
for standby letters of credit. Standby letters of credit and financial
guarantees are conditional commitments issued by the Company to guarantee the
performance of a customer to a third party. Those guarantees are primarily
issued to support public and private borrowing arrangements, including
commercial paper, bond 18




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##### Table of Contents



financing, and similar transactions. Most guarantees extend from one to two
years. The credit risk involved in issuing letters of credit is essentially the
same as that involved in extending loan facilities to customers. Impact of Inflation and Changing Prices The consolidated financial statements of the Company and notes thereto,
presented elsewhere herein, have been prepared in accordance with accounting
principles generally accepted in the United States of America, which require
the measurement of financial condition and operating results in terms of
historical dollars without considering the change in relative purchasing power
of money over time due to inflation. The impact of inflation is reflected in
the increased cost of the Companys operations. Unlike most industrial
companies, nearly all the assets and liabilities of the Company are financial.
As a result, interest rates have a greater impact on the Companys performance
than do the effects of general levels of inflation. Interest rates do not
necessarily move in the same direction or to the same extent as the prices of
goods and services. 
 Item 3. Quantitative and Qualitative Disclosures About Market Risk Market risk arises from changes in interest rates, exchange rates, commodity
prices and equity prices. As a financial institution, the Companys market
risk exposure is primarily that of interest rate risk. The Company has
established policies and procedures to monitor and limit earnings and balance
sheet exposure to changes in interest rates. The Company does not engage in
trading of financial instruments and does not have any exposure to exchange
rates. The matching of assets and liabilities may be analyzed by examining the extent
to which such assets and liabilities are interest rate sensitive and by
monitoring an institutions interest rate sensitivity gap. An asset or
liability is said to be interest rate sensitive within a specific time period
if it will mature or reprice within that time period. The interest rate
sensitivity gap is defined as the difference between the amount of
interest-earning assets maturing or repricing within a specific time period and
the amount of interest-bearing liabilities maturing or repricing within that
time period. A gap is considered positive when the amount of interest rate
sensitive assets exceeds the amount of interest rate sensitive liabilities. A
gap is considered negative when the amount of interest rate sensitive
liabilities exceeds the amount of interest rate sensitive assets. During a
period of rising interest rates, a negative gap would tend to result in a
decrease in net interest income while a positive gap would tend to result in an
increase in net interest income. During a period of falling interest rates, a
negative gap would tend to result in an increase in net interest income while a
positive gap would tend to result in a decrease in net interest income. Interest rate risk is managed in accordance with policies approved by the
Companys Board of Directors. Management formulates strategies based on
appropriate levels of interest rate risk. In determining the appropriate level
of interest rate risk, management considers the impact on earnings and capital
of the current outlook on interest rates, potential changes in interest rates,
regional economy, liquidity, business strategies and other factors. Management
meets regularly to review, among other things, the sensitivity of assets and
liabilities to interest rate changes, the book and market value of assets and
liabilities, unrealized gains and losses, purchase and sales activities,
commitments to originate loans and the maturities of investments. Management
uses an analysis of relationships between interest-earning assets and
interest-bearing liabilities to manage interest rate risk. The following table presents the Companys repricing gap at September 30, 2004.
The table indicates that at September 30, 2004 the Company was liability
sensitive up to twelve months. This would indicate a decrease in earnings in a
rising rate environment. 19




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##### Table of Contents



At September 30, 2004MoreThanWithin
    
    One Year
    
    OverTwelve
    
    to Five
    
    FiveMonths
    
    Years
    
    Years
    
    Total(Dollars in thousands)Rate-Sensitive Assets:Interest-bearing deposits at other financial institutions
    
    $
    8,909
    
    
    $
    594
    
    
    
    
    
    
    $
    9,503Fed funds sold
    
    
    26,805
    
    
    
    
    
    
    
    
    
    
    
    26,805Securities - all available for sale
    
    
    
    
    
    
    11,920
    
    
    
    917
    
    
    
