**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-Q**

 

**ý****   QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the Quarterly PeriodEnded   March 31, 2004**

 

**o****   TRANSITION REPORT PURSUANT TOSECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**Commission File No. 0-31525**

 

**COMMUNITY VALLEY BANCORP**

(Exact name of registrant as specified in itscharter)

 

| **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 Actof 1934 during the preceding 12 months (or such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements 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 – 3,641,457 shares outstanding atApril 30, 2004.

 

 

----

 

PART 1-FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

 

COMMUNITY VALLEY BANCORP

CONSOLIDATED BALANCE SHEET (Unaudited)

 
| **(In thousands)**                                                                                                                                                                     |   | **March 31,  2004** |    | **December 31,  2003** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|---------|-----------------------------|--------|
| ASSETS                                                                                                                                                                                 |   |                     |    |                        |   |
|                                                                                                                                                                                   |   |                     |    |                        |   |
| Cash and due from banks                                                                                                                                                                |   | $                        | 24,367  |                        | $      | 26,205 |   |
| Federal funds sold                                                                                                                                                                     |   | 52,450                   |    | 50,605                      |   |
| Interest-bearing deposits in banks                                                                                                                                                     |   | 8,617                    |    | 7,925                       |   |
| Investment securities (market value of  $4,725 at March 31, 2004 and $4,326 at December 31, 2003)                                                                            |   | 4,684                    |    | 4,325                       |   |
| Loans held for sale                                                                                                                                                                    |   | 3,459                    |    | 2,279                       |   |
| Loans, less allowance for loan losses of $3,822  at March 31, 2004 and $3,587 at December 31, 2003                                                                           |   | 279,914                  |    | 270,231                     |   |
| Bank premises and equipment, net                                                                                                                                                       |   | 8,831                    |    | 8,554                       |   |
| Accrued interest receivable and other  assets                                                                                                                                          |   | 15,378                   |    | 16,599                      |   |
|                                                                                                                                                                                   |   | $                        | 397,700 |                        | $      | 386,723 |   |
|                                                                                                                                                                                   |   |                     |    |                        |   |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                                                                              |   |                     |    |                        |   |
|                                                                                                                                                                                   |   |                     |    |                        |   |
| Deposits:                                                                                                                                                                              |   |                     |    |                        |   |
| Non-interest bearing                                                                                                                                                                   |   | $                        | 69,750  |                        | $      | 68463 |   |
| Interest bearing                                                                                                                                                                       |   | 282,085                  |    | 274,048                     |   |
| Total deposits                                                                                                                                                                         |   | 351,835                  |    | 342,511                     |   |
|                                                                                                                                                                                   |   |                     |    |                        |   |
| Employee stock ownership plan note payable                                                                                                                                             |   | 795                 |    | 832                         |   |
|                                                                                                                                                                                   |   |                     |    |                        |   |
| Subordinated debentures                                                                                                                                                                |   | 8,248                    |    | 8,248                       |   |
|                                                                                                                                                                                   |   |                     |    |                        |   |
| Accrued interest payable and other  liabilities                                                                                                                                        |   | 5,768                    |    | 5,183                       |   |
|                                                                                                                                                                                   |   |                     |    |                        |   |
| Total liabilities                                                                                                                                                                      |   | 366,646                  |    | 356,774                     |   |
|                                                                                                                                                                                   |   |                     |    |                        |   |
| Commitments and contingencies                                                                                                                                                          |   |                     |    |                        |   |
|                                                                                                                                                                                   |   |                     |    |                        |   |
| Shareholders’ equity:                                                                                                                                                             |   |                     |    |                        |   |
| Common stock – no par value; 20,000,000  shares authorized; issued and outstanding – 3,638,912 shares at  March 31, 2004 and 3,621,824 shares at December 31, 2003 |   | 7,544               |    | 7,272                       |   |
| Unearned ESOP shares (88,950 shares at  March 31, 2004 and 90,909 shares at December 31, 2003, at cost)                                                                           |   | (1,051                   | )       | (1,071                      | )      |
|                                                                                                                                                                                   |   |                     |    |                        |   |
| Retained earnings                                                                                                                                                                      |   | 24,561                   |    | 23,746                      |   |
|                                                                                                                                                                                   |   |                     |    |                        |   |
| Accumulated other comprehensive income  (Note 3)                                                                                                                                       |   |                     |    | 2                           |   |
|                                                                                                                                                                                   |   |                     |    |                        |   |
| Total shareholders’ equity                                                                                                                                                        |   | 31,054                   |    | 29,949                      |   |
|                                                                                                                                                                                   |   | $                        | 397,700 |                        | $      | 386,723 |   |

