**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM10-Q**

 

**ý****  QUARTERLY REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the Quarterly Period Ended  September30, 2004**

 

**o****  TRANSITION REPORT PURSUANT TO SECTION 13 OR15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**Commission File No. 0-31525**

 

**COMMUNITYVALLEY BANCORP**

(Exact name of registrantas specified in its charter)

 

| **California**                                                   |   | **68-0479553**            |
|------------------------------------------------------------------|--------|---------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (IRS Employer ID  Number) |
|                                                             |   |                      |
| **2041  Forest Avenue, Chico, California**                       |   | **95928**                 |
| (Address of principal  executive offices)                        |   | (Zip code)                |
|                                                             |   |                      |
| **(530)  899-2344**                                              |
| (Registrant’s telephone  number,                            |
| including area code)                                             |
|                                                             |   |                      |
| **not  applicable**                                              |
| (Former name, former  address and former fiscal year, if changed |
| since last report.)                                              |

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or such shorter period that the registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 

Yes     ý     No     o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Exchange Act Rule 12-b-2)

 

Yes     o     No     ý

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date:

 

No par value Common Stock    3,636,291 sharesoutstanding at October 31, 2004.

 

 

----

 

PART 1-FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

 

COMMUNITY VALLEY BANCORP

CONDENSED CONSOLIDATEDBALANCE SHEET (Unaudited)

 
| **(In thousands except per share  data)**                                                                                                                                         | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                        | ** ** | ** **              | ** ** | ** **             | ** ** |
| **ASSETS**                                                                                                                                                                        | ** ** | ** **              | ** ** | ** **             | ** ** |
| ** **                                                                                                                                                                        | ** ** | ** **              | ** ** | ** **             | ** ** |
| Cash and due  from banks                                                                                                                                                          |       | $                       | 25,677     |                   | $          | 26,205 |   |
| Federal funds  sold                                                                                                                                                               |       | 14,425                  |       | 50,605                 |       |
| Interest-bearing  deposits in banks                                                                                                                                               |       | 9,607                   |       | 7,925                  |       |
| Investment  securities (market value of $7,133 at September 30, 2004 and $4,325 at  December 31, 2003)                                                                            |       | 7,128                   |       | 4,325                  |       |
| Loans held for  sale                                                                                                                                                              |       | 1,569                   |       | 2,279                  |       |
| Loans, less  allowance for loan losses of $4,233 at September 30, 2004 and $3,587 at  December 31, 2003                                                                           |       | 339,852                 |       | 270,231                |       |
| Bank premises  and equipment, net                                                                                                                                                 |       | 9,045                   |       | 8,554                  |       |
| Accrued interest  receivable and other assets                                                                                                                                     |       | 15,874                  |       | 16,599                 |       |
|                                                                                                                                                                              |       | $                       | 423,177    |                   | $          | 386,723 |   |
|                                                                                                                                                                              |       |                    |       |                   |       |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                                                                                                        |       |                    |       |                   |       |
|                                                                                                                                                                              |       |                    |       |                   |       |
| Deposits:                                                                                                                                                                         |       |                    |       |                   |       |
| Non-interest  bearing                                                                                                                                                             |       | $                       | 76,987     |                   | $          | 68,463 |   |
| Interest bearing                                                                                                                                                                  |       | 297,830                 |       | 274,048                |       |
| Total deposits                                                                                                                                                                    |       | 374,817                 |       | 342,511                |       |
|                                                                                                                                                                              |       |                    |       |                   |       |
| Employee stock  ownership plan note payable                                                                                                                                       |       | 722                     |       | 832                    |       |
| Subordinated  debentures                                                                                                                                                          |       | 8,248                   |       | 8,248                  |       |
|                                                                                                                                                                              |       |                    |       |                   |       |
| Accrued interest  payable and other liabilities                                                                                                                                   |       | 6,012                   |       | 5,183                  |       |
|                                                                                                                                                                              |       |                    |       |                   |       |
| Total  liabilities                                                                                                                                                                |       | 389,799                 |       | 356,774                |       |
|                                                                                                                                                                              |       |                    |       |                   |       |
| Commitments and  contingencies                                                                                                                                                    |       |                    |       |                   |       |
|                                                                                                                                                                              |       |                    |       |                   |       |
| Shareholders’  equity:                                                                                                                                                       |       |                    |       |                   |       |
| Common stock –  no par value; 20,000,000 shares authorized; issued and outstanding –  3,632,391 shares at September 30, 2004 and 3,621,824 shares at December 31,  2003 |       | 7,773                   |       | 7,271                  |       |
| Unearned ESOP  shares (85,691 shares at September 30, 2004 and 90,909 shares at December 31,  2003, at cost)                                                                      |       | (1,014                  | )          | (1,070                 | )          |
|                                                                                                                                                                              |       |                    |       |                   |       |
| Retained  earnings                                                                                                                                                                |       | 26,612                  |       | 23,746                 |       |
|                                                                                                                                                                              |       |                    |       |                   |       |
| Accumulated  other comprehensive income, net (Note 3)                                                                                                                             |       | 7                       |       | 2                      |       |
|                                                                                                                                                                              |       |                    |       |                   |       |
| Total  shareholders’ equity                                                                                                                                                  |       | 33,378                  |       | 29,949                 |       |
|                                                                                                                                                                              |       | $                       | 423,177    |                   | $          | 386,723 |   |

 

See Notes to UnauditedConsolidated Financial Statements

 

2

----

 

COMMUNITY VALLEY BANCORP

CONDENSED CONSOLIDATEDSTATEMENT OF INCOME

(Unaudited)

 
| ** **                                           | ** ** | **For the periods ended September 30,** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------|------------|
|                                                 |       | **Three  months**                       | ** ** | **Nine  Months** |   |
| **(In  thousands, except per share data)**           |       | **2004**                                |       | **2003** |   | **2004** |   | **2003** |   |
|                                                 | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |   |
| Interest income:                                     |       |                                    |       |   |   |   |   |   |   |
| Interest and  fees on loans                          |       | $                                       | 6,306      |   | $ | 5,308 |   | $ | 17,278 |   | $ | 14,493 |   |
| Interest on  Federal funds sold                      |       | 86                                      |       | 152 |   | 329 |   | 533 |   |
| Interest on  deposits in banks                       |       | 64                                      |       | 55 |   | 180 |   | 145 |   |
| Interest and  dividends on investment securities:    |       |                                    |       |   |   |   |   |   |   |
| Taxable                                              |       | 47                                      |       | 9 |   | 108 |   | 70 |   |
| Exempt from  Federal income taxes                    |       | 16                                      |       | 0 |   | 36 |   | 38 |   |
| Dividends                                            |       | 0                                       |       | 1 |   | 3 |   | 1 |   |
|                                                 |       |                                    |       |   |   |   |   |   |   |
| Total interest  income                               |       | 6,519                                   |       | 5,525 |   | 17,934 |   | 15,740 |   |
| Interest  expense:                                   |       |                                    |       |   |   |   |   |   |   |
| Interest on  deposits                                |       | 878                                     |       | 964 |   | 2,605 |   | 2,996 |   |
| Interest on  subordinated debentures                 |       | 112                                     |       | 103 |   | 315 |   | 336 |   |
| Interest on note  payable                            |       | 8                                       |       | 8 |   | 25 |   | 25 |   |
| Total interest  expense                              |       | 998                                     |       | 1,075 |   | 2,945 |   | 3,357 |   |
|                                                 |       |                                    |       |   |   |   |   |   |   |
| Net interest  income                                 |       | 5,521                                   |       | 4,449 |   | 14,989 |   | 12,383 |   |
|                                                 |       |                                    |       |   |   |   |   |   |   |
| Provision for  loan losses                           |       | 225                                     |       | 210 |   | 640 |   | 480 |   |
| Net interest  income after provision for loan losses |       | 5,296                                   |       | 4,239 |   | 14,349 |   | 11,903 |   |
|                                                 |       |                                    |       |   |   |   |   |   |   |
| Non-interest  income                                 |       | 1,366                                   |       | 1,519 |   | 4,150 |   | 4,085 |   |
|                                                 |       |                                    |       |   |   |   |   |   |   |
| Non-interest  expense:                               |       |                                    |       |   |   |   |   |   |   |
| Salaries and  employee benefits                      |       | 2,243                                   |       | 2,005 |   | 6,623 |   | 5,891 |   |
| Occupancy                                            |       | 283                                     |       | 236 |   | 767 |   | 612 |   |
| Furniture and  equipment                             |       | 399                                     |       | 284 |   | 1,103 |   | 757 |   |
| Other expense                                        |       | 1,107                                   |       | 910 |   | 3,076 |   | 2,726 |   |
| Total  non-interest expense                          |       | 4,032                                   |       | 3,435 |   | 11,569 |   | 9,986 |   |
|                                                 |       |                                    |       |   |   |   |   |   |   |
| Income before  income taxes                          |       | 2,630                                   |       | 2,323 |   | 6,930 |   | 6,002 |   |
|                                                 |       |                                    |       |   |   |   |   |   |   |
| Income taxes                                         |       | 1,036                                   |       | 889 |   | 2,783 |   | 2,415 |   |
|                                                 |       |                                    |       |   |   |   |   |   |   |
| Net income                                           |       | $                                       | 1,594      |   | $ | 1,434 |   | $ | 4,147 |   | $ | 3,587 |   |
|                                                 |       |                                    |       |   |   |   |   |   |   |
| Basic earnings  per share                            |       | $                                       | .45        |   | $ | .41 |   | $ | 1.17 |   | $ | 1.02 |   |
| Diluted earnings  per share                          |       | $                                       | .42        |   | $ | .39 |   | $ | 1.09 |   | $ | .97 |   |
|                                                 |       |                                    |       |   |   |   |   |   |   |
| Cash dividends  per share                            |       | $                                       | .075       |   | $ | .056 |   | $ | .225 |   | $ | .17 |   |

 

See Notes to Unaudited Consolidated FinancialStatements

 

