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 1934For the period ended March 31, 2010.o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934For 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

of incorporation or organization)

(IRS Employer ID Number)




300 Park Marina Circle, Redding, CA

96001(Address of principal executive offices)

(Zip code)




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




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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).


Yes o 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 oNon-accelerated filer x

Smaller reporting company o




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


Yes o No x




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




Common Stock – 7,495,817 shares as of May 14, 2010.










INDEX




NORTH VALLEY BANCORP AND SUBSIDIARIES




PagePART I. FINANCIAL INFORMATIONItem 1.
Financial Statements (Unaudited)
3Condensed Consolidated Balance Sheets—March 31, 2010 and December 31, 2009
3Condensed Consolidated Statement of Operations—For the three months ended March 31, 2010 and 2009
4Condensed Consolidated Statements of Cash Flows—For the three months ended March 31, 2010 and 2009
5Notes to Condensed Consolidated Financial Statements
6Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
15Item 3.
Quantitative and Qualitative Disclosures about Market Risk
29Item 4.
Controls and Procedures
29PART II. OTHER INFORMATIONItem 1.
Legal Proceedings
30Item 1A.
Risk Factors
30Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
30Item 3.
Defaults Upon Senior Securities
30Item 4.
Submission of Matters to a Vote of Security Holders
30Item 5.
Other Information
30Item 6.
Exhibits
30SIGNATURES
31




2




PART I. FINANCIAL INFORMATION


ITEM 1. FINANCIAL STATEMENTS




NORTH VALLEY BANCORP AND SUBSIDIARIES


CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)


(In thousands except share data)




March 31,2010


December 31,2009ASSETSCash and cash equivalents:Cash and due from banks

$
20,546


$
19,378Federal funds sold


75,865



48,250Total cash and cash equivalents


96,411



67,628Time deposits at other financial institutions


425



425Investment securities available for sale, at fair value


141,035



146,335Investment securities held to maturity, at amortized cost


8



9Loans and leases


580,929



602,417Less: Allowance for loan and lease losses


(17,708
)


(18,539
)Net loans and leases


563,221



583,878Premises and equipment, net


9,898



10,319Accrued interest receivable


2,450



2,565Other real estate owned


12,998



12,377FHLB and FRB stock and other securities


5,833



5,833Bank-owned life insurance policies


33,030



32,745Core deposit intangibles, net


656



692Other assets


21,421



21,556TOTAL ASSETS

$
887,386


$
884,362LIABILITIES AND STOCKHOLDERS’ EQUITYLIABILITIES:Deposits:Noninterest-bearing

$
148,171


$
152,421Interest-bearing


641,161



635,388Total deposits


789,332



787,809Subordinated debentures


31,961



31,961Accrued interest payable and other liabilities


13,409



12,290Total liabilities


834,702



832,060Commitments 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 at March 31, 2010 and December 31, 2009


41,829



41,781Retained earnings


11,266



11,578Accumulated other comprehensive loss, net of tax


(411
)


(1,057
)Total stockholders’ equity


52,684



52,302TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

$
887,386


$
884,362




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




3




NORTH VALLEY BANCORP AND SUBSIDIARIES


CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(Unaudited)


(In thousands except per share data)




For the three months ended March 31,2010


2009INTEREST INCOME:Interest and fees on loans and leases

$
8,616


$
10,536Interest on investments:Taxable interest income


1,049



694Nontaxable interest income


178



180Interest on federal funds sold and repurchase agreements


32



9Total interest income


9,875



11,419INTEREST EXPENSE:Deposits


2,019



2,768Subordinated debentures


514



542Other borrowings


—



1Total interest expense


2,533



3,311NET INTEREST INCOME


7,342



8,108PROVISION FOR CREDIT LOSSES


1,000



7,000NET INTEREST INCOME AFTER PROVISIONFOR CREDIT LOSSES


6,342



1,108NONINTEREST INCOME:Service charges on deposit accounts


1,481



1,528Other fees and charges


1,031



964Earnings on cash surrender value of life insurance policies


346



336Gain on sale of loans


49



97Loss on sale of other assets


(125
)


—Other


230



239Total noninterest income


3,012



3,164NONINTEREST EXPENSES:Salaries and employee benefits


4,287



5,064Occupancy expense


734



761Furniture and equipment expense


423



469FDIC and state assessments


706



411Professional services


692



327Other real estate owned expense


850



998Other


2,327



2,305Total noninterest expenses


10,019



10,335LOSS BEFORE BENEFIT FOR INCOME TAXES


(665
)


(6,063
)BENEFIT FOR INCOME TAXES


(353
)


(2,956
)NET LOSS

$
(312
)

$
(3,107
)Per Share AmountsBasic and Diluted Loss Per Share

$
(0.04
)

$
(0.41
)




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




4




NORTH VALLEY BANCORP AND SUBSIDIARIES


CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)


(In thousands except per share data)




For the three months ended March 31,2010


2009CASH FLOWS FROM OPERATING ACTIVITIES:Net Loss

$
(312
)

$
(3,107
)Adjustments to reconcile net loss to net cash provided by operating activities:Depreciation and amortization


443



478Amortization (accretion) of premium on securities, net


202



(17
)Amortization of core deposit intangible


36



36Provision for credit losses


1,000



7,000Net losses on sale and writedown of other real estate owned


794



890Gain on sale of loans


(49
)


(97
)Loss on sale of premises and equipment


125



—Stock-based compensation expense


48



74Effect of changes in:Accrued interest receivable


115



33Other assets


(599
)


(3,354
)Accrued interest payable and other liabilities


1,119



(1,739
)Net cash provided by operating activities


2,922



197CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of available for sale securities


—



(23,243
)Proceeds from maturities/calls of available for sale securities


6,193



3,275Proceeds from maturities/calls of held to maturity securities


1



6Net decrease in loans and leases


16,859



30,233Proceeds from sales of other real estate owned


1,432



3,768Proceeds from sales of premises and equipment


—



7Purchases of premises and equipment


(147
)


(258
)Net cash provided by  investing activities


24,338



13,788CASH FLOWS FROM FINANCING ACTIVITIES:Net increase in deposits


1,523



31,888Net change in other borrowed funds


—



(3,516
)Net cash  provided by financing activities


1,523



28,372NET INCREASE CASH AND CASH EQUIVALENTS


28,783



42,357CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR


67,628



27,153CASH AND CASH EQUIVALENTS, END OF YEAR

$
96,411


$
69,510Supplemental Disclosures of Cash Flow InformationCash paid during the year for:Interest

$
1,986


$
3,729Noncash investing and financing activities:Unrealized gain on available for sale investment securities, net of tax


1,095



1,185Transfer from loans to other real estate owned


2,847



193




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




5




NORTH VALLEY BANCORP AND SUBSIDIARIES
 NOTES 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, 2009, as amended. Operating results for the three months ended March 31, 2010 are not necessarily indicative of the results that may be expected for any subsequent period or for the year ended December 31, 2010.
  The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries North Valley Bank, a California banking corporation (“NVB”) and North Valley Trading Company, a California corporation, 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. On November 9, 2009, the Company elected to defer the payment of interest on the Company’s 10.25% Junior Subordinated Deferrable Interest Debentures Due 2031 (the “2031 Debentures”) issued to North Valley Capital Trust I in 2001; the Company’s Floating Rate Junior Subordinated Debt Securities Due 2033 (the “2033 Debentures”) issued to North Valley Capital Trust II in 2003; the Company’s Floating Rate Junior Subordinated Debt Securities Due 2034 (the “2034 Debentures”) issued to North Valley Capital Trust III in 2004; and the Company’s Junior Subordinated Debt Securities Due 2036 (the “2036 Debentures”) issued to North Valley Capital Statutory Trust IV in 2005. The 2031, 2033, 2034 and 2036 Debentures are administered under the terms and conditions of four separate Indentures and the Company gave notice of deferral to each Indenture Trustee on November 12, 2009.
  The Indentures provide generally that the payment of interest is deferrable, at the option of the Company, for up to 20 consecutive quarters (or 10 consecutive semi-annual periods). Nonpayment of interest for more than 20 consecutive quarters (or 10 semi-annual periods) is an event of default pursuant to which the payment of principal and interest may be accelerated by the Indenture Trustee.
  This deferral of interest is the first time that the Company has deferred payment of interest on the Debentures. The obligation to pay interest on the Debentures is cumulative and will continue to accrue, currently at a fixed rate of 10.25% on the 2031 Debentures, variable rate of 3.50% on the 2033 Debentures, variable rate of 3.05% on the 2034 Debentures and a fixed rate (until March 2011) of 6.16% on the 2036 Debentures. Interest is generally set at variable rates based on the three-month LIBOR, reset and payable quarterly, plus 3.25% for the 2033 Debentures, plus 2.80% for the 2034 Debentures and plus 1.33% for the 2036 Debentures. See page 14 regarding the amount of accrued interest payable on the Debentures at March 31, 2010.
  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.
 6
 