 

See Notes to Unaudited Consolidated Financial Statements

 

2

----

 

COMMUNITY VALLEY BANCORP

CONSOLIDATED STATEMENT OF INCOME(Unaudited)

 
| **(In thousands, except per share  data)**                       |   |     |       |     |       |
|------------------------------------------------------------------|--------|----------|------------|----------|------------|
| **For the 3 months ended  March 31,**                       |   | **2004** |       | **2003** |       |
|                                                             |   |     | ** ** |     | ** ** |
| Interest income:                                                 |   |     |       |     |       |
| Interest and fees on loans                                       |   | $        | 5,357      |     | $          | 4,775 |   |
| Interest on federal funds sold                                   |   | 122      |       | 182      |       |
| Interest on deposits in banks                                    |   | 58       |       | 41       |       |
| Interest and dividends on investment  securities:                |   |     |       |     |       |
| Taxable                                                          |   | 28       |       | 36       |       |
| Exempt from Federal income taxes                                 |   | 10       |       | 19       |       |
|                                                             |   |     |       |     |       |
| Total interest income                                            |   | 5,575    |       | 5,053    |       |
| Interest expense:                                                |   |     |       |     |       |
| Interest on deposits                                             |   | 878      |       | 1,013    |       |
| Interest on long-term debt                                       |   | 110      |       | 138      |       |
| Total interest expense                                           |   | 988      |       | 1,151    |       |
|                                                             |   |     |       |     |       |
| Net interest income                                              |   | 4,587    |       | 3,902    |       |
|                                                             |   |     |       |     |       |
| Provision for loan losses                                        |   | 225      |       | 150      |       |
| Net interest income after provision for  loan losses             |   | 4,362    |       | 3,752    |       |
|                                                             |   |     |       |     |       |
| Non-interest income                                              |   | 1,229    |       | 1,183    |       |
|                                                             |   |     |       |     |       |
| Non-interest expense:                                            |   |     |       |     |       |
| Salaries and employee benefits                                   |   | 2,279    |       | 2,138    |       |
| Occupancy                                                        |   | 239      |       | 172      |       |
| Furniture and equipment                                          |   | 373      |       | 240      |       |
| Other expense                                                    |   | 896      |       | 670      |       |
| Total non-interest expense                                       |   | 3,787    |       | 3,220    |       |
|                                                             |   |     |       |     |       |
| Income before income taxes                                       |   | 1,804    |       | 1,715    |       |
|                                                             |   |     |       |     |       |
| Income taxes                                                     |   | 716      |       | 678      |       |
|                                                             |   |     |       |     |       |
| Net income                                                       |   | $        | 1,088      |     | $          | 1,037 |   |
|                                                             |   |     |       |     |       |
| Basic earnings per share (Note 2)                                |   | $        | .31        |     | $          | .30 |   |
| Diluted earnings per share (Note 2)                              |   | $        | .29        |     | $          | .28 |   |
|                                                             |   |     |       |     |       |
| Cash dividends per share of issued and  outstanding common stock |   | $        | .075       |     | $          | .075 |   |

 

See Notes to Unaudited Consolidated Financial Statements

 

3

----

 

COMMUNITY VALLEY BANCORP

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

(In thousands except number of shares)

