**UNITED STATES        SECURITIES AND EXCHANGE COMMISSION****WASHINGTON, D.C. 20549**

**FORM 10-Q**

|       |                                                                                     |
|------------|------------------------------------------------------------------------------------------|
| (Mark One) |
| x          | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934  |
|       | For the period ended September 30, 2008.                                                 |
|       |                                                                                     |
| o          | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
|       | For the Quarterly Transition Period From ___________ to ___________                      |

Commission file number 0-10652

|                                                   |
|--------------------------------------------------------|
| **NORTH VALLEY BANCORP**                               |
|                                                        |
| (Exact name of registrant as specified in its charter) |

|                                     |   |                     |
|------------------------------------------|--------|--------------------------|
| **California**                           |   | **94-2751350**           |
|                                          |   |                          |
| (State or other jurisdiction             |   | (IRS Employer ID Number) |
| of incorporation or organization)        |   |                     |
|                                     |   |                     |
| **300 Park Marina Circle, Redding, CA**  |   | **96001**                |
|                                          |   |                          |
| (Address of principal executive offices) |   | (Zip code)               |

Registrant’s telephone number, including area code **(530) 226-2900**

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the preceding 12 months (or for such shorter periods 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 a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

|   |                    |   |                      |   |
|--------|-------------------------|--------|---------------------------|--------|
|   | Large accelerated filer | o      | Accelerated filer         | x      |
|   |                    |   |                      |   |
|   | Non-accelerated filer   | o      | Smaller reporting company | o      |

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

Common Stock – 7,495,817 shares as of November 7, 2008.

----

**INDEX**

**NORTH VALLEY BANCORP AND SUBSIDIARIES**

|                              |                                                                                                              |   |   |
|-----------------------------------|-------------------------------------------------------------------------------------------------------------------|--------|--------|
| **PART I. FINANCIAL INFORMATION** |
|                              |                                                                                                              |
| Item 1.                           | Financial Statements (Unaudited)                                                                                  |   |   |
|                              |                                                                                                              |   |   |
|                              | Condensed Consolidated Balance Sheets—September 30, 2008 and December 31, 2007                              |   | 3      |
|                              |                                                                                                              |   |   |
|                              | Condensed Consolidated Statements of Income—For the three and nine months ended September 30, 2008 and 2007 |   | 4      |
|                              |                                                                                                              |   |   |
|                              | Condensed Consolidated Statements of Cash Flows—For the nine months ended September 30, 2008 and 2007       |   | 6      |
|                              |                                                                                                              |   |   |
|                              | Notes to Condensed Consolidated Financial Statements                                                              |   | 7-14   |
|                              |                                                                                                              |   |   |
| Item 2.                           | Management’s Discussion and Analysis of Financial Condition and Results of Operations                       |   | 14     |
|                              |                                                                                                              |   |   |
| Item 3.                           | Quantitative and Qualitative Disclosures about Market Risk                                                        |   | 31     |
|                              |                                                                                                              |   |   |
| Item 4.                           | Controls and Procedures                                                                                           |   | 31     |
|                              |                                                                                                              |   |   |
|                              |                                                                                                              |   |   |
| **PART II. OTHER INFORMATION**    |
|                              |                                                                                                              |
| Item 1.                           | Legal Proceedings                                                                                                 |   | 32     |
|                              |                                                                                                              |   |   |
| Item 1A.                          | Risk Factors                                                                                                      |   | 32     |
|                              |                                                                                                              |   |   |
| Item 2.                           | Unregistered Sales of Equity Securities and Use of Proceeds                                                       |   | 33     |
|                              |                                                                                                              |   |   |
| Item 3.                           | Defaults Upon Senior Securities                                                                                   |   | 33     |
|                              |                                                                                                              |   |   |
| Item 4.                           | Submission of Matters to a Vote of Security Holders                                                               |   | 33     |
|                              |                                                                                                              |   |   |
| Item 5.                           | Other Information                                                                                                 |   | 33     |
|                              |                                                                                                              |   |   |
| Item 6.                           | Exhibits                                                                                                          |   | 33     |
|                              |                                                                                                              |   |   |
| SIGNATURES                        | 34                                                                                                                |

2

----

**PART I. FINANCIAL INFORMATION****ITEM 1. FINANCIAL STATEMENTS****NORTH VALLEY BANCORP AND SUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)        (In thousands except share data)**

|                                                                                                                                      |   |                   |    |                  |   |    |   |
|-------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------|---------|-----------------------|--------|---------|--------|
|                                                                                                                                           |
|                                                                                                                                      |   | **September 30, 2008** |    | **December 31, 2007** |   |
|                                                                                                                                      |   |                   |    |                  |   |    |   |
| **ASSETS**                                                                                                                                |   |                   |    |                  |   |    |   |
| Cash and due from banks                                                                                                                   |   | $                      | 25,961  |                  | $      | 28,569  |   |
|                                                                                                                                      |   |                   |    |                  |   |    |   |
| Investment securities available for sale, at fair value                                                                                   |   |                   | 83,258  |                  |   | 104,341 |   |
| Investment securities held to maturity, at amortized cost                                                                                 |   |                   | 22      |                  |   | 31      |   |
|                                                                                                                                      |   |                   |    |                  |   |    |   |
| Loans and leases                                                                                                                          |   |                   | 696,308 |                  |   | 746,253 |   |
| Less: Allowance for loan and lease losses                                                                                                 |   |                   | (9,958  | )                     |   | (10,755 | )      |
|                                                                                                                                      |   |                   |    |                  |   |    |   |
| Net loans and leases                                                                                                                      |   |                   | 686,350 |                  |   | 735,498 |   |
|                                                                                                                                      |   |                   |    |                  |   |    |   |
| Premises and equipment, net                                                                                                               |   |                   | 11,568  |                  |   | 12,431  |   |
| Accrued interest receivable                                                                                                               |   |                   | 2,900   |                  |   | 3,912   |   |
| Other real estate owned                                                                                                                   |   |                   | 5,852   |                  |   | 902     |   |
| FHLB and FRB stock and other securities                                                                                                   |   |                   | 5,789   |                  |   | 6,238   |   |
| Bank-owned life insurance policies                                                                                                        |   |                   | 31,315  |                  |   | 30,526  |   |
| Core deposit intangibles, net                                                                                                             |   |                   | 874     |                  |   | 1,236   |   |
| Goodwill                                                                                                                                  |   |                   | 15,187  |                  |   | 15,187  |   |
| Other assets                                                                                                                              |   |                   | 15,100  |                  |   | 10,148  |   |
|                                                                                                                                      |   |                   |    |                  |   |    |   |
|                                                                                                                                      |   |                   |    |                  |   |    |   |
| TOTAL ASSETS                                                                                                                              |   | $                      | 884,176 |                  | $      | 949,019 |   |
|                                                                                                                                      |   |                   |    |                  |   |    |   |
|                                                                                                                                      |   |                   |    |                  |   |    |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                            |   |                   |    |                  |   |    |   |
|                                                                                                                                      |   |                   |    |                  |   |    |   |
| LIABILITIES:                                                                                                                              |   |                   |    |                  |   |    |   |
| Deposits:                                                                                                                                 |   |                   |    |                  |   |    |   |
| Noninterest-bearing                                                                                                                       |   | $                      | 157,069 |                  | $      | 167,615 |   |
| Interest-bearing                                                                                                                          |   |                   | 598,062 |                  |   | 569,124 |   |
|                                                                                                                                      |   |                   |    |                  |   |    |   |
| Total deposits                                                                                                                            |   |                   | 755,131 |                  |   | 736,739 |   |
|                                                                                                                                      |   |                   |    |                  |   |    |   |
| Other borrowed funds                                                                                                                      |   |                   | 8,255   |                  |   | 87,192  |   |
| Accrued interest payable and other liabilities                                                                                            |   |                   | 12,095  |                  |   | 11,656  |   |
| Subordinated debentures                                                                                                                   |   |                   | 31,961  |                  |   | 31,961  |   |
|                                                                                                                                      |   |                   |    |                  |   |    |   |
| Total liabilities                                                                                                                         |   |                   | 807,442 |                  |   | 867,548 |   |
|                                                                                                                                      |   |                   |    |                  |   |    |   |
|                                                                                                                                      |   |                   |    |                  |   |    |   |
| Commitments and Contingencies (Note H)                                                                                                    |   |                   |    |                  |   |    |   |
|                                                                                                                                      |   |                   |    |                  |   |    |   |
| STOCKHOLDERS’ EQUITY:                                                                                                               |   |                   |    |                  |   |    |   |
| Preferred stock, no par value: authorized 5,000,000 shares; none outstanding                                                              |   |                   | — |                  |   | — |   |
| Common stock, no par value: authorized 20,000,000 shares; outstanding 7,495,817 and 7,413,066 at September 30, 2008 and December 31, 2007 |   |                   | 41,494  |                  |   | 40,642  |   |
| Retained earnings                                                                                                                         |   |                   | 37,325  |                  |   | 42,212  |   |
| Accumulated other comprehensive loss, net of tax                                                                                          |   |                   | (2,085  | )                     |   | (1,383  | )      |
|                                                                                                                                      |   |                   |    |                  |   |    |   |
| Total stockholders’ equity                                                                                                          |   |                   | 76,734  |                  |   | 81,471  |   |
|                                                                                                                                      |   |                   |    |                  |   |    |   |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                          |   | $                      | 884,176 |                  | $      | 949,019 |   |
|                                                                                                                                      |   |                   |    |                  |   |    |   |

*The accompanying notes are an integral part of these condensed consolidated financial statements (unaudited).*

3

----

**NORTH VALLEY BANCORP AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)        (In thousands except per share data)**

|                                                          |   |                                         |   |     |   |   |   |
|---------------------------------------------------------------|--------|----------------------------------------------|--------|----------|--------|--------|--------|
|                                                               |
|                                                          |   | **For the three months ended September 30,** |   |
|                                                          |   | **2008**                                     |   | **2007** |   |
|                                                          |   |                                         |   |     |   |
| **INTEREST INCOME:**                                          |   |                                         |   |     |   |   |   |
| Interest and fees on loans and leases                         |   | $                                            | 11,686 |     | $      | 13,790 |   |
| Interest on investments:                                      |   |                                         |   |     |   |   |   |
| Taxable interest income                                       |   |                                         | 827    |     |   | 1,045  |   |
| Nontaxable interest income                                    |   |                                         | 228    |     |   | 236    |   |
| Interest on Federal funds sold and repurchase agreements      |   |                                         | 3      |     |   | 12     |   |
|                                                          |   |                                         |   |     |   |   |   |
| Total interest income                                         |   |                                         | 12,744 |     |   | 15,083 |   |
|                                                          |   |                                         |   |     |   |   |   |
|                                                          |   |                                         |   |     |   |   |   |
| **INTEREST EXPENSE:**                                         |   |                                         |   |     |   |   |   |
| Deposits                                                      |   |                                         | 3,187  |     |   | 3,760  |   |
| Subordinated debentures                                       |   |                                         | 581    |     |   | 611    |   |
| Other borrowings                                              |   |                                         | 164    |     |   | 467    |   |
|                                                          |   |                                         |   |     |   |   |   |
| Total interest expense                                        |   |                                         | 3,932  |     |   | 4,838  |   |
|                                                          |   |                                         |   |     |   |   |   |
|                                                          |   |                                         |   |     |   |   |   |
| NET INTEREST INCOME                                           |   |                                         | 8,812  |     |   | 10,245 |   |
|                                                          |   |                                         |   |     |   |   |   |
| PROVISION FOR LOAN AND LEASE LOSSES                           |   |                                         | 1,500  |     |   | 850    |   |
|                                                          |   |                                         |   |     |   |   |   |
|                                                          |   |                                         |   |     |   |   |   |
| NET INTEREST INCOME AFTER PROVISION FOR LOAN AND LEASE LOSSES |   |                                         | 7,312  |     |   | 9,395  |   |
|                                                          |   |                                         |   |     |   |   |   |
|                                                          |   |                                         |   |     |   |   |   |
| **NONINTEREST INCOME:**                                       |   |                                         |   |     |   |   |   |
| Service charges on deposit accounts                           |   |                                         | 1,850  |     |   | 1,791  |   |
| Other fees and charges                                        |   |                                         | 1,003  |     |   | 939    |   |
| Earnings on cash surrender value of life insurance policies   |   |                                         | 329    |     |   | 333    |   |
| Gain on sale of loans                                         |   |                                         | 4      |     |   | 34     |   |
| Loss on sales, calls and impairment of securities             |   |                                         | (3,284 | )        |   | (1     | )      |
| Other                                                         |   |                                         | 382    |     |   | 254    |   |
|                                                          |   |                                         |   |     |   |   |   |
| Total noninterest income                                      |   |                                         | 284    |     |   | 3,350  |   |
|                                                          |   |                                         |   |     |   |   |   |
|                                                          |   |                                         |   |     |   |   |   |
| **NONINTEREST EXPENSES:**                                     |   |                                         |   |     |   |   |   |
| Salaries and employee benefits                                |   |                                         | 5,213  |     |   | 5,306  |   |
| Occupancy expense                                             |   |                                         | 773    |     |   | 773    |   |
| Furniture and equipment expense                               |   |                                         | 485    |     |   | 499    |   |
| Other                                                         |   |                                         | 3,223  |     |   | 2,903  |   |
|                                                          |   |                                         |   |     |   |   |   |
| Total noninterest expenses                                    |   |                                         | 9,694  |     |   | 9,481  |   |
|                                                          |   |                                         |   |     |   |   |   |
|                                                          |   |                                         |   |     |   |   |   |
| (LOSS) INCOME BEFORE PROVISION FOR INCOME TAXES               |   |                                         | (2,098 | )        |   | 3,264  |   |
|                                                          |   |                                         |   |     |   |   |   |
| (BENEFIT) PROVISION FOR INCOME TAXES                          |   |                                         | (679   | )        |   | 1,044  |   |
|                                                          |   |                                         |   |     |   |   |   |
|                                                          |   |                                         |   |     |   |   |   |
| **NET (LOSS) INCOME**                                         |   | $                                            | (1,419 | )        | $      | 2,220  |   |
|                                                          |   |                                         |   |     |   |   |   |
|                                                          |   |                                         |   |     |   |   |   |
| **Per Share Amounts**                                         |   |                                         |   |     |   |   |   |
| Basic (Loss) Earnings Per Share                               |   | $                                            | (0.19  | )        | $      | 0.30   |   |
|                                                          |   |                                         |   |     |   |   |   |
| Diluted (Loss) Earnings Per Share                             |   | $                                            | (0.19  | )        | $      | 0.29   |   |
|                                                          |   |                                         |   |     |   |   |   |
| Cash Dividends Per Common Share                               |   | $                                            | 0.10   |     | $      | 0.10   |   |
|                                                          |   |                                         |   |     |   |   |   |

*The accompanying notes are an integral part of these condensed consolidated financial statements (unaudited).*

4

----

**NORTH VALLEY BANCORP AND SUBSIDIARIES        CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)        (In thousands except per share data)**

|                                                          |   |                                        |   |     |   |   |   |
|---------------------------------------------------------------|--------|---------------------------------------------|--------|----------|--------|--------|--------|
|                                                               |
|                                                          |   | **For the nine months ended September 30,** |   |
|                                                          |   | **2008**                                    |   | **2007** |   |
|                                                          |   |                                        |   |     |   |
| **INTEREST INCOME:**                                          |   |                                        |   |     |   |   |   |
| Interest and fees on loans and leases                         |   | $                                           | 36,908 |     | $      | 39,622 |   |
| Interest on investments:                                      |   |                                        |   |     |   |   |   |
| Taxable interest income                                       |   |                                        | 2,646  |     |   | 3,437  |   |
| Nontaxable interest income                                    |   |                                        | 694    |     |   | 729    |   |
| Interest on Federal funds sold and repurchase agreements      |   |                                        | 9      |     |   | 391    |   |
|                                                          |   |                                        |   |     |   |   |   |
| Total interest income                                         |   |                                        | 40,257 |     |   | 44,179 |   |
|                                                          |   |                                        |   |     |   |   |   |
|                                                          |   |                                        |   |     |   |   |   |
| **INTEREST EXPENSE:**                                         |   |                                        |   |     |   |   |   |
| Deposits                                                      |   |                                        | 10,406 |     |   | 10,624 |   |
| Subordinated debentures                                       |   |                                        | 1,754  |     |   | 1,829  |   |
| Other borrowings                                              |   |                                        | 1,088  |     |   | 1,052  |   |
|                                                          |   |                                        |   |     |   |   |   |
| Total interest expense                                        |   |                                        | 13,248 |     |   | 13,505 |   |
|                                                          |   |                                        |   |     |   |   |   |
|                                                          |   |                                        |   |     |   |   |   |
| NET INTEREST INCOME                                           |   |                                        | 27,009 |     |   | 30,674 |   |
|                                                          |   |                                        |   |     |   |   |   |
| PROVISION FOR LOAN AND LEASE LOSSES                           |   |                                        | 9,100  |     |   | 850    |   |
|                                                          |   |                                        |   |     |   |   |   |
|                                                          |   |                                        |   |     |   |   |   |
| NET INTEREST INCOME AFTER PROVISION FOR LOAN AND LEASE LOSSES |   |                                        | 17,909 |     |   | 29,824 |   |
|                                                          |   |                                        |   |     |   |   |   |
|                                                          |   |                                        |   |     |   |   |   |
| **NONINTEREST INCOME:**                                       |   |                                        |   |     |   |   |   |
| Service charges on deposit accounts                           |   |                                        | 5,460  |     |   | 5,122  |   |
| Other fees and charges                                        |   |                                        | 2,947  |     |   | 2,797  |   |
| Earnings on cash surrender value of life insurance policies   |   |                                        | 971    |     |   | 942    |   |
| Gain on sale of loans                                         |   |                                        | 99     |     |   | 131    |   |
| Loss on sales, calls and impairment of securities             |   |                                        | (3,284 | )        |   | (36    | )      |
| Other                                                         |   |                                        | 1,059  |     |   | 698    |   |
|                                                          |   |                                        |   |     |   |   |   |
| Total noninterest income                                      |   |                                        | 7,252  |     |   | 9,654  |   |
|                                                          |   |                                        |   |     |   |   |   |
|                                                          |   |                                        |   |     |   |   |   |
| **NONINTEREST EXPENSES:**                                     |   |                                        |   |     |   |   |   |
| Salaries and employee benefits                                |   |                                        | 15,854 |     |   | 16,340 |   |
| Occupancy expense                                             |   |                                        | 2,247  |     |   | 2,296  |   |
| Furniture and equipment expense                               |   |                                        | 1,438  |     |   | 1,552  |   |
| Other                                                         |   |                                        | 9,536  |     |   | 10,255 |   |
|                                                          |   |                                        |   |     |   |   |   |
| Total noninterest expenses                                    |   |                                        | 29,075 |     |   | 30,443 |   |
|                                                          |   |                                        |   |     |   |   |   |
|                                                          |   |                                        |   |     |   |   |   |
| (LOSS) INCOME BEFORE PROVISION FOR INCOME TAXES               |   |                                        | (3,914 | )        |   | 9,035  |   |
|                                                          |   |                                        |   |     |   |   |   |
| (BENEFIT) PROVISION FOR INCOME TAXES                          |   |                                        | (1,266 | )        |   | 2,891  |   |
|                                                          |   |                                        |   |     |   |   |   |
|                                                          |   |                                        |   |     |   |   |   |
| **NET (LOSS) INCOME**                                         |   | $                                           | (2,648 | )        | $      | 6,144  |   |
|                                                          |   |                                        |   |     |   |   |   |
|                                                          |   |                                        |   |     |   |   |   |
| **Per Share Amounts**                                         |   |                                        |   |     |   |   |   |
| Basic (Loss) Earnings Per Share                               |   | $                                           | (0.36  | )        | $      | 0.84   |   |
|                                                          |   |                                        |   |     |   |   |   |
| Diluted (Loss) Earnings Per Share                             |   | $                                           | (0.36  | )        | $      | 0.80   |   |
|                                                          |   |                                        |   |     |   |   |   |
| Cash Dividends Per Common Share                               |   | $                                           | 0.30   |     | $      | 0.30   |   |
|                                                          |   |                                        |   |     |   |   |   |