    12,837Construction and land development loans
    
    
    28,899
    
    
    
    3,672
    
    
    
    
    
    
    
    32,571Raw land loans
    
    
    21,764
    
    
    
    466
    
    
    
    
    
    
    
    22,230Commercial real estate loans (1)
    
    
    25,070
    
    
    
    68,399
    
    
    
    
    
    
    
    93,469Commercial and industrial loans
    
    
    24,468
    
    
    
    9,047
    
    
    
    
    
    
    
    33,515Other loans
    
    
    5,843
    
    
    
    1,774
    
    
    
    
    
    
    
    7,617Total Rate-Sensitive Assets
    
    
    141,758
    
    
    
    95,872
    
    
    
    917
    
    
    
    238,547Rate-Sensitive Liabilities:Interest-bearing demand deposits
    
    
    72,688
    
    
    
    
    
    
    
    
    
    
    
    72,688Savings deposits
    
    
    12,748
    
    
    
    
    
    
    
    
    
    
    
    12,748Time deposits
    
    
    76,317
    
    
    
    2,825
    
    
    
    
    
    
    
    79,142Note payable
    
    
    41
    
    
    
    195
    
    
    
    241
    
    
    
    477Total Rate-Sensitive Liabilities
    
    $
    161,794
    
    
    $
    3,020
    
    
    $
    241
    
    
    $
    165,055Excess (deficiency) of Rate-Sensitive Assets
over Rate-Sensitive Liabilities
    
    $
    (20,036
    )
    
    $
    92,852
    
    
    $
    676Cumulative Excess (deficiency) of Rate-Sensitive Assets
over Rate-Sensitive Liabilities
    
    $
    (20,036
    )
    
    $
    72,816
    
    
    $
    73,492Cumulative Excess (deficiency) of Rate-Sensitive Assets
over Rate-Sensitive Liabilities as a percentage of total
assets
    
    
    (7.98
    )%
    
    
    28.99
    %
    
    
    29.26
    %
    (1)
    
    Includes commercial real estate loans and commercial and industrial loans secured by real estate. Although gap analysis as reflected in the table above is a useful measurement
device available to management to determine the existence of interest rate
exposure, its static focus as of a particular date makes it necessary for
management to utilize other techniques to measure exposure to changes in
interest rates. For example, gap analysis is limited in its ability to predict
trends in future earnings and includes no assumptions regarding changes in
prepayment tendencies, deposit or loan maturity preferences or repricing time
lags that may occur in response to a change in interest rates. As a result of the limitations inherent in gap analysis, the Company also uses
the FinServ asset liability management model, a proprietary dynamic system
that incorporates data regarding the Companys loans, investments, deposits and
borrowings into an interest sensitivity analysis designed for financial
institutions. This analysis measures interest rate risk by computing changes in
net interest income and net interest margin in the event of assumed changes in
interest rates. The analysis assesses the effect on net interest income and net
interest margin in the event of an increase or decrease in interest rates,
assuming that such increase or decrease occurs ratably over the next 12 months
and remains constant over the subsequent 12 months. The Companys sensitivity
to gains or losses in future earnings due to hypothetical increases or
decreases in the Federal Funds rate as measured by this model as of September
30, 2004 is as follows: Increase in
    
    Net Interest Change
    
    Decrease in
    
    Net Interest ChangeInterest Rates
    
    $
    
    %
    
    Interest Rates
    
    $
    
    %(Dollars in thousands)+1.00%
    
    $
    487
    
    
    
    4
    %
    
    
    -1.00
    %
    
    $
    (447
    )
    
    
    (4
    )%+2.00%
    
    $
    946
    
    
    
    8
    %
    
    
    -2.00
    %
    
    $
    (904
    )
    