 NOTE B – INVESTMENT SECURITIES
  At March 31, 2010 and December 31, 2009, the amortized cost of securities and their approximate fair value were as follows (in thousands):
  Gross


Gross


EstimatedAmortized


Unrealized


Unrealized


FairCost


Gains


Losses


ValueMarch 31, 2010Available-for-Sale:Obligations of U.S. government agencies

$
11,504


$
64


$
(4
)

$
11,564Obligations of state and political subdivisions


15,444



504



(159
)


15,789Mortgage-backed securities


104,980



1,532



(78
)


106,434Corporate debt securities


6,000



—



(1,752
)


4,248Equity securities


3,000



—



—



3,000$
140,928


$
2,100


$
(1,993
)

$
141,035Held-to-Maturity:Mortgage-backed securities

$
8


$
—


$
—


$
8December 31, 2009Available-for-Sale:Obligations of U.S. government agencies

$
11,507


$
59


$
(95
)

$
11,471Obligations of state and political subdivisions


15,633



520



(164
)


15,989Mortgage-backed securities


111,182



961



(366
)


111,777Corporate debt securities


6,000



—



(1,902
)


4,098Equity securities


3,000



—



—



3,000$
147,322


$
1,540


$
(2,527
)

$
146,335Held-to-Maturity:Mortgage-backed securities

$
9


$
—


$
—


$
9
  For the three months ended March 31, 2010 and 2009 there were no gross realized gains on sales or calls of available for sale securities. For three months ended March 31, 2010 and 2009 there were no 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 three months ended March 31, 2010 and 2009. For the three months ended March 31, 2010 and 2009 there were $6,193,000 and $3,275,000 in gross proceeds from maturities or calls of available for sale securities. For the three months ended March 31, 2010 and 2009 there were $1,000 and $6,000 in gross proceeds from maturities or calls of held to maturity securities.
  At March 31, 2010 and December 31, 2009, securities having fair value amounts of approximately $130,101,000 and $134,594,000 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.
  At March 31, 2010, the Company held $26,205,000 of available for sale investment securities in an unrealized loss position of which $21,056,000 were in an unrealized loss position for less than twelve months and $5,149,000 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.
  7
  NOTE C – STOCK-BASED COMPENSATION
  Stock Option Plans
  At March 31, 2010, the Company had three shareholder approved stock-based compensation plans: 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. 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 1998 Employee Stock Incentive Plan there were outstanding options to purchase 409,040 shares of Common Stock at March 31, 2010. As provided in the 1998 Employee Stock Incentive Plan, the authorization to award incentive stock options terminated on February 19, 2008. As of March 31, 2010, there were options outstanding under the 1999 Director Stock Option Plan for the purchase of 90,000 shares of Common Stock. As provided in the 1999 Director Stock Option Plan, the authorization to award stock options terminated on April 1, 2009. As of March 31, 2010, there were options outstanding under the 2008 Stock Incentive Plan for the purchase of 269,925 shares of Common Stock. A total of 429,908 shares of Common Stock were available for the grant of additional options under the 2008 Stock Incentive Plan at March 31, 2010. Options for a total of 1,198,873 shares were authorized under all three plans at March 31, 2010.
  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 2008 Stock Incentive Plan consist of 699,833 shares of the Company’s Common Stock of which 269,925 shares were outstanding and 429,908 shares remained available for grant at March 31, 2010. 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. On July 29, 2009, the Board of Directors elected to forego their 900 share retainer grant for 2009. 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. Outstanding options under the plans are exercisable until their expiration.
  Stock Option Compensation
  There were no options granted in the three month period ended March 31, 2010. There were 19,500 options granted in the three month period ended March 31, 2009. The weighted average grant date fair value of options granted for the three month period ended March 31, 2009 was $1.50. For the three month periods ended March 31, 2010 and 2009, the compensation cost recognized for stock option compensation was $48,000 and $60,000, respectively. There was no Director stock grant expense for the three month period ended March 31, 2010. Director stock grant expense for the three month period ended March 31, 2009 was $14,000. There was no recognized tax benefit for stock option compensation expense for the three month period ended March 31, 2010 and 2009. At March 31, 2010, the total unrecognized compensation cost related to stock-based awards granted to employees under the Company’s stock option plans was $332,000. This cost will be amortized on a straight-line basis over a weighted average period of approximately 2.5 years and will be adjusted for subsequent changes in estimated forfeitures.
  8
 
 The fair value of each option is estimated on the date of grant with the following assumptions:
  Three months

ended March 31,

2009Average dividend yield


—Expected volatility


36.76
%Average risk-free interest rate


2.34
%Expected option life

7 yearsWeighted average grant date fair value

$
1.50
  Stock-Based Compensation
  Under the Company’s stock option plans as of March 31, 2010, 429,908 shares of the Company’s common stock are available for future grants to directors and employees of the Company. Under the Employee Stock Incentive 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. The vesting period is generally four years; however the vesting period can be modified at the discretion of the Company’s Board of Directors, and for all options granted in the fourth quarter in 2008 and first quarter 2009 the vesting period is five years. 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, 2010


768,965

$
10.16


6 years

$3.15-$24.75Granted


—


—




—Exercised


—


—




—Expired or Forfeited


—


—




—Outstanding at March 31, 2010


768,965

$
10.16


6 years

$3.15-$24.75

$
—Fully vested and exercisable at March 31, 2010


487,882

$
11.99


5 years

$3.15-$24.75

$
—Options expected to vest


281,083

$
6.99


8 years

$3.15-$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 March 31, 2010. There were no options exercised during the three months ended March 31, 2010 and 2009.
  NOTE D – COMPREHENSIVE INCOME (LOSS)
  Comprehensive income (loss) includes net loss and other comprehensive income. The Company’s only sources of other comprehensive income are unrealized gains on available for sale investment securities and adjustments to the minimum pension liability. The Company’s total comprehensive income (loss) was as follows (in thousands):
 
 Three months ended March 31,2010


2009Net loss

$
(312
)

$
(3,107
)Other comprehensive gain, net of tax:Holding gain arising during period


646



698Total comprehensive income (loss)

$
334


$
(2,409
)
  NOTE E – IMPAIRED AND NONPERFORMING LOANS AND LEASES AND OREO
  At March 31, 2010 and December 31, 2009, the recorded investment in impaired and nonperforming loans and leases (defined as nonaccrual loans and loans 90 days or more past due and still accruing interest) was approximately $45,875,000 and $46,598,000, respectively. The Company had $3,026,000 of specific allowance for loan losses on impaired loans of $10,488,000 at March 31, 2010 as compared to $3,043,000 of specific allowance for loan losses on impaired loans of $10,015,000 at December 31, 2009.
  9
  At March 31, 2010 and December 31, 2009, the recorded investment in other real estate owned (“OREO”) was approximately $12,998,000 and $12,377,000, respectively. For the three months ended March 31, 2010, the Company transferred property from eight loans in the amount of $2,847,000 to OREO, received $1,432,000 in proceeds on sales of OREO and recorded a $794,000 loss on the sale/writedown of OREO. The March 31, 2010 balance of OREO of $12,998,000 consists of 26 properties with the largest property representing $1,450,000 of the balance at March 31, 2010.
  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 are summarized as follows (in thousands):
  March 31, 2010