*The accompanying notes are an integral part of these condensed consolidated financial statements (unaudited).*

5

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**NORTH VALLEY BANCORP AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)        (In thousands except per share data)**

|                                                                                     |   |                                        |    |     |   |    |   |
|------------------------------------------------------------------------------------------|--------|---------------------------------------------|---------|----------|--------|---------|--------|
|                                                                                          |
|                                                                                     |   | **For the nine months ended September 30,** |    |
|                                                                                     |   | **2008**                                    |    | **2007** |   |
|                                                                                     |   |                                        |    |     |   |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                                |   |                                        |    |     |   |    |   |
| Net (Loss) Income                                                                        |   | $                                           | (2,648  | )        | $      | 6,144   |   |
| Adjustments to reconcile net (loss) income to net cash provided by operating activities: |   |                                        |    |     |   |    |   |
| Depreciation and amortization                                                            |   |                                        | 1,514   |     |   | 1,668   |   |
| Amortization of premium on securities                                                    |   |                                        | (12     | )        |   | 63      |   |
| Amortization of core deposit intangible                                                  |   |                                        | 362     |     |   | 487     |   |
| Provision for loan and lease losses                                                      |   |                                        | 9,100   |     |   | 850     |   |
| Loss on sales, calls and impairment of investment securities                             |   |                                        | 3,284   |     |   | 36      |   |
| Gain on sale of loans                                                                    |   |                                        | (99     | )        |   | (131    | )      |
| Gain on sale of premises and equipment                                                   |   |                                        | — |     |   | (3      | )      |
| FHLB stock dividends                                                                     |   |                                        | (179    | )        |   | (146    | )      |
| Stock-based compensation expense                                                         |   |                                        | 293     |     |   | 270     |   |
| Excess tax benefit from exercise of stock options                                        |   |                                        | (41     | )        |   | (92     | )      |
| Effect of changes in:                                                                    |   |                                        |    |     |   |    |   |
| Accrued interest receivable                                                              |   |                                        | 1,012   |     |   | 18      |   |
| Other assets                                                                             |   |                                        | (5,254  | )        |   | (1,628  | )      |
| Accrued interest payable and other liabilities                                           |   |                                        | 480     |     |   | 284     |   |
|                                                                                     |   |                                        |    |     |   |    |   |
| Net cash provided by operating activities                                                |   |                                        | 7,812   |     |   | 7,820   |   |
|                                                                                     |   |                                        |    |     |   |    |   |
|                                                                                     |   |                                        |    |     |   |    |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                                |   |                                        |    |     |   |    |   |
| Proceeds from maturities/calls of available for sale securities                          |   |                                        | 16,630  |     |   | 24,635  |   |
| Redemptions of FHLB and FRB stock and other securities                                   |   |                                        | 628     |     |   | — |   |
| Net decrease (increase) in loans and leases                                              |   |                                        | 29,205  |     |   | (57,590 | )      |
| Proceeds from sales of other real estate owned                                           |   |                                        | 5,993   |     |   | — |   |
| Proceeds from sales of premises and equipment                                            |   |                                        | — |     |   | 3       |   |
| Purchases of premises and equipment                                                      |   |                                        | (651    | )        |   | (804    | )      |
|                                                                                     |   |                                        |    |     |   |    |   |
| Net cash provided by (used in) investing activities                                      |   |                                        | 51,805  |     |   | (33,756 | )      |
|                                                                                     |   |                                        |    |     |   |    |   |
|                                                                                     |   |                                        |    |     |   |    |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                |   |                                        |    |     |   |    |   |
| Net increase (decrease) in deposits                                                      |   |                                        | 18,392  |     |   | (13,849 | )      |
| Net (decrease) increase in other borrowed funds                                          |   |                                        | (78,937 | )        |   | 28,090  |   |
| Cash dividends paid                                                                      |   |                                        | (2,239  | )        |   | (2,208  | )      |
| Exercise of stock options, including tax benefit                                         |   |                                        | 559     |     |   | 740     |   |
|                                                                                     |   |                                        |    |     |   |    |   |
| Net cash (used in) provided by financing activities                                      |   |                                        | (62,225 | )        |   | 12,773  |   |
|                                                                                     |   |                                        |    |     |   |    |   |
| **NET DECREASE IN CASH AND CASH EQUIVALENTS**                                            |   |                                        | (2,608  | )        |   | (13,163 | )      |
| **CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR**                                         |   |                                        | 28,569  |     |   | 41,496  |   |
|                                                                                     |   |                                        |    |     |   |    |   |
| **CASH AND CASH EQUIVALENTS, END OF PERIOD**                                             |   | $                                           | 25,961  |     | $      | 28,333  |   |
|                                                                                     |   |                                        |    |     |   |    |   |
|                                                                                     |   |                                        |    |     |   |    |   |
| **Supplemental Disclosures of Cash Flow Information**                                    |   |                                        |    |     |   |    |   |
| Cash paid during the year for:                                                           |   |                                        |    |     |   |    |   |
| Interest                                                                                 |   | $                                           | 13,790  |     | $      | 14,180  |   |
| Income taxes                                                                             |   | $                                           | 2,390   |     | $      | 2,865   |   |
| Loans transferred to other real estate owned                                             |   | $                                           | 10,942  |     | $      | — |   |

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

6

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**NORTH VALLEY BANCORP AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

**NOTE A - BASIS OF PRESENTATION**

The accompanying unaudited condensed consolidated financial statements of North Valley Bancorp and subsidiaries (the “Company”) have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission. Accordingly, certain information and notes required by accounting principles generally accepted in the United States for annual financial statements are not included herein.        Management believes that the disclosures are adequate to make the information not misleading. In the opinion of management, all adjustments (consisting solely of normal recurring adjustments) considered necessary for a fair presentation of the results for the interim periods presented have been included. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December        31, 2007. Operating results for the three and nine months ended September 30, 2008 are not necessarily indicative of the results that may be expected for any subsequent period or for the year ended December 31, 2008.

The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries North Valley Bank (“NVB”) and North Valley Trading Company, which is inactive. Significant intercompany items and transactions have been eliminated in consolidation. North Valley Capital Trust I, North Valley Capital Trust II, North Valley Capital Trust III and North Valley Capital Statutory Trust IV are unconsolidated        subsidiaries formed solely for the purpose of issuing trust preferred securities.

The preparation of condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ        from these estimates.

Management has determined that since all of the banking products and services offered by the Company are available in each branch of NVB, all branches are located within the same economic environment and management does not allocate resources based on the performance of different lending or transaction activities, it is appropriate to aggregate NVB branches and report them as a single operating segment. No single customer accounts for more than 10        percent of revenues for the Company or NVB.

7

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**NOTE B – INVESTMENT SECURITIES**

At September 30, 2008 and December 31, 2007, the amortized cost of securities and their approximate fair value were as follows (in thousands):

|                                            |   |                                  |                                  |                                                             |   |                                                              |   |                                        |                                                              |   |   |                                        |   |
|-------------------------------------------------|--------|---------------------------------------|---------------------------------------|------------------------------------------------------------------|--------|-------------------------------------------------------------------|--------|---------------------------------------------|-------------------------------------------------------------------|--------|--------|---------------------------------------------|--------|
|                                            |   | **Amortized                    Cost** |                                  | **Gross                    Unrealized                    Gains** |   | **Gross                    Unrealized                    Losses** |   | **Estimated                    Fair Value** |                                                              |
|                                            |   |                                  |                                  |                                                             |   |                                                              |   |                                        |                                                              |
| **Available for sale securities:**              |   |                                  |                                  |                                                             |   |                                                              |   |                                        |                                                              |   |   |                                        |   |
|                                            |   |                                  |                                  |                                                             |   |                                                              |   |                                        |                                                              |   |   |                                        |   |
| **September 30, 2008**                          |   |                                  |                                  |                                                             |   |                                                              |   |                                        |                                                              |   |   |                                        |   |
| Obligations of U.S. government agencies         |   | $                                     | 1,500                                 |                                                             | $      | 52                                                                |   | $                                           | —                                                           |   | $      | 1,552                                       |   |
| Obligations of state and political subdivisions |   |                                  | 20,041                                |                                                             |   | 226                                                               |   |                                        | (392                                                              | )      |   | 19,875                                      |   |
| Mortgage-backed securities                      |   |                                  | 55,346                                |                                                             |   | 83                                                                |   |                                        | (1,040                                                            | )      |   | 54,389                                      |   |
| Corporate debt securities                       |   |                                  | 6,008                                 |                                                             |   | —                                                           |   |                                        | (1,566                                                            | )      |   | 4,442                                       |   |
| Equity securities                               |   |                                  | 3,000                                 |                                                             |   | —                                                           |   |                                        | —                                                           |   |   | 3,000                                       |   |
|                                            |   |                                  |                                  |                                                             |   |                                                              |   |                                        |                                                              |   |   |                                        |   |
|                                            |   | $                                     | 85,895                                |                                                             | $      | 361                                                               |   | $                                           | (2,998                                                            | )      | $      | 83,258                                      |   |
|                                            |   |                                  |                                  |                                                             |   |                                                              |   |                                        |                                                              |   |   |                                        |   |
|                                            |   |                                  |                                  |                                                             |   |                                                              |   |                                        |                                                              |   |   |                                        |   |
| **December 31, 2007**                           |   |                                  |                                  |                                                             |   |                                                              |   |                                        |                                                              |   |   |                                        |   |
| Obligations of U.S. government agencies         |   | $                                     | 3,499                                 |                                                             | $      | 46                                                                |   | $                                           | (11                                                               | )      | $      | 3,534                                       |   |
| Obligations of state and political subdivisions |   |                                  | 20,563                                |                                                             |   | 526                                                               |   |                                        | (11                                                               | )      |   | 21,078                                      |   |
| Mortgage-backed securities                      |   |                                  | 69,433                                |                                                             |   | 57                                                                |   |                                        | (1,350                                                            | )      |   | 68,140                                      |   |
| Corporate debt securities                       |   |                                  | 6,009                                 |                                                             |   | —                                                           |   |                                        | (670                                                              | )      |   | 5,339                                       |   |
| Equity securities                               |   |                                  | 6,284                                 |                                                             |   | —                                                           |   |                                        | (34                                                               | )      |   | 6,250                                       |   |
|                                            |   |                                  |                                  |                                                             |   |                                                              |   |                                        |                                                              |   |   |                                        |   |
|                                            |   | $                                     | 105,788                               |                                                             | $      | 629                                                               |   | $                                           | (2,076                                                            | )      | $      | 104,341                                     |   |
|                                            |   |                                  |                                  |                                                             |   |                                                              |   |                                        |                                                              |   |   |                                        |   |
|                                            |   |                                  |                                  |                                                             |   |                                                              |   |                                        |                                                              |   |   |                                        |   |
|                                            |   |                                  | **Amortized                    Cost** |                                                             |   | **Gross                    Unrealized                    Gains**  |   |                                        | **Gross                    Unrealized                    Losses** |   |   | **Estimated                    Fair Value** |   |
|                                            |   |                                  |                                  |                                                             |   |                                                              |   |                                        |                                                              |
| **Held to maturity securities:**                |   |                                  |                                  |                                                             |   |                                                              |   |                                        |                                                              |   |   |                                        |   |
|                                            |   |                                  |                                  |                                                             |   |                                                              |   |                                        |                                                              |   |   |                                        |   |
| **September 30, 2008**                          |   |                                  |                                  |                                                             |   |                                                              |   |                                        |                                                              |   |   |                                        |   |
| Mortgage-backed securities                      |   | $                                     | 22                                    |                                                             | $      | —                                                           |   | $                                           | (1                                                                | )      | $      | 21                                          |   |
|                                            |   |                                  |                                  |                                                             |   |                                                              |   |                                        |                                                              |   |   |                                        |   |
|                                            |   |                                  |                                  |                                                             |   |                                                              |   |                                        |                                                              |   |   |                                        |   |
| **December 31, 2007**                           |   |                                  |                                  |                                                             |   |                                                              |   |                                        |                                                              |   |   |                                        |   |
| Mortgage-backed securities                      |   | $                                     | 31                                    |                                                             | $      | —                                                           |   | $                                           | —                                                           |   | $      | 31                                          |   |
|                                            |   |                                  |                                  |                                                             |   |                                                              |   |                                        |                                                              |   |   |                                        |   |

For the nine months ended September 30, 2008 and 2007 there was $1,000 and $17,000, respectively, in gross realized gains on sales or calls of available for sale securities. For the nine months ended September 30, 2008 and 2007 there was $3,284,000 and $53,000, respectively, in gross realized losses on sales, impairment or calls of securities categorized as available for sale securities. There were no sales or transfers of held to maturity securities        for the nine months ended September 30, 2008 and 2007.

At September 30, 2008 and December 31, 2007, securities having fair value amounts of approximately $69,900,000 and $68,410,000, respectively, were pledged to secure public deposits, short-term borrowings, treasury, tax and loan balances and for other purposes required by law or contract.

Investment securities are evaluated for other-than-temporary impairment on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation to determine whether a decline in their value below amortized cost is other-than-temporary. Management utilizes criteria such as the magnitude and duration of the decline and the intent and ability of the Company to retain its investment in the issues for a period of time        sufficient to allow for an anticipated recovery in fair value, in addition to the reasons underlying the decline, to determine whether the loss in value is other-than-temporary. The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of        the investment. Once a decline in value is determined to be other-than-temporary, the value of the security is reduced and a corresponding charge to earnings is recognized.

During the third quarter of 2008, the Company recognized impairment on its FNMA Preferred Stock of $3,284,000. The Company had purchased 100,000 shares of this security in June 2003 at par, $50.00 per share, and recognized an impairment charge in the fourth quarter of 2007 to its December 31, 2007 market value of $32.84. Due to the United States Treasury and the Federal Housing Finance Agency (FHFA) decision to place FNMA and FHLMC under conservatorship        on September 7, 2008, the Company concluded that these securities were further impaired and were written down by $3,284,000 to zero at September 30, 2008.

After consideration of the above, at September 30, 2008, the Company held $60,344,000 of available for sale investment securities in an unrealized loss position of which $39,283,000 were in an unrealized loss position for less than twelve months and $21,061,000 were in an unrealized loss position and had been in an unrealized loss position for twelve months or more. Management periodically evaluates each investment security for other-than-temporary        impairment, relying primarily on industry analyst reports, observation of market conditions and interest rate fluctuations. Management has the ability and intent to hold securities with established maturity dates until recovery of fair value, which may be at maturity, and believes it will be able to collect all amounts due according to the contractual terms for all of the underlying investment securities; therefore, management does not consider these investments to be        other-than-temporarily impaired.

8

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**NOTE C – STOCK-BASED COMPENSATION**

**Stock Option Plans**

At September 30, 2008, the Company had four shareholder approved stock-based compensation plans: the North Valley Bancorp 1989 Director Stock Option Plan, the 1998 Employee Stock Incentive Plan, the 1999 Director Stock Option Plan and the 2008 Stock Incentive Plan. The plans do not provide for the settlement of awards in cash and new shares are issued upon exercise of the options. Under the North Valley Bancorp 1989 Director Stock Option Plan each        member of the Board of Directors, including employees who are Directors, automatically received every January a non-statutory stock option to purchase 1,000 shares of the Company’s Common Stock. Effective upon adoption of the North Valley Bancorp 1999 Director Stock Option Plan, no further grants of options have been made or will be made under the 1989 Director Plan. Pursuant to the 1989 Director Plan, there were outstanding options to purchase 1,200 shares of Common Stock at        September 30, 2008. The North Valley Bancorp 1998 Employee Stock Incentive Plan provides for awards in the form of options (which may constitute incentive stock options (“ISOs”) or non-statutory stock options (“NSOs”) to key employees) and also provides for the award of shares of Common Stock to outside directors. Pursuant to the Stock Incentive Plan there were outstanding options to purchase 494,390 shares of Common Stock at September 30, 2008. As provided in        the Stock Incentive Plan, the authorization to award incentive stock options terminated on February 19, 2008. The 1999 Director Stock Option Plan replaced the existing North Valley Bancorp 1989 Director Stock Option Plan. As of September 30, 2008, there were options outstanding under the 1999 Director Stock Option Plan for the purchase of 241,000 shares of Common Stock. A total of 225,767 shares of Common Stock were available for the grant of additional options under the 1999 Director        Stock Option Plan at September 30, 2008. As of September 30, 2008, there were options outstanding under the 2008 Stock Incentive Plan for the purchase of 5,000 shares of Common Stock. A total of 395,000 shares of Common Stock were available for the grant of additional options under the 2008 Stock Incentive Plan at September 30, 2008.

The North Valley Bancorp 2008 Stock Incentive Plan was adopted by the Company’s Board of Directors on February 27, 2008, effective that date, and was approved by the Company’s shareholders at the annual meeting, May 22, 2008. The terms of the 2008 Stock Incentive Plan are substantially the same as the North Valley Bancorp 1998 Employee Stock Incentive Plan. The 2008 Stock Incentive Plan provides for the grant to key employees of stock        options, which may consist of NSOs and ISOs. The 2008 Stock Incentive Plan also provides for the grant to outside directors, and to consultants and advisers to the Company, of stock options, all of which must be NSOs. The shares of Common Stock authorized to be granted as options under the Stock Incentive Plan consist of 400,000 shares of the Company’s Common Stock. Effective January 1, 2009, and on each January 1 thereafter for the remaining term of the 2008 Stock Incentive Plan,        the aggregate number of shares of Common Stock which are reserved for issuance pursuant to options granted under the terms of the 2008 Stock Incentive Plan shall be increased by a number of shares of Common Stock equal to 2% of the total number of the shares of Common Stock of the Company outstanding at the end of the most recently concluded calendar year. Any shares of Common Stock that have been reserved but not issued as options during any calendar year shall remain available for        grant during any subsequent calendar year. Each outside director of the Company shall also be eligible to receive a stock award of 900 shares of Common Stock as part of his or her annual retainer paid by the Company for his or her services as a director. Each stock award shall be fully vested when granted to the outside director. The number of shares of Common Stock available as stock awards to outside directors shall equal the number of shares of Common Stock to be awarded to such        outside directors.