3

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COMMUNITY VALLEY BANCORP

CONDENSED CONSOLIDATEDSTATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

(In thousands exceptshare data)

 
| ** **                                                   | ** ** | ** **        | ** ** | ** **                 | ** **             | ** ** | ** ** | ** ** | ** **                            | **Accumulated  Other  Comprehensive  Income** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------|------------|-------------------|------------|----------------------------|------------------------|------------|------------|------------|---------------------------------------|-----------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                                   | ** ** | ** **        | ** ** | **Unearned  ESOP  Shares** | ** **             | ** ** | ** ** | ** ** | **Total  Shareholders’  Equity** | ** **                                    | ** ** | ** ** |
| ** **                                                   | ** ** | **Common  Stock** | ** ** | ** **                 | **Retained  Earnings** | ** ** | ** ** | ** ** | **Comprehensive  Income**             | ** **                                    |
| ** **                                                   | ** ** | **Shares**        | ** ** | **Amount**                 | ** **             | ** ** | ** ** | ** ** | ** **                            | ** **                                    |
|                                                         |       |              |       |                       |                   |       |       |       |                                  |                                          |       |       |       |       |       |
| Balance, January  1, 2003                                    |       | 3,580,468         |       | $                          | 6,660                  |       | $          | (852       | )                                     | $                                             | 19,559     |       | $          | 14         |       | $ | 25,381 |   |   |   |
|                                                         |       |              |       |                       |                   |       |       |       |                                  |                                          |       |       |       |       |       |
| Comprehensive  income (Note 3):                              |       |              |       |                       |                   |       |       |       |                                  |                                          |       |       |       |       |       |
| Net income                                                   |       |              |       |                       |                   |       |       | 5,269      |                                  |                                          |       | 5,269      |       | $          | 5,269      |   |
| Other comprehensive  loss, net of tax                        |       |              |       |                       |                   |       |       |       |                                  |                                          |       |       |       |       |       |
| Unrealized loss  on available-for-sale investment securities |       |              |       |                       |                   |       |       |       |                                  | (12                                           | )          | (12        | )          | (12        | )          |
|                                                         |       |              |       |                       |                   |       |       |       |                                  |                                          |       |       |       | $          | 5,257      |   |
|                                                         |       |              |       |                       |                   |       |       |       |                                  |                                          |       |       |       |       |       |
| Exercise of stock  options and related tax benefit           |       | 41,356            |       | 462                        |                   |       |       |       |                                  |                                          |       | 462        |       |       |       |
| Earned ESOP  shares                                          |       |              |       | 150                        |                   | 102        |       |       |                                  |                                          |       | 252        |       |       |       |
| Shares acquired  or redeemed by ESOP                         |       |              |       |                       |                   | (321       | )          |       |                                  |                                          |       | (321       | )          |       |       |
| Cash dividends-  $.30 per share                              |       |              |       |                       |                   |       |       | (1,082     | )                                     |                                          |       | (1,082     | )          |       |       |
|                                                         |       |              |       |                       |                   |       |       |       |                                  |                                          |       |       |       |       |       |
| Balance, December  31, 2003                                  |       | 3,621,824         |       | 7,272                      |                   | (1,071     | )          | 23,746     |                                  | 2                                             |       | 29,949     |       |       |       |
|                                                         |       |              |       |                       |                   |       |       |       |                                  |                                          |       |       |       |       |       |
| Comprehensive  income (Note 3):                              |       |              |       |                       |                   |       |       |       |                                  |                                          |       |       |       |       |       |
| Net income                                                   |       |              |       |                       |                   |       |       | 4,146      |                                  |                                          |       | 4,146      |       | $          | 4,146      |   |
| Other  comprehensive loss, net of tax:                       |       |              |       |                       |                   |       |       |       |                                  |                                          |       |       |       |       |       |
| Unrealized gain  on available-for-sale investment securities |       |  

     |       |                       |                   |       |       |       |                                  | 5                                             |       | 5          |       | 5          |       |
|                                                         |       |              |       |                       |                   |       |       |       |                                  |                                          |       |       |       |       |       |
| Total  comprehensive income                                  |       |              |       |                       |                   |       |       |       |                                  |                                          |       |       |       | $          | 4,151      |   |
| Purchase of  common stock                                    |       | (19,015           | )          | (40                        | )                      |       |       | (462       | )                                     |                                          |       | (502       | )          |       |       |
| Exercise of stock  options and related tax benefit           |       | 29,582            |       | 470                        |                   |       |       |       |                                  |                                          |       | 470        |       |       |       |
| Fractional shares                                            |       |              |       | (6                         | )                      |       |       |       |                                  |                                          |       | (6         | )          |       |       |
| Earned ESOP  shares                                          |       |              |       | 77                         |                   | 57         |       |       |                                  |                                          |       | 134        |       |       |       |
| Cash dividends declared - $.225 per share                    |       |              |       |                       |                   |       |       | (818       | )                                     |                                          |       | (818       | )          |       |       |
|                                                         |       |              |       |                       |                   |       |       |       |                                  |                                          |       |       |       |       |       |
| Balance,  September 30, 2004                                 |       | 3,632,391         |       | $                          | 7,773                  |       | $          | (1,014     | )                                     | $                                             | 26,612     |       | $          | 7          |       | $ | 33,378 |   |   |   |

 

See Notes to Unaudited Condensed Consolidated Financial Statements

 

4

----

 

COMMUNITY VALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS                  (Unaudited**)**

 
| **(In thousands)  For the nine months ended September 30,**                        | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                               |       |     |       |     |       |
| Cash flows from  operating activities:                                             |       |     |       |     |       |
| Net income                                                                         |       | $        | 4,146      |     | $          | 3,587 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |     |       |     |       |
| Provision for  loan losses                                                         |       | 640      |       | 480      |       |
| Deferred loan  origination costs, net                                              |       | 59       |       | 224      |       |
| Depreciation and  amortization                                                     |       | 999      |       | 671      |       |
| Gain on  disposition of Bank premises and equipment                                |       |     |       | (3       | )          |
| Net decrease in  loans held for sale                                               |       | 711      |       | 2,252    |       |
| Increase in cash  surrender value of bank-owned life insurance                     |       | (335     | )          | (166     | )          |
| Non-cash  compensation expense associated with the ESOP                            |       | 135      |       | 116      |       |
| Decrease in  accrued interest receivable and other assets                          |       | 1,259    |       | 47       |       |
| Increase  (decrease) in accrued interest payable and other liabilities             |       | 829      |       | (1,005   | )          |
|                                                                               |       |     |       |     |       |
| Net cash  provided by operating activities                                         |       | 8,443    |       | 6,203    |       |
|                                                                               |       |     |       |     |       |
| Cash flows from  investing activities:                                             |       |     |       |     |       |
|                                                                               |       |     |       |     |       |
| Increase in  interest-bearing deposits in banks                                    |       | (1,682   | )          | (3,666   | )          |
| Proceeds from  called available-for-sale investment securities                     |       | 300      |       |     |       |
| Proceeds from  called held-to-maturity investment securities                       |       | 1,598    |       | 2,200    |       |
| Proceeds from  matured held-to-maturity investment securities                      |       | 130      |       |     |       |
| Proceeds from  principal payments of held-to-maturity investment securities        |       | 310      |       |     |       |
| Purchase of  held-to-maturity investment securities                                |       | (1,012   | )          | (2,030   | )          |
| Purchase of  available-for-sale investment securities                              |       | (4,148   | )          |     |       |
| Purchases of  premises and equipment                                               |       | (1,454   | )          | (1,857   | )          |
| Proceeds from  sale of premises and equipment                                      |       |     |       | 155      |       |
| Purchase of  bank-owned life insurance                                             |       |     |       | (1,608   | )          |
| Investment in  ATM program                                                         |       |     |       | (9,989   | )          |
| Net increase in  loans                                                             |       | (70,319  | )          | (38,454  | )          |
|                                                                               |       |     |       |     |       |
| Net cash used in  investing activities                                             |       | (76,277  | )          | (55,249  | )          |
|                                                                               |       |     |       |     |       |
| Cash flows from  financing activities:                                             |       |     |       |     |       |
|                                                                               |       |     |       |     |       |
| Net increase in  demand, interest-bearing and savings deposits                     |       | $        | 21,109     |     | $          | 36,254 |   |
| Net increase in  time deposits                                                     |       | 11,195   |       | 2,549    |       |
| Repayment of  ESOP loan, net                                                       |       | (110     | )          | 92       |       |
| Payment of cash  dividends                                                         |       | (817     | )          | (810     | )          |
| Cash paid for  fractional shares                                                   |       | (6       | )          |     |       |
| Exercise of  stock options                                                         |       | 259      |       | 236      |       |
| Purchase of  unearned ESOP shares                                                  |       |     |       | (186     | )          |
| Repurchase of  common stock                                                        |       | (502     | )          |     |       |
|                                                                               |       |     |       |     |       |
| Net cash  provided by financing activities                                         |       | 31,128   |       | 38,135   |       |
|                                                                               |       |     |       |     |       |
| Decrease in cash  and cash equivalents                                             |       | (36,708  | )          | (10,911  | )          |
|                                                                               |       |     |       |     |       |
| Cash and cash  equivalents at beginning of year                                    |       | 76,810   |       | 73,031   |       |
|                                                                               |       |     |       |     |       |
| Cash and cash  equivalents at end of period                                        |       | $        | 40,102     |     | $          | 62,120 |   |

 

See Notes to Unaudited Consolidated Financial Statements

 

5

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**Community Valley Bancorp andSubsidiaries**

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIALSTATEMENTS

 

1.  BASIS OFPRESENTATION

 

The accompanying unaudited condensed consolidatedfinancial statements of Community Valley Bancorp and subsidiaries (the “Company”)have been prepared in accordance with the instructions to Form 10-Q and Article10 of Regulation S-X.  Accordingly,certain information and notes required by accounting principles generallyaccepted in the United States for annual financial statements are not includedherein.  In the opinion of management,all adjustments (which consist solely of normal recurring accruals) considerednecessary for a fair presentation of the results for the interim periodspresented have been included.  Theseinterim consolidated financial statements should be read in conjunction withthe financial statements and related notes contained in the Company’s 2003Annual Report to Shareholders on Form 10-K.

 

The condensed consolidated financial statementsinclude the accounts of the Company and its wholly owned bank subsidiary, ButteCommunity Bank.  Community ValleyStatutory Trust is not consolidated into the Company’s consolidated financialstatements and, accordingly, is accounted for under the equity method.  All significant inter-company balances andtransactions have been eliminated in consolidation.  The results of operations for the three and ninemonth periods ended September 30, 2004 may not necessarily be indicative of theoperating results for the full year 2004.

 

On February 20, 2004, the Board of Directorsdeclared a four-for-three stock split effective March 26, 2004 forshareholders of record on March 2, 2004.  All share and per sharedata has been retroactively adjusted to reflect the stock split.

 

Management has determined that since all of thecommercial banking products and services offered by the Company are availablein each branch of the bank, all branches are located within the same economicenvironment and management does not allocate resources based on the performanceof different lending or transaction activities, it is appropriate to aggregatethe Bank branches and report them as a single operating segment.

 

The preparation of consolidated financial statementsin conformity with accounting principles generally accepted in the UnitedStates of America requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period.  Actual results could differfrom these estimates.

 

2.  EARNINGS PER SHARECOMPUTATION

 

Basic earnings per share are computed by dividing netincome by the weighted average common shares outstanding for the period (3,560,903and 3,552,469 shares for the three and nine month periods ended September 30,2004 and 3,518,621 and 3,507,809 shares for the three and nine month periodsended September 30, 2003).  Dilutedearnings per share reflect the potential dilution that could occur ifoutstanding stock options were exercised using the treasury stock method.   Diluted earnings per share is computed bydividing net income by the weighted average common shares outstanding for theperiod plus the dilutive effect of options (230,192 and 247,793 shares for the threeand nine month periods ended September 30, 2004 and 194,245 and 189,644 sharesfor the three and  nine month periodsended September 30, 2003).  Earnings pershare are retroactively adjusted for stock splits and dividends for all periodspresented.  During the periods coveredthe Company had no stock options that were considered anti-dilutive.

 

6

----

 

3.  COMPREHENSIVE INCOME

 

Comprehensive income is reported in addition to netincome for all periods presented. Comprehensive income is made up of net income plus other comprehensiveincome or loss.  The Company’s onlysource of  comprehensive income or loss,is comprised of changes in unrealized gains or losses, net of taxes, onavailable-for-sale securities, adjusted for the effect of realized gains orlosses on available-for-sale securities, net of taxes.