December 31, 2009Nonaccrual loans and leases

$
45,577


$
46,598Loans and leases past due 90 days and accruing interest


298



—Other real estate owned


12,998



12,377Total nonperforming assets

$
58,873


$
58,975Nonaccrual loans and leases to total gross loans and leases


7.85
%


7.74
%Nonperforming loans and leases to total gross loans and leases


7.90
%


7.74
%Total nonperforming assets to total assets


6.63
%


6.67
%
  Interest income forgone on nonaccrual loans or leases approximated $585,000 and $374,000 for the periods ended March 31, 2010 and 2009.
  At March 31, 2010, there were no commitments to lend additional funds to borrowers whose loans or leases were on nonaccrual status.
  NOTE F – LOSS PER SHARE
  Basic loss per share is computed by dividing net loss by the weighted average common shares outstanding for the period. Diluted loss per share reflects 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.
  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 $57,000 for each of the three month periods ended March 31, 2010 and 2009, respectively. Effective October 1, 2009, the Company entered into an agreement to “freeze” the vested benefits under the North Valley Bancorp Salary Continuation Plan (amended and restated effective January 1, 2007) with respect to each active officer currently participating in the Plan. Components of net periodic benefit cost for the Company’s supplemental nonqualified defined benefit plans for the three months ended March 31, 2010 and 2009 are presented in the following table (in thousands):
  Three months ended March 31,2010


2009Components of net periodic benefits cost:Service cost

$
—


$
135Interest cost


85



83Prior service amortization


8



8Recognized net actuarial loss


4



5Total components of net periodic cost

$
97


$
231
  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, results of its operations or its cash flows.
  10
  The Company was contingently liable under letters of credit issued on behalf of its customers in the amount of $4,530,000 and $5,241,000 at March 31, 2010 and December 31, 2009, respectively. At March 31, 2010, commercial and consumer lines of credit and real estate loans of approximately $52,811,000 and $47,990,000, respectively, were undisbursed. At December 31, 2009, commercial and consumer lines of credit and real estate loans of approximately $52,831,000 and $58,589,000, respectively, 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 March 31, 2010 and December 31, 2009. 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. At March 31, 2010, the Company had a reserve for unfunded commitments of $218,000.
  A large portion of the loan portfolio of the Company is collateralized by real estate. At March 31, 2010 and December 31, 2009, real estate served as the principal source of collateral with respect to approximately 78% of the Company’s loan portfolio. At March 31, 2010, real estate construction loans totaled $87,900,000, or 15% of the total loan portfolio, and commercial loans secured by real estate totaled $306,386,000, or 53% of the total loan portfolio. See the discussion under “Loan and Lease Portfolio” starting on page 23. A further 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, results of operations or its cash flows.
  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.
  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 operations. There have been no significant changes to unrecognized tax benefits or accrued interest and penalties for the three months ended March 31, 2010.
  The determination of the amount of deferred income tax assets which are more likely than not to be realized is primarily dependent on projections of future earnings, which are subject to uncertainty and estimates that may change given economic conditions and other factors. The realization of deferred income tax assets is assessed and a valuation allowance is recorded if it is “more likely than not” that all or a portion of the deferred tax asset will not be realized. “More likely than not” is defined as greater than a 50% chance. All available evidence, both positive and negative is considered to determine whether, based on the weight of that evidence, a valuation allowance is needed. Based upon management’s analysis of available evidence, it has determined that it is “more likely than not” that all of the Company’s deferred income tax assets as of March 31, 2010 and December 31, 2009 will be fully realized and therefore no valuation allowance was recorded.
  11
  NOTE J – FAIR VALUE MEASUREMENTS
  The Company groups its assets and liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:
  ●
Quoted prices in active markets for identical assets (Level 1): Inputs that are quoted unadjusted prices in active markets for identical assets that the Company has the ability to access at the measurement date. An active market for the asset is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
  ●
Significant other observable inputs (Level 2): Inputs that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the reporting entity including quoted prices for similar assets or liabilities, quoted prices for securities in inactive markets and inputs derived principally from, or corroborated by, observable market data by correlation or other means.
  ●
Significant unobservable inputs (Level 3): Inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.
  Assets Recorded at Fair Value on a Recurring Basis
  The table below presents assets measured at fair value on a recurring basis (in thousands).
  At March 31, 2010Fair Value


Level 1


Level 2


Level 3Available for sale securities

$
141,035


$
—


$
141,035


$
—At December 31, 2009Fair Value


Level 1


Level 2


Level 3Available for sale securities

$
146,335


$
—


$
146,335


$
—
  Assets Recorded at Fair Value on a Nonrecurring Basis
  The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from application of lower-of-cost-or-market accounting or writedowns of individual assets. For assets measured at fair value on a nonrecurring basis that were still held in the balance sheet at quarter end, the following table provides the level of valuation assumptions used to determine each adjustment and the carrying value of the related assets at quarter end (in thousands).
  Total LossesAt March 31, 2010


For the Three

Months EndedFair Value


Level 1


Level 2


Level 3


At March 31, 2010Impaired loans

$
21,548


$
—


$
11,270


$
10,278


$
1,617Other real estate owned

$
12,998



—



12,730



268



839Total assets measured at fair value on a nonrecurring basis

$
34,546


$
—


$
24,000


$
10,546


$
2,456
  Total LossesAt December 31, 2009


For the Twelve

Months EndedFair Value


Level 1


Level 2


Level 3


December 31, 2009Impaired loans

$
21,242


$
—


$
11,102


$
10,140


$
12,928Other real estate owned

$
12,377



—



11,987



390



1,518Total assets measured at fair value on a nonrecurring basis

$
33,619


$
—


$
23,089


$
10,530


$
14,446
  Impaired loans -Impaired loans, carried at fair value, which are measured for impairment using the fair value of the collateral for the collateral dependent loans, had a carrying amount of $21,548,000, with a specific reserve of $3,026,000.
  12
 
 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. Subsequent declines in fair value are written off as incurred through a valuation allowance.
  Disclosures about Fair Value of Financial Instruments
  The fair values presented represent the Company’s best estimate of fair value using the methodologies discussed below. The fair values of financial instruments which have a relatively short period of time between their origination and their expected realization were valued using historical cost. The values assigned do not necessarily represent amounts which ultimately may be realized. In addition, these values do not give effect to discounts to fair value which may occur when financial instruments are sold in larger quantities.
  The following assumptions were used as of March 31, 2010 and December 31, 2009 to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value.
  a)
Cash and Due From Banks - The carrying amount represents a reasonable estimate of fair value.
  b)
Federal Funds Sold - The carrying amount represents a reasonable estimate of fair value.
  c)
Time deposits at other financial institutions - The carrying amount represents a reasonable estimate of fair value due to the short-term nature of such deposits.
  d)
FHLB, FRB Stock and Other Securities - The carrying amount represents a reasonable estimate of fair value.
  e)
Investment Securities – The fair value of investment securities are based on quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Available for sale securities are carried at fair value.
  f)
Loans and Leases - Commercial loans, residential mortgages, construction loans and direct financing leases are segmented by fixed and adjustable rate interest terms, by maturity, and by performing and nonperforming categories.
  The fair value of performing loans and leases is estimated by discounting contractual cash flows using the current interest rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Assumptions regarding credit risk, cash flow, and discount rates are determined using available market information.
  The fair value of nonperforming loans and leases is estimated by discounting estimated future cash flows using current interest rates with an additional risk adjustment reflecting the individual characteristics of the loans, or using the fair value of underlying collateral for collateral dependent loans as a practical expedient.
  g)
Bank-owned Life Insurance - The carrying amount and estimated fair values are based on current cash surrender values at each reporting date provided by the insurers.
  h)
Mortgage servicing assets – The fair value of mortgage servicing assets is estimated using projected cash flows adjusted for the effects of anticipated prepayments, using a market discount rate.
  i)
Deposits – Noninterest-bearing and interest-bearing demand deposits and savings accounts are payable on demand and their carrying values are assumed to be at fair value. The fair value of the core deposit intangible has not been included as a component of the fair value estimate. The fair value of time deposits is based on the discounted value of contractual cash flows. The discount rate is based on rates currently offered for deposits of similar size and remaining maturities.
  j)
Other Borrowed Funds - The fair value of other borrowed funds is estimated by discounting the contractual cash flows using the current interest rate at which similar borrowings for the same remaining maturities could be made.
  13
  k)
Subordinated Debentures - The fair value of the subordinated debentures is estimated by discounting the contractual cash flows using the current interest rate at which similar securities with the same remaining expected life could be made.
  l)
Commitments to Fund Loans/Standby Letters of Credit - The fair values of commitments are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. The differences between the carrying value of commitments to fund loans or stand by letters of credit and their fair value are not significant and therefore not included in the following table.
  m)
Accrued Interest Receivable/Payable – The carrying amount of accrued interest receivable and accrued interest payable represents a reasonable estimate of fair value.
  The carrying amounts and estimated fair values of the Company’s financial instruments are as follows (in thousands):
  March 31, 2010