**Stock Option Compensation**

There were 5,000 options granted in the three month period ended September 30, 2008. There were no options granted in the three month period ended September 30, 2007. The weighted average grant date fair value of options granted for the three month period ended September 30, 2008 was $1.14. For the three month periods ended September 30, 2008 and 2007, the compensation cost recognized for stock option compensation was $59,000 and $43,000, respectively.        Director stock grant expense for the three month periods ended September 30, 2008 and 2007 was $5,000 and ($23,000), respectively. The recognized tax benefit for stock option compensation expense was $1,000 and $6,000, for the three month periods ended September 30, 2008 and 2007, respectively. At September 30, 2008, the total unrecognized compensation cost related to stock-based awards granted to employees under the Company’s stock option plans was $498,000. This cost will be        amortized on a straight-line basis over a weighted average period of approximately 1.5 years and will be adjusted for subsequent changes in estimated forfeitures. The fair value of each option is estimated on the date of grant with the following assumptions:

9

----

|                                   |   |                                 |   |                                |   |            |   |              |
|----------------------------------------|--------|--------------------------------------|--------|-------------------------------------|--------|-----------------|--------|-------------------|
|                                   |   | **Three months ended September 30,** |   | **Nine months ended September 30,** |
|                                   |   |                                 |   |                                |
|                                   |   | **2008**                             |   | **2007**                            |   | **2008**        |   | **2007**          |
|                                   |   |                                 |   |                                |   |            |   |              |
|                                   |   |                                 |   |                                |   |            |   |              |
| Dividend yield                         |   | 5.90%                                |   | —                             |   | 5.90%-3.08%     |   | 2.25%             |
| Expected volatility                    |   | 31.46%                               |   | —                             |   | 31.46%-27.08%   |   | 23.51%            |
| Risk-Free interest rate                |   | 3.40%                                |   | —                             |   | 3.40%-3.67%     |   | 4.85%             |
| Expected option life                   |   | 6.89 years                           |   | —                             |   | 6.89-6.52 years |   | 6.25 years        |
| Weighted average grant date fair value |   | $1.14                 |   | —                             |   | $1.14/$3.03     |   | $5.26   |

**Stock-Based Compensation**

Under the Company’s stock option plans as of September 30, 2008, 620,767 shares of the Company’s common stock are available for future grants to directors and employees of the Company. Under the Director Plans, options may not be granted at a price less than 85% of fair market value at the date of the grant. Under the Employee Plans, options may not be granted at a price less than the fair market value at the date of the grant. Under all        plans, options may be exercised over a ten year term and vest ratably over four years from the date of the grant. A summary of outstanding stock options follows:

|                                               |   |   |    |                                                                                     |   |                                                                                                                    |   |                                                       |    |                                                                   |   |        |   |   |    |   |
|----------------------------------------------------|--------|--------|---------|------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------|---------|------------------------------------------------------------------------|--------|-------------|--------|--------|---------|--------|
|                                               |   | Shares |    | Weighted                    Average                    Exercise                    Price |   | Weighted                    Average                    Remaining                    Contractual                    Term |   | Exercise                    Price                    Range |    | Aggregate                    Intrinsic                    Value ($000) |   |
|                                               |   |   |    |                                                                                     |   |                                                                                                                    |   |                                                       |    |                                                                   |   |
|                                               |
| Outstanding at January 1, 2008                     |   |   | 723,642 |                                                                                     | $      | 10.75                                                                                                                   |   |                                                       | 4 years |                                                                   | $      | 5.36-24.75  |   |   |    |   |
|                                               |   |   |    |                                                                                     |   |                                                                                                                    |   |                                                       |    |                                                                   |   |        |   |   |    |   |
| Granted                                            |   |   | 140,899 |                                                                                     |   | 12.78                                                                                                                   |   |                                                       |    |                                                                   |   | 6.51-13.01  |   |   |    |   |
|                                               |   |   |    |                                                                                     |   |                                                                                                                    |   |                                                       |    |                                                                   |   |        |   |   |    |   |
| Exercised                                          |   |   | (75,551 | )                                                                                        |   | 6.86                                                                                                                    |   |                                                       |    |                                                                   |   | 5.36-8.27   |   |   |    |   |
|                                               |   |   |    |                                                                                     |   |                                                                                                                    |   |                                                       |    |                                                                   |   |        |   |   |    |   |
| Expired or Forfeited                               |   |   | (47,400 | )                                                                                        |   | 11.94                                                                                                                   |   |                                                       |    |                                                                   |   | 10.63-20.62 |   |   |    |   |
|                                               |   |   |    |                                                                                     |   |                                                                                                                    |   |                                                       |    |                                                                   |   |        |   |   |    |   |
|                                               |   |   |    |                                                                                     |   |                                                                                                                    |   |                                                       |    |                                                                   |   |        |   |   |    |   |
| Outstanding at September 30, 2008                  |   |   | 741,590 |                                                                                     | $      | 11.45                                                                                                                   |   |                                                       | 4 years |                                                                   |   | 6.51-24.75  |   | $      | — |   |
|                                               |   |   |    |                                                                                     |   |                                                                                                                    |   |                                                       |    |                                                                   |   |        |   |   |    |   |
|                                               |   |   |    |                                                                                     |   |                                                                                                                    |   |                                                       |    |                                                                   |   |        |   |   |    |   |
| Fully vested and exercisable at September 30, 2008 |   |   | 569,113 |                                                                                     | $      | 10.36                                                                                                                   |   |                                                       | 3 years |                                                                   |   | 6.51-24.75  |   | $      | — |   |
|                                               |   |   |    |                                                                                     |   |                                                                                                                    |   |                                                       |    |                                                                   |   |        |   |   |    |   |
|                                               |   |   |    |                                                                                     |   |                                                                                                                    |   |                                                       |    |                                                                   |   |        |   |   |    |   |
| Options expected to vest                           |   |   | 172,477 |                                                                                     | $      | 15.05                                                                                                                   |   |                                                       | 9 years |                                                                   |   | 6.51-24.75  |   | $      | — |   |
|                                               |   |   |    |                                                                                     |   |                                                                                                                    |   |                                                       |    |                                                                   |   |        |   |   |    |   |

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of the Company’s common stock as of September 30, 2008. The intrinsic value of exercised options is calculated as the difference between exercise price of the underlying awards and the quoted price of the Company’s common stock at the date of exercise. The intrinsic value of options exercised during the three        months ended September 30, 2008 and 2007 totaled $3,000 and $93,000, respectively.

**NOTE D – COMPREHENSIVE INCOME**

Comprehensive income includes net income (loss) and other comprehensive income or loss. The Company’s only sources of other comprehensive income (loss) are unrealized gains and losses on available for sale investment securities and adjustments to the minimum pension liability. Reclassification adjustments resulting from gains or losses on investment securities that were realized and included in net income (loss) of the current period that also had        been included in other comprehensive income (loss) as unrealized holding gains or losses in the period in which they arose are excluded from comprehensive income of the current period. The Company’s total comprehensive income (loss) was as follows (in thousands):

|                                      |   |                                 |   |                                |   |     |   |     |   |   |   |   |   |
|-------------------------------------------|--------|--------------------------------------|--------|-------------------------------------|--------|----------|--------|----------|--------|--------|--------|--------|--------|
|                                      |   | **Three months ended September 30,** |   | **Nine months ended September 30,** |   |
|                                      |   | **2008**                             |   | **2007**                            |   | **2008** |   | **2007** |   |
|                                      |   |                                 |   |                                |   |     |   |     |   |
|                                      |   |                                 |   |                                |   |     |   |     |   |
| Net (loss) income                         |   | $                                    | (1,419 | )                                   | $      | 2,220    |   | $        | (2,648 | )      | $      | 6,144  |   |
| Other comprehensive loss, net of tax:     |   |                                 |   |                                |   |     |   |     |   |   |   |   |   |
| Holding gain (loss) arising during period |   |                                 | 9      |                                |   | 292      |   |     | (702   | )      |   | (148   | )      |
|                                      |   |                                 |   |                                |   |     |   |     |   |   |   |   |   |
|                                      |   |                                 |   |                                |   |     |   |     |   |   |   |   |   |
| Total comprehensive (loss) income         |   | $                                    | (1,410 | )                                   | $      | 2,512    |   | $        | (3,350 | )      | $      | 5,996  |   |
|                                      |   |                                 |   |                                |   |     |   |     |   |   |   |   |   |

10

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**NOTE E – IMPAIRED, NONPERFORMING LOANS AND LEASES AND OTHER REAL ESTATE OWNED**

At September 30, 2008 and December 31, 2007, the recorded investment in impaired loans and leases was approximately $20,190,000 and $1,608,000, respectively. Of the September 30, 2008 balance, there were charge-offs taken against these loans of $4,460,000 and a remaining valuation allowance of $792,000. Related to the December 31, 2007 balance, there were no charge-offs against these loans and a remaining valuation allowance of $83,000. If interest had        been accruing on the nonperforming loans, such income would have approximated $507,000 and $1,563,000 for the three and nine months ended September 30, 2008. Approximately 56% of the nonperforming loans are centered in three real estate projects with loans totaling $11,262,000 at September 30, 2008.

At September 30, 2008 and December 31, 2007, the recorded investment in other real estate owned was approximately $5,852,000 and $902,000, respectively. During the quarter ended September 30, 2008, the Company did not transfer any property from loans to other real estate owned, had $2,625,000 in proceeds in sales of other real estate owned and recorded a $114,000 gain on the sale in other noninterest income. The September 30, 2008 balance of other real        estate owned of $5,852,000 is centered in one property totaling $4,950,000 at September 30, 2008.

Nonperforming loans and leases include all such loans and leases that are either on nonaccrual status or are 90 days past due as to principal or interest but still accrue interest because such loans are well-secured and in the process of collection. Nonperforming loans and leases and other real estate owned at September 30, 2008 and December 31, 2007 are summarized as follows (in thousands):

|                                                           |   |                   |   |                  |   |   |   |
|----------------------------------------------------------------|--------|------------------------|--------|-----------------------|--------|--------|--------|
|                                                           |   | **September 30, 2008** |   | **December 31, 2007** |   |
|                                                           |   |                   |   |                  |   |
|                                                           |   |                   |   |                  |   |   |   |
| Nonaccrual loans and leases                                    |   | $                      | 20,136 |                  | $      | 1,608  |   |
| Loans and leases past due 90 days and accruing interest        |   |                   | 54     |                  |   | 156    |   |
| Other real estate owned                                        |   |                   | 5,852  |                  |   | 902    |   |
|                                                           |   |                   |   |                  |   |   |   |
| Total nonperforming assets                                     |   | $                      | 26,042 |                  | $      | 2,666  |   |
|                                                           |   |                   |   |                  |   |   |   |
|                                                           |   |                   |   |                  |   |   |   |
| Nonaccrual loans and leases to total gross loans and leases    |   |                   | 2.89   | %                     |   | 0.22   | %      |
| Nonperforming loans and leases to total gross loans and leases |   |                   | 2.90   | %                     |   | 0.24   | %      |
| Total nonperforming assets to total assets                     |   |                   | 2.95   | %                     |   | 0.28   | %      |

**NOTE F - EARNINGS PER SHARE**

Basic earnings per share are computed by dividing net income by the weighted average common shares outstanding for the period. Diluted earnings per share reflect the potential dilution that could occur if options or other contracts to issue common stock were exercised and converted into common stock. When a net loss occurs there is no effect on the calculation of diluted loss per share for common stock equivalents because the conversion is        anti-dilutive.

There was no difference in the numerator, net income, used in the calculation of basic earnings per share and diluted earnings per share. The denominator used in the calculation of basic earnings per share and diluted earnings per share for the three and nine month period ended September 30, 2008 and 2007 is reconciled as follows (in thousands, except per share amounts):

|                                                                    |   |                                 |    |                                |   |     |   |     |    |   |   |   |   |
|-------------------------------------------------------------------------|--------|--------------------------------------|---------|-------------------------------------|--------|----------|--------|----------|---------|--------|--------|--------|--------|
|                                                                    |   | **Three months ended September 30,** |    | **Nine months ended September 30,** |   |
|                                                                    |   | **2008**                             |    | **2007**                            |   | **2008** |   | **2007** |    |
|                                                                    |   |                                 |    |                                |   |     |   |     |    |
| **Calculation of basic (loss) earnings per share:**                     |   |                                 |    |                                |   |     |   |     |    |   |   |   |   |
| Numerator – net (loss) income                                     |   | $                                    | (1,419  | )                                   | $      | 2,220    |   | $        | (2,648  | )      | $      | 6,144  |   |
| Denominator – weighted average common shares outstanding          |   |                                 | 7,491   |                                |   | 7,366    |   |     | 7,449   |   |   | 7,355  |   |
|                                                                    |   |                                 |    |                                |   |     |   |     |    |   |   |   |   |
|                                                                    |   |                                 |    |                                |   |     |   |     |    |   |   |   |   |
| Basic (loss) earnings per share                                         |   | $                                    | (0.19   | )                                   | $      | 0.30     |   | $        | (0.36   | )      | $      | 0.84   |   |
|                                                                    |   |                                 |    |                                |   |     |   |     |    |   |   |   |   |
|                                                                    |   |                                 |    |                                |   |     |   |     |    |   |   |   |   |
| **Calculation of diluted (loss) earnings per share:**                   |   |                                 |    |                                |   |     |   |     |    |   |   |   |   |
| Numerator – net (loss) income                                     |   | $                                    | (1,419  | )                                   | $      | 2,220    |   | $        | (2,648  | )      | $      | 6,144  |   |
| Denominator:                                                            |   |                                 |    |                                |   |     |   |     |    |   |   |   |   |
| Weighted average common shares outstanding                              |   |                                 | 7,491   |                                |   | 7,366    |   |     | 7,449   |   |   | 7,355  |   |
| Dilutive effect of outstanding options                                  |   |                                 | — |                                |   | 271      |   |     | — |   |   | 293    |   |
|                                                                    |   |                                 |    |                                |   |     |   |     |    |   |   |   |   |
| Weighted average common shares outstanding and common stock equivalents |   |                                 | 7,491   |                                |   | 7,637    |   |     | 7,449   |   |   | 7,648  |   |
|                                                                    |   |                                 |    |                                |   |     |   |     |    |   |   |   |   |
|                                                                    |   |                                 |    |                                |   |     |   |     |    |   |   |   |   |
| Diluted (loss) earnings per share                                       |   | $                                    | (0.19   | )                                   | $      | 0.29     |   | $        | (0.36   | )      | $      | 0.80   |   |
|                                                                    |   |                                 |    |                                |   |     |   |     |    |   |   |   |   |

11

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**NOTE G - PENSION PLAN BENEFITS**

The Company has a supplemental retirement plan for key executives and a supplemental retirement plan for certain retired key executives and directors. These plans are nonqualified defined benefit plans and are unsecured. Total contributions paid were $62,000 for each of the three month periods ended September 30, 2008 and 2007. Total contributions paid were $176,000 and $678,000 for each of the nine month periods ended September 30, 2008 and 2007,        respectively. Components of net periodic benefit cost for the Company’s supplemental nonqualified defined benefit plans for the three and nine months ended September 30, 2008 and 2007 are presented in the following table (in thousands):

|                                          |   |                                 |   |                                |   |     |   |     |   |   |   |   |   |
|-----------------------------------------------|--------|--------------------------------------|--------|-------------------------------------|--------|----------|--------|----------|--------|--------|--------|--------|--------|
|                                          |   | **Three months ended September 30,** |   | **Nine months ended September 30,** |   |
|                                          |   |                                 |   |                                |   |     |
|                                          |   | **2008**                             |   | **2007**                            |   | **2008** |   | **2007** |   |
|                                          |   |                                 |   |                                |   |     |   |     |   |
| **Components of net periodic benefits cost:** |   |                                 |   |                                |   |     |   |     |   |   |   |   |   |
| Service cost                                  |   | $                                    | 137    |                                | $      | 118      |   | $        | 411    |   | $      | 351    |   |
| Interest cost                                 |   |                                 | 75     |                                |   | 63       |   |     | 225    |   |   | 189    |   |
| Prior service amortization                    |   |                                 | 8      |                                |   | 7        |   |     | 23     |   |   | 23     |   |
| Recognized net actuarial loss                 |   |                                 | 12     |                                |   | 8        |   |     | 36     |   |   | 24     |   |
|                                          |   |                                 |   |                                |   |     |   |     |   |   |   |   |   |
| **Total components of net periodic cost**     |   | $                                    | 232    |                                | $      | 196      |   | $        | 695    |   | $      | 587    |   |
|                                          |   |                                 |   |                                |   |     |   |     |   |   |   |   |   |

**NOTE H – COMMITMENTS AND CONTINGENCIES**

The Company is involved in legal actions arising from normal business activities. Management, based upon the advice of legal counsel, believes that the ultimate resolution of all pending legal actions will not have a material effect on the Company’s financial position or results of its operations or its cash flows.

The Company was contingently liable under standby letters of credit issued on behalf of its customers in the amount of $11,562,000 and $10,314,000 at September 30, 2008 and December 31, 2007. At September 30, 2008, commercial and consumer lines of credit and real estate loans of approximately $90,934,000 and $78,711,000 were undisbursed. At December 31, 2007, commercial and consumer lines of credit and real estate loans of approximately $79,024,000 and        $134,570,000 were undisbursed.

Loan commitments are typically contingent upon the borrower meeting certain financial and other covenants and such commitments typically have fixed expiration dates and require payment of a fee. As many of these commitments are expected to expire without being drawn upon, the total commitments do not necessarily represent future cash requirements. The Company evaluates each potential borrower and the necessary collateral on an individual basis.        Collateral varies, but may include real property, bank deposits, debt securities, equity securities or business or personal assets.

Standby letters of credit are conditional commitments written by the Company to guarantee the performance of a customer to a third party. These guarantees are issued primarily relating to real estate projects and inventory purchases by the Company’s commercial customers and such guarantees are typically short term. Credit risk is similar to that involved in extending loan commitments to customers and the Company, accordingly, uses evaluation and        collateral requirements similar to those for loan commitments. Most of such commitments are collateralized. The fair value of the liability related to these standby letters of credit, which represents the fees received for issuing the guarantees, was not significant at September 30, 2008 and December 31, 2007. The Company recognizes these fees as revenues over the term of the commitment or when the commitment is used.

Loan commitments and standby letters of credit involve, to varying degrees, elements of credit and market risk in excess of the amounts recognized in the balance sheet and do not necessarily represent the actual amount subject to credit loss. However, at September 30, 2008, no losses are anticipated as a result of these commitments.