    
    (8
    )%
 20




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##### Table of Contents



Accordingly, a rise of 1.00% in interest rates would result in an increase in
our net interest income of $487,000, while a decline of 1.00% in interest rates
would result in a decrease of $447,000 in our net interest income, in each case
over the 12 months following September 30, 2004. Management believes that the assumptions used in its interest sensitivity
analysis to evaluate the vulnerability of its net interest income to changes in
interest rates are reasonable. However, the interest rate sensitivity of the
Companys assets and liabilities, and the estimated effects of changes in
interest rates on net interest income, could vary substantially if different
assumptions were used or if actual experience differs from the projections upon
which they are based. 
 Item 4. Controls and Procedures Evaluation of disclosure controls and procedures In accordance with Rule 13a-15(b) of the Securities Exchange Act of 1934 (the
Exchange Act), an evaluation was carried out with the participation of the
Companys management, including the Companys Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of the
Companys disclosure controls and procedures (as defined in Rule 13a-15(e) and
15d-15(e) under the Exchange Act) as of the end of the period covered by this
report. Based upon their evaluation of these disclosure controls and
procedures, the Chief Executive Officer and the Chief Financial Officer
concluded that the disclosure controls and procedures were effective as of the
end of the period covered by this report to ensure that material information
relating to the Company, including its consolidated subsidiaries, was made
known to them by others within those entities, particularly during the period
in which this quarterly report on Form 10-Q was being prepared. Changes in Internal Controls In the quarter ended September 30, 2004, the Company did not make any
significant changes in, or take any corrective actions regarding, its internal
controls or other factors that could significantly affect these controls. 21




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##### Table of Contents



Part II. Other Information 
 Item 1. Legal Proceedings None. 
 Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities (d) On September 22, 2004, the Companys Registration Statement on Form S-1
covering the offering of 925,000 shares of the Companys common stock,
Commission file number 333-117312 was declared effective. The offering
commenced on September 23, 2004 and closed on September 28, 2004. As of the
date of the filing of this report, all offered securities have been sold and
the offering has terminated. The offering was managed solely by Sandler
ONeill & Partners, L.P (the Underwriter). The Underwriter exercised an over-allotment option to purchase an additional
138,750 shares of the Companys common stock. The total price to the public
for the shares offered and sold by the Company, including the over-allotment,
was $19.1 million. The amount of expenses incurred for the Companys account
in connection with the offering includes approximately $1.2 million of
underwriting discounts and commissions and offering expenses of approximately
$860,000. All of the foregoing expenses were direct or indirect payments to persons other
than (i) directors, officers or their associates; (ii) persons owning ten
percent (10%) or more of the Companys common stock; or (iii) affiliates of the
Company. The net proceeds of the offering, including the exercise of the over-allotment
option, to the Company (after deducting the foregoing expenses) were $17.1
million. A total of $15.5 million of the net proceeds has been contributed to
Valley Bank as an additional paid-in capital. The remainder has been retained
by the Company and invested in accordance with its investment policy. There has been no material change in the planned use of proceeds from this
initial public offering as described in the Companys final prospectus filed
with the SEC. 
 Item 3. Defaults Upon Senior Securities Not applicable. 
 Item 4. Submission of Matters to a Vote of Security Holders None. 
 Item 5. Other Information None. 
 Item 6. Exhibits 31.1
    
    CEO Certification Pursuant Rule 13a-14(a)/15d-14(a)31.2
    
    CFO Certification Pursuant Rule 13a-14(a)/15d-14(a)32
    
    CEO and CFO Certification Pursuant 18 U.S.C. Section 1350, as adopted
pursuant to section 906 of the Sarbanes  Oxley Act of 2002
 22




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##### Table of Contents



Pursuant to the requirements of section 13 or 15(d) of the Securities Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized. VALLEY BANCORPDate: November 3, 2004
    
    By:
    
    /s/ Barry L. HulinBarry L. HulinPresident and Chief Executive OfficerDate: November 3, 2004
    
    By:
    
    /s/ Dick HoltzclawDick HoltzclawExecutive Vice President andChief Financial Officer(Principal Financial and AccountingOfficer)
 23