 
|                                                         |   |              |       |       |       |         |       |              |       | **Accumulated**        |       |              |   |       |       |
|--------------------------------------------------------------|--------|-------------------|------------|------------|------------|--------------|------------|-------------------|------------|------------------------|------------|-------------------|--------|------------|------------|
|                                                         |   |              |       |       |       | **Unearned** |       |              |       | **Other**              |       |              |   |       |       |
|                                                         |   | **Common  Stock** |       | **ESOP**   |       | **Retained** |       | **Comprehensive** |       | **Shareholders’** |       | **Comprehensive** |   |
|                                                         |   | **Shares**        | ** ** | **Amount** | ** ** | **Shares**   | ** ** | **Earnings**      | ** ** | **Income**             | ** ** | **Equity**        |   | **Income** | ** ** |
|                                                         |   |              |       |       |       |         |       |              |       |                   |       |              |   |       |       |
| 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:                                    |   |              |       |       |       |         |       |              |       |                   |       |              |   |       |       |
| 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 (Note 15)                                 |   |              |       | 150        |       | 102          |       |              |       |                   |       | 252               |   |       |       |
| Shares acquired or redeemed by ESOP (Note 15)                |   |              |       |       |       | (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                                                   |   |              |       |       |       |         |       | 1,088             |       |                   |       | 1,088             |   | $          | 1,088      |   |
| Other comprehensive loss, net of tax:                        |   |              |       |       |       |         |       |              |       |                   |       |              |   |       |       |
| Unrealized loss on available-for-sale investment  securities |   |              |       |       |       |         |       |              |       | (2                     | )          | (2                | )      | (2         | )          |
|                                                         |   |              |       |       |       |         |       |              |       |                   |       |              |   |       |       |
| Total comprehensive income                                   |   |              |       |       |       |         |       |              |       |                   |       |              |   | $          | 1,086      |   |
|                                                         |   |              |       |       |       |         |       |              |       |                   |       |              |   |       |       |
| Exercise of stock options and related tax benefit            |   | 17,088            |       | 248        |       |         |       |              |       |                   |       | 248               |   |       |       |
|                                                         |   |              |       |       |       |         |       |              |       |                   |       |              |   |       |       |
| Earned ESOP shares                                           |   |              |       | 24         |       | 20           |       |              |       |                   |       | 44                |   |       |       |
|                                                         |   |              |       |       |       |         |       |              |       |                   |       |              |   |       |       |
| Cash dividends declared                                      |   |              |       |       |       |         |       | (273              | )          |                   |       | (273              | )      |       |       |
|                                                         |   |              |       |       |       |         |       |              |       |                   |       |              |   |       |       |
| Balance, March 31, 2004                                 |   | 3,638,912         |       | $          | 7,544      |         | $          | (1,051            | )          | $                      | 24,561     |              | $      | 0          |       | $ | 31,054 |   |   |   |

 

See Notes to Unaudited Consolidated Financial Statements

 

4

----

 

COMMUNITY VALLEY BANCORP

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

 

## **(In thousands)**

## **For the three months endedMarch 31,**

 
|                                                                               |   | **2004** |   | **2003** |   |
|------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|
| Cash flows from operating activities:                                              |   |     |   |     |   |
| Net income                                                                         |   | $        | 1,088  |     | $      | 1,037 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |   |     |   |     |   |
| Provision for loan losses                                                          |   | 225      |   | 150      |   |
| Deferred loan origination costs, net                                               |   | (126     | )      | (158     | )      |
| Depreciation and amortization                                                      |   | 312      |   | 210      |   |
| Net (increase) decrease in loans held for  sale                                    |   | (1,180   | )      | 2,670    |   |
| (Increase) in cash surrender value of life  insurance                              |   | (19      | )      | (49      | )      |
| Non-cash compensation expense associated  with the ESOP                            |   | 45       |   | 39       |   |
| Decrease in accrued interest receivable and  other assets                          |   | 1,359    |   | 1,052    |   |
| Decrease (increase) in accrued interest  payable and other liabilities             |   | 583      |   | (1,038   | )      |
|                                                                               |   |     |   |     |   |
| Net cash provided by operating activities                                          |   | 2,212    |   | 3,913    |   |
|                                                                               |   |     |   |     |   |
| Cash flows from investing activities:                                              |   |     |   |     |   |
|                                                                               |   |     |   |     |   |
| Net increase in interest-bearing deposits  in banks                                |   | (692     | )      | (1,090   | )      |
| Proceeds from called available-for-sale investment  Securities                     |   | 300      |   |     |   |
| Proceeds from called held-to-maturity  investment securities                       |   | 250      |   | 1,000    |   |
| Purchase of held-to-maturity investment  securities                                |   | (927     | )      | (1,311   | )      |
| Purchases of bank premises and equipment                                           |   | (574     | )      | (243     | )      |
| Net (increase in loans)                                                            |   | (9,707   | )      | (2,491   | )      |
|                                                                               |   |     |   |     |   |
| Net cash (used in) provided by investing  activities                               |   | (11,350  | )      | (4,135   | )      |
|                                                                               |   |     |   |     |   |
| Cash flows from financing activities:                                              |   |     |   |     |   |
|                                                                               |   |     |   |     |   |
| Net increase in demand, interest-bearing  and savings deposits                     |   | $        | 9,374  |     | $      | 2,158 |   |
| Net (increase) decrease in time deposits                                           |   | (50      | )      | 2,972    |   |
| Proceeds from repayment of ESOP loan, net                                          |   | (36      | )      | 48       |   |
| Payment of cash dividends                                                          |   | (278     | )      | (269     | )      |
| Exercise of stock options                                                          |   | 135      |   | 58       |   |
| Purchase of unearned ESOP shares                                                   |   |     |   | (78      | )      |
|                                                                               |   |     |   |     |   |
| Net cash provided by in financing  activities                                      |   | 9,145    |   | 4,889    |   |
|                                                                               |   |     |   |     |   |
| Increase in cash and cash equivalents                                              |   | 7        |   | 4,667    |   |
|                                                                               |   |     |   |     |   |
| Cash and cash equivalents at beginning of  year                                    |   | 76,810   |   | 73,031   |   |
|                                                                               |   |     |   |     |   |
| Cash and cash equivalents at end of period                                         |   | $        | 76,817 |     | $      | 77,698 |   |