December 31, 2009Carrying


Fair


Carrying


FairAmount


Value


Amount


ValueFINANCIAL ASSETSCash and due from banks

$
20,546


$
20,546


$
19,378


$
19,378Federal funds sold


75,865



75,865



48,250



48,250Time deposits at other financial institutions


425



425



425



425FHLB, FRB and other securities


5,833



5,833



5,833



5,833Securities:Available for sale


141,035



141,035



146,335



146,335Held to maturity


8



8



9



9Loans and leases


563,221



573,506



583,878



593,278Bank owned life insurance


33,030



33,030



32,745



32,745Mortgage servicing assets


697



697



712



642Accrued interest receivable


2,450



2,450



2,565



2,565FINANCIAL LIABILITIESDeposits

$
789,332



791,386


$
787,809


$
790,803Other borrowed funds


—



—



—



—Subordinated debentures


31,961



18,452



31,961



22,005Accrued interest payable


1,647



1,647



1,100



1,100
  NOTE K – CAPITAL RAISE: ISSUANCE OF $40 MILLION IN PREFERRED STOCK
  On April 20, 2010, the Company entered into a Securities Purchase Agreement with a limited number of institutional and other accredited investors, including certain directors and executive officers of the Company (collectively, the “Purchasers”) to sell a total of 40,000 shares of Mandatorily Convertible Cumulative Perpetual Preferred Stock, Series A, without par value (the “Series A Preferred Stock”) at a price of $1,000 per share, for an aggregate gross purchase price of $40,000,000 (the “Private Placement”). The Private Placement closed on April 22, 2010, after the Company issued an aggregate of 40,000 shares of Series A Preferred Stock against receipt of $40,000,000 in cash, for net proceeds of $37.5 million after estimated costs of $2.5 million.
  The Series A Preferred Stock will automatically convert into a number of shares of the Company’s common stock after the Company has received shareholder approval of such conversion at the Annual Meeting of Shareholders scheduled to be held on or before July 30, 2010. The conversion ratio for each share of Series A Preferred Stock will be equal to the quotient obtained by dividing the Series A Preferred Stock share price by the conversion price. The initial conversion price is $1.50 per share and is subject to possible adjustments in the future under certain circumstances, including failure to obtain shareholder approval for the conversion by October 20, 2010, which would decrease the conversion price by 10%. The holders of the Series A Preferred Stock will be entitled to receive cumulative cash dividends which shall accrue and be payable at a per annum rate equal to 12%, payable semi-annually in arrears commencing on October 20, 2010; provided, however, if shareholder approval is obtained on or before October 20, 2010, then no accrued dividends shall be payable. If shareholder approval is not obtained on or before October 20, 2010, the interest rate will increase to 15% per annum for the six month period starting October 20, 2010, and if shareholder approval is still not obtained on or before the end of that six month period, the interest rate will increase to 20% per annum for the next following six month period (and for each six month period thereafter). The Series A Preferred Stock is not redeemable by the Company or by the holders and carries a liquidation preference of $1,000 per share, subject to certain adjustments. Complete details concerning the liquidation, redemption and other provisions of the Series A Preferred Stock are contained in the Certificate of Determination filed with the California Secretary of State on April 16, 2010.
  14
  In accordance with the Securities Purchase Agreement, the Company intends to call a meeting of the Company shareholders to vote on proposals to (a) approve an amendment of the Company’s Amended and Restated Articles of Incorporation, increasing the number of authorized shares of common stock from 20,000,000 to 60,000,000, and (b) approve the conversion of shares of Series A Preferred Stock into shares of common stock as required by NASDAQ Stock Market Rule 5635. The Board of Directors of the Company intends to unanimously recommend shareholder approval of these proposals and will promptly prepare and file a preliminary proxy statement with the Securities and Exchange Commission containing the Board’s recommendation. As mentioned above, certain directors and executive officers of the Company are among the Purchasers. Additional information regarding the interests of directors and executive officers participating in the Private Placement will be available in the proxy materials to be filed with the Securities and Exchange Commission and sent to the shareholders prior to the meeting.
  Also on April 20, 2010, pursuant to the Securities Purchase Agreement, the Company entered into a Registration Rights Agreement with each of the Purchasers. Pursuant to the Registration Rights Agreement, the Company has agreed to file a registration statement with the Securities and Exchange Commission to register for resale both the Series A Preferred Stock and the common stock to be issued upon conversion of the Series A Preferred Stock, within 30 calendar days after the closing of the Private Placement, and to use commercially reasonable efforts to cause such registration statement to be declared effective within 60 calendar days of closing (or 90 calendar days in the event of review by the Securities and Exchange Commission). Failure to meet these deadlines and certain other events may result in the Company’s payment of liquidated damages to the holders of the rights, monthly in the amount of 0.5% of the purchase price.
  The foregoing descriptions of the Securities Purchase Agreement, the Registration Rights Agreement and the Certificate of Determination do not purport to be complete and are qualified in their entirety by reference to the full text of the Securities Purchase Agreement, the Registration Rights Agreement and the Certificate of Determination which were filed with the Securities and Exchange Commission as exhibits to the Company’s Current Report on Form 8-K, filed on April 22, 2010.
  NOTE L - NEW ACCOUNTING PRONOUNCEMENTS
  In January 2010, the Financial Accounting Standards Board (the “FASB”) issued ASU 2010-06, Fair Value Measurements and Disclosures (“Topic 820”): Improving Disclosures about Fair Value Measurements (“ASU 10-06”). ASU 10-06 revised two disclosure requirements concerning fair value measurements and clarifies two others. It requires separate presentation of significant transfers into and out of Level 1 and 2 of the fair value hierarchy and disclosure of the reasons for such transfers. It will also require the presentation of purchases, sales, issuances and settlements within Level 3 on a gross basis rather than a net basis. The amendments also clarify that disclosures should be disaggregated by class of asset or liability and that disclosures about inputs and valuation techniques should be provided for both recurring and non-recurring fair value measurements. The Company’s disclosures about fair value measurements are presented in Note J, Fair Value Measurements. These new disclosure requirements were adopted by the Company during the current period, with the exception of the requirement concerning gross presentation of Level 3 activity, which is effective for fiscal years beginning after December 15, 2010. With respect to the portions of this ASU that were adopted during the current period, the adoption of this standard did not have a material impact on the Company’s financial position, results of operations, cash flows, or disclosures. Management does not believe that the adoption of the remaining portion of this ASU will have a material impact on the Company’s financial position, results of operation, cash flows, or disclosures.
  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; California state budget problems; the U.S. “war on terrorism” and military action by the U.S. in the Middle East, and changes in the securities markets.
  15
  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.
  Allowance for Credit Losses.The allowance for credit losses is based on the probable estimated losses in our loan and lease portfolio. The allowance is based on two basic principles of accounting: (1) The Contingencies Topic of the Financial Accounting Standards Board (FASB) Accounting Standards Codification requires that losses be accrued when they are probable of occurring and estimable; and (2) The Impairment Topic of the FASB Accounting Standards Codification requires that losses be accrued on impaired loans (as defined) based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.
  The allowance for credit losses is established through a provision for credit 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 credit losses is maintained at an amount management considers adequate to cover losses in loans and leases receivable which are considered probable and estimable. 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. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for credit losses. Such agencies may require the Company to recognize additions to the allowance based on judgments different from those of management.
  Other Real Estate Owned. Other Real Estate Owned (OREO) represents properties acquired through foreclosure or physical possession. Write-downs to fair value at the time of transfer to OREO are charged to allowance for loan losses. Subsequent to foreclosure, management periodically evaluates the value of OREO held for sale and records a valuation allowance for any subsequent declines in fair value less selling costs. Subsequent declines in value are charged to operations. Fair value is based on our assessment of information available to us at the end of a reporting period and depends upon a number of factors, including our historical experience, economic conditions, and issues specific to individual properties. Management’s evaluation of these factors involves subjective estimates and judgments that may change.
  Share Based Compensation. At March 31, 2010, the Company had three stock-based compensation plans: the 1998 Employee Stock Incentive Plan, the 1999 Director Stock Option Plan and the 2008 Stock Incentive Plan. Compensation cost is recognized on all share-based payments over the requisite service periods of the awards based on the grant-date fair value of the options determined using the Black-Scholes-Merton based option valuation model. Critical assumptions that are assessed in computing the fair value of share-based payments include stock price volatility, expected dividend rates, the risk free interest rate and the expected lives of such options. Compensation cost recorded is net of estimated forfeitures expected to occur prior to vesting. See Note C - Stock-Based Compensation - to the Unaudited Condensed Consolidated Financial Statements in Item 1 – Financial Statements on page 8 of this report.
  Goodwill.During the fourth quarter of 2009 the Company recorded a goodwill impairment charge of $15,187,000, reducing the balance of goodwill to zero. 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. The Company records impairment losses as charges to noninterest expense and adjustments to the carrying value of goodwill. Goodwill is tested at a reporting unit level annually and the Company engaged the assistance of an independent consulting firm since the end of 2008. The comparison of the fair value of the reporting unit to its carrying value and the decline in the Company’s stock price and market capitalization indicated that potential impairment existed. As a result of this analysis, the Company determined that impairment had occurred and recorded an impairment charge of $15,187,000, the entire amount of its goodwill.
  16
  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 Bank 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.
  Accounting for Income Taxes.The Company files its income taxes on a consolidated basis with its subsidiary. The allocation of income tax expense (benefit) represents each entity’s proportionate share of the consolidated provision for 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.
  Since January 1, 2007, the Company has accounted for uncertainty in income taxes by recording only tax positions that met the more likely than not recognition threshold, that the tax position would be sustained in a tax examination.
  When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. 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 taken are not offset or aggregated with other positions. 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.
  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 California state-chartered banking corporation, operates out of its main office located at 300 Park Marina Circle, Redding, CA 96001, with twenty-five commercial banking offices, including two supermarket branches and six Business Banking Centers. 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 10 percent of its revenues.
  17
  Operating Results
  (in thousands except per share amounts)