 

4.  STOCK –BASED COMPENSATION

 

The Company issues stock options under threestock-based compensation plans, the Community Valley Bancorp 1991, 1997 and2000 Stock Option Plans.  The Companyaccounts for these plans under the recognition and measurement principles ofAPB Opinion No. 25, *Accounting for StockIssued to Employees*, and related Interpretations.  No stock-based compensation cost is reflectedin net income, as all options granted under these plans had an exercise priceequal to the market value of the underlying common stock on the date ofgrant.  In accordance with FinancialAccounting Standards Board (“FASB”) No. 148, *Accountingfor Stock-Based Compensation– Transition and Disclosure, an Amendment of FASBNo. 123,* the following table illustrates the effect on net incomeand earnings per share if the Company had applied the fair value recognitionprovisions of FASB Statement No. 123, *Accounting for Stock-BasedCompensation*, to stock-based employee compensation.

 

Pro forma adjustments to the Company’s consolidatednet earnings and earnings per share are disclosed during the periods in whichthe options become vested.

 

(In thousands, except per share data)

 
| ** **                                                                                                                              | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                                                              | ** ** | **September 30, 2004** | ** ** | **September 30, 2003** | ** ** |
| ** **                                                                                                                              |       |                   |       |   |   |
| Net income as reported                                                                                                                  |       | $                      | 1,594      |   | $ | 1,434 |   |
| Deduct: Total stock-based compensation expense determined under the  fair value based method for all awards, net of related tax effects |       | (71                    | )          | (65 | )  |
|                                                                                                                                    |       |                   |       |   |   |
| Pro forma net income                                                                                                                    |       | $                      | 1,523      |   | $ | 1,369 |   |
|                                                                                                                                    |       |                   |       |   |   |
| Basic earnings per share - as reported                                                                                                  |       | $                      | 0.45       |   | $ | 0.41 |   |
| Basic earnings per share - pro forma                                                                                                    |       | $                      | 0.43       |   | $ | 0.39 |   |
|                                                                                                                                    |       |                   |       |   |   |
| Diluted earnings per share - as reported                                                                                                |       | $                      | 0.42       |   | $ | 0.39 |   |
| Diluted earnings per share - pro forma                                                                                                  |       | $                      | 0.40       |   | $ | 0.38 |   |

 

7

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| ** **                                                                                                                              | ** ** | **Nine Months Ended**  | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                                                              | ** ** | **September 30, 2004** | ** ** | **September 30, 2003** | ** ** |
| ** **                                                                                                                              |       |                   |       |   |   |
| Net earnings as reported                                                                                                                |       | $                      | 4,147      |   | $ | 3,588 |   |
| Deduct: Total stock-based compensation expense determined under the  fair value based method for all awards, net of related tax effects |       | (214                   | )          | (194 | ) |
|                                                                                                                                    |       |                   |       |   |   |
| Pro forma net income                                                                                                                    |       | $                      | 3,933      |   | $ | 3,393 |   |
|                                                                                                                                    |       |                   |       |   |   |
| Basic earnings per share - as reported                                                                                                  |       | $                      | 1.17       |   | $ | 1.02 |   |
| Basic earnings per share - pro forma                                                                                                    |       | $                      | 1.11       |   | $ | 0.97 |   |
|                                                                                                                                    |       |                   |       |   |   |
| Diluted earnings per share - as reported                                                                                                |       | $                      | 1.09       |   | $ | 0.97 |   |
| Diluted earnings per share - pro forma                                                                                                  |       | $                      | 1.04       |   | $ | 0.93 |   |

 
| ** **                                                      | ** ** | **Nine Months Ended**  | ** ** |
|-----------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                      | ** ** | **September 30, 2004** | ** ** | **September 30, 2003** | ** ** |
| Dividend yield  (not applicable)                                |       |                   |       |   |   |
| Expected  volatility                                            |       | 79.07 – 92.26     | %          | 95.16 | % |
|                                                            |       |                   |       |   |   |
| Risk-free  interest rate                                        |       | 4.02 – 4.12       | %          | 4.52 | % |
|                                                            |       |                   |       |   |   |
| Expected option  life                                           |       | 10 years               |       | 10 years |   |
| Weighted average  fair value of options granted during the year |       | $                      | 9.51       |   | $ | 9.86 |   |
|                                                                 |            |                        |            |  |  |  |  |

 

8

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5.  COMMITMENTS AND CONTINGENCIES

 

The Company has certain ongoing commitments underoperating leases.  These commitments donot significantly impact operating results. As of September 30, 2004 andDecember 31, 2003, commitments to extend credit and letters of credit were theonly financial instruments with off-balance sheet risk.  The Company has not entered into anycontracts for financial derivative instruments such as futures, swaps, optionsor similar instruments.  Loan commitmentsand letters of credit were $153,673,000 and $141,308,000 at September 30, 2004and December 31, 2003, respectively.  Asa percentage of net loans, these off-balance sheet items represent 45.0% and52.3%, respectively.

 

**Item  2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS OF COMMUNITY VALLEY BANCORP**

 

The following is Community Valley Bancorp’s (the “Company”)management’s discussion and analysis of the significant changes in balancesheet accounts for September 30, 2004 and December 31, 2003 and income andexpense accounts for the three and nine month periods ended September 30, 2004and 2003. The discussion is designed to provide a better understanding ofsignificant trends related to the Company’s financial condition, results ofoperations, liquidity, capital resources and interest rate sensitivity.

 

In addition to the historical information containedherein, this report on Form 10-Q contains certain forward-lookingstatements.  The reader of this reportshould understand that all such forward-looking statements are subject tovarious uncertainties and risks that could affect their outcome.   The Company’s actual results could differmaterially from those suggested by such forward-looking statements.  Factors that could cause or contribute to such differencesinclude, but are not limited to, variances in the actual versus projectedgrowth in assets, return on assets, loan losses, expenses, rates charged onloans and earned on securities investments, rates paid on deposits, competitioneffects, fee and other noninterest income earned, general economic conditions,nationally, regionally and in the operating market areas of the Company and itssubsidiaries, changes in the regulatory environment, changes in businessconditions and inflation, changes in securities markets, data processingproblems, a decline in real estate values in the Company’s market area,  theeffects of terrorism, including the events of September 11, 2001 andthereafter, and the conduct of the war on terrorism by the United States andits allies, as well asother factors. This entire report should be read putting suchforward-looking statements in context.

 

**General Development of Business**

** **

The Company is a bank holding company registered underthe Bank Holding Company Act of 1956, as amended. The Company was incorporatedunder the laws of the State of California in 2002.  As a bank holding company, the Company isauthorized to engage in the activities permitted under the Bank Holding CompanyAct of 1956, as amended, and regulations thereunder.** **Its principal office is located at2041 Forest Avenue, Chico, California 95928 and its telephone number is (530)899-2344.

 

The Company owns 100% of the issued and outstandingcommon shares of Butte Community Bank. Butte Community Bank was incorporated and commenced business in Paradiseand Oroville, California in 1990.  ButteCommunity Bank operates ten full service offices within its primary serviceareas of Butte, Sutter, Yuba and Tehama Counties.  The Bank also maintains Loan ProductionOffices in Citrus Heights and Redding. Butte Community Bank’s primary businessis serving the commercial banking needs of small to mid-sized businesses andconsumers within those counties.  ButteCommunity Bank accepts checking and savings deposits, offers money marketdeposit accounts and certificates of deposit, makes secured and unsecuredcommercial, secured real estate, and other installment and term loans andoffers other customary banking services.

 

9

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**Critical Accounting Policies**

 

*General*

 

The Company’s significant accounting principles aredescribed in Note 1 of the consolidated financial statements in the Company’s2003 Annual Report to Shareholders on Form 10-K and are essential tounderstanding Management’s Discussion and Analysis of Results of Operations andFinancial Condition. Community Valley Bancorp’s consolidated financialstatements are prepared in accordance with accounting principles generallyaccepted in the United States of America (GAAP). The financial informationcontained within our statements is, to a significant extent, financialinformation that is based on measures of the financial effects of transactionsand events that have already occurred. Some of the Company’s accountingprinciples require significant judgement to estimate values of assets orliabilities. In addition, certain accounting principles require significantjudgment in applying the complex accounting principles to transactions todetermine the most appropriate treatment. The following is a summary of themore judgmental and complex accounting estimates and principles.

 

*Allowancefor Loan Losses (ALL)*

 

The allowance for loan losses is management’s bestestimate of the probable losses that may be sustained in our loan portfolio.The allowance is based on two basic principles of accounting: (1) SFAS No.5 which requires that losses be accrued when they are probableof occurring and estimable and (2) SFAS No. 114, which requires thatlosses be accrued on impaired loans based on the differences between the valueof collateral, present value of future cash flows or values that are observablein the secondary market and the loan balance. The Company performs periodic andsystematic detailed evaluations of its lending portfolio to identify andestimate the inherent risks and assess the overall collectibility. Theseevaluations include general conditions such as the portfolio composition, sizeand maturities of various segmented portions of the portfolio such as secured,unsecured, construction, and Small Business Administration (“SBA”).

 

Additional factors include concentrations ofborrowers, industries, geographical sectors, loan product, loan classes andcollateral types, volume and trends of loan delinquencies and non-accrual,criticized and classified assets and trends in the aggregate in significantcredits identified as watch list items. There are several components to thedetermination of the adequacy of the ALL. Each of these components isdetermined based upon estimates that can and do change when the actual eventsoccur. The Company estimates the SFAS No. 5 portion of the ALL based onthe segmentation of its portfolio. For those segments that require an ALL, theCompany estimates loan losses on a monthly basis based upon its ongoing loanreview process and analysis of loan performance. The Company follows asystematic and consistently applied approach to select the most appropriateloss measurement methods and support its conclusions and rationale with writtendocumentation. One method of estimating loan losses for groups of loans is throughthe application of loss rates to the groups’ aggregate loan balances. Suchrates typically reflect historical loss experience for each group of loans,adjusted for relevant economic factors over a defined period of time. TheCompany evaluates and modifies its loss estimation model as needed to ensurethat the resulting loss estimate is consistent with GAAP.

 

For individually impaired loans, SFAS No. 114provides guidance on the acceptable methods to measure impairment.Specifically, SFAS No. 114 states that when a loan is impaired, theCompany should measure impairment based on the present value of expected futureprincipal and interest cash flows discounted at the loan’s effective interestrate, except that as a practical expedient, a creditor may measure impairmentbased on a loan’s observable market price or the fair value of collateral, ifthe loan is collateral dependent. When developing the estimate of future cashflows for a loan, the Company considers all available information reflectingpast events and current conditions, including the effect of existingenvironmental factors.

 

10

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*LoanSales and Servicing*

 

The Company originates government guaranteed loans andmortgage loans that may be sold in the secondary market.  The amounts ofgains recorded on sales of loans and the initial recording of servicing assetsand interest only (I/O) strips is based on the estimated fair values of therespective components.  In recording the initial value of the servicingassets and the fair value of the I/O strips receivable, the Company usesestimates which are based on management’s expectations of future prepaymentsand discount rates.  Servicing assets are amortized over the estimatedlife of the related loan.  I/O strips are not significant at September 30,2004.  These prepayment and discount rates were based on current marketconditions and historical performance of the various pools of servicedloans.  If actual prepayments with respect to sold loans occur more quicklythan projected the carrying value of the servicing assets may have to beadjusted through a charge to earnings.