A large portion of the loan portfolio of the Company is dependent on real estate. At September 30, 2008 and at December 31, 2007, real estate served as the principal source of collateral with respect to approximately 75% and 77% of the Company’s loan portfolio. At September 30, 2008, real estate construction loans totaled $148,819,000, or 21% of the total loan portfolio, and commercial loans secured by real estate totaled $317,159,000, or 45% of        the total loan portfolio. See the discussion under “Loan and Lease Portfolio” starting on page 22. A substantial decline in the state and national economy, in general, combined with further deterioration in real estate values in the Company’s primary operating market areas, would have an adverse effect on the value of real estate as well as other collateral securing loans, plus the ability of certain borrowers to repay their outstanding loans and the overall demand for        new loans, and this could have a material impact on the Company’s financial position or results of operations or its cash flows. Reference should be made to the risk factors discussed under Item 1A of Part I of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007, as supplemented by the responses to Item 1A of Part II of the Quarterly Report on Form 10-Q for the period ended June 30, 2008 and this Quarterly Report on Form 10-Q.

12

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**NOTE I – INCOME TAXES**

The Company applies the asset and liability method to account for income taxes. Deferred tax assets and liabilities are calculated by applying applicable tax laws to the differences between the financial statement basis and the tax basis of assets and liabilities. The effect on deferred taxes of changes in tax laws and rates is recognized in income in the period that includes the enactment date. On the consolidated balance sheet, net deferred tax assets        are included in other assets.

Accounting for uncertainty in income taxes - The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of        tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. The Company recognizes accrued interest and        penalties related to unrecognized tax benefits, if applicable, as a component of interest expense in the consolidated statements of income. There have been no significant changes to unrecognized tax benefits or accrued interest and penalties for the nine months ended September 30, 2008.

**NOTE J – FAIR VALUE MEASUREMENT**

On January 1, 2008, the Company adopted Financial Accounting Standards Board (FASB) Statement No. 157 (SFAS 157), *Fair Value Measurements*. SFAS No. 157 defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurement. There was no cumulative effect adjustment to beginning retained earnings recorded upon adoption and no impact on the financial statements in the first nine months        of 2008.

The following tables present information about the Company’s assets measured at fair value on a recurring and nonrecurring 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. 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. 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 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. Level 3 inputs are unobservable        inputs for the asset or liability, and includes situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The        Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

Assets measured at fair value on a recurring basis are summarized below (in thousands):

|                                                     |   |                              |   |                                                                        |   |                                                                                           |   |                                                                                                   |    |   |   |    |   |
|----------------------------------------------------------|--------|-----------------------------------|--------|-----------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------|---------|--------|--------|---------|--------|
|                                                     |   |                              |   | **Fair Value Measurements                    at September 30, 2008, Using** |   |
|                                                     |   |                              |   |                                                                        |   |
| **Description**                                          |   | **Fair Value September 30, 2008** |   | **Quoted Prices in Active Markets for Identical Assets (Level 1)**          |   | **Other                    Observable                    Inputs                    (Level 2)** |   | **Significant                    Unobservable                    Inputs                    (Level 3)** |    |
|                                                     |   |                              |   |                                                                        |   |                                                                                           |   |                                                                                                   |    |
| Available-for-Sale Securities                            |   |                              | 83,258 |                                                                        |   | 83,258                                                                                         |   |                                                                                                   | — |   |   | — |   |
| Mortgage Servicing Rights                                |   |                              | 585    |                                                                        |   | —                                                                                        |   |                                                                                                   | 585     |   |   | — |   |
|                                                     |   |                              |   |                                                                        |   |                                                                                           |   |                                                                                                   |    |   |   |    |   |
|                                                     |   |                              |   |                                                                        |   |                                                                                           |   |                                                                                                   |    |   |   |    |   |
| Total assets measured at fair value on a recurring basis |   | $                                 | 83,843 |                                                                        | $      | 83,258                                                                                         |   | $                                                                                                      | 585     |   | $      | — |   |
|                                                     |   |                              |   |                                                                        |   |                                                                                           |   |                                                                                                   |    |   |   |    |   |

***Available-for-Sale Securities*****-** Fair values for investment securities are based on quoted market prices.

***Mortgage Servicing Rights —***The fair value of mortgage servicing rights is estimated using a discounted cash flow model.

13

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Assets measured at fair value on a nonrecurring basis are summarized below (in thousands):

|                                                        |   |                                                 |   |                                                                                                                        |   |                                                                                           |   |                                                                                                   |   |   |   |    |   |
|-------------------------------------------------------------|--------|------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------|--------|--------|--------|---------|--------|
|                                                        |   |                                                 |   | **Fair Value Measurements                    at September 30, 2008, Using**                                                 |   |
|                                                        |   |                                                 |   |                                                                                                                        |   |
| **Description**                                             |   | **Fair Value                    September 30, 2008** |   | **Quoted Prices in                    Active Markets for                    Identical Assets                    (Level 1)** |   | **Other                    Observable                    Inputs                    (Level 2)** |   | **Significant                    Unobservable                    Inputs                    (Level 3)** |   |
|                                                        |   |                                                 |   |                                                                                                                        |   |                                                                                           |   |                                                                                                   |   |
| Impaired Loans                                              |   |                                                 | 19,398 |                                                                                                                        |   | —                                                                                        |   |                                                                                                   | 19,398 |   |   | — |   |
| Other Real Estate Owned                                     |   |                                                 | 5,852  |                                                                                                                        |   | —                                                                                        |   |                                                                                                   | 5,852  |   |   | — |   |
|                                                        |   |                                                 |   |                                                                                                                        |   |                                                                                           |   |                                                                                                   |   |   |   |    |   |
|                                                        |   |                                                 |   |                                                                                                                        |   |                                                                                           |   |                                                                                                   |   |   |   |    |   |
| Total assets measured at fair value on a nonrecurring basis |   | $                                                    | 25,250 |                                                                                                                        | $      | —                                                                                        |   | $                                                                                                      | 25,250 |   | $      | — |   |
|                                                        |   |                                                 |   |                                                                                                                        |   |                                                                                           |   |                                                                                                   |   |   |   |    |   |

***Impaired loans -*** Impaired loans, which are measured for impairment using the fair value of the collateral for the collateral dependent loans, had a carrying amount of $20,190,000, with a specific reserve of $792,000.

***Other Real Estate Owned -*** Other real estate owned represents real estate which the Company has taken control of in partial or full satisfaction of loans. At the time of foreclosure, other real estate owned is recorded at the fair value of the real estate less costs to sell, which becomes the property’s new basis.

**NOTE K - NEW ACCOUNTING PRONOUNCEMENTS**

In May 2008, the FASB issued SFAS No. 162, *“*The Hierarchy of Generally Accepted Accounting Principles”(SFAS No. 162)*.* This standard identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with GAAP. The provisions of SFAS No. 162 did not have a material impact on the        Company’s condensed consolidated financial statements.

On October 10, 2008, the FASB issued FSP FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active. The FSP clarifies the application of FASB Statement No. 157, Fair Value Measurements, in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. The FSP is effective        immediately, and includes prior period financial statements that have not yet been issued, and therefore the Company is subject to the provision of the FSP effective September 30, 2008. The implementation of FSP FAS 157-3 did not affect the Company’s fair value measurement as of September 30, 2008.

**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.**

Certain statements in this Form 10-Q (excluding statements of fact or historical financial information) involve forward-looking information within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the “safe harbor” created by those sections. These forward-looking statements involve certain risks and uncertainties that could cause actual        results to differ materially from those in the forward-looking statements. Such risks and uncertainties include, but are not limited to, the following factors: competitive pressure in banking industry increases significantly; changes in the interest rate environment reduce margins; general economic conditions, either nationally or regionally, are less favorable than expected, resulting in, among other things, a deterioration in credit quality and an increase in the provision for        possible loan losses; changes in the regulatory environment; changes in business conditions, particularly in the Northern California region; volatility of rate sensitive deposits; operational risks including data processing system failures or fraud; asset/liability matching risks and liquidity risks; the California power crises; the U.S. “war on terrorism” and military action by the U.S. in the Middle East, and changes in the securities markets.

**Critical Accounting Policies**

**General**

North Valley Bancorp’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The financial information contained within our financial statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained        either when earning income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss factors as one factor in determining the inherent loss that may be present in our loan and lease portfolio. Actual losses could differ significantly from the historical factors that we use. Another estimate that we use is related to the expected useful lives of our depreciable assets. In addition, GAAP itself may change from one previously acceptable method to another        method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.

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**Allowance for Loan and Lease Losses**

The allowance for loan and lease losses is maintained to provide for losses related to impaired loans and leases and other losses that can be reasonably expected to occur in the normal course of business. The allowance for loan and lease losses is established through a provision for loan and lease losses charged to operations. Loans and leases are charged against the allowance for loan and lease losses when management believes that the collectibility of        the principal is unlikely or, with respect to consumer installment loans, according to an established delinquency schedule. Management attributes formula reserves to different types of loans using percentages which are based upon perceived risk associated with the portfolio and underlying collateral, historical loss experience, and vulnerability to existing economic conditions, which may affect the collectibility of the loans. Specific reserves are allocated for impaired loans and        leases which have experienced a decline in internal grading and when management believes additional loss exposure exists. The unallocated allowance is based upon management’s evaluation of various conditions that are not directly measured in the determination of the formula and specific allowances. The evaluation of inherent losses with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits or        portfolio segments. Although the allowance for loan and lease losses is allocated to various portfolio segments, it is general in nature and is available for the loan and lease portfolio in its entirety. The allowance is an amount that management believes will be adequate to absorb losses inherent in existing loans and leases. Actual amounts could differ from those estimates.

The Company considers a loan or lease impaired if, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan or lease agreement. The measurement of impaired loans and leases is generally based on the present value of expected future cash flows discounted at the historical effective interest rate, except that        all collateral-dependent loans and leases are measured for impairment based on the fair value of the collateral.

**Share Based Compensation**

At September 30, 2008, the Company had four shareholder approved stock-based compensation plans: the North Valley Bancorp 1989 Director Stock Option Plan, the 1998 Employee Stock Incentive Plan, the 1999 Director Stock Option Plan and the 2008 Stock Incentive Plan. The 1999 Director Stock Option Plan replaced the existing North Valley Bancorp 1989 Director Stock Option Plan. The North Valley Bancorp 2008 Stock Incentive Plan was adopted by the        Company’s Board of Directors on February 27, 2008, effective that date, and was approved by the Company’s shareholders at the Annual Meeting, May 22, 2008. The terms of the 2008 Stock Incentive Plan are substantially the same as the North Valley Bancorp 1998 Employee Stock Incentive Plan. See Note C – Stock-Based Compensation to the Unaudited Condensed Consolidated Financial Statements in Item 1 – Financial Statements.

Prior to January 1, 2006, the Company accounted for the plans under the recognition and measurement provisions of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations, as permitted by Financial Accounting Standards Board (“FASB”) Statement No. 123, Accounting for Stock-Based Compensation (“Statement 123”) and FASB Statement No. 148, Accounting for        Stock-Based Compensation - Transition and Disclosure. Effective January 1, 2006, the Company adopted the fair value recognition provisions of FASB Statement No. 123(R), Share-Based Payment (“Statement 123 (R)”), using the modified prospective transition method. Under this transition method, compensation cost recognized in fiscal year 2007 and 2008 includes: (a) compensation cost for all share-based payments vesting during 2007 and 2008 that were granted prior to, but not yet        vested as of, January 1, 2006 based on the grant-date fair value estimated in accordance with the original provisions of Statement 123; and, (b) compensation cost for all share-based payments vesting during 2007 and 2008 that were granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of Statement 123(R). The Company has elected the alternative method prescribed by FASB Staff Position No. FAS 123(R)-3, *Transition Election        Related to Accounting for the Tax Effects of Share-Based Payment Awards,* commonly referred to as the “short-cut” method, for accounting for the tax consequences of share-based awards.

**Goodwill**

Business combinations involving the Company’s acquisition of the equity interests or net assets of another enterprise may give rise to goodwill. Goodwill represents the excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed in transactions accounted for under the purchase method of accounting. Goodwill of $15,187,000 was recorded in the Company’s acquisition of Yolo Community        Bank. The value of goodwill is ultimately derived from the Company’s ability to generate net earnings. A decline in net earnings could be indicative of a decline in the fair value of goodwill and result in impairment. For that reason, goodwill will be assessed for impairment at a reporting unit level at least annually. Management will conduct its annual assessment of impairment during the fourth quarter of 2008.

15

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**Impairment of Investment Securities**

Investment securities are evaluated for other-than-temporary impairment on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation to determine whether a decline in their value below amortized cost is other-than-temporary. Management utilizes criteria such as the magnitude and duration of the decline, the financial condition of the issuer, rating agency changes related to the issuer’s securities        and the intent and ability of the Company to retain its investment in the issues for a period of time sufficient to allow for an anticipated recovery in fair value, in addition to the reasons underlying the decline, to determine whether the loss in value is other-than-temporary. The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that        there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value is determined to be other-than-temporary, the value of the security is reduced and a corresponding charge to earnings is recognized. See Note B – Investment Securities to the Unaudited Condensed Consolidated Financial Statements in Item 1 – Financial Statements.

**Fair Value**

Effective January 1, 2008, the Company adopted SFAS No. 157, *Fair Value Measurements,* which among other things, requires enhanced disclosures about financial instruments carried at fair value. SFAS No. 157 establishes a hierarchical disclosure framework associated with the level of observable pricing scenarios utilized in measuring financial instruments at fair value. The degree of judgment utilized in measuring the fair value of financial        instruments generally correlates to the level of the observable pricing scenario. Financial instruments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of observable pricing and a lesser degree of judgment utilized in measuring fair value. Conversely, financial instruments rarely traded or not quoted will generally have little or no observable pricing and a higher degree of judgment        utilized in measuring fair value. Observable pricing scenarios are impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established and the characteristics specific to the transaction.

See Note J – Fair Value Measurement to the Unaudited Condensed Consolidated Financial Statements in Item 1 – Financial Statements for additional information about the financial instruments carried at fair value.

**Overview**

North Valley Bancorp (the “Company”) is a bank holding company headquartered in Redding, California. The Company’s wholly owned subsidiary, North Valley Bank (“NVB”), a state-chartered bank, operates out of its main office located at 300 Park Marina Circle, Redding, CA 96001, with twenty-six commercial banking offices, including two in-store supermarket branches, seven Business Banking Centers and a loan production office,        in Northern California. The Company’s principal business consists of attracting deposits from the general public and using the funds to originate commercial, real estate and installment loans to customers, who are predominately small and middle market businesses and middle income individuals. The Company’s primary source of revenues is interest income from its loan and investment securities portfolios. The Company is not dependent on any single customer for more than ten        percent of its revenues.

16

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**Earnings Summary**

|                                       |     |                                 |     |                                |     |   |     |   |   |   |   |   |   |
|--------------------------------------------|----------|--------------------------------------|----------|-------------------------------------|----------|--------|----------|--------|--------|--------|--------|--------|--------|
| (in thousands except per share amounts)    |     | **Three months ended September 30,** |     | **Nine months ended September 30,** |     |
|                                       | **2008** |                                 | **2007** |                                | **2008** |   | **2007** |   |
|                                       |     |                                 |     |                                |     |   |     |   |   |
|                                       |     |                                 |     |                                |     |   |     |   |   |
| Net interest income                        |     | $                                    | 8,812    |                                | $        | 10,245 |     | $      | 27,009 |   | $      | 30,674 |   |
| Provision for loan and lease losses        |     |                                 | 1,500    |                                |     | 850    |     |   | 9,100  |   |   | 850    |   |
| Noninterest income                         |     |                                 | 284      |                                |     | 3,350  |     |   | 7,252  |   |   | 9,654  |   |
| Noninterest expense                        |     |                                 | 9,694    |                                |     | 9,481  |     |   | 29,075 |   |   | 30,443 |   |
| (Benefit) provision for income taxes       |     |                                 | (679     | )                                   |     | 1,044  |     |   | (1,266 | )      |   | 2,891  |   |
|                                       |     |                                 |     |                                |     |   |     |   |   |   |   |   |   |
| Net (loss) income                          |     | $                                    | (1,419   | )                                   | $        | 2,220  |     | $      | (2,648 | )      | $      | 6,144  |   |
|                                       |     |                                 |     |                                |     |   |     |   |   |   |   |   |   |
|                                       |     |                                 |     |                                |     |   |     |   |   |   |   |   |   |
| (Loss)/Earnings Per Share                  |     |                                 |     |                                |     |   |     |   |   |   |   |   |   |
| Basic                                      |     | $                                    | (0.19    | )                                   | $        | 0.30   |     | $      | (0.36  | )      | $      | 0.84   |   |
| Diluted                                    |     | $                                    | (0.19    | )                                   | $        | 0.29   |     | $      | (0.36  | )      | $      | 0.80   |   |
|                                       |     |                                 |     |                                |     |   |     |   |   |   |   |   |   |
| Annualized (Loss)/Return on Average Assets |     |                                 | (0.62    | %)                                  |     | 0.97   | %        |   | (0.38  | %)     |   | 0.92   | %      |
| Annualized (Loss)/Return on Average Equity |     |                                 | (7.13    | %)                                  |     | 11.15  | %        |   | (4.33  | %)     |   | 10.55  | %      |

The Company had a net loss of $1,419,000, or $0.19 per diluted share, and $2,648,000, or $0.36 per diluted share, for the three and nine months ended September 30, 2008, respectively. This represents a decrease in net income of $3,639,000 and $8,792,000 when compared to the three and nine months ended September 30, 2007. The decrease in net income for the three and nine months ended September 30, 2008 compared to the same periods in 2007 was principally        driven by an impairment charge of $3,284,000 on FNMA Preferred Stock that management concluded was impaired during the third quarter of 2008 and a $1,500,000 provision for loan and lease losses for the three months ended September 30, 2008 and a total provision of $9,100,000 for the nine months ended September 30, 2008 compared to an $850,000 provision for the three and nine month periods in 2007. Additionally, net interest income decreased $1,433,000 for the three months ended        September 30, 2008 and decreased $3,665,000 for the nine months ended September 30, 2008 compared to the same periods in 2007. Noninterest income decreased $3,066,000 and $2,402,000 for the three and nine months ended September 30, 2008 compared to the same periods in 2007 due to the impairment charge discussed above. Noninterest expense increased $213,000 for the three months ended September 30, 2008 compared to the same period in 2007, and decreased $1,367,000 for the nine months        ended September 30, 2008 compared to the same period in 2007. As a result of the net losses, the Company recorded a benefit for income taxes of $679,000 and $1,266,000 for the three and nine months ended September 30, 2008 compared to a provision for income taxes of $2,220,000 and $2,891,000 for the same periods in 2007.

**Net Interest Income**

Net interest income is the principal source of the Company’s operating earnings and represents the difference between interest earned on loans and leases and other investments and interest paid on deposits and other borrowings. The amount of interest income and expense is affected by changes in the volume and mix of earning assets and interest-bearing deposits and borrowings, along with changes in interest rates.