Three months ended March 31,2010


2009Net interest income

$
7,342


$
8,108Provision for credit losses


1,000



7,000Noninterest income


3,012



3,164Noninterest expense


10,019



10,335Benefit for income taxes


(353
)


(2,956
)Net loss

$
(312
)

$
(3,107
)Loss Per ShareBasic

$
(0.04
)

$
(0.41
)Diluted

$
(0.04
)

$
(0.41
)Annualized Loss on Average Assets


(0.14
%)


(1.43
%)Annualized Loss on Average Equity


(2.39
%)


(16.26
%)
  The Company had a net loss of $312,000, or $0.04 per diluted share, for the three months ended March 31, 2010 compared to a net loss of $3,107,000, or $0.41 per diluted share, for the three months ended March 31, 2009. The decrease in net loss for the three months ended March 31, 2010 compared to the same period in 2009 was principally driven by a reduction in provision for credit losses to $1,000,000 for the first three month period ended March 31, 2010 compared to $7,000,000 for the same period in 2009. Net interest income decreased $766,000 for the three months ended March 31, 2010 compared to the same period in 2009, and noninterest income decreased $152,000 for the three months ended March 31, 2010 compared to the same period in 2009 offset by a decrease in noninterest expense of $316,000 for the three months ended March 31, 2010.
  A written agreement was signed on January 6, 2010 among the Company, the Bank and the Federal Reserve Bank of San Francisco (the final written agreement, as executed by the parties, is herein called the “Written Agreement”). Among other things, the Written Agreement provides that the Company and the Bank shall submit to the Federal Reserve Bank of San Francisco their continuing plans to enhance lending and credit administration functions, to maintain policies and procedures for the maintenance of an adequate allocation for credit losses, to strengthen the management of commercial real estate concentrations and to update its capital plan in order to maintain capital ratios at or above the required minimums. The Written Agreement also restricts the payment of dividends and any payments on trust preferred securities, any reduction in capital or the purchase or redemption of stock without the prior approval of the Federal Reserve Bank of San Francisco. Progress reports detailing the form and manner of all actions taken to secure compliance with the Written Agreement must be submitted to the Federal Reserve Bank of San Francisco at least quarterly. This description of the Written Agreement is a summary and does not purport to be a complete description of all of the terms of such agreement and is qualified in its entirety by reference to the copy of the Written Agreement filed by the Company on Form 8-K on January 8, 2010. The Directors of the Company and the Bank have recognized and unanimously agree with the goal of financial soundness represented by the Written Agreement and have confirmed the intent of the Directors and senior management of the Company and the Bank to diligently seek to comply with all requirements (including timelines) specified in the Written Agreement. All plans, reports and other information required by the Written Agreement have been provided to the Federal Reserve Bank of San Francisco on a timely basis. Management believes the Bank is currently in substantial compliance with the terms of the Written Agreement.
  Net Interest Income and Net Interest Margin (fully taxable equivalent basis).
  Net interest income is the difference between interest earned on loans and investments and interest paid on deposits and borrowings, and is the primary revenue source for the Company. Net interest margin is net interest income expressed as a percentage of average earning assets. These items have been adjusted to give effect to $85,000 and $86,000 in taxable-equivalent interest income on tax-free investments for the periods ended March 31, 2010 and 2009, respectively.
  Net interest income for the three months ended March 31, 2010 was $7,427,000, a $767,000, or 9.4%, decrease from net interest income of $8,194,000 for the same period in 2009. Interest income decreased $1,545,000, or 13.4%, to $9,960,000 for the three month period ended March 31, 2010 due primarily to a decrease in average loans and leases. The Company also had $585,000 in foregone interest income for the loans placed on nonaccrual status during the three months ended March 31, 2010. The average loans outstanding decreased $89,327,000, or 13.1%, to $591,511,000. This lower loan volume decreased interest income by $1,402,000. The average yield earned on the loan portfolio decreased 37 basis points to 5.91% for the three months ended March 31, 2010. This decrease in yield reduced interest income by $518,000. The total decrease to interest income from the loan portfolio was $1,920,000. The average balance of the investment portfolio increased $60,850,000, or 68.2%, which accounted for a $581,000 increase in interest income and a decrease in average yield of the investment portfolio of 82 basis points reduced interest income by $229,000.
  18
 
 Interest expense for the three months ended March 31, 2010 decreased $778,000, or 23.5%, to $2,533,000 compared to the same period in 2009. The largest decrease to interest expense was in time deposit accounts which decreased $8,386,000 as the average rates paid on these accounts decreased 82 basis points to 2.28% and reduced interest expense by $561,000 while a decrease in the average balances of these accounts decreased interest expense by $65,000. The average rate paid on savings and money market accounts decreased 33 basis points to 0.73% for the three month period ended March 31, 2010 compared to 1.06% for the same period in 2009, resulting in a decrease to interest expense of $163,000. This decrease was offset partially by higher average balances in savings and money market accounts of $28,973,000, resulting in a $77,000 increase in interest expense.
  The net interest margin for the three months ended March 31, 2010 decreased 45 basis points to 3.78% from 4.23% for the same period in 2009 and a 10 basis point increase from the 3.68% net interest margin for the linked quarter ended December 31, 2009.
  19
  The following table sets forth the Company’s consolidated condensed average daily balances and the corresponding average yields received and average rates paid of each major category of assets, liabilities, and stockholders’ equity for the periods indicated:
  Schedule of Average Daily Balance and Average Yields and Rates(Dollars in thousands)Three months ended March 31, 2010


Three months ended March 31, 2009Average


Yield/


Interest


Average


Yield/


InterestBalance


Rate


Amount


Balance


Rate


AmountAssetsEarning assets:Federal funds sold

$
55,970



0.23
%

$
32


$
15,010



0.24
%

$
9Investment securities:Taxable


134,457



3.16
%


1,049



73,279



3.84
%


694Non-taxable (1)


15,570



6.85
%


263



15,898



6.79
%


266Total investments


150,027



3.55
%


1,312



89,177



4.37
%


960Loans and leases (2)(3)


591,511



5.91
%


8,616



680,838



6.28
%


10,536Total earning assets


797,508



5.06
%


9,960



785,025



5.94
%


11,505Non earning assets


97,037











104,785Allowance for loan andlease losses


(18,789
)










(11,434
)Total non-earning assets


78,248











93,351Total assets

$
875,756










$
878,376Liabilities and Shareholders’ EquityInterest bearing liabilities:Transaction accounts

$
157,314



0.27
%

$
104


$
153,395



0.37
%

$
141Savings and money market


196,775



0.73
%


354



167,802



1.06
%


440Time certificates


277,276



2.28
%


1,561



285,662



3.10
%


2,187Other borrowed funds


31,961



6.52
%


514



33,328



6.61
%


543Total interest bearingliabilities


663,326



1.55
%


2,533



640,187



2.10
%


3,311Demand deposits


146,988











149,582Other liabilities


12,561











11,106Total liabilities


822,875











800,875Shareholders’ equity


52,881











77,501Total liabilities andshareholders’ equity

$
875,756










$
878,376Net interest income









$
7,427










$
8,194Net interest spread






3.51
%










3.84
%Net interest margin






3.78
%










4.23
%
 (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 $51 and $237 for the three months ended March 31, 2010 and 2009, respectively.
 20
 
  The following table sets forth a summary of the changes in interest income and interest expense due to changes in average asset and liability balances (volume) and changes in average interest rates for the periods indicated. The change in interest due to both rate and volume has been allocated to the change in rate.
 