 

*Stock-BasedCompensation*

 

The Company uses the intrinsic value based method formeasuring compensation cost related to stock options. Under the intrinsic valuebased method, compensation cost is the excess, if any, of the quoted marketprice of the stock at grant date over the amount an employee must pay toacquire the stock. This cost is amortized on a straight-line basis over thevesting period of the options granted. The Company applies AccountingPrinciples Board Opinion (“APB”) No. 25 *Accountingfor Stock Issued to Employees*and related interpretations inaccounting for stock options.  No compensation cost has been recorded inthe accompanying financial statements because all options have been granted atan exercise price of no less than the fair market value at date of grant.

 

*Revenuerecognition*

 

The Company’s primary source of revenue is interestincome, which is the difference between the interest income it receives oninterest-earning assets and the interest expense it pays on interest-bearingliabilities, and (ii) fee income, which includes fees earned on depositservices, income from SBA lending, electronic-based cash management services,mortgage brokerage fee income and merchant credit card processing services.Interest income is recorded on an accrual basis. Note 1 to the ConsolidatedFinancial Statements in the Company’s 2003 Annual Report to Shareholders onForm 10-K offers an explanation of the process for determining when the accrualof interest income is discontinued on an impaired loan.

 

**Overview**

 

The Company recorded net income of $1,594,000 for thequarter ended September 30, 2004, which was an 11% increase from the $1,434,000reported for the same period of 2003. Diluted earnings per share for the third quarter of 2004 were $0.42,compared to the $0.39 recorded in the third quarter of 2003.  The annualized return on average equity(ROAE) and the return on average assets (ROA) for the third quarter of 2004were 17.34% and 1.36%, respectively, as compared to 17.80% and 1.34%,respectively, for the same period in 2003.

 

Net income for the nine months ended September 30, 2004was $4,147,000 (up 15.6%) compared to the $3,587,000 recorded in the first ninemonths of 2003.   The primary reasons forthe increase in net income were the growth in earning assets the companyexperienced as well as decreases in average rates paid, primarily oncertificates of deposit and demand deposits.

 

Total assets of the Company increased by $36,454,000 or(9.4%) from December 31, 2003 to $423,177,000 at September 30, 2004.  Net loans totaled $341,421,000, up $71,190,000(26.3%) from the ending balances on December 31, 2003.  Deposit balances at September 30, 2004totaled $374,817,000, up $32,306,000 (9.4%) from December 31, 2003.

 

11

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Table One below provides a summary of the componentsof net income for the periods indicated:

 

**Table One: Components of Net Income**

 
| ** **                                                       | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| **(In thousands, except percentages)**                           |       | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** |   |
|                                                             |       |                                  |       |                                 |       |   |   |   |   |
| Net interest  income                                             |       | $                                     | 5,521      |                                 | $          | 4,449 |   | $ | 14,989 |   | $ | 12,383 |   |
| Provision for  loan losses                                       |       | (225                                  | )          | (210                                 | )          | (640 | ) | (480 | ) |
| Non-interest  income                                             |       | 1,366                                 |       | 1,519                                |       | 4,150 |   | 4,085 |   |
| Non-interest  expense                                            |       | (4,032                                | )          | (3,435                               | )          | (11,569 | ) | (9,986 | ) |
| Provision for  income taxes                                      |       | (1,036                                | )          | (889                                 | )          | (2,783 | ) | (2,415 | ) |
|                                                             |       |                                  |       |                                 |       |   |   |   |   |
| Net income                                                       |       | $                                     | 1,594      |                                 | $          | 1,434 |   | $ | 4,147 |   | $ | 3,587 |   |
|                                                             |       |                                  |       |                                 |       |   |   |   |   |
| Average total  assets (In millions)                              |       | $                                     | 421.1      |                                 | $          | 381.1 |   | $ | 408.1 |   | $ | 363.2 |   |
| Net income  (annualized) as a percentage of average total assets |       | 1.51                                  | %          | 1.53                                 | %          | 1.36 | % | 1.34 | % |

 

**Results of Operations**

 

**Net Interest Income and Net Interest Margin**

** **

Net interest income represents the excess of interestand fees earned on interest earning assets (loans, securities, federal fundssold and investments in time deposits) over the interest paid on deposits andborrowed funds.  Net interest margin isnet interest income expressed as a percentage of average earning assets.

 

The Company’s net interest margin was 5.86% for thethree months ended September 30, 2004 and 5.58% for the nine month period endingSeptember 30, 2004.  Net interest incomeincreased $1,071,000 (24%) for the third quarter of 2004 compared to the sameperiod in 2003.  Net interest incomeincreased $2,604,000 (21%) for the nine months ended September 30, 2004 overthe same period in 2003.   The primaryreason for this increase was the loan growth and the resulting interest incomeand fees associated with that growth together with the decrease in the interestrates paid on deposits.

 

The average balances of interest bearing liabilitieswere $27,748,000 (10%) higher in the third quarter of 2004 versus the samequarter in 2003. Even though the interest bearing balances increased, ratespaid on these liabilities decreased 23 basis points on a quarter over quarterbasis.   As a result, interest expensewas $77,000 (7.7%) lower in the third quarter of 2004 versus the prior yearperiod.  The average balances of interestbearing liabilities were $32,585,000 (12.4%) higher in the nine-month periodended September 30, 2004 versus the same period in 2003.  Rates paid on interest bearing liabilitiesdecreased 38 basis points on a year over year basis.  The reason for this decrease was the abilityof management to channel the growth of the deposits away from higher interestrate certificates of deposit to lower rate demand deposits and to lower theaverage cost of certificates of deposit as higher cost deposits were re-pricedin a lower rate environment.  As aresult, interest expense was $412,000 (12.3%) lower in the nine month periodended September 30, 2004 versus the prior year period.

 

Table Two, Analysis of Net Interest Margin, and TableThree, Analysis of Volume and Rate Changes on Net Interest Income and Expenses,are provided to enable the reader to understand the components and past trendsof the Company’s interest income and expense. Table Two provides an analysis of net interest margin setting forthaverage assets, liabilities and shareholders’ equity; interest income earnedand interest expense paid and average rates earned and paid; and the netinterest margin.

 

12

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**Table Two:  Analysis of Net Interest Margin**

 
| ** **                                       | ** ** | **Three  Months Ended September 30,** | ** ** |
|--------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                       | ** ** | **2004**                              | ** ** | **2003** | ** ** |
| ** **                                       | ** ** | **Avg**                               | ** ** | ** ** | ** ** | **Avg** | ** ** | **Avg** | ** ** | ** ** | ** ** | **Avg** | ** ** |
| **(In thousands, except  percentages)**          | ** ** | **Balance**                           | ** ** | **Interest** | ** ** | **Yield (4)** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Yield (4)** | ** ** |
| ** **                                       | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Assets:**                                      |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Earning assets                                   |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Loans (1)                                        |       | $                                     | 334,154    |   | $ | 6,306 |   | 7.51 | % | $ | 268,306 |   | $ | 5,308 |   | 7.85 | % |
| Taxable  investment securities                   |       | 5,529                                 |       | 47 |   | 3.31 | % | 2,061 |   | 10 |   | 1.73 | % |
| Tax-exempt  investment securities (2)            |       | 1,219                                 |       | 16 |   | 5.22 | % | 817 |   |   |   | 0 | % |
| Federal funds  sold                              |       | 24,784                                |       | 86 |   | 1.38 | % | 60,593 |   | 152 |   | 1.00 | % |
| Interest bearing  deposits in banks              |       | 9,305                                 |       | 64 |   | 2.74 | % | 7,298 |   | 55 |   | 2.99 | % |
| Total earning  assets                            |       | 374,991                               |       | 6,519 |   | 6.91 | % | 339,075 |   | 5,525 |   | 6.46 | % |
| Cash & due from  banks                       |       | 27,040                                |       |   |   |   |   | 17,151 |   |   |   |   |   |
| Other assets                                     |       | 19,118                                |       |   |   |   |   | 24,883 |   |   |   |   |   |
|                                             |       | $                                     | 421,149    |   |   |   |   |   | $ | 381,109 |   |   |   |   |   |
|                                             |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| **Liabilities  & Shareholders’ Equity** |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  liabilities:                   |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| NOW & MMDA                                   |       | $                                     | 175,330    |   | 262 |   | 0.59 | % | $ | 157,307 |   | 348 |   | 0.88 | % |
| Savings                                          |       | 31,172                                |       | 37 |   | 0.47 | % | 23,329 |   | 28 |   | 0.47 | % |
| Time deposits                                    |       | 88,377                                |       | 579 |   | 2.61 | % | 86,644 |   | 588 |   | 2.69 | % |
| Other borrowings                                 |       | 8,984                                 |       | 120 |   | 5.31 | % | 8,772 |   | 111 |   | 5.02 | % |
| Total interest bearing liabilities               |       | 303,863                               |       | 998 |   | 1.31 | % | 276,115 |   | 1,075 |   | 1.54 | % |
| Demand deposits                                  |       | 77,711                                |       |   |   |   |   | 70,082 |   |   |   |   |   |
| Other  liabilities                               |       | 6,512                                 |       |   |   |   |   | 6,923 |   |   |   |   |   |
| Total  liabilities                               |       | 388,086                               |       |   |   |   |   | 353,120 |   |   |   |   |   |
| Shareholders’  equity                       |       | 33,063                                |       |   |   |   |   | 27,989 |   |   |   |   |   |
|                                             |       | $                                     | 421,129    |   |   |   |   |   | $ | 381,109 |   |   |   |   |   |
| Net interest  income & margin (3)            |       |                                  |       | $ | 5,521 |   | 5.86 | % |   |   | $ | 4,449 |   | 5.21 | % |

 

----

(1)  Loan interest includes loan fees of $628,000and $497,000 during the three months ended September 30, 2004 and September 30,2003 respectively.

(2)  Does not include taxable-equivalentadjustments that primarily relate to income on certain securities that areexempt from federal income taxes.

(3)  Net interest margin is computed by dividingnet interest income by total average earning assets.

(4)  Average yield is calculated based on actualdays in quarter (92 for September 30, 2004 and September 30, 2003) andannualized to actual days in year (366 for 2004 and 365 for 2003).