17

----

The following tables are a summary of the Company’s net interest income, presented on a fully taxable equivalent (FTE) basis for tax-exempt investments included in earning assets, for the periods indicated:

**Schedule of Average Daily Balance and Average Yields and Rates***(Dollars in thousands)*

|                                             |   |                                      |    |                                      |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
|--------------------------------------------------|--------|-------------------------------------------|---------|-------------------------------------------|--------|----------------------------------------|--------|----------------------------------------|--------|------------------------------------|--------|----------------------------------------|--------|--------|--------|--------|--------|--------|--------|
|                                             |   | **Three months ended September 30, 2008** |    | **Three months ended September 30, 2007** |   |
|                                             |   |                                      |    |                                      |   |
|                                             |   | **Average                    Balance**    |    | **Yield/                    Rate**        |   | **Interest                    Amount** |   | **Average                    Balance** |   | **Yield/                    Rate** |   | **Interest                    Amount** |   |
|                                             |   |                                      |    |                                      |   |                                   |   |                                   |   |                               |   |                                   |   |
|                                             |   |                                      |    |                                      |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| **Assets**                                       |   |                                      |    |                                      |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Earning assets:                                  |   |                                      |    |                                      |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Federal funds sold                               |   | $                                         | 604     |                                      |   | 1.97                                   | %      | $                                      | 3      |                               | $      | 977                                    |   |   | 4.87   | %      | $      | 12     |   |
| Investment securities:                           |   |                                      |    |                                      |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Taxable                                          |   |                                      | 73,827  |                                      |   | 4.13                                   | %      |                                   | 769    |                               |   | 90,946                                 |   |   | 4.30   | %      |   | 986    |   |
| Non-taxable (1)                                  |   |                                      | 20,019  |                                      |   | 6.74                                   | %      |                                   | 340    |                               |   | 20,748                                 |   |   | 6.73   | %      |   | 352    |   |
| FNMA preferred stock (1)                         |   |                                      | 3,248   |                                      |   | 9.53                                   | %      |                                   | 78     |                               |   | 5,000                                  |   |   | 6.19   | %      |   | 78     |   |
|                                             |   |                                      |    |                                      |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Total investments                                |   |                                      | 97,094  |                                      |   | 4.85                                   | %      |                                   | 1,187  |                               |   | 116,694                                |   |   | 4.81   | %      |   | 1,416  |   |
| Loans and leases (2)(3)                          |   |                                      | 714,546 |                                      |   | 6.49                                   | %      |                                   | 11,686 |                               |   | 696,861                                |   |   | 7.85   | %      |   | 13,790 |   |
|                                             |   |                                      |    |                                      |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Total earning assets                             |   |                                      | 812,244 |                                      |   | 6.29                                   | %      |                                   | 12,876 |                               |   | 814,532                                |   |   | 7.41   | %      |   | 15,218 |   |
|                                             |   |                                      |    |                                      |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Non earning assets                               |   |                                      | 102,698 |                                      |   |                                   |   |                                   |   |                               |   | 99,286                                 |   |   |   |   |   |   |   |
| Allowance for loan and lease losses              |   |                                      | (13,547 | )                                         |   |                                   |   |                                   |   |                               |   | (8,786                                 | )      |   |   |   |   |   |   |
|                                             |   |                                      |    |                                      |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Total non-earning assets                         |   |                                      | 89,151  |                                      |   |                                   |   |                                   |   |                               |   | 90,500                                 |   |   |   |   |   |   |   |
|                                             |   |                                      |    |                                      |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Total assets                                     |   | $                                         | 901,395 |                                      |   |                                   |   |                                   |   |                               | $      | 905,032                                |   |   |   |   |   |   |   |
|                                             |   |                                      |    |                                      |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
|                                             |
| **Liabilities and Shareholders’ Equity**   |   |                                      |    |                                      |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Interest bearing liabilities:                    |   |                                      |    |                                      |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Transaction accounts                             |   | $                                         | 154,408 |                                      |   | 0.58                                   | %      | $                                      | 227    |                               | $      | 156,414                                |   |   | 0.51   | %      | $      | 200    |   |
| Savings and money market                         |   |                                      | 177,654 |                                      |   | 1.51                                   | %      |                                   | 678    |                               |   | 189,995                                |   |   | 1.92   | %      |   | 918    |   |
| Time certificates                                |   |                                      | 261,105 |                                      |   | 3.47                                   | %      |                                   | 2,282  |                               |   | 224,154                                |   |   | 4.68   | %      |   | 2,642  |   |
| Other borrowed funds                             |   |                                      | 61,363  |                                      |   | 4.82                                   | %      |                                   | 745    |                               |   | 71,269                                 |   |   | 6.00   | %      |   | 1,078  |   |
|                                             |   |                                      |    |                                      |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Total interest bearing liabilities               |   |                                      | 654,530 |                                      |   | 2.38                                   | %      |                                   | 3,932  |                               |   | 641,832                                |   |   | 2.99   | %      |   | 4,838  |   |
|                                             |   |                                      |    |                                      |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Demand deposits                                  |   |                                      | 156,427 |                                      |   |                                   |   |                                   |   |                               |   | 174,123                                |   |   |   |   |   |   |   |
| Other liabilities                                |   |                                      | 11,488  |                                      |   |                                   |   |                                   |   |                               |   | 10,098                                 |   |   |   |   |   |   |   |
|                                             |   |                                      |    |                                      |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Total liabilities                                |   |                                      | 822,445 |                                      |   |                                   |   |                                   |   |                               |   | 826,053                                |   |   |   |   |   |   |   |
|                                             |   |                                      |    |                                      |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Shareholders’ equity                       |   |                                      | 78,950  |                                      |   |                                   |   |                                   |   |                               |   | 78,979                                 |   |   |   |   |   |   |   |
|                                             |   |                                      |    |                                      |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Total liabilities and shareholders’ equity |   | $                                         | 901,395 |                                      |   |                                   |   |                                   |   |                               | $      | 905,032                                |   |   |   |   |   |   |   |
|                                             |   |                                      |    |                                      |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Net interest income                              |   |                                      |    |                                      |   |                                   |   | $                                      | 8,944  |                               |   |                                   |   |   |   |   | $      | 10,380 |   |
|                                             |   |                                      |    |                                      |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Net interest spread                              |   |                                      |    |                                      |   | 3.91                                   | %      |                                   |   |                               |   |                                   |   |   | 4.42   | %      |   |   |   |
|                                             |   |                                      |    |                                      |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Net interest margin                              |   |                                      |    |                                      |   | 4.37                                   | %      |                                   |   |                               |   |                                   |   |   | 5.06   | %      |   |   |   |
|                                             |   |                                      |    |                                      |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
|                                             |   |                                      |    |                                      |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
|                                                  |

|   |                                                                                                     |
|--------|----------------------------------------------------------------------------------------------------------|
| (1)    | Tax-equivalent basis; non-taxable securities are exempt from federal taxation.                           |
|   |                                                                                                     |
| (2)    | Loans on nonaccrual status have been included in the computations of averages balances.                  |
|   |                                                                                                     |
| (3)    | Includes loan fees of $95 and $351 for the three months ended September 30, 2008 and 2007, respectively. |

18

----

**Schedule of Average Daily Balance and Average Yields and Rates***(Dollars in thousands)*

|                                             |   |                                     |    |                                     |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
|--------------------------------------------------|--------|------------------------------------------|---------|------------------------------------------|--------|----------------------------------------|--------|----------------------------------------|--------|------------------------------------|--------|----------------------------------------|--------|--------|--------|--------|--------|--------|--------|
|                                             |   | **Nine months ended September 30, 2008** |    | **Nine months ended September 30, 2007** |   |
|                                             |   |                                     |    |                                     |   |
|                                             |   | **Average                    Balance**   |    | **Yield/                    Rate**       |   | **Interest                    Amount** |   | **Average                    Balance** |   | **Yield/                    Rate** |   | **Interest                    Amount** |   |
|                                             |   |                                     |    |                                     |   |                                   |   |                                   |   |                               |   |                                   |   |
| **Assets**                                       |   |                                     |    |                                     |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Earning assets:                                  |   |                                     |    |                                     |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Federal funds sold                               |   | $                                        | 475     |                                     |   | 2.52                                   | %      | $                                      | 9      |                               | $      | 9,933                                  |   |   | 5.26   | %      | $      | 391    |   |
| Investment securities:                           |   |                                     |    |                                     |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Taxable                                          |   |                                     | 79,858  |                                     |   | 4.12                                   | %      |                                   | 2,469  |                               |   | 96,972                                 |   |   | 4.38   | %      |   | 3,177  |   |
| Non-taxable (1)                                  |   |                                     | 20,248  |                                     |   | 6.72                                   | %      |                                   | 1,021  |                               |   | 21,007                                 |   |   | 6.82   | %      |   | 1,072  |   |
| FNMA preferred stock (1)                         |   |                                     | 3,272   |                                     |   | 9.57                                   | %      |                                   | 235    |                               |   | 7,175                                  |   |   | 6.45   | %      |   | 346    |   |
|                                             |   |                                     |    |                                     |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Total investments                                |   |                                     | 103,378 |                                     |   | 4.80                                   | %      |                                   | 3,725  |                               |   | 125,154                                |   |   | 4.91   | %      |   | 4,595  |   |
| Loans and leases (2)(3)                          |   |                                     | 734,913 |                                     |   | 6.69                                   | %      |                                   | 36,908 |                               |   | 670,469                                |   |   | 7.90   | %      |   | 39,622 |   |
|                                             |   |                                     |    |                                     |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Total earning assets                             |   |                                     | 838,766 |                                     |   | 6.45                                   | %      |                                   | 40,642 |                               |   | 805,556                                |   |   | 7.40   | %      |   | 44,608 |   |
|                                             |   |                                     |    |                                     |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Non earning assets                               |   |                                     | 99,708  |                                     |   |                                   |   |                                   |   |                               |   | 99,603                                 |   |   |   |   |   |   |   |
| Allowance for loan and lease losses              |   |                                     | (12,472 | )                                        |   |                                   |   |                                   |   |                               |   | (8,809                                 | )      |   |   |   |   |   |   |
|                                             |   |                                     |    |                                     |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Total non-earning assets                         |   |                                     | 87,236  |                                     |   |                                   |   |                                   |   |                               |   | 90,794                                 |   |   |   |   |   |   |   |
| Total assets                                     |   | $                                        | 926,002 |                                     |   |                                   |   |                                   |   |                               | $      | 896,350                                |   |   |   |   |   |   |   |
|                                             |   |                                     |    |                                     |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
|                                             |   |                                     |    |                                     |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| **Liabilities and Shareholders’ Equity**   |   |                                     |    |                                     |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Interest bearing liabilities:                    |   |                                     |    |                                     |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Transaction accounts                             |   | $                                        | 155,624 |                                     |   | 0.63                                   | %      | $                                      | 732    |                               | $      | 158,883                                |   |   | 0.48   | %      | $      | 574    |   |
| Savings and money market                         |   |                                     | 181,149 |                                     |   | 1.64                                   | %      |                                   | 2,231  |                               |   | 195,453                                |   |   | 1.88   | %      |   | 2,746  |   |
| Time certificates                                |   |                                     | 252,463 |                                     |   | 3.93                                   | %      |                                   | 7,443  |                               |   | 214,403                                |   |   | 4.55   | %      |   | 7,304  |   |
| Other borrowed funds                             |   |                                     | 86,150  |                                     |   | 4.39                                   | %      |                                   | 2,842  |                               |   | 63,551                                 |   |   | 6.06   | %      |   | 2,881  |   |
|                                             |   |                                     |    |                                     |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Total interest bearing liabilities               |   |                                     | 675,386 |                                     |   | 2.61                                   | %      |                                   | 13,248 |                               |   | 632,290                                |   |   | 2.86   | %      |   | 13,505 |   |
|                                             |   |                                     |    |                                     |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Demand deposits                                  |   |                                     | 159,564 |                                     |   |                                   |   |                                   |   |                               |   | 175,200                                |   |   |   |   |   |   |   |
| Other liabilities                                |   |                                     | 9,579   |                                     |   |                                   |   |                                   |   |                               |   | 10,970                                 |   |   |   |   |   |   |   |
|                                             |   |                                     |    |                                     |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Total liabilities                                |   |                                     | 844,529 |                                     |   |                                   |   |                                   |   |                               |   | 818,460                                |   |   |   |   |   |   |   |
|                                             |   |                                     |    |                                     |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Shareholders’ equity                       |   |                                     | 81,473  |                                     |   |                                   |   |                                   |   |                               |   | 77,890                                 |   |   |   |   |   |   |   |
|                                             |   |                                     |    |                                     |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
|                                             |   |                                     |    |                                     |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Total liabilities and shareholders’ equity |   | $                                        | 926,002 |                                     |   |                                   |   |                                   |   |                               | $      | 896,350                                |   |   |   |   |   |   |   |
|                                             |   |                                     |    |                                     |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Net interest income                              |   |                                     |    |                                     |   |                                   |   | $                                      | 27,394 |                               |   |                                   |   |   |   |   | $      | 31,103 |   |
|                                             |   |                                     |    |                                     |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Net interest spread                              |   |                                     |    |                                     |   | 3.84                                   | %      |                                   |   |                               |   |                                   |   |   | 4.54   | %      |   |   |   |
|                                             |   |                                     |    |                                     |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
| Net interest margin                              |   |                                     |    |                                     |   | 4.35                                   | %      |                                   |   |                               |   |                                   |   |   | 5.16   | %      |   |   |   |
|                                             |   |                                     |    |                                     |   |                                   |   |                                   |   |                               |   |                                   |   |   |   |   |   |   |   |
|                                             |
|                                             |

|   |                                                                                                       |
|--------|------------------------------------------------------------------------------------------------------------|
| (1)    | Tax-equivalent basis; non-taxable securities are exempt from federal taxation.                             |
|   |                                                                                                       |
| (2)    | Loans on nonaccrual status have been included in the computations of averages balances.                    |
|   |                                                                                                       |
| (3)    | Includes loan fees of $387 and $1,076 for the nine months ended September 30, 2008 and 2007, respectively. |

Net interest income has been adjusted to a fully taxable equivalent basis (FTE) for tax-exempt investments included in earning assets. Net interest income, which represents the Company’s largest component of revenues and is the difference between interest earned on loans and investments and interest paid on deposits and borrowings, decreased $1,436,000, or 13.8%, for the three months ended September 30, 2008 compared to the same period in 2007.        Interest income decreased by $2,342,000 for the third quarter of 2008, primarily due to foregone interest income of $507,000 due to loans placed on nonaccrual status and a reduction in yield on the loan portfolio and in the interest earned on investment securities and Federal funds sold due primarily to the decreases in the average balances. Interest expense decreased $906,000 as the increase in the average balance of interest bearing liabilities of $12,698,000 was more than offset by        the decrease on rates paid on deposits and borrowings for the quarter ended September 30, 2008 compared to the same period in 2007. Average loans increased $17,685,000 in the third quarter of 2008 compared to the third quarter of 2007, however the yield on the loan portfolio for the comparable periods decreased 136 basis points to 6.49%. This decrease is reflective of the declining interest rate environment and the impact of foregone interest income on the loans placed on nonaccrual.        Interest rates set by the Federal Reserve Board have declined 325 basis points since September 2007. The increase in average total loans was primarily funded by a decrease in average investments and Federal funds sold of $19,973,000. Average yields on total average earning assets decreased 112 basis points from the quarter ended September 30, 2007 to 6.29% for the quarter ended September 30, 2008. Over the same period the average rate paid on interest-bearing liabilities decreased by 61        basis points to 2.38%. As a result of the above, the Company’s net interest margin for the quarter ended September 30, 2008 was 4.37%, a decrease of 69 basis points from the 5.06% for the quarter ended September 30, 2007 but consistent with the 4.34% net interest margin for the linked quarter ended June 30, 2008.

19

----

Net interest income decreased $3,709,000 for the nine months ended September 30, 2008 compared to the same period in 2007. Interest income decreased by $3,966,000 for the nine months ended September 30, 2008, primarily due to foregone interest income of $1,563,000 due to loans placed on nonaccrual status, an overall reduction in yields earned of 95 basis points, primarily on the loan portfolio even with the increase in the average balances of loans and        leases, and a reduction in the interest earned on investment securities and Federal funds sold as a result of both lower average balances and lower yields. Interest expense decreased $257,000 due primarily to a decrease in rates paid on average interest bearing liabilities of 25 basis points for the nine months ended September 30, 2008 compared to the same period in 2007 having a greater impact than the increase in the average balances of interest bearing liabilities. As a result of the        above, the Company’s net interest margin for the nine months ended September 30, 2008 decreased 81 basis points to 4.35% from 5.16% for the nine months ended September 30, 2007.

Currently the Company is retaining fixed-rate 15-and 30-year conforming residential mortgages to better diversify the portfolio and also adding fixed rate mortgages with the steepening of the yield curve in this declining interest rate environment. The Company will continue to sell the fixed rate jumbo mortgage loans it originates.

**Provision for Loan and Lease Losses**

The Company recorded a provision for loan and lease losses of $1,500,000 for the three months ended September 30, 2008 and a total provision of $9,100,000 for the nine months ended September 30, 2008. The Company recorded an $850,000 provision for the three and nine months ended September 30, 2007. The process for determining allowance adequacy and the resultant provision for loan losses includes a comprehensive analysis of the loan portfolio. Factors        in the analysis include size and mix of the loan portfolio, nonperforming loan levels, charge-off/recovery activity and other qualitative factors including economic environment and activity. The decision to record the $1,500,000 and $9,100,000 provisions for the three and nine months ended September 30, 2008 reflects management’s assessment of the overall adequacy of the allowance for loan and lease losses including the consideration of the increase in nonperforming loans and the        overall effect of the slowing economy, particularly in real estate. Management believes that the current level of allowance for loan and lease losses as of September 30, 2008 of $9,958,000, or 1.43% of total loans and leases, is adequate at this time. The allowance for loan and lease losses was $10,755,000, or 1.44% of total loans and leases, at December 31, 2007. For further information regarding our allowance for loan and lease losses, see “Allowance for Loan and Lease        Losses” on page 25.