 Changes in Volume/Rate(Dollars in thousands)

Three months ended March 31, 2010compared withThree months ended March 31, 2009TotalAverage


Average


IncreaseVolume


Rate


(Decrease)Interest IncomeInterest on Federal funds sold

$
25


$
(2
)

$
23Interest on investments:


—



—Taxable securities


587



(232
)


355Nontaxable securities (1)


(6
)


3



(3
)Total investments


581



(229
)


352Interest on loans and leases


(1,402
)


(518
)


(1,920
)Total interest income


(796
)


(749
)


(1,545
)Interest ExpenseTransaction accounts


4


$
(41
)

$
(37
)Savings and money market


77



(163
)


(86
)Time deposits


(65
)


(561
)


(626
)Other borrowed funds


(23
)


(6
)


(29
)Total interest expense


(7
)


(771
)


(778
)Total change in net interest income

$
(789
)

$
22


$
(767
)
 
 (1) Taxable equivalent
  Provision for Credit Losses
  The provision for credit losses is comprised of two components, a provision for loans losses related to outstanding loans and a provision for losses related to unfunded commitments. The provision for credit losses reflects changes in the credit quality of the entire loan portfolio. The provision for credit losses is recorded to bring the allowance for loan losses and the reserve for unfunded commitments to amounts considered appropriate by management based on factors which are described in the “Allowance for Credit Losses” sections of this report on page 25.
  The Company recorded a provision for credit losses of $1,000,000 for the three months ended March 31, 2010, compared to a provision for credit losses of $7,000,000 for the three months ended March 31, 2009. 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 $1,000,000 provision for the three months ended March 31, 2010 reflects management’s assessment of the overall adequacy of the allowance for credit losses including the consideration of the level of 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 March 31, 2010 of $17,708,000, or 3.05% of total loans and leases, is adequate at this time. The allowance for loan and lease losses was $18,539,000, or 3.08% of total loans and leases, at December 31, 2009. For further information regarding our allowance for credit losses, see “Allowance for Credit Losses” on page 25.
  21
  Noninterest Income
  The following table is a summary of the Company’s noninterest income for the periods indicated (in thousands):
 
 Three months ended March 31,2010


2009Service charges on deposit accounts

$
1,481


$
1,528Other fees and charges


1,031



964Increase in cash value of life insurance


346



336Gain on sale of loans


49



97Loss on sale other assets


(124
)


—Other


229



239Total

$
3,012


$
3,164
  Noninterest income decreased $152,000 to $3,012,000 for the three months ended March 31, 2010 from $3,164,000 for the three months ended March 31, 2009. Service charges on deposits decreased slightly by $47,000 to $1,481,000 for the three months ended March 31, 2010 compared to $1,528,000 for the same period in 2009 while other fees and charges increased by $67,000 to $1,031,000 for the three months ended March 31, 2010 compared to $964,000 for the same period in 2009. The Company recorded $49,000 in gains on sales of mortgages for the three months ended March 31, 2010 compared to $97,000 in gains on sales of mortgages for the same period in 2009. The loss on sale of other assets is primarily due to the closure of the Fairfield office.
  Noninterest Expense
  The following table is a summary of the Company’s noninterest expense for the periods indicated (in thousands):
  Three months ended March 31,2010


2009Salaries and benefits

$
4,287


$
5,064Other real estate owned expense


850



998Occupancy


734



761FDIC and state assessments


706



411Professional services


692



327Data processing


521



581Furniture and equipment


423



469ATM and online banking


259



285Marketing


168



121Postage


150



164Messenger


143



84Operations expense


132



143Loan expense


120



85Director


105



132Printing and supplies


104



137Amortization of intangibles


36



36Other


589



537$
10,019


$
10,335
  Noninterest expense totaled $10,019,000 for the three months ended March 31, 2010, compared to $10,335,000 for the same period in 2009. This represents a decrease of $316,000, or 3.1%, for the three months ended March 31, 2010 from the comparable period in 2009. Salaries and benefits decreased by $777,000 to $4,287,000 for the three months ended March 31, 2010 compared to $5,064,000 for the same period in 2009 as a result of a reduction in salary and benefit expense, lower commission expense, lower expenses from stock incentive plans and pension cost, along with eliminated contributions to North Valley Bancorp’s 401K Plan. Offsetting this decrease was the Company’s FDIC and state assessments which increased $295,000 to $706,000 for the three months ended March 31, 2010 compared to $411,000 for the same period in 2009. This increase is expected to continue as the FDIC is expected to increase or accelerate the timing of assessments and the Company has elevated levels of nonperforming loans which impact the factors used in the calculation. Professional services increased by $365,000 to $692,000 for the three months ended March 31, 2010 compared to $327,000 for the same period in 2009 as a result of an external loan review, and legal and consulting expenses. Noninterest expense experienced a decrease in the recording of loss on sale, writedowns and expenses of OREO of $148,000 to $850,000 for the three months ended March 31, 2010 compared to $998,000 for the same period in 2009. Most other expense categories for the three months ended March 31, 2010 experienced relatively small changes from the same respective period in 2009. The Company’s ratio of noninterest expense to average assets was 4.58% for the three months ended March 31, 2010 compared to 4.71% for the same period in 2009. The Company’s efficiency ratio was 96.76% and 91.69% for the three months ended March 31, 2010 and 2009, respectively.
  22
  Income Taxes
  The Company recorded a benefit for income taxes for the quarter ended March 31, 2010 of $353,000, resulting in an effective tax rate of 53.1%, compared to a benefit for income taxes of $2,956,000, or an effective tax benefit rate of 48.8%, for the quarter ended March 31, 2009. The difference in the effective tax rate compared to the statutory tax rate (approximately 42.05%) is primarily the result of the Company’s investment in municipal securities and Company-owned life insurance policies whose income is exempt from Federal taxes. In addition, the Company receives certain tax benefits from the State of California Franchise Tax Board for operating and providing loans, as well as jobs, in designated ‘Enterprise Zones’.
  As of March 31, 2010 the Company had recorded net deferred income tax assets (which are included in other assets in the accompanying condensed consolidated balance sheets) of approximately $11,471,000. The determination of the amount of deferred income tax assets which are more likely than not to be realized is primarily dependent on projections of future earnings, which are subject to uncertainty and estimates that may change given economic conditions and other factors. The realization of deferred income tax assets is assessed and a valuation allowance is recorded if it is “more likely than not” that all or a portion of the deferred tax asset will not be realized. “More likely than not” is defined as greater than a 50% chance. All available evidence, both positive and negative is considered to determine whether, based on the weight of that evidence, a valuation allowance is needed. Based upon management’s analysis of available evidence, it has determined that it is “more likely than not” that all of the Company’s deferred income tax assets as of March 31, 2010 will be fully realized and therefore no valuation allowance was recorded.
  Financial Condition as of March 31, 2010 As Compared to December 31, 2009
  Total assets at March 31, 2010 increased $3,024,000, or 0.3%, to $887,386,000, compared to $884,362,000 at December 31, 2009. Loans and leases decreased $21,488,000, or 3.6%, to $580,929,000 at March 31, 2010 from $602,417,000 at December 31, 2009. Deposits increased $1,523,000, or 0.2%, from December 31, 2009 to $789,332,000 at March 31, 2010. Investment securities decreased $5,301,000, or 3.6%, to $141,043,000 at March 31, 2010 from $146,344,000 at December 31, 2009, and Federal funds sold increased to $75,865,000 at March 31, 2010 from $48,250,000 at December 31, 2009. The increase in Federal funds sold was due to a decrease in investment securities and a decrease in loans and leases for the first three months of 2010.
  Loan and Lease Portfolio
  Loans and leases, the Company’s major component of earning assets, decreased $21,488,000 during the first three months of 2010 to $580,929,000 at March 31, 2010 from $602,417,000 at December 31, 2009. Real estate construction loans decreased by $4,211,000, real estate commercial loans decreased by $7,531,000 and commercial loans decreased by $7,769,000, while the remaining loan categories remained relatively unchanged from their December 31, 2009 balances.
  The Company’s average loan to deposit ratio was 76.0% for the quarter ended March 31, 2010 compared to 90.0% for the same period in 2009. The decrease in the Company’s average loan to deposit ratio is driven by both the decrease in total average loans of $89,327,000 and the increase in total average deposits of $21,912,000.
  (in thousands)