 

13

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| ** **                                       | ** ** | **Nine  Months Ended September 30,** | ** ** |
|--------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                       | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| **(In thousands, except  percentages)**          | ** ** | **Avg  Balance**                     | ** ** | **Interest** | ** ** | **Avg  Yield (4)** | ** ** | **Avg  Balance** | ** ** | **Interest** | ** ** | **Avg  Yield (4)** | ** ** |
| ** **                                       |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| **Assets:**                                      |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Earning assets                                   |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Loans (1)                                        |       | $                                    | 302,302    |   | $ | 17,278 |   | 7.63 | % | $ | 250,711 |   | $ | 14,953 |   | 7.97 | % |
| Taxable  investment securities                   |       | 4,260                                |       | 111 |   | 3.45 | % | 2,047 |   | 71 |   | 4.70 | % |
| Tax-exempt  investment securities (2)            |       | 889                                  |       | 36 |   | 5.41 | % | 957 |   | 38 |   | 5.31 | % |
| Federal funds  sold                              |       | 41,407                               |       | 329 |   | 1.06 | % | 63,206 |   | 533 |   | 1.13 | % |
| Interest bearing  deposits in banks              |       | 8,806                                |       | 180 |   | 2.73 | % | 5,918 |   | 145 |   | 3.28 | % |
| Total earning  assets                            |       | 357,664                              |       | 17,934 |   | 6.70 | % | 322,839 |   | 15,740 |   | 6.52 | % |
| Cash & due  from banks                       |       | 26,339                               |       |   |   |   |   | 15,715 |   |   |   |   |   |
| Other assets                                     |       | 24,095                               |       |   |   |   |   | 24,605 |   |   |   |   |   |
|                                             |       | $                                    | 408,098    |   |   |   |   |   | $ | 363,159 |   |   |   |   |   |
|                                             |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| **Liabilities  & Shareholders’ Equity** |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  liabilities:                   |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| NOW & MMDA                                   |       | $                                    | 172,296    |   | 827 |   | 0.64 | % | $ | 146,492 |   | 1,075 |   | 0.98 | % |
| Savings                                          |       | 28,353                               |       | 103 |   | 0.49 | % | 21,620 |   | 91 |   | 0.56 | % |
| Time deposits                                    |       | 86,242                               |       | 1,674 |   | 2.59 | % | 86,281 |   | 1,830 |   | 2.84 | % |
| Other borrowings                                 |       | 8,859                                |       | 340 |   | 5.13 | % | 8,772 |   | 361 |   | 5.50 | % |
| Total interest  bearing liabilities              |       | 295,750                              |       | 2,944 |   | 1.33 | % | 263,165 |   | 3,357 |   | 1.71 | % |
| Demand deposits                                  |       | 73,506                               |       |   |   |   |   | 65,447 |   |   |   |   |   |
| Other  liabilities                               |       | 6,910                                |       |   |   |   |   | 7,554 |   |   |   |   |   |
| Total  liabilities                               |       | 376,166                              |       |   |   |   |   | 336,166 |   |   |   |   |   |
| Shareholders’  equity                       |       | 31,932                               |       |   |   |   |   | 26,993 |   |   |   |   |   |
|                                             |       | $                                    | 408,098    |   |   |   |   |   | $ | 363,159 |   |   |   |   |   |
| Net interest  income & margin (3)            |       |                                 |       | 14,989 |   | 5.58 | % |   |   | 12,383 |   | 5.13 | % |
|                                                  |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)  Loan interest includes loan fees of$1,659,000 and $1,414,000 during the nine months ended September 30, 2004 andSeptember 30, 2003, respectively.

(2)  Does not include taxable-equivalentadjustments that primarily relate to income on certain securities that isexempt from federal income taxes.

(3)  Net interest margin is computed by dividingnet interest income by total average earning assets.

(4)  Average yield is calculated based on actualdays in period (274 for September 30, 2004 and 273 days for September 30, 2003)and annualized to actual days in year (366 for 2004 and 365 for 2003).

 

14

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Table Three sets forth a summary of the changes in interest income andinterest expense from changes in average asset and liability balances (volume)and changes in average interest rates. On a quarter over quarter basis for the period ending September 30, 2004net interest income has increased $1,071,000 over the same time period in2003.  Interest income from earningassets has increased by $994,000. Changes in the volume of earning assets,primarily loans, have resulted in an increase in interest income of $1,240,000while interest income from changes in rates has decreased by $246,000.   Changes in the volume of interest bearingliabilities, primarily the increase in balances of demand deposits, hasresulted in a net increase of interest expense of $64,000.  Decreases in average rates paid, primarily oncertificates of deposit and demand deposits have resulted in an interestexpense reduction of $141,000.   On ayear-to-date basis through September 30, 2004, net interest income hasincreased $2,604,000 over the same time period in 2003.  Interest income from earning assets hasincreased by $2,191,000.  Changes in thevolume of earning assets, primarily loans, have resulted in an increase ininterest income of $3,042,000 while interest income from changes in rates hasdecreased by $851,000.  Interest expensefor the nine month period was $413,000 less than the same time period in2003.  Changes in the volume of interestbearing liabilities, primarily the increase in balances of demand deposits,have resulted in a net increase of interest expense of $221,000.  Decreases in average rates paid, primarily oncertificates of deposit and demand deposits have resulted in an interestexpense reduction of $634,000.

 

**Table Three: Analysis of Volume and Rate Changes on Net Interest Income and Expenses**

(In thousands) Three Months Ended September 30, 2004 over 2003

 

Increase (decrease) due to change in:

 
| ** **                            | ** ** | **Volume** | ** ** | **Rate (3)** | ** ** | **Net Change** | ** ** |
|---------------------------------------|------------|------------|------------|--------------|------------|----------------|------------|
| Interest-earning  assets:             |       |       |       |         |       |           |       |
| Net loans (1)                         |       | $          | 1,299      |         | $          | (301           | )          | $ | 998 |   |
| Taxable  investment securities        |       | 15         |       | 22           |       | 37             |       |
| Tax exempt  investment securities (2) |       | 0          |       | 16           |       | 16             |       |
| Federal funds  sold                   |       | (90        | )          | 24           |       | (66            | )          |
| Interest bearing  deposits in banks   |       | 15         |       | (6           | )          | 9              |       |
| Total                                 |       | 1,240      |       | (246         | )          | 994            |       |
| Interest-bearing  liabilities:        |       |       |       |         |       |           |       |
| NOW & MMDA                        |       | 40         |       | (126         | )          | (86            | )          |
| Savings deposits                      |       | 9          |       |         |       | 9              |       |
| Time deposits                         |       | 12         |       | (21          | )          | (9             | )          |
| Other borrowings                      |       | 3          |       | 6            |       | 9              |       |
| Total                                 |       | 64         |       | (141         | )          | (77            | )          |
| Interest  differential                |       | $          | 1,176      |         | $          | (105           | )          | $ | 1,071 |   |

 

----

(1)  The average balance of non-accruing loans isimmaterial as a percentage of total loans and, as such, has been included innet loans.

(2)  Does not include taxable-equivalentadjustments that primarily relate to income on certain securities that isexempt from federal income taxes.

(3)  The rate/volume variance has been included inthe rate variance.

 

15

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**Table Three: Analysis of Volume and Rate Changes on Net Interest Income and Expenses**

(In thousands) Nine Months Ended September 30, 2004 over 2003

 

Increase (decrease) due to change in:

 
| ** **                            | ** ** | **Volume** | ** ** | **Rate (3)** | ** ** | **Net Change** | ** ** |
|---------------------------------------|------------|------------|------------|--------------|------------|----------------|------------|
| Interest-earning  assets:             |       |       |       |         |       |           |       |
| Net loans (1)                         |       | $          | 3,080      |         | $          | (755           | )          | $ | 2,325 |   |
| Taxable  investment securities        |       | 78         |       | (38          | )          | 40             |       |
| Tax exempt  investment securities (2) |       | (3         | )          | 1            |       | (2             | )          |
| Federal funds  sold                   |       | (184       | )          | (20          | )          | (204           | )          |
| Investment in  time deposits          |       | 71         |       | (36          | )          | 35             |       |
| Total                                 |       | 3,042      |       | (848         | )          | 2,194          |       |
| Interest-bearing  liabilities:        |       |       |       |         |       |           |       |
| Demand deposits                       |       | 190        |       | (438         | )          | (248           | )          |
| Savings deposits                      |       | 28         |       | (16          | )          | 12             |       |
| Time deposits                         |       | (1         | )          | (154         | )          | (155           | )          |
| Other borrowings                      |       | 4          |       | (25          | )          | (21            | )          |
| Total                                 |       | 221        |       | (633         | )          | (412           | )          |
| Interest  differential                |       | $          | 2,821      |         | $          | (215           | )          | $ | 2,606 |   |

 

----

(1)  The average balance of non-accruing loans isimmaterial as a percentage of total loans and, as such, has been included innet loans.

(2)  Does not include taxable-equivalentadjustments that primarily relate to income on certain securities that isexempt from federal income taxes.

(3)  The rate/volume variance has been included inthe rate variance.

 

16

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## **Non-interest Income**

 

Table Four below providesa summary of the components of noninterest income for the periods indicated(dollars in thousands) (percent of assets annualized):

 

**Table Four: Components of Noninterest Income**

 

Three Months Ended September 30,

 
| ** **                           | ** ** | **2004** | ** ** | **% of Avg.  Assets** | ** ** | **2003** | ** ** | **% of Avg.  Assets** | ** ** |
|--------------------------------------|------------|----------|------------|-----------------------|------------|----------|------------|-----------------------|------------|
|                                 |       |     |       |                  |       |     |       |                  |       |
| Service charges  on deposit accounts |       | $        | 575        |                  | .55        |     | $          | 415                   |       | .44 |   |
| Loan servicing  fees                 |       | 103      |       | .10                   |       | 240      |       | .26                   |       |
| Fees -  alternative investment sales |       | 85       |       | .08                   |       | 70       |       | .07                   |       |
| Merchant fee  income                 |       | 81       |       | .08                   |       | 64       |       | .07                   |       |
| Gain on the sale  of loans           |       | 255      |       | .24                   |       | 460      |       | .49                   |       |
| Other                                |       | 268      |       | .25                   |       | 270      |       | .29                   |       |
|                                 |       |     |       |                  |       |     |       |                  |       |
| Total  non-interest income           |       | $        | 1,367      |                  | 1.30       |     | $          | 1,519                 |       | 1.62 |   |

 

Nine Months Ended September 30,

 
| ** **                           | ** ** | **2004** | ** ** | **% of Avg.  Assets** | ** ** | **2003** | ** ** | **% of Avg.  Assets** | ** ** |
|--------------------------------------|------------|----------|------------|-----------------------|------------|----------|------------|-----------------------|------------|
|                                 |       |     |       |                  |       |     |       |                  |       |
| Service charges  on deposit accounts |       | $        | 1,539      |                  | .50        |     | $          | 937                   |       | .35 |   |
| Loan servicing  fees                 |       | 289      |       | .09                   |       | 354      |       | .13                   |       |
| Fees -  alternative investment sales |       | 315      |       | .10                   |       | 150      |       | .06                   |       |
| Merchant fee  income                 |       | 243      |       | .08                   |       | 215      |       | .08                   |       |
| Gain on the sale  of loans           |       | 1,043    |       | .34                   |       | 1,962    |       | .72                   |       |
| Other                                |       | 721      |       | .24                   |       | 467      |       | .17                   |       |
|                                 |       |     |       |                  |       |     |       |                  |       |
| Total  non-interest income           |       | $        | 4,150      |                  | 1.36       |     | $          | 4,085                 |       | 1.51 |   |

 

## **Non-interestincome was down $152,000 (10%) to $1,367,000 for the three months endedSeptember 30, 2004 as compared to $1,519,000 for the three months endedSeptember 30, 2003.    Increases innon-interest income were realized in fees from service charges (up 38.6%), feesfrom alternative investment sales (up 21.4%) and merchant processing fees (up32.8%). Loan servicing income and gains on the sale of loans declined (133% and81.8% respectively) as a result of fewer loans being sold in the secondarymarket through FNMA (Fannie Mae) as many customers of the Company had alreadytaken advantage of the low levels in mortgage financing rates during 2003.   Other income also declined on a quarter overquarter basis by (1.5%) The increase in service charge income was the result ofadditional deposit accounts opened during the third quarter, an overall increasein fees charged for services which were increased in the third quarter of 2004and fees resulting from the overdraft privilege deposit product.  The Alternative Investment Department, whichsells third-party mutual funds and annuities, experienced an increase in feesdue to an increase in sales during the third quarter.**

 

17

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For the ninemonths ended September 30, 2004, non-interest income was up $65,000 (1.6%) to$4,150,000 as compared to the $4,085,000 total for the nine months endedSeptember 30, 2003.   All of thecomponents of non-interest income showed gains with the exception of loanservicing fees which was down $65,000 or (18.4%) and gains on the sale of loanswhich was down $920,000 or (46.8%) for the same reasons stated above for thethree month period.  Increases wererealized in service charges on deposit accounts up $602,000 or (64.2%),alternative investment sales up $165,000 or (110.0%), merchant fee income up$32,000 or (14.9%) and other up $251,000 or (53.7%).