**Noninterest Income**

The following table is a summary of the Company’s noninterest income for the periods indicated (in thousands):

|                                                         |   |                                 |   |                                |   |     |   |     |   |   |   |   |   |
|--------------------------------------------------------------|--------|--------------------------------------|--------|-------------------------------------|--------|----------|--------|----------|--------|--------|--------|--------|--------|
|                                                         |   | **Three months ended September 30,** |   | **Nine months ended September 30,** |   |
| (In thousands)                                               |   | **2008**                             |   | **2007**                            |   | **2008** |   | **2007** |   |
|                                                         |   |                                 |   |                                |   |     |   |     |   |
|                                                         |   |                                 |   |                                |   |     |   |     |   |
| Service charges on deposit accounts                          |   | $                                    | 1,850  |                                | $      | 1,791    |   | $        | 5,460  |   | $      | 5,122  |   |
| Other fees and charges                                       |   |                                 | 1,003  |                                |   | 939      |   |     | 2,947  |   |   | 2,797  |   |
| Earnings on cash surrender value of life insurance policies  |   |                                 | 329    |                                |   | 333      |   |     | 971    |   |   | 942    |   |
| Gain on sale of loans                                        |   |                                 | 4      |                                |   | 34       |   |     | 99     |   |   | 131    |   |
| Loss on sales, calls and impariment of investment securities |   |                                 | (3,284 | )                                   |   | (1       | )      |     | (3,284 | )      |   | (36    | )      |
| Other                                                        |   |                                 | 382    |                                |   | 254      |   |     | 1,059  |   |   | 698    |   |
|                                                         |   |                                 |   |                                |   |     |   |     |   |   |   |   |   |
| Total noninterest income                                     |   | $                                    | 284    |                                | $      | 3,350    |   | $        | 7,252  |   | $      | 9,654  |   |
|                                                         |   |                                 |   |                                |   |     |   |     |   |   |   |   |   |

Noninterest income decreased $3,066,000 from $3,350,000 for the three months ended September 30, 2007 to $284,000 for the same period in 2008. During the third quarter of 2008, the Company recognized an impairment loss on its FNMA Preferred Stock of $3,284,000. The Company had purchased 100,000 shares of this security in June 2003 at par, $50.00 per share, and recognized an impairment charge in the fourth quarter of 2007 to its December 31, 2007 market        value of $32.84. Due to the United States Treasury and the Federal Housing Finance Agency (FHFA) decision to place Fannie Mae (FNMA) and Freddie Mac (FHLMC) under conservatorship on September 7, 2008, the Company concluded that these securities were further impaired and were written down by $3,284,000 to zero at September 30, 2008. This impairment was the primary reason for the decrease in noninterest income for the quarter ended September 30, 2008. Service charges on deposits increased        $59,000 from the three months ended September 30, 2007 compared to the same period in 2008, driven by growth in the number of demand accounts. Other fees and charges increased $64,000 to $1,003,000 for the three months ended September 30, 2008 compared to $939,000 for the same period in 2007. The Company recorded $4,000 in gains on sales of mortgages for the three months ended September 30, 2008 compared to $34,000 in gains on sales of mortgages for the same period in 2007. Other income        increased $128,000 to $382,000 for the three months ended September 30, 2008 from $254,000 for the same period in 2007 primarily due to a $114,000 gain on the sale of other real estate owned.

Noninterest income decreased $2,402,000 to $7,252,000 for the nine months ended September 30, 2008 from $9,654,000 for the same period in 2007, primarily due to the impairment charge discussed above. The remaining components of noninterest income were positive with service charges on deposit accounts increasing $338,000, other fees and charges increasing $150,000, and other noninterest income increasing $358,000, for the nine months ended September 30,        2008 compared to the same period in 2007.

20

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**Noninterest Expense**

The following table is a summary of the Company’s noninterest expense for the periods indicated (in thousands):

|                             |   |                                 |    |                                |   |     |   |     |   |   |   |   |   |
|----------------------------------|--------|--------------------------------------|---------|-------------------------------------|--------|----------|--------|----------|--------|--------|--------|--------|--------|
|                             |   | **Three months ended September 30,** |    | **Nine months ended September 30,** |   |
| (In thousands)                   |   | **2008**                             |    | **2007**                            |   | **2008** |   | **2007** |   |
|                             |   |                                 |    |                                |   |     |   |     |   |
|                             |   |                                 |    |                                |   |     |   |     |   |
| Salaries & employee benefits |   | $                                    | 5,213   |                                | $      | 5,306    |   | $        | 15,854 |   | $      | 16,340 |   |
| Occupancy expense                |   |                                 | 773     |                                |   | 773      |   |     | 2,247  |   |   | 2,296  |   |
| Data processing expenses         |   |                                 | 544     |                                |   | 552      |   |     | 1,651  |   |   | 1,674  |   |
| Equipment expense                |   |                                 | 485     |                                |   | 499      |   |     | 1,438  |   |   | 1,552  |   |
| Professional services            |   |                                 | 426     |                                |   | 161      |   |     | 1,025  |   |   | 971    |   |
| ATM expense                      |   |                                 | 275     |                                |   | 237      |   |     | 764    |   |   | 742    |   |
| Marketing                        |   |                                 | 199     |                                |   | 266      |   |     | 647    |   |   | 794    |   |
| Operations expense               |   |                                 | 182     |                                |   | 215      |   |     | 602    |   |   | 651    |   |
| Director                         |   |                                 | 148     |                                |   | 92       |   |     | 501    |   |   | 407    |   |
| Amortization of intangibles      |   |                                 | 37      |                                |   | 163      |   |     | 362    |   |   | 488    |   |
| Postage                          |   |                                 | 158     |                                |   | 141      |   |     | 461    |   |   | 395    |   |
| Printing & supplies          |   |                                 | 157     |                                |   | 143      |   |     | 503    |   |   | 531    |   |
| Merger expense                   |   |                                 | — |                                |   | 5        |   |     |   |   |   | 761    |   |
| Other                            |   |                                 | 1,097   |                                |   | 928      |   |     | 3,020  |   |   | 2,841  |   |
|                             |   |                                 |    |                                |   |     |   |     |   |   |   |   |   |
| Total noninterest expense        |   | $                                    | 9,694   |                                | $      | 9,481    |   | $        | 29,075 |   | $      | 30,443 |   |
|                             |   |                                 |    |                                |   |     |   |     |   |   |   |   |   |

Noninterest expense totaled $9,694,000 for the three months ended September 30, 2008, compared to $9,481,000 for the same period in 2007. This represents an increase of $213,000, or 2.3%, for the three months ended September 30, 2008 from the comparable period in 2007. Salaries and benefits decreased by $93,000 or 1.8% to $5,213,000 for the three months ended September 30, 2008 compared to $5,306,000 for the same period in 2007 due primarily to a        reduction in bonus accruals and a slight reduction in staffing. Professional services expense increased $265,000 for the three months ended September 30, 2008 compared to the same period in 2007. Professional services expense was greater for the three months ended September 30, 2008 compared to the same period a year ago which reflects that the amounts for the three months ended September 30, 2007 were lower for audit, legal and tax work due to the pending merger with Sterling Financial        Corporation which was later terminated. Most other expense categories for the three months ended September 30, 2008 experienced relatively small decreases or increases from the same respective period in 2007. The Company’s ratio of noninterest expense to average assets was 4.27% for the three months ended September 30, 2008 compared to from 4.16% for the same period in 2007. The Company’s efficiency ratio was 106.57% for the three months ended September 30, 2008 compared to        69.74% for the same period in 2007.

Noninterest expense totaled $29,075,000 for the nine months ended September 30, 2008, compared to $30,443,000 for the same period in 2007. This represents a decrease of $1,368,000, or 4.5%, for the nine months ended September 30, 2008 from the comparable period in 2007. This decrease is due primarily to merger related expenses associated with the terminated merger with Sterling Financial Corporation of $1,086,000 recognized for the nine months ended        September 30, 2007. Salaries and benefits decreased by $486,000 to $15,854,000 for the nine months ended September 30, 2008 compared to $16,340,000 for the same period in 2007 due primarily to a reduction in bonus accruals and a slight reduction in staffing. Most other expense categories for the nine months ended September 30, 2008 experienced relatively small changes from the same respective period in 2007. The Company’s ratio of noninterest expense to average assets was 4.19%        for the nine months ended September 30, 2008 compared to 4.53% for the same period in 2007. The Company’s efficiency ratio was 84.87% compared to 75.49% for the nine months ended September 30, 2008 and 2007, respectively.

**Income Taxes**

The Company recorded a benefit for income taxes for the quarter ended September 30, 2008 of $679,000, resulting in an effective tax benefit rate of 32.4%, compared to a provision for income taxes of $1,044,000, or an effective tax rate of 32.0%, for the quarter ended September 30, 2007. The benefit for income taxes for the nine month period ended September 30, 2008 was $1,266,000, resulting in an effective tax benefit rate of 32.4%, compared to a        provision for income taxes of $2,891,000, or an effective tax rate of 32.0%, for the same period in 2007.

**Financial Condition as of September 30, 2008 As Compared to December 31, 2007**

Total assets at September 30, 2008 decreased $64,843,000 to $884,176,000, compared to $949,019,000 at December 31, 2007. Loans and leases decreased $49,945,000, or 6.7%, to $696,308,000 at September 30, 2008 from $746,253,000 at December 31, 2007. Deposits increased $18,392,000, or 2.5%, from December 31, 2007 to $755,131,000 at September 30, 2008. Investment securities decreased $21,092,000 to $83,280,000 at September 30, 2008, compared to $104,372,000        at December 31, 2007. Other borrowed funds decreased $78,937,000 or 90.5% to $8,255,000 at September 30, 2008 compared to $87,192,000 at December 31, 2007.

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**Loan and Lease Portfolio**

Loans and leases, the Company’s major component of earning assets, decreased $49,945,000 during the first nine months of 2008 to $696,308,000 at September 30, 2008, from $746,253,000 at December 31, 2007. Commercial real estate loans and commercial loans increased by $19,887,000 and $1,771,000, respectively, during the first nine months of 2008, which was offset due to real estate construction loans decreasing by $76,939,000 over the same period.        Real estate – mortgage loans increased $9,411,000, while installment loans decreased $7,849,000 during the first nine months of 2008. Direct financing leases and other loans increased from December 31, 2007 by $3,641,000.

The Company’s average loan to deposit ratio was 95.3% for the quarter ended September 30, 2008 compared to 93.6% for the same period in 2007. The increase in the Company’s average loan to deposit ratio is driven by an increase in total average loans of $17,685,000 while total average deposits increased by $4,908,000.

|                                |   |                   |    |                  |   |    |   |
|-------------------------------------|--------|------------------------|---------|-----------------------|--------|---------|--------|
| (in thousands)                      |   | **September 30, 2008** |    | **December 31, 2007** |   |
|                                |   |                   |    |                  |   |
|                                |   |                   |    |                  |   |
| Commercial                          |   | $                      | 94,190  |                  | $      | 92,419  |   |
| Real estate - commercial            |   |                   | 317,159 |                  |   | 297,272 |   |
| Real estate - construction          |   |                   | 148,819 |                  |   | 225,758 |   |
| Real estate - mortgage              |   |                   | 59,542  |                  |   | 50,131  |   |
| Installment                         |   |                   | 33,312  |                  |   | 41,161  |   |
| Direct financing leases             |   |                   | 1,146   |                  |   | 1,307   |   |
| Other                               |   |                   | 43,100  |                  |   | 39,297  |   |
|                                |   |                   |    |                  |   |    |   |
|                                |   |                   |    |                  |   |    |   |
|                                |   |                   | 697,268 |                  |   | 747,345 |   |
|                                |   |                   |    |                  |   |    |   |
| Deferred loan fees, net             |   |                   | (960    | )                     |   | (1,092  | )      |
| Allowance for loan and lease losses |   |                   | (9,958  | )                     |   | (10,755 | )      |
|                                |   |                   |    |                  |   |    |   |
|                                |   | $                      | 686,350 |                  | $      | 735,498 |   |
|                                |   |                   |    |                  |   |    |   |

**Impaired, Nonaccrual, Past Due and Restructured Loans and Leases and Other Nonperforming Assets**

The Company considers a loan or lease impaired if, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans and leases is generally based on the present value of expected future cash flows discounted at the historical effective interest rate, except that all        collateral-dependent loans and leases are measured for impairment based on the fair value of the collateral.

At September 30, 2008, the recorded investment in loans and leases for which impairment had been recognized was approximately $20,136,000 compared to $3,359,000 at September 30, 2007 and $1,608,000 at December 31, 2007. Of the 2008 balance, there was a related valuation allowance of $792,000. If interest had been accrued on the nonperforming loans, such income would have approximated $507,000 and $1,563,000 for the three and nine months ended September        30, 2008, respectively, compared to $9,000 and $29,000 for the three and nine months ended September 30, 2007, respectively.

At December 31, 2007, the recorded investment in loans and leases for which impairment had been recognized was approximately $1,608,000. Of the 2007 balance, there was a related valuation allowance of $83,000. For the year ended December 31, 2007, the average recorded investment in loans and leases for which impairment had been recognized was approximately $1,572,000. During the portion of the year that the loans and leases were impaired, the Company        recognized interest income of approximately $38,000 for cash payments received in 2007.

Nonperforming loans (defined as nonaccrual loans and loans 90 days or more past due and still accruing interest) totaled $20,190,000 at September 30, 2008, an increase of $16,823,000 from the total at September 30, 2007 and an increase of $18,426,000 from December 31, 2007. Nonperforming loans as a percentage of total loans were 2.90% at September 30, 2008, compared to 0.47% at September 30, 2007, and 0.24% at December 31, 2007. Nonperforming assets        (nonperforming loans and OREO) totaled $26,042,000 at September 30, 2008, an increase of $21,773,000 from September 30, 2007, and an increase of $23,376,000 from December 31, 2007. Nonperforming assets as a percentage of total assets were 2.95% at September 30, 2008 compared to 0.46% at September 30, 2007, and 0.28% at December 31, 2007.

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The level of nonperforming loans decreased $2,390,000 to $20,190,000 at September 30, 2008 from $22,580,000 at June 30, 2008 primarily as a result of charging off the specific reserves set for certain of these credits of $4,316,000 and secondarily due to paydowns received on certain loans. Specific reserves have been recorded totaling $792,000 for nonperforming loans at September 30, 2008. Nonperforming assets decreased $4,746,000 to $26,042,000 at        September 30, 2008 from $30,788,000 at June 30, 2008. As discussed in the Company’s first quarter 2008 Form 10-Q, there were four real estate projects with loans totaling $24,047,000 which were the primary reason for the increase in nonperforming loans at March 31, 2008: two loans were for residential development projects for $9,509,000 and $6,750,000, respectively, and the other two were residential acquisition and development loans for $4,876,000 and $2,912,000, respectively.        Set forth below is a discussion and update on those four loans.

The larger of the two residential development project loans (for $9,509,000 at March 31, 2008) was included in our classified loans and risk-rated – Substandard at December 31, 2007 based on slower sales and a weakening real estate market. During the first quarter of 2008, the project’s absorption rates slowed from one sale per month to an estimated one sale per two to three months and the updated sales projections through March 31, 2008        raised a concern as to whether the borrower could continue to make the scheduled interest payments. Interest payments were current at December 31, 2007 (last payment for this loan was December 20, 2007). The Company met with the borrower in the first quarter of 2008 to discuss the status of the project and potential other sources of payments on the project and concluded the best strategy would be for the borrower to finish the houses under construction, have no new house starts and sell        the finished lots. To understand the potential loss exposure and properly value the collateral support provided by the property with the continuing decline in real estate values in California, a new appraisal was ordered on the project in February 2008. The Company received the appraisal on March 7, 2008 and the appraisal demonstrated the continuing decline in the value of the underlying project. Although interest payments were current at December 31, 2007, the Company’s        assessment that the borrower did not have the ability to continue to make the scheduled interest payments coupled with the decline in appraised value resulted in a decision to consider this loan as impaired, place the loan on nonaccrual and revaluate the level of specific reserve for the credit. This loan was placed on nonaccrual on March 25, 2008. As of September 30, 2008, this loan with a balance of $4,497,000 remains on nonaccrual. The decrease of $4,959,000 from its June 30, 2008        balance of $9,456,000 is a result of the collection of $2,246,000 from the borrower and the charge-off of the $2,713,000 specific reserve on this credit during the third quarter of 2008 to reduce the loan to its net realizable value.

The second of the two residential development project loans (for $6,750,000 at March 31, 2008) was included in our classified loans and risk-rated – Substandard at December 31, 2007 based on slower sales and a weakening real estate market. During the first quarter of 2008, the project’s absorption rates slowed and the updated sales projections through March 31, 2008 raised a concern as to whether the borrower could continue to make the        scheduled interest payments. Interest payments were current at December 31, 2007 (last payment for this loan was January 3, 2008). The Company met with the borrower in the first quarter of 2008 to discuss the status of the project and potential other sources of payments on the project and concluded the best strategy would be for the borrower to finish the houses under construction, have no new house starts and sell the finished lots. To understand the potential loss exposure and        properly value the collateral support provided by the properties with the continuing decline in real estate values in California, a new appraisal was ordered on the project in January 2008. The Company received the appraisal on February 25, 2008 and the appraisal demonstrated the continuing decline in the values of the underlying project. Although interest payments were current at December 31, 2007, the Company’s assessment that the borrower did not have the ability to continue to        make the scheduled interest payments coupled with the decline in appraised value resulted in a decision to consider this loan as impaired, place the loan on nonaccrual and revaluate the level of specific reserves for the credit. This loan was placed on nonaccrual on March 25, 2008. This loan was paid down by $1,703,000 to $5,047,000 during the second quarter of 2008, and on June 27, 2008 the Company negotiated a deed in lieu of foreclosure and took the property into OREO (21 finished        lots and 8 homes) at a carrying value of $3,263,000 which represented the fair value of the property less estimated costs to sell at the time of transfer. On transfer to OREO, the Company took a charge to the Allowance for Loan and Lease Losses (ALLL) of $2,012,000 to reflect the fair value of the OREO compared to the specific reserve at that time of $1,300,000. The charge-off taken was $712,000 greater than the reserve established as a result of the actual sales price of the lots being        less than the value established based on the February 25, 2008 appraisal. The Company sold the 21 lots for $1,372,000 on June 30, 2008, and the remaining 8 homes remained in OREO at a carrying value of $1,891,000. These 8 homes were sold during the third quarter of 2008 and the Company recognized a $114,000 gain on the sale.

23

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The larger of the two residential acquisition and development loans (for $4,876,000 at March 31, 2008) was risk-rated – Special Mention at December 31, 2007. Interest payments were current at December 31, 2007 (last payment was February 8, 2008). The Company met with the borrower during the first quarter of 2008 and concluded from the meeting that due to a lack of sales the borrower was not capable of making the scheduled interest payments and the        loan was placed on nonaccrual on March 31, 2008. The Company ordered a new appraisal on the property in May 2008 as part of the Company’s comprehensive review of its construction portfolio. The appraisal was received on May 23, 2008 and it demonstrated the continuing decline in the value of the underlying project. Although interest payments were current through February 2008, the Company’s assessment that the borrower did not have the ability to continue to make the        scheduled interest payments coupled with the decline in appraised value resulted in the decision to consider this loan as impaired, place the loan on nonaccrual and revaluate the level of the related specific reserve for the credit. The Company negotiated a deed in lieu of foreclosure with the borrower as a strategy to avoid the threat of bankruptcy and potentially create an extended workout period. The deed in lieu of foreclosure represented the best course of action for the Company as        we had spoken to interested buyers for the collateral and because we believed that having control of the asset improved our overall business position given the continuing decline in real estate values and the time requirements to work through a lengthy bankruptcy and foreclosure process. In negotiating the deed in lieu of foreclosure, the Company released certain existing collateral positions back to the borrower which resulted in a deficiency in the remaining available collateral        supporting this loan. Additionally, the Company obtained a new appraisal on May 23, 2008 for the 57 multi-family lots which indicated a further decline in value. At June 30, 2008, the Company took $5,414,000 of property into OREO consisting of 57 multi-family lots at a carrying value of $2,875,000 and 11 rental homes at a carrying value of $2,539,000 (the homes were from another loan that was cross-collateralized) and the Company took a charge against the allowance for loan and lease        losses on the transfer to OREO of $1,316,000. The Company did not have any specific reserves on this borrowing prior to the transfer. A portion of this property was sold at its carrying value during the third quarter of 2008 for $464,000, and the carrying value of the remaining OREO was $4,950,000 at September 30, 2008.