March 31,2010


December 31,2009Commercial

$
58,744


$
66,513Real estate - commercial


306,386



313,917Real estate - construction


87,900



92,111Real estate - mortgage


58,088



59,816Installment


20,474



22,289Direct financing leases


784



813Other


49,246



47,665581,622



603,124Deferred loan fees, net


(693
)


(707
)Allowance for loan and lease losses


(17,708
)


(18,539
)$
563,221


$
583,878
  
 23
 
 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.
  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.
  At March 31, 2010 and December 31, 2009, the recorded investment in nonperforming loans and leases (defined as nonaccrual loans and loans 90 days or more past due and still accruing interest) was approximately $45,875,000 and $46,598,000, respectively. The Company had $3,026,000 of specific allowance for loan losses on impaired loans of $10,488,000 at March 31, 2010 as compared to $3,043,000 of specific allowance for loan losses on impaired loans of $10,015,000 at December 31, 2009. Nonperforming loans as a percentage of total loans were 7.90% at March 31, 2010, compared to 7.74% at December 31, 2009. Nonperforming assets (nonperforming loans and OREO) totaled $58,873,000 at March 31, 2010, a decrease of $102,000 from December 31, 2009. Nonperforming assets as a percentage of total assets were 6.63% at March 31, 2010 compared to 6.67% at December 31, 2009. If interest on nonaccrual loans and leases had been accrued, such income would have approximated $585,000 and $374,000 for the three months ended March 31, 2010 and 2009, respectively.
  During the first quarter of 2010, the Company identified fifteen loans totaling $5,560,000 as nonaccrual loans. The addition was centered in three loans totaling $2,920,000. The largest loan of this group is a commercial real estate loan in the amount of $1,069,000 for a multi-tenant mixed-use property located in Shasta County. The Company has completed an internal evaluation of the property and established a specific reserve of $372,000. The second relationship in this group is a commercial real estate loan in the amount of $967,000 for an owner occupied multi-tenant building loan located in Sacramento County. The Company has completed an internal evaluation of the property and established a specific reserve of $287,000. The third loan in this group is an SBA 504 loan for a single-tenant office building in the amount of $884,000 located in Sacramento County. The Company has completed an internal evaluation of the property and no specific reserve has been established for this loan. The remaining twelve loans in this group that were placed on nonaccrual during the first quarter of 2010 total $2,640,000 and specific reserves totaling $495,000 have been established.
  Nonperforming assets at March 31, 2010 and December 31, 2009, are summarized as follows (in thousands):
 
 March 31,2010


December 31,2009Nonaccrual loans and leases

$
45,577


$
46,598Loans and leases past due 90 days and accruing interest


298



-Other real estate owned


12,998



12,377Total nonperforming assets

$
58,873


$
58,975Nonaccrual loans and leases to total gross loans and leases


7.85
%


7.74
%Nonperforming loans and leases to total gross loans and leases


7.90
%


7.74
%Total nonperforming assets to total assets


6.63
%


6.67
%
  24
  The composition of nonaccrual loans and leases as of March 31, 2010, December 31, 2009, September 30, 2009, June 30, 2009 and March 31, 2009 was as follows (in thousands):
  March


% of


December


% of


September


% of


June


% of


March


% of2010


total


2009


total


2009


total


2009


total


2009


totalCommercial

$
538


1.2
%

$
215


0.5
%

$
1,079


2.0
%

$
4,097


9.2
%

$
60


0.3
%Real estate - commercial


14,485


31.8
%


13,825


29.7
%


12,729


23.4
%


11,024


24.9
%


7,915


39.7
%Real estate - construction


27,229


59.7
%


29,042


62.3
%


37,483


68.8
%


26,785


60.5
%


9,492


47.6
%Real estate - mortgage


3,082


6.8
%


2,980


6.4
%


2,927


5.4
%


2,131


4.8
%


2,206


11.1
%Installment


39


0.1
%


34


0.1
%


40


0.1
%


45


0.1
%


49


0.2
%Direct financing leases


—


0.0
%


—


0.0
%


—


0.0
%


—


0.0
%


—


0.0
%Other


204


0.4
%


502


1.1
%


204


0.4
%


222


0.5
%


204


1.0
%Total nonaccrual loans

$
45,577


100.0
%

$
46,598


100.0
%

$
54,462


100.0
%

$
44,304


100.0
%

$
19,926


100.0
%
 At March 31, 2010, nonaccrual real-estate-construction loans totaled $27,229,000, or 59.7%, of the nonaccrual loans and leases. There are twenty loans that make up the balance. Charge-offs of $8,038,000 have been taken on these loans and specific reserves of $1,644,000 have been established for these loans at March 31, 2010. Eleven of these loans are residential land loans totaling $17,762,000. There are seven loans for nonaccrual residential construction development projects totaling $8,604,000. Charge-offs of $1,933,000 have been taken on these loans and specific reserves of $1,385,000 have been established for these loans at March 31, 2010. The remaining two nonaccrual real estate-construction loans are commercial land loans totaling $863,000. There have been no charge-offs on either of these loans and no specific reserve has been established.
  At March 31, 2010, there were eighteen nonaccrual real-estate-commercial loans totaling $14,485,000, or 31.8%, of the nonaccrual loans and leases. Four of these loans exceed a million dollars. The largest real estate-commercial loan is for multi-tenant light industrial buildings located in Shasta County for $1,980,000. No specific reserve has been established for this loan. The second largest real estate-commercial loan is for a single-tenant office building located in Sacramento County for $1,907,000. The Company has recorded a charge-off of $972,000 on this loan and no specific reserve has been established for this loan. The third largest real estate-commercial loan is for multi-tenant buildings in Sonoma County for $1,701,000. The Company has recorded a charge-off of $613,000 on this loan and no specific reserve has been established for this loan. The fourth largest real estate-commercial loan is for a multi-tenant mixed-use property located in Shasta County for $1,069,000 (discussed above). A specific reserve of $372,000 has been established for this loan. The remaining fifteen real estate-commercial loans total $7,828,000 (approximate average loan of $522,000). Charge-offs of $429,000 have been taken on these loans and specific reserves of $565,000 have been established for these loans at March 31, 2010.
  At March 31, 2010 there were no commitments to lend additional funds to borrowers whose loans or leases were classified as nonaccrual.
  At March 31, 2010, net carrying value of other real estate owned increased $621,000 to $12,998,000 from $12,377,000 at December 31, 2009. During the three months ended March 31, 2010, the Company transferred eight properties into OREO totaling $2,847,000, sold five properties totaling $1,432,000, had write-downs of OREO of $538,000, and recorded loss on sale of OREO of $256,000. At March 31, 2010, OREO was comprised of twenty-six properties which are broken down by type: residential construction of $5,219,000, residential land of $1,357,000, commercial land of $1,378,000, non-farm non-residential properties of $4,069,000 and residential properties of $975,000.
  Allowance for Credit Losses
  A summary of the allowance for credit losses at March 31, 2010 and March 30, 2009 is as follows (in thousands):
  Three months ended March 31,2010


2009Balance, beginning of period

$
18,539


$
11,327Provision for credit losses


1,000



7,000Loan charge-offs


(1,795
)


(2,635
)Loan recoveries


182



195Net loan charge-offs


(1,613
)


(2,440
)Total allowance for credit losses, end of period

$
17,926


$
15,887Components of allowance for credit lossesAllowance for loan and lease losses