 

See Notes to Unaudited Consolidated Financial Statements

 

5

----

 

**Community Valley Bancorp and Subsidiaries**

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

1. BASIS OF PRESENTATION

 

The accompanying unaudited consolidated financial statements ofCommunity Valley Bancorp and subsidiaries (the “Company”) have been prepared inaccordance with accounting principles generally accepted in the United Statesof America for interim financial information and with the instructions to Form10-Q and Article 10 of Regulation S-X. In the opinion of management, all adjustments (which consist solely ofnormal recurring accruals) considered necessary for a fair presentation of theresults for the interim periods presented have been included.  These interim consolidated financialstatements should be read in conjunction with the financial statements andrelated notes contained in the Company’s 2003 Annual Report to Shareholders onForm 10-K.

 

The consolidated financial statements include the accounts of theCompany and its wholly owned bank subsidiary, Butte Community Bank. Allsignificant inter-company balances and transactions have been eliminated inconsolidation.  The results of operationsfor the three-month period ended March 31, 2004 may not necessarily beindicative of the operating results for the full year 2004.

 

2.  EARNINGS PER SHARECOMPUTATION

 

Basic earnings per share are computed by dividing net income by theweighted average common shares outstanding for the period (3,540,713 shares forthe three month period ended March 31, 2004 and 3,500,360 shares for thethree month period ended March 31, 2003). Diluted earnings per share reflect the potential dilution that couldoccur if outstanding stock options were exercised using the treasury stockmethod.   Diluted earnings per share iscomputed by dividing net income by the weighted average common sharesoutstanding for the period plus the dilutive effect of options (271,007 sharesfor the three-month period ended March 31, 2004 and 177,568 shares for thethree-month period ended March 31, 2003). Earnings per share are retroactively adjusted for stock splits anddividends for all periods presented.

 

3.  COMPREHENSIVE INCOME

 

Comprehensiveincome is reported in addition to net income for all periods presented.  Comprehensive income is made up of netincome plus other comprehensive income. Other comprehensive income, net of taxes, is comprised of changes inunrealized gains or losses, net of taxes, on available-for-sale securities,adjusted for the effect of realized gains or losses on available-for-salesecurities, net of taxes. Total comprehensive income for the three-month periodended March 31, 2004 was $1,086,000. The Company experienced a $2,000unrealized loss in other comprehensive income during the three months endedMarch 31, 2004.

 

## **4.**  STOCK –BASED COMPENSATION

 

The Company issues stock options under three stock-based compensationplans, the Community Valley Bancorp 1991, 1997 and 2000 Stock OptionPlans.  The Company accounts for theseplans under the recognition and measurement principles of APB Opinion No. 25, *Accountingfor Stock Issued to Employees*, and related Interpretations.  No stock-based compensation cost isreflected in net income, as all options granted under these plans had anexercise price equal to the market value of the underlying common stock on thedate of grant.  In accordance withFinancial Accounting Standards Board (“FASB”) No. 148, *Accounting for Stock-Based Compensation – Transitionand Disclosure, an Amendment of FASB No. 12,* the following tableillustrates the effect on net income and earnings per share if the Company hadapplied the fair value recognition provisions of

 

6

----

 

FASB Statement No. 123, *Accounting for Stock-Based Compensation*,to stock-based employee compensation.