The second of the two residential acquisition and development loans (for $2,912,000 at March 31, 2008) was risk-rated – Substandard at December 31, 2007. The loan was 30 days past due at December 31, 2007 (last payment was November 21, 2007). The Company met with the borrower during the first quarter of 2008 and concluded from the meeting that due to a lack of sales the borrower was not capable of making the scheduled interest payments and the        loan was placed on nonaccrual on March 4, 2008. The Company ordered a new appraisal on the property in January 2008 as part of the Company’s comprehensive review of its construction portfolio. The appraisal was received on February 29, 2008 and it demonstrated the continuing decline in the value of the underlying project. The Company’s assessment that the borrower did not have the ability to continue to make the scheduled interest payments coupled with the decline in        appraised value resulted in the decision to consider this loan as impaired, place the loan on nonaccrual and revaluate the level of the related specific reserves for this credit. During the second quarter of 2008, the Company negotiated a deed in lieu of foreclosure and transferred the property into OREO at a carrying value of $1,996,000 which represented the fair value of the property less estimated costs to sell at the time of the transfer. Upon transfer the Company took a charge to        the allowance of $1,018,000, compared to the specific reserve established of $900,000. On June 30, 2008, the Company sold the OREO property for $1,996,000 with no additional gain or loss on the sale being recorded.

As discussed in the Company’s 2008 second quarter Form 10-Q for the period ended June 30, 2008, the total dollar amount of reductions in nonperforming loans from pay downs and the transfers to OREO during the second quarter of 2008 was $15,195,000. This decrease was offset by increases in certain other identified nonperforming loans totaling $12,025,000 added to nonperforming loans during the second quarter of 2008. The increase was primarily due        to the addition of two construction loans identified as impaired, totaling $10,201,000, in the second quarter of 2008. Set forth below is a discussion of those two loans.

The larger of the two loans (for $7,262,000 at June 30, 2008) is a mixed-use construction loan for a project located in Sonoma County and was risk-rated – Substandard at March 31, 2008. Interest payments were current at June 30, 2008 (last payment was June 13, 2008). The Company ordered a new appraisal on the property in April, 2008 as part of the Company’s comprehensive review of its construction portfolio. The appraisal was received on May        9, 2008 and it demonstrated the continuing decline in the value of the underlying project. When the Company received the updated appraisal showing the decline in collateral values on this loan, the Company met with the borrower, requiring the borrower to bring in additional cash to re-margin the loan and establish interest reserves. When the borrower was unable to comply with the requests, the Company determined that the loan was impaired, placed the loan on nonaccrual status, reversed        all accrued and unpaid interest and recorded a specific reserve of $750,000 representing the amount of the probable loss based on the estimated fair value of the underlying collateral, per the updated appraisal less estimated costs to sell. Although interest payments were current at June 30, 2008, the Company’s assessment that the borrower did not have the ability to continue to make the scheduled interest payments coupled with a decline in the recently appraised value resulted in        the decision to consider this loan as impaired and to place the loan on nonaccrual. As of September 30, 2008, this loan with a balance of $4,506,000 remains on nonaccrual. The decrease of $2,756,000 from the June 30, 2008 balance of $7,262,000 is a result of the collection of $2,256,000 from the borrower and the charge-off of $500,000 of the specific reserve. At September 30, 2008, this loan had a $250,000 specific reserve.

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The second of the two loans (for $2,939,000 at June 30, 2008) is a residential development project located in Placer County and was risk-rated – Substandard at March 31, 2008. Interest payments were current at June 30, 2008 (last payment was June 25, 2008). The Company ordered a new appraisal on the property in February, 2008 as part of the Company’s comprehensive review of its construction portfolio. The appraisal was received on March 26,        2008 and it demonstrated the continuing decline in the value of the underlying project. When the Company received the updated appraisal showing the decline in collateral values on this loan, the Company met with the borrower, requiring the borrower to bring in additional cash to re-margin the loan and establish interest reserves. When the borrower was unable to comply with the requests, the Company determined that the loan was impaired, placed the loan on nonaccrual status, reversed all        accrued and unpaid interest and recorded a specific reserve of $250,000 representing the amount of the probable loss based on the estimated fair value of the underlying collateral, per the updated appraisal less estimated costs to sell. Although interest payments were current at June 30, 2008, the Company’s assessment that the borrower did not have the ability to continue to make the scheduled interest payments coupled with a decline in the recently appraised value resulted in the        decision to consider this loan as impaired and to place the loan on nonaccrual. During the third quarter of 2008, the specific reserve for this loan was increased to $680,000 and it was charged-off to reduce the loan to its nets realizable value of $2,259,000 at September 30, 2008.

The total dollar amount of reductions in nonperforming loans during the third quarter of 2008 was $9,982,000 due primarily to the pay downs and charge-offs noted above. There were no transfers to OREO during the third quarter of 2008. This decrease was offset by the addition of 23 loans on nonaccrual status totaling $7,592,000 (which are primarily secured by real-estate) during the third quarter of 2008. The largest of this group is a $1,125,000        residential lot development loan located in Shasta County. This loan was risk-rated – Special Mention at June 30, 2008. The loan was 30 days past due at June 30, 2008 (last payment was May 14, 2008). During the second quarter of 2008, sales activity on the project had slowed, and to understand the potential loss exposure and properly value the collateral support provided by the property with the continuing decline in real estate values in California, the Company ordered a new        appraisal on the project in June, 2008. The appraisal was received on July 6, 2008 and it demonstrated the continuing decline in the value of the underlying project. When the Company received the updated appraisal showing the decline in collateral values on this loan, the Company met with the borrower, requiring the borrower to bring in additional cash to re-margin the loan and establish interest reserves. When the borrower was unable to comply with the requests, the Company determined        that the loan was impaired, placed the loan on nonaccrual status and reversed all accrued and unpaid interest. The Company has not recorded a specific reserve for this loan as it does not anticipate a loss based on the estimated fair value of the underlying collateral, per the updated appraisal less estimated costs to sell.

Gross loan and lease charge offs for the third quarter of 2008 were $5,305,000 and recoveries totaled $86,000 resulting in net charge offs of $5,219,000. This compares to net recoveries of $6,000 for the third quarter of 2007. Gross charge offs for the nine months ended September 30, 2008 were $10,081,000 and recoveries totaled $184,000 resulting in net charge offs of $9,897,000. This compares to net charge-offs of $79,000 for the nine months ended        September 30, 2007.

The Company continues to evaluate the loan and lease portfolio as part of a focused internal credit review process. As part of the ongoing evaluation, the Company has identified additional internal downgrades to certain credits subsequent to September 30, 2008. If these credits deteriorate further, the Company may have additional increases in nonperforming loans and it may require additional provisions for loan and lease losses.

Loans on which the accrual of interest has been discontinued are designated as nonaccrual loans. Accrual of interest on loans is discontinued either when reasonable doubt exists as to the full and timely collection of interest or principal, or when a loan becomes contractually past due by 90 days or more with respect to interest or principal (except that when management believes a loan is well secured and in the process of collection, interest accruals        are continued on loans deemed by management to be fully collectible). When a loan is placed on nonaccrual status, all interest previously accrued but not collected is reversed against current period interest income. Income on such loans is then recognized only to the extent that cash is received and where the future collection of principal is probable. Interest accruals are resumed on such loans when, in the judgment of management, the loans are estimated to be fully collectible as to        both principal and interest.

25

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Nonperforming assets at September 30, 2008, and December 31, 2007, are summarized as follows (in thousands):

|                                                           |   |                   |   |                  |   |   |   |
|----------------------------------------------------------------|--------|------------------------|--------|-----------------------|--------|--------|--------|
|                                                           |   | **September 30, 2008** |   | **December 31, 2007** |   |
|                                                           |   |                   |   |                  |   |
|                                                           |   |                   |   |                  |   |
| Nonaccrual loans and leases                                    |   | $                      | 20,136 |                  | $      | 1,608  |   |
| Loans and leases past due 90 days and accruing interest        |   |                   | 54     |                  |   | 156    |   |
| Other real estate owned                                        |   |                   | 5,852  |                  |   | 902    |   |
|                                                           |   |                   |   |                  |   |   |   |
| Total nonperforming assets                                     |   | $                      | 26,042 |                  | $      | 2,666  |   |
|                                                           |   |                   |   |                  |   |   |   |
|                                                           |   |                   |   |                  |   |   |   |
| Nonaccrual loans and leases to total gross loans and leases    |   |                   | 2.89   | %                     |   | 0.22   | %      |
| Nonperforming loans and leases to total gross loans and leases |   |                   | 2.90   | %                     |   | 0.24   | %      |
| Total nonperforming assets to total assets                     |   |                   | 2.95   | %                     |   | 0.28   | %      |

**Allowance for Loan and Lease Losses**

A summary of the allowance for loan and lease losses at September 30, 2008 and September 30, 2007 is as follows (in thousands):

|                                                          |   |                                |   |     |   |   |   |
|---------------------------------------------------------------|--------|-------------------------------------|--------|----------|--------|--------|--------|
|                                                          |   | **Nine months ended September 30,** |   |
|                                                          |   | **2008**                            |   | **2007** |   |
|                                                          |   |                                |   |     |   |
|                                                          |   |                                |   |     |   |   |   |
| Balance beginning of period                                   |   | $                                   | 10,755 |     | $      | 8,831  |   |
| Provision for loan and lease losses                           |   |                                | 9,100  |     |   | 850    |   |
| Net (charge-offs) recoveries                                  |   |                                | (9,897 | )        |   | (79    | )      |
|                                                          |   |                                |   |     |   |   |   |
| Balance end of period                                         |   | $                                   | 9,958  |     | $      | 9,602  |   |
|                                                          |   |                                |   |     |   |   |   |
|                                                          |
| Allowance for loan and lease losses to total loans and leases |   |                                | 1.43   | %        |   | 1.34   | %      |

The allowance for loan and lease losses is established through a provision for loan and lease losses based on management’s evaluation of the risks inherent in the loan and lease portfolio. In determining levels of risk, management considers a variety of factors, including, but not limited to, asset classifications, economic trends, industry experience and trends, geographic concentrations, estimated collateral values, historical loan and lease        loss experience, and the Company’s underwriting policies. The allowance for loan and lease losses is maintained at an amount management considers adequate to cover the probable losses in loans and leases receivable. While management uses the best information available to make these estimates, future adjustments to allowances may be necessary due to economic, operating, regulatory, and other conditions that may be beyond the Company’s control. The Company also engages a third        party credit review consultant to analyze the Company’s loan and lease loss adequacy. In addition, various regulatory agencies, as an integral part of their examination process, periodically reviews the Company’s allowance for loan and lease losses. Such agencies may require the Company to recognize additions to the allowance based on judgments different from those of management.

          The allowance for loan and lease losses is comprised of two primary types of allowances:

|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 1.     | Formula Allowance                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   |   | Formula allowances are based upon loan and lease loss factors that reflect management’s estimate of probable losses in various segments or pools within the loan and lease portfolio. The loss factor for each segment or pool is multiplied by the portfolio segment (e.g. multifamily permanent mortgages) balance to derive the formula allowance amount. The loss factors are updated periodically by the Company to reflect current information                    that has an effect on the amount of loss inherent in each segment.                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   |   | The formula allowance is adjusted for qualitative factors that are based upon management’s evaluation of conditions that are not directly measured in the determination of the formula and specific allowances. The evaluation of inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits or historical performance of loan and lease portfolio                    segments. The conditions evaluated to determine the adjustment to the formula allowance at September 30, 2008 included the following, which existed at the balance sheet date: |
|   |        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |

|   |     |                                                                                     |
|--------|----------|------------------------------------------------------------------------------------------|
|   | · | General business and economic conditions effecting the Company’s key lending areas |
|   |     |                                                                                     |
|   | · | Real estate values and market trends in Northern California                              |

26

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|   |     |                                                                                  |
|--------|----------|---------------------------------------------------------------------------------------|
|   | · | Loan volumes and concentrations, including trends in past due and nonperforming loans |
|   |     |                                                                                  |
|   | · | Seasoning of the loan portfolio                                                       |
|   |     |                                                                                  |
|   | · | Status of the current business cycle                                                  |
|   |     |                                                                                  |
|   | · | Specific industry or market conditions within portfolio segments                      |
|   |     |                                                                                  |
|   | · | Model imprecision                                                                     |

|   |   |                                                                                                                                                                                                                                                                                                                                                                                                           |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 2.     | Specific Allowance                                                                                                                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   | Specific allowances are established in cases where management has identified significant conditions or circumstances related to an individually impaired credit. In other words, these allowances are specific to the loss inherent in a particular loan. The amount for a specific allowance is calculated in accordance with SFAS No. 114, “*Accounting By Creditors For Impairment Of A Loan.”* |

The $9,958,000 in formula and specific allowances reflects management’s estimate of the inherent loss in various pools or segments in the portfolio and individual loans and leases, and includes adjustments for general economic conditions, trends in the portfolio and changes in the mix of the portfolio.

Management anticipates continued growth in commercial lending and commercial real estate and to a lesser extent consumer and real estate mortgage lending. As a result, future provisions will be required and the ratio of the allowance for loan and lease losses to loans and leases outstanding may increase to reflect portfolio risk, increasing concentrations, loan type and changes in economic conditions.

**Deposits**

Total deposits increased $18,392,000, or 2.50%, to $755,131,000 at September 30, 2008 compared to $736,739,000 at December 31, 2007. Time certificate deposits and interest-bearing demand deposits increased $25,555,000, or 10.6%, and $16,402,000, or 11.2%, respectively from December 31, 2007. These increases were partially offset by decreases in noninterest-bearing demand deposits and savings and money market deposits of $10,546,000, or 6.3%, and        $13,019,000, or 7.2%, respectively from December 31, 2007. During the first nine months of 2008, the Company continued to experience a shift in deposits from noninterest-bearing demand to interest-bearing demand and time certificates.

|                       |   |                   |    |                  |   |    |   |
|----------------------------|--------|------------------------|---------|-----------------------|--------|---------|--------|
| (in thousands)             |   | **September 30, 2008** |    | **December 31, 2007** |   |
|                       |   |                   |    |                  |   |
|                       |   |                   |    |                  |   |
| Noninterest-bearing demand |   | $                      | 157,069 |                  | $      | 167,615 |   |
| Interest-bearing demand    |   |                   | 163,458 |                  |   | 147,056 |   |
| Savings                    |   |                   | 168,173 |                  |   | 181,192 |   |
| Time certificates          |   |                   | 266,431 |                  |   | 240,876 |   |
|                       |   |                   |    |                  |   |    |   |
|                       |   |                   |    |                  |   |    |   |
| Total deposits             |   | $                      | 755,131 |                  | $      | 736,739 |   |
|                       |   |                   |    |                  |   |    |   |

As a result of the deposit increase (coupled with the reduction in loans outstanding and the pay downs on investment securities), the Company relied less on other borrowed funds which decreased $78,937,000, or 90.5%, to $8,255,000 at September 30, 2008 compared to $87,192,000 at December 31, 2007.

The Emergency Economic Stabilization Act of 2008 included a provision for an increase in the amount of deposits insured by the FDIC to $250,000. If not renewed, the additional FDIC insurance provision expires December 31, 2009. On October 14, 2008, the FDIC announced a new program -- the Temporary Liquidity Guarantee Program that provides unlimited deposit insurance on funds in noninterest-bearing transaction deposit accounts not otherwise covered by        the existing deposit insurance limit of $250,000. All eligible institutions will be covered under the program for the first 30 days without incurring any costs. After the initial period, participating institutions will be assessed a 10 basis point surcharge on the additional insured deposits.

**Liquidity**

The objective of liquidity management is to ensure the continuous availability of funds to meet the demands of depositors and borrowers. Collection of principal and interest on loans and leases, the liquidations and maturities of investment securities, deposits with other banks, customer deposits and short term borrowings, when needed, are primary sources of funds that contribute to liquidity. Unused lines of credit from correspondent banks to provide        federal funds of $24,515,000 as of September 30, 2008 were also available to provide liquidity. In addition, NVB is a member of the Federal Home Loan Bank (“FHLB”) providing additional unused borrowing capacity of $132,112,000 secured by certain loans and investment securities as of September 30, 2008. The Company also has a line of credit with the Federal Reserve Bank of San Francisco (“FRB”) of $1,618,000 secured by first deeds of trust on eligible commercial        real estate loans and leases. As of September 30, 2008, borrowings consisted of overnight advances of $8,255,000 with the FHLB and correspondent bank lines of credit, and $31,961,000 was outstanding in the form of subordinated debt issued by the Company.

27

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The Company manages both assets and liabilities by monitoring asset and liability mixes, volumes, maturities, yields and rates in order to preserve liquidity and earnings stability. Total liquid assets (cash and due from banks, federal funds sold and available for sale investment securities) totaled $109,219,000 and $132,910,000 (or 12.4% and 14.0% of total assets) at September 30, 2008 and December 31, 2007, respectively.

Core deposits, defined as demand deposits, interest bearing demand deposits, regular savings, money market deposit accounts and time deposits of less than $100,000, continue to provide a relatively stable and low cost source of funds. Core deposits totaled $635,857,000 and $632,236,000 at September 30, 2008 and December 31, 2007, respectively.

In assessing liquidity, historical information such as seasonal loan demand, local economic cycles and the economy in general are considered along with current ratios, management goals and unique characteristics of the Company. Management believes the Company is in compliance with its policies relating to liquidity.

**Interest Rate Sensitivity**

The Company constantly monitors earning asset and deposit levels, developments and trends in interest rates, liquidity, capital adequacy and marketplace opportunities. Management responds to all of these to protect and possibly enhance net interest income while managing risks within acceptable levels as set forth in the Company’s policies. In addition, alternative business plans and contemplated transactions are also analyzed for their impact.        This process, known as asset/liability management, is carried out by changing the maturities and relative proportions of the various types of loans, investments, deposits and other borrowings in the ways prescribed above.

The tool used to manage and analyze the interest rate sensitivity of a financial institution is known as a simulation model and is performed with specialized software built for this specific purpose for financial institutions. This model allows management to analyze three specific types of risks: market risk, mismatch risk, and basis risk.

***Market Risk***

Market risk results from the fact that the market values of assets or liabilities on which the interest rate is fixed will increase or decrease with changes in market interest rates. If the Company invests in a fixed-rate, long term security and then interest rates rise, the security is worth less than a comparable security just issued because the older security pays less interest than the newly issued security. If the security had to be sold before        maturity, then the Company would incur a loss on the sale. Conversely, if interest rates fall after a fixed-rate security is purchased, its value increases, because it is paying at a higher rate than newly issued securities. The fixed rate liabilities of the Company, like certificates of deposit and fixed-rate borrowings, also change in value with changes in interest rates. As rates drop, they become more valuable to the depositor and hence more costly to the Company. As rates rise,        they become more valuable to the Company. Therefore, while the value changes when rates move in either direction, the adverse impacts of market risk to the Company’s fixed-rate assets are due to rising rates and for the Company’s fixed-rate liabilities, they are due to falling rates. In general, the change in market value due to changes in interest rates is greater in financial instruments that have longer remaining maturities. Therefore, the exposure to market risk of        assets is lessened by managing the amount of fixed-rate assets and by keeping maturities relatively short. These steps, however, must be balanced against the need for adequate interest income because variable-rate and shorter-term assets generally yield less interest than longer-term or fixed-rate assets.