 

**Non-interestExpense**

 

Non-interestexpense increased $597,000 (17.4%) to $4,032,000 in the third quarter of 2004versus $3,435,000 in the third quarter of 2003. On a quarter over quarter basis, full time equivalent employeesincreased by 6 to 195.  Salary andemployee benefits increased $238,000 (11.9%) resulting from normal cost ofliving raises, and staffing additions made during the year as the Companycontinues to grow and implement the new technology acquired during theyear.  Benefit costs and employer taxesincreased commensurate with the salaries.   On a quarter over quarter basis, occupancy expenses were higher by$47,000 (19.9%).  This increase in costsis associated with the opening of the Red Bluff office and the Marysvilleoffice, and is related to building depreciation, utilities, janitorial servicesand property taxes.   Furniture and equipmentexpense was $399,000 in the third quarter of 2004 compared to $284,000 in thesame period of 2003, representing a 40.5% increase.   Other expenses increased $197,000 (21.6%) inthe third quarter of 2004 versus the second quarter of 2003.

 

Non-interestexpense for the nine month period ended September 30, 2004 was $11,569,000versus $9,987,000 for the same period in 2003. Salaries and benefits increased by $732,000 (12.4%) due to cost ofliving raises added benefit costs and employer taxes associated with thestaffing additions made during the year as the Company continues to grow andimplement the new technology acquired during the year.  On a year over year basis, full timeequivalent employees increased by 17 to 195.  Occupancy expense was up $155,000 (25.3%) from the first nine months of2003 to the first nine months of 2004. Furniture and equipment expense was up 346,000 (46%).  This increase relates to technology upgradesmade to our core banking systems and the furniture fixtures and equipment neededto open the two offices mentioned above. As with the quarter-to-quartercomparison, much of the increase in occupancy expense is also related to theopening of the new Red Bluff and Marysville offices.   Other expenses increased by $300,000(12.8%).

 

## **Provision for Loan Losses**

 

The Companyprovided $225,000 for loan losses for the third quarter of 2004 as compared to$210,000 for the third quarter of 2003. Net loan charge-offs for the three months ended September 30, 2004 was$5,000 as compared to $14,000 for the three months ended September 30,2003.   For the first nine months of2004, the Company made provisions for loan losses of $640,000.   This compares to the provision for loanlosses of $480,000 for the first nine months of 2003.  Net loan recoveries for the nine months endedSeptember 30, 2004 was $6,000 as compared to $14,000 in net loan charge-offsfor the same period in 2003.  Managementassesses its loan quality on a monthly basis to maintain an adequate allowancefor loan losses.  The Company’s loanportfolio composition, non-performing assets and allowance for loan losses arefurther discussed under the balance sheet Analysis section below.

 

**Provisionfor Income Taxes**

 

The effective taxrate for the third quarter and first nine months of 2004 was 39.4% and 40.2%,versus 38.3% and 40.2%, for the same period in 2003.

 

18

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**BalanceSheet Analysis**

 

The Company’stotal assets were $423,177,000 at September 30, 2004 as compared to$386,723,000 at December 31, 2003, representing an increase of 9.4%.  The average balance of total assets for thenine months ended September 30, 2004 was $408,098,000, which represents anincrease of $50,041,000 (12.4%) over the $363,159,000 during the nine-monthperiod ended September 30, 2003.

 

## **Loans**

 

The Companyconcentrates its lending activities in the following principal areas: 1)commercial; 2) real estate; 3) residential real estate and real estateconstruction (both commercial and residential); 4) agriculture; and 5) consumerloans.  Commercial and residential realestate loans are generally secured by improved property, with originalmaturities of 3-10 years.  At September30, 2004, these principal areas accounted for approximately 19%, 42%, 23%, 8%and 8%, respectively, of the Company’s loan portfolio.    The mix at December 31, 2003 was 20%, 42%,23%, 7% and 8%.  Continuing strongeconomic activity in the Company’s market area, new borrowers developed throughthe Company’s marketing efforts and credit extensions expanded to existingborrowers, offset by normal loan pay-downs and payoffs, resulted in netincreases in loan balances for commercial loans.  These changes are consistent with the Company’shistory of increased real estate construction activity during the summermonths.  Continuing strong economicactivity in the Company’s market area, new borrowers developed through theCompany’s marketing efforts and credit extensions expanded to existingborrowers, offset by normal loan pay-downs and payoffs, resulted in netincreases in loan balances for commercial loans ($10,793,000 or 20%),residential real estate ($30,465,000 or 26.5%), real estate construction($17,031,000 or 26.9%), agricultural loans ($8,433,000 or 40.5%) and consumer($3,603,000 or 16.5%).  Table Five belowsummarizes the composition of the loan portfolio as of September 30, 2004 andDecember 31, 2003.

 

**TableFive: Loan Portfolio Composition**

 
| **(In thousands)**        | ** ** | **September  30,  2004** | ** ** | **December  31,  2003** | ** ** |
|---------------------------|------------|--------------------------|------------|-------------------------|------------|
| Commercial                |       | $                        | 64,869     |                    | $          | 54,076 |   |
| Real estate:              |       |                     |       |                    |       |
| Mortgage                  |       | 145,377                  |       | 114,912                 |       |
| Construction              |       | 80,227                   |       | 63,196                  |       |
|                      |       |                     |       |                    |       |
| Agriculture               |       | 29,253                   |       | 20,820                  |       |
| Consumer                  |       | 25,450                   |       | 21,847                  |       |
| Total loans               |       | 345,176                  |       | 274,851                 |       |
| Allowance for loan losses |       | (4,233                   | )          | (3,587                  | )          |
| Deferred loan fees, net   |       | (1,091                   | )          | (1,033                  | )          |
| Total net loans           |       | $                        | 339,852    |                    | $          | 270,231 |   |
|                           |            |                          |            |                         |            |  |  |  |  |

 

Themajority of the Company’s loans are direct loans made to individuals and localbusinesses.  The Company reliessubstantially on local promotional activity and personal contacts by bankofficers, directors and employees to compete with other financialinstitutions.  The Company makes loans toborrowers whose applications include a sound purpose and a viable primaryrepayment source, generally supported by a secondary source of repayment.

 

Commercial loans consist of credit lines for operating needs, loans forequipment purchases, working capital, and various other business loanproducts.  Consumer loans include a rangeof traditional consumer loan products such as personal lines of credit andloans to finance purchases of autos, boats, recreational vehicles, mobile homesand various other consumer items.

 

19

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Realestate construction loans are generally composed of commitments to customerswithin the Company’s service area for construction of both commercialproperties and custom and semi-custom single-family residences.  Real estate mortgage loans consist primarilyof loans secured by first trust deeds on commercial and residential propertiestypically with maturities from 3 to 10 years and original loan to value ratiosgenerally from 65% to 80%.  Agricultureloans consist primarily of crop loans to farmers of peaches, prunes, walnuts,almonds and rice.  In general, except inthe case of loans with SBA or FMHA guarantees, the Company does not retainlong-term mortgage loans; however, Butte Community Bank has a residentiallending division to assist customers in securing most forms of longer termsingle-family mortgage financing.

 

## **Risk Elements**

 

TheCompany assesses and manages credit risk on an ongoing basis through a creditculture that emphasizes excellent credit quality, extensive internal monitoringand established formal lending policies. Additionally, the Company contracts with an outside loan review consultantto periodically review the existing loan portfolio.  Management believes its ability to identifyand assess risk and return characteristics of the Company’s loan portfolio iscritical for profitability and growth. Management strives to continue its emphasis on credit quality in theloan approval process, active credit administration and regularmonitoring.  With this in mind,management has designed and implemented a comprehensive loan review and gradingsystem that functions to continually assess the credit risk inherent in theloan portfolio.

 

Ultimately,underlying trends in economic and business cycles may influence creditquality.  The Company’s business isconcentrated in the Butte and Sutter County Area. The economy of these twocounties is diversified with professional services, manufacturing, agricultureand real estate investment and construction.

 

Specialemphasis is placed within the communities in which the Company has offices(Chico, Paradise, Magalia, Oroville, Yuba City, Red Bluff, andMarysville).  The Company also maintainsloan production offices in the cities of Citrus Heights and Redding.  Single-family residential construction is theprimary lending product from the Roseville location serving the greaterSacramento area.  The primary focus ofthe loan production office in Redding is commercial loans with an emphasis onSBA and other government loan programs.

 

TheCompany has significant extensions of credit and commitments to extend creditthat are secured by real estate.  The ultimaterepayment of these loans is generally dependent on personal or business cashflows or the sale or refinancing of the real estate.  The Company monitors the effects of currentand expected market conditions and other factors on the collectability of realestate loans.  The more significantfactors management considers involve the following:  lease, absorption and sale rates; real estatevalues and rates of return; operating expenses; inflation; and sufficiency ofcollateral independent of the real estate including, in limited instances,personal guarantees.

 

Inextending credit and commitments to borrowers, the Company generally requirescollateral and/or guarantees as security. The repayment of such loans is expected to come from cash flow or from proceedsfrom the sale of selected assets of the borrowers.  The Company’s requirement for collateraland/or guarantees is determined on a case-by-case basis in connection withmanagement’s evaluation of the creditworthiness of the borrower.  Collateral held varies but may includeaccounts receivable, inventory, property, plant and equipment, income-producingproperties, residences and other real property. The Company secures its collateral by perfecting its security interestin business assets, obtaining deeds of trust, or outright possession amongother means.

 

## **In management’s judgment, aconcentration exists in real estate loans, which represented approximately64.8% of the Company’s loan portfolio at September 30, 2004, which is the same,on a percentage basis, as the 64.8% concentration level at December 31,2003.  Management believes theconcentration to have no more than the normal risk of collectability; however,a substantial decline in the economy in general, or a decline in real estatevalues in the Company’s primary market areas in particular, could have anadverse impact on the collectability of these loans and require an increase inthe provision for loan losses which could adversely affect**

 

20

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## **the Company’s future prospects, results of operations,profitability and stock price. Management believes that its lending policies and underwriting standardswill tend to minimize losses in an economic downturn; however, there is noassurance that losses will not occur under such circumstances.  The Company’s loan policies and underwritingstandards include, but are not limited to, the following: (1) maintaining athorough understanding of the Company’s service area and originating asignificant majority of its loans within that area, (2) maintaining a thoroughunderstanding of borrowers’ knowledge, capacity, and market position in theirfield of expertise, (3) basing real estate loan approvals not only on marketdemand for the project, but also on the borrowers’ capacity to support theproject financially in the event it does not perform to expectations (whethersale or income performance), and (4) maintaining conforming and prudent loan tovalue and loan to cost ratios based on independent outside appraisals andongoing inspection and analysis by the Company’s lending officers.**

 

## **Nonaccrual, Past Due andRestructured Loans**

 

Managementgenerally places loans on nonaccrual status when they become 90 days past due,unless the loan is well secured and in the process of collection.  Loans are charged off when, in the opinion ofmanagement,

collectionappears unlikely.