 

Pro forma adjustments to the Company’s consolidated net earnings andearnings per share are disclosed during the periods in which the options becomevested. 

 
|                                                                                                                                           |   | **March 31, 2004** |       | **March 31, 2003** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|------------|-------------------------|--------|
|                                                                                                                                           |   |                    |       |                    |   |
| Net earnings  as reported                                                                                                                      |   | $                       | 1,088,200  |                    | $      | 1,036,800 |   |
|                                                                                                                                           |   |                    |       |                    |   |   |   |
| Deduct:  Total stock-based compensation expense  determined under the fair value based method for all awards, net of related  tax effects |   | (71,200                 | )          | (64,500                 | )      |
|                                                                                                                                           |   |                    |       |                    |   |
| Pro forma net  income                                                                                                                          |   | $                       | (1,017,000 | )                       | $      | 972,300 |   |
|                                                                                                                                           |   |                    |       |                    |   |
| Basic earnings  per share - as reported                                                                                                        |   | $                       | 0.31       |                    | $      | 0.30 |   |
|                                                                                                                                           |   |                    |       |                    |   |
| Basic earnings  per share - pro forma                                                                                                          |   | $                       | 0.29       |                    | $      | 0.28 |   |
|                                                                                                                                           |   |                    |       |                    |   |
| Diluted  earnings per share - as reported                                                                                                      |   | $                       | 0.29       |                    | $      | 0.28 |   |
|                                                                                                                                           |   |                    |       |                    |   |
| Diluted  earnings per share - pro forma                                                                                                        |   | $                       | 0.27       |                    | $      | 0.26 |   |

 

7

----

 

**Item 2. MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OFCOMMUNITY VALLEY BANCORP**

 

The following is Community Valley Bancorp’s (the “Company”)management’s discussion and analysis of the significant changes in balancesheet accounts for March 31, 2004 and December 31, 2003 and incomeand expense accounts for the three-month period ended March 31, 2004 and2003. 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 contained herein, this reporton Form 10-Q contains certain forward-looking statements.  The reader of this report should understandthat all such forward-looking statements are subject to various uncertaintiesand risks that could affect their outcome.  The Company’s actual results could differ materially from thosesuggested by such forward-looking statements. Factorsthat could cause or contribute to such differences include, but are not limitedto, variances in the actual versus projected growth in assets, return onassets, loan losses, expenses, rates charged on loans and earned on securitiesinvestments, rates paid on deposits, competition effects, fee and othernoninterest income earned, general economic conditions, nationally, regionallyand in the operating market areas of the Company and its subsidiaries, changesin the regulatory environment, changes in business conditions and inflation,changes in securities markets, data processing problems, a decline inreal estate values in the Company’s market area,  the effects of terrorism,including the events of September 11, 2001 and thereafter, and the conductof the war on terrorism by the United States and its allies, as well as other factors. Thisentire report should be read putting such forward-looking statements incontext.

 

## **GeneralDevelopment of Business**

 

The Company is a bank holding company registered under the Bank HoldingCompany Act of 1956, as amended. The Company was incorporated under the laws ofthe State of California in 2002.  As abank holding company, the Company is authorized to engage in the activitiespermitted under the Bank Holding Company Act of 1956, as amended, andregulations thereunder.** **Itsprincipal office is located at 2041 Forest Avenue, Chico, California 95928 andits telephone number is (530) 899-2344.

 

The Company owns 100% of the issued and outstanding common shares ofButte Community Bank.  Butte CommunityBank was incorporated and commenced business in Paradise and Oroville,California in 1990.  Butte CommunityBank operates seven full service offices within its primary service areas ofButte and Sutter Counties.  The Bankalso maintains a Loan Production Offices in Citrus Heights and Redding. ButteCommunity Bank’s primary business is serving the commercial banking needs ofsmall to mid-sized businesses and consumers within those counties.  Butte Community Bank accepts checking andsavings deposits, offers money market deposit accounts and certificates of deposit,makes secured and unsecured commercial, secured real estate, and otherinstallment and term loans and offers other customary banking services.