$
17,708


$
15,887Reserve for unfunded commitments


218



—Total allowance for credit losses

$
17,926


$
15,887
  25
  The allowance for credit losses is established through a provision for credit 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 credit 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 each calendar quarter. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for credit losses. Such agencies may require the Company to recognize additions to the allowance based on judgments different from those of management.
  The allowance for credit losses is comprised of two components: the allowance for loan losses, which is the sum of the specific, formula and unallocated allowance relating to loans in the loan portfolio, and the reserve for unfunded commitments. The reserve for unfunded commitments is included within accrued interest and other liabilities on the consolidated balance sheet. Our methodology for determining the allowance for credit losses consists of several key elements, which include:
  ●
Specific Allowances. A specific allowance is established when management has identified unique or particular risks that were related to a specific loan that demonstrated risk characteristics consistent with impairment. Specific allowances are established when management can estimate the amount of an impairment of a loan.●
Formula Allowance. The formula allowance is calculated by applying loss factors through the assignment of loss factors to homogenous pools of loans. Changes in risk grades of both performing and nonperforming loans affect the amount of the formula allowance. Loss factors are based on our historical loss experience and such other data as management believes to be pertinent. Management, also, considers a variety of subjective factors, including regional economic and business conditions that impact important segments of our portfolio, loan growth rates, the depth and skill of lending staff, the interest rate environment, and the results of bank regulatory examinations and findings of our internal credit examiners to establish the formula allowance.●
Unallocated Allowance. The unallocated loan loss allowance represents an amount for imprecision or uncertainty that is inherent in estimates used to determine the allowance.●
Reserve for Unfunded Commitments. A reserve for unfunded commitments is maintained at a level that, in the opinion of management, is adequate to absorb probable losses associated with commitments to lend funds under existing agreements, for example, the Bank’s commitment to fund advances under lines of credit. The reserve amount for unfunded commitments is determined based on our methodologies described above with respect to the formula allowance.
  Management anticipates modest growth in commercial lending and commercial real estate and to a lesser extent consumer and real estate mortgage lending, while it anticipates a further decline in construction lending. As a result, future provisions may be required and the ratio of the allowance for credit 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 $1,523,000, or 0.2%, to $789,332,000 at March 31, 2010 compared to $787,809,000 at December 31, 2009. During the three months ended March 31, 2010, savings increased $26,083,000, or 13.7%, while certificates of deposit decreased $15,330,000, or 5.4%, interest-bearing demand deposits decreased $4,980,000, or 3.1%, and noninterest-bearing demand deposits decreased $4,250,000, or 2.8%.
  (in thousands)

March 31,2010


December 31,2009Noninterest-bearing demand

$
148,171


$
152,421Interest-bearing demand


155,236



160,216Savings


215,865



189,782Time certificates


270,060



285,390Total deposits

$
789,332


$
787,809
  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. As of March 31, 2010, $31,961,000 was outstanding in the form of subordinated debt issued by the Company. Unused lines of credit from correspondent banks to provide federal funds of $10,000,000 as of March 31, 2010 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 $153,960,000 secured by certain loans and investment securities as of March 31, 2010. The Company also has an unused line of credit with the Federal Reserve Bank of San Francisco (“FRB”) of $14,992,000 secured by investment securities.
  26
  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 $237,446,000 and $213,963,000 (or 26.8% and 24.2% of total assets) at March 31, 2010 and December 31, 2009, 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 $676,772,000 and $661,715,000 at March 31, 2010 and December 31, 2009, 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 continuously 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.
  27
  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, 2009.
  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 maintain financial strength 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 increased $382,000 to $52,684,000 as of March 31, 2010, as compared to $52,302,000 at December 31, 2009. The increase was the result of a net loss of $312,000 which was partially offset by a change in accumulated other comprehensive gain of $646,000 and stock based compensation expense of $48,000. Under current regulations, management believes that the Company meets all capital adequacy requirements. The Company suspended indefinitely the payment of quarterly cash dividends on its common stock beginning in 2009. This Board decision was made to strengthen and preserve the Company’s capital base in these challenging economic times. See “Subsequent Event” below regarding the Company’s recent capital raise.
  28
  The Company’s and North Valley Bank’s capital amounts and risk-based capital ratios are presented below (in thousands).
  To be Well CapitalizedFor Capital

Under Prompt CorrectiveAdequacy Purposes

Action ProvisionsActual

Minimum


Minimum

Minimum


MinimumAmount


Ratio

Amount


Ratio

Amount


RatioCompanyAs of March 31, 2010:Total capital (to risk weighted assets)

$
83,679


12.02
%

$
55,693


8.00
%


N/A


N/ATier 1 capital (to risk weighted assets)

$
61,560


8.84
%

$
27,855


4.00
%


N/A


N/ATier 1 capital (to average assets)

$
61,560


7.10
%

$
34,682


4.00
%


N/A


N/AAs of December 31, 2009:Total capital (to risk weighted assets)

$
87,791


12.19
%

$
57,615


8.00
%


N/A


N/ATier 1 capital (to risk weighted assets)

$
65,457


9.09
%

$
28,804


4.00
%


N/A


N/ATier 1 capital (to average assets)

$
65,457


7.16
%

$
36,568


4.00
%


N/A


N/ANorth Valley BankAs of March 31, 2010:Total capital (to risk weighted assets)

$
86,910


12.48
%

$
55,712


8.00
%

$
69,639


10.00
%Tier 1 capital (to risk weighted assets)

$
78,094


11.22
%

$
27,841


4.00
%

$
41,761


6.00
%Tier 1 capital (to average assets)

$
78,094


9.01
%

$
34,670


4.00
%

$
43,337


5.00
%As of December 31, 2009:Total capital (to risk weighted assets)

$
89,015


12.38
%

$
57,522


8.00
%

$
71,902


10.00
%Tier 1 capital (to risk weighted assets)

$
79,907


11.11
%

$
28,769


4.00
%

$
43,154


6.00
%Tier 1 capital (to average assets)

$
79,907


8.80
%

$
36,321


4.00
%

$
45,402


5.00
%
  Subsequent Event
  On April 20, 2010, North Valley Bancorp, a California corporation (the “Company”) entered into a Securities Purchase Agreement with a limited number of institutional and other accredited investors, including certain directors and executive officers of the Company (collectively, the “Purchasers”) to sell a total of 40,000 shares of Mandatorily Convertible Cumulative Perpetual Preferred Stock, Series A, without par value (the “Series A Preferred Stock”) at a price of $1,000 per share, for an aggregate gross purchase price of $40,000,000 (the “Private Placement”). The Private Placement closed on April 22, 2010, after the Company issued an aggregate of 40,000 shares of Series A Preferred Stock against receipt of $40,000,000 in cash.
  Set forth below is a table showing the actual capital ratios of the Company and North Valley Bank at March 31, 2010 and the pro forma effect of the private placement on such capital ratios, assuming net proceeds of $37,500,000, full conversion of the Series A Preferred Stock into shares of common stock (upon receipt of shareholder approval for such conversion), and contribution of the entire net proceeds to the capital of North Valley Bank.
 (Dollars in thousands)

Actual

Pro Forma3/31/2010

3/31/2010Capital


Ratio

Capital


RatioCompany:Tier 1 capital (to average assets)

$
61,560


7.10
%

$
111,560


12.34
%Tier 1 capital (to risk weighted assets)

$
61,560


8.84
%

$
111,560


16.02
%Total capital (to risk weighted assets)

$
83,679


12.02
%

$
121,179


17.40
%Bank:Tier 1 capital (to average assets)

$
78,094


9.01
%

$
115,594


12.78
%Tier 1 capital (to risk weighted assets)

$
78,094


11.22
%

$
115,594


16.60
%Total capital (to risk weighted assets)

$
86,910


12.48
%

$
124,410


17.87
%
  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 three months ended March 31, 2010 compared to December 31, 2009. Please see discussion under the caption “Interest Rate Sensitivity” on page 27.
  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.
  29
  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 March 31, 2010. 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 March 31, 2010 that has materially affected or is reasonable likely to materially affect, the Company’s internal control over financial reporting.
  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 from risk factors as previously disclosed by the Company in its response to Item 1A of Part 1 of Form 10-K for the fiscal year ended December 31, 2009.
  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) Certifications32
Section 1350 Certifications
  30
 
 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 May 14, 2010
  By:/s/ Michael J. CushmanMichael J. CushmanPresident & Chief Executive Officer(Principal Executive Officer)/s/ Kevin R. WatsonKevin R. WatsonExecutive Vice President & Chief Financial Officer(Principal Financial Officer & Principal Accounting Officer)
  31