 

Table Six belowsets forth nonaccrual loans as of September 30, 2004 and December 31,2003.  There were no loans past due 90days or more and still accruing interest at September 30, 2004 or December 31,2003.

 

**TableSix:  Non-Performing Loans**

 
| **(In thousands)**         | ** ** | **September  30,  2004** | ** ** | **December  31,  2003** | ** ** |
|----------------------------|------------|--------------------------|------------|-------------------------|------------|
| Nonaccrual:                |       |                     |       |                    |       |
| Commercial                 |       | 17                       |       | 46                      |       |
| Real estate                |       | 71                       |       |                    |       |
| Consumer and other         |       |                     |       | 8                       |       |
| Total non-performing loans |       | $                        | 88         |                    | $          | 54 |   |
|                            |            |                          |            |                         |            |  |  |

 

At September 30, 2004, non-performing loans and leases were .03% oftotal loans and leases.  The recordedinvestments in loans that were considered to be impaired totaled $88,000 atSeptember 30, 2004 and $54,000 at December 31, 2003.  Foreclosure proceedings are underway on thereal estate loan for $71,000.  This loanand the commercial loan for $17,000 are well secured and have very lowpotential for loss.  There were no loanconcentrations in excess of 10% of total loans not otherwise disclosed as acategory of loans as of September 30, 2004 or December 31, 2003.  Management is not aware of any potentialproblem loans, which were accruing and current at September 30, 2004, whereserious doubt exists as to the ability of the borrower to comply with thepresent repayment terms.

 

## **Allowance for Loan LossesActivity**

 

We employ asystematic methodology for determining the allowance for loan losses thatincludes a monthly review process and monthly adjustment of theallowance.  Our process includes a periodic review of individual loansthat have been specifically identified as problem loans or have characteristicswhich could lead to impairment, as well as detailed reviews of other loans(either individually or in pools).  While this methodology utilizeshistorical and other objective information, the establishment of the allowancefor loan losses and the classification of loans are, to some extent, based onmanagement’s judgment and experience.

 

21

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Our methodologyincorporates a variety of risk considerations, both quantitative andqualitative, in establishing an allowance for loan losses that managementbelieves is appropriate at each reporting date.  Quantitative factorsinclude our historical loss experience, delinquency and charge-off trends,collateral values, changes in non-performing loans, and other factors. Quantitative factors also incorporate known information about individual loans,including borrowers’ sensitivity to interest rate movements and borrowers’sensitivity to quantifiable external factors including commodity prices as wellas acts of nature (freezes, earthquakes, fires, etc.) that occur in aparticular period.

 

Qualitativefactors include the general economic environment in our markets and, inparticular, the state of the agriculture industry and other key industries inthe Northern Sacramento Valley.  The way a particular loan might bestructured, the extent and nature of waivers of existing loan policies, loan concentrationsand the rate of portfolio growth are other qualitative factors that areconsidered.

 

Our methodologyis, and has been, consistently followed.  However, as we add new products,increase in complexity, and expand our geographic coverage, we expect toenhance our methodology to keep pace with the size and complexity of the loanportfolio.  On an ongoing basis we engage outside firms to independentlyassess our methodology, and to perform independent credit reviews of our loanportfolio.  The FDIC and the California Department of FinancialInstitutions review the allowance for loan losses as an integral part of theexamination processes.  Management believes that our current methodologyis appropriate given our size and level of complexity.  Further,management believes that the allowance for loan losses is adequate as ofSeptember 30, 2004 to cover known and inherent risks in the loanportfolio.  However, fluctuations in credit quality, or changes ineconomic conditions or other factors could cause management to increase ordecrease the allowance for loan losses as necessary.

 

The Board ofDirectors of the Bank reviews the adequacy of the allowance for loan losses atleast quarterly to include consideration of the relative risks in the portfolioand current economic conditions.  Theallowance is adjusted based on that review if, in the judgment of the loancommittee and management, changes are warranted.  The allowance for loan losses totaled$4,233,000 or 1.22% of total loans at September 30, 2004 and $3,587,000 or1.31% at December 31, 2003.  Netcharge-offs to average loans for the third quarter were .006% and year to datethrough September 30, 2004 are zero.

 

22

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Table Seven belowsummarizes, for the periods indicated, the activity in the allowance for loanlosses.

 

**TableSeven: Allowance for Loan Losses**

 
| **(In thousands, except for percentages)**                                | ** ** | **Three  Months  Ended  September 30,** | ** ** | **Nine  Months  Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                | ** ** | **2004**                                | ** ** | **2003**                               | ** ** | **2004** | ** ** | **2003** | ** ** |
| Average loans outstanding                                                 |       | $                                       | 334,154    |                                   | $          | 268,306 |   | $ | 302,502 |   | $ | 250,711 |   |
|                                                                      |       |                                    |       |                                   |       |   |   |   |   |
| Allowance for possible loan losses at  beginning of period                |       | $                                       | 4,013      |                                   | $          | 3,277 |   | $ | 3,587 |   | $ | 3,007 |   |
|                                                                      |       |                                    |       |                                   |       |   |   |   |   |
| Loans charged off:                                                        |       |                                    |       |                                   |       |   |   |   |   |
| Commercial                                                                |       | (6                                      | )          | (14                                    | )          | (6 | ) | (14 | ) |
| Real estate                                                               |       |                                    |       |                                   |       |   |   |   |   |
| Consumer                                                                  |       | (8                                      | )          |                                   |       | (15 | ) | (4 | ) |
| Total                                                                     |       | (14                                     | )          | (14                                    | )          | (21 | ) | (18 | ) |
| Recoveries of loans previously charged off:                               |       |                                    |       |                                   |       |   |   |   |   |
| Commercial                                                                |       |                                    |       |                                   |       | 14 |   |   |   |
| Real estate                                                               |       |                                    |       |                                   |       |   |   |   |   |
| Consumer                                                                  |       | 9                                       |       |                                   |       | 13 |   | 4 |   |
| Total                                                                     |       | (5                                      | )          |                                   |       | 27 |   | 4 |   |
| Net loan recoveries (charge-offs)                                         |       | (5                                      | )          | (14                                    | )          | 6 |   | (14 | ) |
|                                                                      |       |                                    |       |                                   |       |   |   |   |   |
| Additions to allowance charged to operating  expenses                     |       | 225                                     |       | 210                                    |       | 640 |   | 480 |   |
| Allowance for loan losses at end of period                                |       | $                                       | 4,233      |                                   | $          | 3,473 |   | 4,233 |   | 3,473 |   |
| Ratio of net charge-offs to average loans  outstanding                    |       | .00                                     | %          | (.005                                  | )%         | .00 | % | (.006 | )% |
| Provision for possible loan losses to  average loans outstanding          |       | .06                                     | %          | .08                                    | %          | .20 | % | .19 | % |
| Allowance for loan losses to loans net of  deferred fees at end of period |       | 1.22                                    | %          | 1.28                                   | %          | 1.22 | % | 1.28 | % |
|                                                                           |            |                                         |            |                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

It isthe policy of management to maintain the allowance for loan losses at a leveladequate for known and inherent risks in the portfolio.  Based on information currently available toanalyze inherent credit risk, including economic factors, overall creditquality, historical delinquencies and a history of actual charge-offs,management believes that the provision for loan losses and the allowance areprudent and adequate.  The Companygenerally makes monthly allocations to the allowance for loan losses.  The budgeted allocation is based on estimatesof loss risk and loan growth. Adjustments may be made based on differences from estimated loan growth,the types of loans constituting this growth, changes in risk ratings within theportfolio, and general economic conditions. However, no prediction of the ultimate level of loans charged off infuture years can be made with any certainty.

 

**OtherReal Estate**

 

At September 30,2004 and December 31, 2003, the Company did not have any other real estate (“ORE”)properties.

 

23

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## **Deposits**

 

At September 30,2004, total deposits were $374,817,000 representing an increase of $32,306,000(9.4%) over the December 31, 2003 balance of $342,511,000.  Non-interest bearing deposits increased$8,524,000 (12.5%) over the December 31, 2003 balance of $68,463,000 andinterest bearing deposits increased $23,782,000 (8.7%) over the December 31,2003 balance of $274,048,000.

 

## **Capital Resources**

 

The current andprojected capital position of the Company and the impact of capital plans andlong-term strategies are reviewed regularly by management. The Company’scapital position represents the level of capital available to support continuedoperations and expansion.

 

The Board ofDirectors of the Company authorized the payment of a cash dividend of $.056 pershare on January 23, 2003, April 24, 2003, July 25, 2003, October 24, 2003, and$.075 per share on January 23, 2004, March 23, 2004, June 15, 2004, andSeptember 16, 2004.  The payment of dividendsin the future is subject to the discretion of the Board of Directors of theCompany and will depend on earnings, the financial condition of the Company andother relevant factors.  The per shareamounts have been retroactively restated for the Company’s 4 for 3 stock splitapproved by the Board of Directors on February 17, 2004.

 

The Company andits subsidiary Bank are subject to certain regulations issued by the Board ofGovernors of the Federal Reserve System and the FDIC which require maintenanceof certain levels of capital.  AtSeptember 30, 2004, shareholders’ equity was $33,378,000, representing anincrease of $3,429,000 (11.4%) from $29,949,000 at December 31, 2003.  The increase is primarily the result of thenet income for the period offset by the repurchase of common stock by thecompany and the cash dividends discussed above. The Bank’s ratio of total risk-based capital to risk adjusted assets was12.2% at September 30, 2004 compared to 12.1% at December 31, 2003.  Tier 1 risk-based capital to risk-adjustedassets was 11.0% at September 30, 2004 and 10.9% at December 31, 2003.

 

Table Eight belowlists the Company and the Bank capital ratios at September 30, 2004 andDecember 31, 2003, as well as the minimum ratios required under regulatorydefinitions of capital adequacy. 

 

**TableEight:  Capital Ratios (Unaudited)**

 
| **Capital to Risk-Adjusted Assets** | ** ** | **At  September 30,  2004** | ** ** | **At  December 31,  2003** | ** ** | **Minimum   Regulatory Requirement** | ** ** |
|-------------------------------------|------------|-----------------------------|------------|----------------------------|------------|--------------------------------------|------------|
| **Company**                         | ** ** | ** **                  | ** ** | ** **                 | ** ** | ** **                           | ** ** |
| Leverage ratio                      |       | 9.8                         | %          | 9.9                        | %          | 4.0                                  | %          |
| Tier 1 Risk-Based Capital           |       | 11.0                        | %          | 12.2                       | %          | 4.0                                  | %          |
| Total Risk-Based Capital            |       | 12.1                        | %          | 13.4                       | %          | 8.0                                  | %          |
| **Bank**                            |       |                        |       |                       |       |                                 |       |
| Leverage ratio                      |       | 9.2                         | %          | 8.8                        | %          | 4.0                                  | %          |
| Tier 1 Risk-Based Capital           |       | 11.0                        | %          | 10.9                       | %          | 4.0                                  | %          |
| Total Risk-Based Capital            |       | 12.2                        | %          | 12.1                       | %          | 8.0                                  | %          |

 

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Capital ratios arereviewed on a regular basis to ensure that capital exceeds the prescribedregulatory minimums and is adequate to meet future needs.  All ratios are in excess of the regulatorydefinition of “Minimum” at September 30, 2004 and December 31, 2003.  The Company was considered “well-capitalized”by regulatory standards, at September 30, 2004 and December 31, 2003.