***Mismatch Risk***

The second interest-related risk, mismatch risk, arises from the fact that when interest rates change, the changes do not occur equally in the rates of interest earned and paid because of differences in the contractual terms of the assets and liabilities held. A difference in the contractual terms, a mismatch, can cause adverse impacts on net interest income.

The Company has a certain portion of its loan portfolio tied to the national prime rate. If these rates are lowered because of general market conditions, e.g., the prime rate decreases in response to a rate decrease by the Federal Reserve Open Market Committee (“FOMC”), these loans will be repriced. If the Company were at the same time to have a large proportion of its deposits in long-term fixed-rate certificates, interest earned on loans        would decline while interest paid on the certificates would remain at higher levels for a period of time until they mature. Therefore net interest income would decrease immediately. A decrease in net interest income could also occur with rising interest rates if the Company had a large portfolio of fixed-rate loans and securities that was funded by deposit accounts on which the rate is steadily rising.

28

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This exposure to mismatch risk is managed by attempting to match the maturities and repricing opportunities of assets and liabilities. This may be done by varying the terms and conditions of the products that are offered to depositors and borrowers. For example, if many depositors want shorter-term certificates while most borrowers are requesting longer-term fixed rate loans, the Company will adjust the interest rates on the certificates and loans to        try to match up demand for similar maturities. The Company can then partially fill in mismatches by purchasing securities or borrowing funds from the FHLB with the appropriate maturity or repricing characteristics.

***Basis Risk***

The third interest-related risk, basis risk, arises from the fact that interest rates rarely change in a parallel or equal manner. The interest rates associated with the various assets and liabilities differ in how often they change, the extent to which they change, and whether they change sooner or later than other interest rates. For example, while the repricing of a specific asset and a specific liability may occur at roughly the same time, the        interest rate on the liability may rise one percent in response to rising market rates while the asset increases only one-half percent. While the Company would appear to be evenly matched with respect to mismatch risk, it would suffer a decrease in net interest income. This exposure to basis risk is the type of interest risk least able to be managed, but is also the least dramatic. Avoiding concentration in only a few types of assets or liabilities is the best means of increasing the        chance that the average interest received and paid will move in tandem. The wider diversification means that many different rates, each with their own volatility characteristics, will come into play.

***Net Interest Income and Net Economic Value Simulations***

To quantify the extent of all of these risks both in its current position and in transactions it might make in the future, the Company uses computer modeling to simulate the impact of different interest rate scenarios on net interest income and on net economic value. Net economic value or the market value of portfolio equity is defined as the difference between the market value of financial assets and liabilities. These hypothetical scenarios include        both sudden and gradual interest rate changes, and interest rate changes in both directions. This modeling is the primary means the Company uses for interest rate risk management decisions.

The hypothetical impact of sudden interest rate shocks applied to the Company’s asset and liability balances are modeled quarterly. The results of this modeling indicate how much of the Company’s net interest income and net economic value are “at risk” (deviation from the base level) from various sudden rate changes. This exercise is valuable in identifying risk exposures. The results for the Company’s most recent        simulation analysis indicate that the Company’s net interest income at risk over a one-year period and net economic value at risk from 2% shocks are within normal expectations for sudden changes and do not materially differ from those of December 31, 2007.

For this simulation analysis, the Company has made certain assumptions about the duration of its non-maturity deposits that are important to determining net economic value at risk.

**Capital Resources**

The Company maintains capital to support future growth and dividend payouts while trying to effectively manage the capital on hand. From the depositor standpoint, a greater amount of capital on hand relative to total assets is generally viewed as positive. At the same time, from the standpoint of the shareholder, a greater amount of capital on hand may not be viewed as positive because it limits the Company’s ability to earn a high rate of return        on stockholders’ equity (ROE). Stockholders’ equity decreased to $76,734,000 as of September 30, 2008, as compared to $81,471,000 at December 31, 2007. The decrease was due to a net loss of $2,648,000, cash dividends paid out in the amount of $2,239,000 and an increase in unrealized loss on available for sale securities of $702,000, partially offset by the stock option exercises and stock based compensation of $852,000. Under current regulations, management believes that the        Company meets all capital adequacy requirements and North Valley Bank was considered well capitalized at September 30, 2008 and December 31, 2007.

29

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On October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 (the “EESA”). Pursuant to the EESA, the Secretary of the Treasury was authorized to establish the Troubled Asset Relief Program (“TARP”) and to invest in financial institutions and purchase mortgages, mortgage-backed securities and certain other financial instruments from financial institutions, in an aggregate amount up to $700        billion, for the purpose of stabilizing and providing liquidity to the U.S. financial markets. On October 14, 2008, the United States Department of the Treasury (the “UST”) announced a Capital Purchase Program (“CPP”) to invest up to $250 billion of this $700 billion amount in certain eligible U.S. banks, thrifts and their holding companies in the form of non-voting, senior preferred stock. Bank holding companies and banks eligible to participate as a Qualifying        Financial Institution (“QFI”) in the CPP will be expected to comply with certain standardized terms and conditions specified by the UST, including the following:

|   |     |                                                                                                                                                                                                                                                                       |
|--------|----------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | · | Submission of an application prior to November 14, 2008 to the QFI’s Federal banking regulator to obtain preliminary approval to participate in the CPP;                                                                                                             |
|   |     |                                                                                                                                                                                                                                                                       |
|   | · | If the QFI receives preliminary approval, it will have 30 days within which to submit final documentation and fulfill any outstanding requirements;                                                                                                                        |
|   |     |                                                                                                                                                                                                                                                                       |
|   | · | The minimum amount of capital eligible for purchase by the UST under the CPP is 1 percent of the Total Risk-Weighted Assets of the QFI and the maximum is the lesser of (i) an amount equal to 3 percent of the Total Risk-Weighted Assets of the QFI or (ii) $25 billion; |
|   |     |                                                                                                                                                                                                                                                                       |
|   | · | Capital acquired by a QFI under the CPP will be accorded Tier 1 capital treatment;                                                                                                                                                                                         |
|   |     |                                                                                                                                                                                                                                                                       |
|   | · | The preferred stock issued to the UST will be non-voting (except in the case of class votes) senior perpetual preferred stock that ranks senior to common stock and pari passu with existing preferred stock (except junior preferred stock);                              |
|   |     |                                                                                                                                                                                                                                                                       |
|   | · | In addition to the preferred stock, the UST will be issued warrants to acquire shares of the QFI’s common stock equal in value to 15 percent of the amount of capital purchased by the UST;                                                                          |
|   |     |                                                                                                                                                                                                                                                                       |
|   | · | Dividends on the preferred stock are payable to the UST at the rate of 5% per annum for the first 5 years and 9% per annum thereafter;                                                                                                                                     |
|   |     |                                                                                                                                                                                                                                                                       |
|   | · | Subject to certain exceptions and other requirements, no redemption of the preferred stock is permitted during the first 3 years;                                                                                                                                          |
|   |     |                                                                                                                                                                                                                                                                       |
|   | · | Certain restrictions on the payment of dividends to shareholders of the QFI shall remain in effect while the preferred stock purchased by the UST is outstanding;                                                                                                          |
|   |     |                                                                                                                                                                                                                                                                       |
|   | · | Any repurchase of QFI shares will require the consent of the UST, subject to certain exceptions;                                                                                                                                                                           |
|   |     |                                                                                                                                                                                                                                                                       |
|   | · | The preferred shares must not be subject to any contractual restrictions on transfer; and                                                                                                                                                                                  |
|   |     |                                                                                                                                                                                                                                                                       |
|   | · | The QFI must agree to be bound by certain executive compensation and corporate governance requirements and senior executive officers must agree to certain compensation restrictions.                                                                                      |

The Company is continuing to evaluate whether to participate in the CPP. Such determination will be made by the Company’s Board of Directors and will depend upon various factors including, without limitation, the requirements imposed upon the Company under the securities purchase agreement and related documentation that will be provided to a participating QFI and the evaluation of other factors including the summary factors listed        above.

30

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The Company’s and North Valley Bank’s capital amounts and risk-based capital ratios are presented below (in thousands).

|                                     |   |       |    |                                                 |                                  |                                                                                                       |                                 |                                  |   |                                 |   |   |   |   |   |   |   |   |   |
|------------------------------------------|--------|------------|---------|------------------------------------------------------|---------------------------------------|------------------------------------------------------------------------------------------------------------|--------------------------------------|---------------------------------------|--------|--------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
|                                     |   | **Actual** |    | **For Capital Adequacy                    Purposes** |                                  | **To be Well Capitalized                    Under Prompt Corrective                    Action Provisions** |                                 |
|                                     |   |       |    |
|                                     |   | **Amount** |    | **Ratio**                                            | **Minimum                    Amount** |                                                                                                       | **Minimum                    Ratio** | **Minimum                    Amount** |   | **Minimum                    Ratio** |
|                                     |   |       |    |
|                                     |   |       |    |                                                 |                                  |                                                                                                       |                                 |                                  |   |                                 |   |   |   |
| **Company**                              |   |       |    |                                                 |                                  |                                                                                                       |                                 |                                  |   |                                 |   |   |   |   |   |   |   |   |   |
| **As of September 30, 2008**             |   |       |    |                                                 |                                  |                                                                                                       |                                 |                                  |   |                                 |   |   |   |   |   |   |   |   |   |
| Total capital (to risk weighted assets)  |   | $          | 103,658 |                                                 |                                  | 12.54                                                                                                      | %                                    | $                                     | 66,130 |                                 |   | 8.00   | %      |   | N/A    |   |   | N/A    |   |
| Tier 1 capital (to risk weighted assets) |   | $          | 88,972  |                                                 |                                  | 10.77                                                                                                      | %                                    | $                                     | 33,044 |                                 |   | 4.00   | %      |   | N/A    |   |   | N/A    |   |
| Tier 1 capital (to average assets)       |   | $          | 88,972  |                                                 |                                  | 10.05                                                                                                      | %                                    | $                                     | 35,412 |                                 |   | 4.00   | %      |   | N/A    |   |   | N/A    |   |
|                                     |   |       |    |                                                 |                                  |                                                                                                       |                                 |                                  |   |                                 |   |   |   |   |   |   |   |   |   |
| **As of December 31, 2007**              |   |       |    |                                                 |                                  |                                                                                                       |                                 |                                  |   |                                 |   |   |   |   |   |   |   |   |   |
| Total capital (to risk weighted assets)  |   | $          | 108,098 |                                                 |                                  | 12.00                                                                                                      | %                                    | $                                     | 72,065 |                                 |   | 8.00   | %      |   | N/A    |   |   | N/A    |   |
| Tier 1 capital (to risk weighted assets) |   | $          | 93,954  |                                                 |                                  | 10.43                                                                                                      | %                                    | $                                     | 36,032 |                                 |   | 4.00   | %      |   | N/A    |   |   | N/A    |   |
| Tier 1 capital (to average assets)       |   | $          | 93,954  |                                                 |                                  | 10.29                                                                                                      | %                                    | $                                     | 36,522 |                                 |   | 4.00   | %      |   | N/A    |   |   | N/A    |   |
|                                     |   |       |    |                                                 |                                  |                                                                                                       |                                 |                                  |   |                                 |   |   |   |   |   |   |   |   |   |
| **North Valley Bank**                    |   |       |    |                                                 |                                  |                                                                                                       |                                 |                                  |   |                                 |   |   |   |   |   |   |   |   |   |
| **As of September 30, 2008**             |   |       |    |                                                 |                                  |                                                                                                       |                                 |                                  |   |                                 |   |   |   |   |   |   |   |   |   |
| Total capital (to risk weighted assets)  |   | $          | 103,310 |                                                 |                                  | 12.50                                                                                                      | %                                    | $                                     | 66,118 |                                 |   | 8.00   | %      | $      | 82,648 |   |   | 10.00  | %      |
| Tier 1 capital (to risk weighted assets) |   | $          | 93,351  |                                                 |                                  | 11.30                                                                                                      | %                                    | $                                     | 33,045 |                                 |   | 4.00   | %      | $      | 49,567 |   |   | 6.00   | %      |
| Tier 1 capital (to average assets)       |   | $          | 93,351  |                                                 |                                  | 10.57                                                                                                      | %                                    | $                                     | 35,327 |                                 |   | 4.00   | %      | $      | 44,158 |   |   | 5.00   | %      |
|                                     |   |       |    |                                                 |                                  |                                                                                                       |                                 |                                  |   |                                 |   |   |   |   |   |   |   |   |   |
| **As of December 31, 2007**              |   |       |    |                                                 |                                  |                                                                                                       |                                 |                                  |   |                                 |   |   |   |   |   |   |   |   |   |
| Total capital (to risk weighted assets)  |   | $          | 105,715 |                                                 |                                  | 11.73                                                                                                      | %                                    | $                                     | 72,099 |                                 |   | 8.00   | %      | $      | 90,124 |   |   | 10.00  | %      |
| Tier 1 capital (to risk weighted assets) |   | $          | 94,960  |                                                 |                                  | 10.54                                                                                                      | %                                    | $                                     | 36,038 |                                 |   | 4.00   | %      | $      | 54,057 |   |   | 6.00   | %      |
| Tier 1 capital (to average assets)       |   | $          | 94,960  |                                                 |                                  | 10.43                                                                                                      | %                                    | $                                     | 36,418 |                                 |   | 4.00   | %      | $      | 45,523 |   |   | 5.00   | %      |

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

In management’s opinion there has not been a material change in the Company’s market risk profile for the nine months ended September 30, 2008 compared to December 31, 2007. Please see discussion under the caption “Interest Rate Sensitivity” on page 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’s management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of September 30, 2008. Based on this evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective.

**Internal Control over Financial Reporting**

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. There was no change in the Company’s internal control over financial reporting that occurred during the quarter ended September 30, 2008 that has materially affected or is reasonable likely to materially affect, the Company’s internal control over financial reporting.

31

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**PART II - OTHER INFORMATION**

**ITEM 1. LEGAL PROCEEDINGS**

There are no material legal proceedings pending against the Company or against any of its property. The Company, because of the nature of its business, is generally subject to various legal actions, threatened or filed, which involve ordinary, routine litigation incidental to its business. Some of the pending cases seek punitive damages in addition to other relief. Although the amount of the ultimate exposure, if any, cannot be determined at this time,        the Company does not expect that the final outcome of threatened or filed suits will have a materially adverse effect on its consolidated financial position.

**ITEM 1a. RISK FACTORS**

There have been no material changes to the risk factors as previously disclosed by the Company in its response to Item 1A of Part I of its Form 10-K for the fiscal year ended December 31, 2007, other than with respect to the risk factor identified as *Real Estate Values*,which was supplemented by the Company in Item 1A of Part II of its Form 10-Q for the period ended June 30, 2008, and with respect to the additional risk factors set forth        below.

**The effects of legislation in response to current credit conditions may adversely affect the Company.**

Legislation passed at the federal level and/or by the State of California in response to current conditions affecting credit markets could cause the Company to experience higher credit losses if such legislation reduces the amount that borrowers are otherwise contractually required to pay under existing loan contracts with North Valley Bank. Such legislation could also result in the imposition of limitations upon North Valley Bank’s ability to        foreclose on property or other collateral or make foreclosure less economically feasible. Such events could result in increased loan losses and require a material increase in the allowance for loan losses and thereby adversely affect the Company’s results of operations, financial condition, future prospects, profitability and stock price.

**The effects of changes to FDIC insurance coverage limits are uncertain and increased premiums may adversely affect the Company.**

The FDIC charges insured financial institutions premiums to maintain the Deposit Insurance Fund. Current economic conditions have increased expectations for bank failures. In such event, the FDIC would take control of failed banks and guarantee payment of deposits up to applicable insured limits from the Deposit Insurance Fund. Insurance premium assessments to insured financial institutions may increase as necessary to maintain adequate funding of the        Deposit Insurance Fund.

The Emergency Economic Stabilization Act of 2008 included a provision for an increase in the amount of deposits insured by the FDIC to $250,000. On October 14, 2008, the FDIC announced the Temporary Liquidity Guarantee Program that provides unlimited deposit insurance on funds in noninterest-bearing transaction deposit accounts not otherwise covered by the existing deposit insurance limit of $250,000. All eligible institutions will be covered under the        program for the first 30 days without incurring any costs. After the initial period, participating institutions will be assessed a 10 basis point surcharge on the additional insured deposits through the scheduled end of the program, currently December 31, 2009. Increased premiums will impact the Company’s earnings.

It is not clear how depositors may respond regarding the increase in insurance coverage. Despite the increase, some depositors may reduce the amount of deposits held at North Valley Bank if concerns regarding bank failures persist, which could affect the level and composition of the Bank’s deposit portfolio and thereby directly impact the Bank’s funding costs and net interest margin. North Valley Bank’s funding costs may also be        adversely affected in the event that activities of the Federal Reserve Board and the U.S. Department of the Treasury to provide liquidity for the banking system and improvement in capital markets are curtailed or are unsuccessful. Such events could reduce liquidity in the markets, thereby increasing funding costs to the Bank or reducing the availability of funds to the Bank to finance its existing operations and thereby adversely affect the Company’s results of operations,        financial condition, future prospects, profitability and stock price.

**The Troubled Asset Relief Program includes restrictions that affect participating institutions and their shareholders.**

The Emergency Economic Stabilization Act of 2008 gave the United States Department of the Treasury authority to deploy up to $700 billion into the financial system with an objective of improving liquidity in capital markets. On October 14, 2008, the Treasury Department announced plans to direct $250 billion of this authority into a Capital Purchase Program (“CPP”) under which the Treasury Department will make preferred stock investments in        bank holding companies, banks and other qualifying financial institutions. The terms and conditions of the CPP could reduce investment returns to shareholders of participating bank holding companies and banks by restricting dividends to common shareholders, diluting existing shareholders’ interests, and restricting capital management practices. The Company is currently evaluating whether to participate in the CPP.

32

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**ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

None

**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     | Rule 13a-14(a) / 15d-14(a) Certifications |
|   |   |                                      |
|   | 32     | Section 1350 Certifications               |

33

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**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.

|                     |   |
|--------------------------|--------|
| **NORTH VALLEY BANCORP** |   |
| (Registrant)             |   |

Date:  November 10, 2008

|                                                             |   |
|------------------------------------------------------------------|--------|
| By:                                                              |   |
|                                                             |   |
| /s/ Michael J. Cushman                                           |   |
|                                                                  |   |
| Michael J. Cushman                                               |   |
| President & Chief Executive Officer                          |   |
| (Principal Executive Officer)                                    |   |
|                                                             |   |
| /s/ Kevin R. Watson                                              |   |
|                                                                  |   |
| Kevin R. Watson                                                  |   |
| Executive Vice President & Chief Financial Officer           |   |
| (Principal Financial Officer & Principal Accounting Officer) |   |

34

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