 

**Item 3.  Quantitativeand Qualitative Disclosures about Market Risk**

 

**MarketRisk Management**

 

*Overview*. Market risk is the risk of loss from adverse changes in market pricesand rates.  The Company’s market riskarises primarily from interest rate risk inherent in its loan, investment anddeposit portfolios.  The goal formanaging the assets and liabilities of the Company is to maximize shareholdervalue and earnings while maintaining a high quality balance sheet withoutexposing the Company to undue interest rate risk.

 

TheBoard of Directors has overall responsibility for the interest rate riskmanagement policies.  The Bank has anAsset and Liability Management Committee (ALCO) that establishes and monitorsguidelines to control the sensitivity of earnings to changes in interest rates.

 

*Asset/LiabilityManagement*.  Activities involved in asset/liability managementinclude, but are not limited to, lending, accepting and placing deposits,investing in securities, using trust preferred securities and borrowings.  Interest rate risk is the primary market riskassociated with asset/liability management. Sensitivity of earnings to interest rate changes arises when yields onassets change in a different time period or in a different amount from that ofinterest costs on liabilities.  Tomitigate interest rate risk, the structure of the balance sheet is managed withthe goal that movements of interest rates on assets and liabilities arecorrelated and contributes to earnings even in periods of volatile interestrates.  The asset/liability managementpolicy sets limits on the acceptable amount of variance in net interest marginand market value of equity under changing interest environments.  The Company uses simulation models toforecast earnings, net interest margin and market value of equity.

 

Simulationof earnings is the primary tool used to measure the sensitivity of earnings tointerest rate changes.  Usingcomputer-modeling techniques, the Company is able to estimate the potentialimpact of changing interest rates on earnings. A balance sheet forecast is prepared monthly using inputs of actualloans, securities and interest bearing liability (i.e. deposits/borrowings)positions as the beginning base.  Theforecast balance sheet is processed against seven interest rate scenarios.  These scenarios include a 100, 200 and 300basis point rising rate forecast, a flat rate forecast and a 100, 200 and 300basis point falling rate forecast which take place within a one year timeframe.  The net interest income ismeasured during the year assuming a gradual change in rates over the twelve-monthhorizon.  The Company’s net interestincome, as forecast below, was modeled utilizing a forecast balance sheetprojected from balances as of the date indicated.

 

TableNine below summarizes the effect on net interest income (NII) of a ±200 basispoint change in interest rates as measured against a constant rate (no change)scenario.  The results shown in Tablenine for the two periods, fall within the parameters of the Bank’s policy forinterest rate risk.

 

**Table Nine: Interest Rate Risk Simulation of Net Interest as of September 30, 2004and December 31, 2003**

 

 

 
| **(In thousands)**                      | ** ** | **$ Change  in NII  from Current  12 Month Horizon  September 30, 2004** | ** ** | **$ Change  in NII  from Current  12 Month Horizon  December 31, 2003** | ** ** |
|-----------------------------------------|------------|-------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------|------------|
| Variation from a constant rate scenario |       |                                                                          |       |                                                                         |       |
| +200bp                                  |       | $                                                                             | 646        |                                                                         | $          | 286 |   |
| - 200bp                                 |       | $                                                                             | 1,140      |                                                                         | $          | 714 |   |

 

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## **The simulations of earnings do notincorporate any management actions which might moderate the negativeconsequences of interest rate deviations. Therefore, they do not reflect likely actual results, but serve asestimates of interest rate risk.  In thissimulation, the exposure to net interest income has increased due to a largervolume of assets maturing than liabilities and re-pricing at lower rates.**

 

## **Inflation**

 

The impact of inflationon a financial institution differs significantly from that exerted onmanufacturing, or other commercial concerns, primarily because its assets andliabilities are largely monetary.  Ingeneral, inflation primarily affects the Company and it subsidiaries throughits effect on market rates of interest, which affects the Company’s ability toattract loan customers.  Inflationaffects the growth of total assets by increasing the level of loan demand, andpotentially adversely affects capital adequacy because loan growth ininflationary periods can increase at rates higher than the rate that capitalgrows through retention of earnings, which may be generated in the future.  In addition to its effects on interest rates,inflation increases overall operating expenses. Inflation has not had a material effect upon the results of operationsof the Company and its subsidiaries during the periods ended September 30,2004, and 2003.

 

**Liquidity**

 

Liquiditymanagement refers to the Company’s ability to provide funds on an ongoing basisto meet fluctuations in deposit levels as well as the credit needs andrequirements of its clients.  Both assetsand liabilities contribute to the Company’s liquidity position.  Federal funds lines, short-term investmentsand securities, and loan repayments contribute to liquidity, along with depositincreases, while loan funding and deposit withdrawals decrease liquidity.  The Company assesses the likelihood ofprojected funding requirements by reviewing historical funding patterns, currentand forecasted economic conditions and individual client funding needs.  Commitments to fund loans at September 30,2004 and December 31, 2003 were approximately $153,673,000 and $141,308,000,respectively.  Such loans relateprimarily to revolving lines of credit and other commercial loans, and to realestate construction loans.

 

TheCompany’s sources of liquidity consist of cash and due from correspondentbanks, overnight Federal funds sold to correspondent banks, unpledgedmarketable investments and loans held for sale. On September 30, 2004, consolidated liquid assets totaled $43.4 millionor 10.3% of total assets compared to $80.1 million or 20.7% of total assets onDecember 31, 2003.  Liquid assets in theform of fed funds sold decreased by approximately $30 million due to the growthin the loan portfolio during the third quarter. In addition to liquid assets, the Company maintains short-term lines ofcredit in the amount of $6,000,000 with correspondent banks.  There were no borrowings outstanding underthese arrangements at September 30, 2004.   The Bank also has informal agreements with various other banks to sellparticipations in loans, if necessary. The Company serves primarily a business and professional customer baseand, as such, its deposit base is susceptible to economic fluctuations.  Accordingly, management strives to maintain abalanced position of liquid assets to volatile and cyclical deposits.

 

Liquidity is alsoaffected by portfolio maturities and the effect of interest rate fluctuationson the marketability of both assets and liabilities.  The Company can sell any of its unpledgedsecurities held in the available-for-sale category to meet liquidity needs.

 

**Item 4. Controls and Procedures**

 

(a) Disclosure Controls and Procedures: An evaluation of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) was carried out under the supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and other members of the Company’s senior management as of the end of the Company’s fiscal quarter ended September 30, 2004. The Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures as currently in effect are effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is (i) accumulated and communicated to the Company’s management (including the Chief Executive Officer and Chief Financial Officer) to allow timely

 

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decisions regarding required disclosure, and (ii) recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms.   (b) Internal Control Over Financial Reporting: An evaluation of any changes in the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)), that occurred during the Company’s fiscal quarter ended September 30, 2004, was carried out under the supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and other members of the Company’s senior management. The Company’s Chief Executive Officer and Chief Financial Officer concluded that no change identified in connection with such evaluation has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

## **Item 5.  Subsequent Events**

 

On September 29, 2004 the Company filed for Financial Holding Companystatus with the Federal Reserve Bank of San Francisco with subsequent approvalgranted on October 29, 2004.  On October15, 2004 the Company filed with the California Department of Insurance forpermission to operate a subsidiary of Community Valley Bancorp called CVBInsurance Agency LLC.

 

## **On October 28, 2004 the Companyfiled applications with the California Department of Financial Institutions andthe Federal Deposit Insurance Corporation for permission to establish a branchoffice in the city of Colusa.**

 

## **PARTII – OTHER INFORMATION**

 

Item1.  Legal Proceedings.

 

None

 

Item2.  Changes in Securities and Use ofProceeds.

 

The Board ofDirectors approved a plan at their June 2003 meeting to repurchase up to$3,000,000 of the outstanding common stock of the Company.  The plan states that stock repurchases may bemade from time to time on the open market or through privately negotiatedtransactions.  The timing of purchasesand the exact number of shares to be purchased depends on marketconditions.  The share repurchase plandoes not include specific price targets or timetables and may be suspended atany time.

 

**For theQuarter Ended September 30, 2004**

 

**ISSUER PURCHASES OF EQUITY SECURITIES**

 
| **Period**           | ** ** | **(a) Total Number   of Shares  purchased** | ** ** | **(b) Average  Price Paid per  Share** | ** ** | **(c) Total Number of  Shares of Publicly  Announced Plan** | ** ** | **(d) Maximum Dollar Value  of Shares that May Yet Be  Purchased Under the Plan** | ** ** |
|----------------------|------------|---------------------------------------------|------------|----------------------------------------|------------|-------------------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|
| Month #1             |       |                                        |       |                                   |       |                                                        |       |                                                                              |       |
| July 1, 2004 to      |       |                                        |       |                                   |       |                                                        |       |                                                                              |       |
| July 31, 2004        |       |                                        |       |                                   |       |                                                        |       |                                                                              |       |
| Month #2             |       |                                        |       |                                   |       |                                                        |       |                                                                              |       |
| August 1, 2004 to    |       |                                        |       |                                   |       |                                                        |       |                                                                              |       |
| August 31, 2004      |       | 5,000                                       |       | 25.45                                  |       | 5,000                                                       |       | 2,548,843                                                                         |       |
| Month #3             |       |                                        |       |                                   |       |                                                        |       |                                                                              |       |
| September 1, 2004 to |       |                                        |       |                                   |       |                                                        |       |                                                                              |       |
| September 30, 2004   |       | 2,015                                       |       | 25.35                                  |       | 2,015                                                       |       | 2,497,763                                                                         |       |

 

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Item3.  Defaults Upon Senior Securities.

 

None

 

Item4.  Submission of Matters to a Vote ofSecurity Holders.

 

None

 

Item5.  Other Information.

 

None

 

Item 6.  Exhibits

 

(a)  Exhibits

 
| **Exhibit  Number** | ** ** | **Document  Description**                                                        |
|---------------------|------------|----------------------------------------------------------------------------------|
|                |       |                                                                             |
| (31.1)              |       | Certification  of CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|                |       |                                                                             |
| (31.2)              |       | Certification  of CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|                |       |                                                                             |
| (32.1)              |       | Certification  of CEO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|                |       |                                                                             |
| (32.2)              |       | Certification  of CFO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

(b)  Reports on Form 8-K

 

On July 16, 2004 the Company filed a Report on Form 8-k announcingsecond quarter earnings for 2004.

 

On September 10, 2004 the Company filed a Report on form 8-k announcinga seven and one half cent per share Cash Dividend for shareholders of record onSeptember 30, 2004 payable October 22, 2004.

 

**SIGNATURES**

 

Pursuant tothe requirements of the Securities and Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 
|               |   | COMMUNITY  VALLEY BANCORP           |   |
|--------------------|--------|-------------------------------------|--------|
|               |   |                                |   |
| November 10,  2004 |   | By: /s/ *Keith C. Robbins*          |   |   |
|               |   |                                |   |
|               |   | Keith C.  Robbins                   |   |
|               |   |                                |   |
|               |   | President,  Chief Executive Officer |   |
|               |   |                                |   |
| November 10,  2004 |   | By*: /s/ John F. Coger*             |   |   |
|               |   |                                |   |
|               |   | John F. Coger                       |   |
|               |   |                                |   |
|               |   | Executive Vice President, CFO/COO   |   |
|                    |        |                                     |        |  |  |

 

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