 

**Overview**

 

The Company recorded net income of $1,088,000 for the quarter endedMarch 31, 2004, which was a 5% increase from the $1,037,000 reported forthe same period of 2003.  Dilutedearnings per share for the first quarter of 2004 were $0.29, compared to the$0.28 recorded in the first quarter of 2003. The return on average equity (ROAE) and the return on average assets(ROA) for the first quarter of 2003 were 14.13% and 1.12%, respectively, ascompared to 15.78% and 1.24%, respectively, for the same period in 2003.  The primary reason for the increase inincome was due to significant growth in earning assets. Total assets of theCompany increased by $10,977,000 or (2.8%) from December 31, 2003 to$397,700,000 at March 31, 2004. Net loans totaled $279,914,000, up $9,683,000 (3.6%) from the endingbalances on December 31, 2003. Deposit balances at March 31, 2004 totaled $351,835,000 up$9,324,000 (2.7%) from December 31, 2003. This discussion and analysis of operations should be read in conjunctionwith the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2003.

 

8

----

 

The Company ended the first quarter of 2004 with a Tier 1 risk basedcapital ratio of 12.2% and a total risk-based capital ratio of 13.4% versus12.2% and 13.3%, respectively, at December 31, 2003.

 

Table One below provides a summary of the components of net income forthe periods indicated:

 

**Table One:  Components of Net Income**

 
|                                                             |   | **Three  months ended  March 31,** |       |
|------------------------------------------------------------------|--------|-----------------------------------------|------------|
| **(In thousands, except  percentages)**                          |   | **2004**                                | ** ** | **2003** | ** ** |
|                                                             |   |                                    |       |   |   |
| Net interest income                                              |   | $                                       | 4,587      |   | $ | 3,902 |   |
| Provision for loan losses                                        |   | (225                                    | )          | (150 | ) |
| Non-interest income                                              |   | 1,229                                   |       | 1,183 |   |
| Non-interest expense                                             |   | (3,787                                  | )          | (3,220 | ) |
| (Provision for) income taxes                                     |   | (716                                    | )          | (678 | ) |
|                                                             |   |                                    |       |   |   |
| Net income                                                       |   | $                                       | 1,088      |   | $ | 1,037 |   |
|                                                             |   |                                    |       |   |   |
| Average total assets (In millions)                               |   | $                                       | 390.1      |   | $ | 335.6 |   |
| Net income (annualized) as a percentage of  average total assets |   | 1.12                                    | %          | 1.24 | % |

 

**Results of Operations**

## **Net InterestIncome and Net Interest Margin**

 

Net interest income represents the excess of interest and fees earnedon interest earning assets (loans, securities, federal funds sold and investmentsin time deposits) over the interest paid on deposits and borrowed funds.  Net interest margin is net interest incomeexpressed as a percentage of average earning assets.

 

The Company’s net interest margin was 5.40% for the three months endedMarch 31, 2004 and 5.15% for the three months ended March 31,2003.  Net interest income increased$686,000 (17.6%) for the first quarter of 2004 compared to the same period in2003.  The primary reason for thisincrease was the loan growth and the resulting interest income and feesassociated with that growth together with the decrease in the interest ratespaid on deposits.

 

Interest expense was $163,000 (16.5%) lower in the first quarter of2004 versus the prior year period. The average balances of interest bearingliabilities were $35,483,000 (14.2%) higher in the first quarter of 2004 versusthe same quarter in 2003. Even though the interest bearing balances increased,rates paid on these liabilities decreased 48 basis points on a quarter overquarter basis.  The reason for thisdecrease was the ability of management to channel the growth of the depositsaway from higher interest rate certificates of deposit to lower rate demanddeposits and to lower the average cost of certificates of deposit as highercost deposits were re-priced in a lower rate environment.

 

Table Two, Analysis of Net Interest Margin on Earning Assets, 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 on earning assetssetting forth average assets, liabilities and shareholders’ equity; interestincome earned and interest expense paid and average rates earned and paid; andthe net interest margin on earning assets.

 

9

----

 

**Table Two:  Analysis of Net Interest Margin on EarningAssets (Unaudited)**

 
| **Three Months Ended March 31,  (In thousands, except percentages)** |             | **2004** |         | **2003** |               |
|---------------------------------------------------------------------------|------------------|----------|--------------|----------|--------------------|
|                                                                      | **Avg  Balance** |     | **Interest** |     | **Avg  Yield (4)** |   | **Avg  Balance** |   | **Interest** |   | **Avg  Yield (4)** |   |
| **Assets:**                                                               |             |     |         |     |               |   |   |   |   |   |   |   |   |
| Earning assets                                                            |             |     |         |     |               |   |   |   |   |   |   |   |   |
| Loans (1)                                                                 |             | $        | 278,857      |     | $                  | 5,357 |   | 7.71 | % | $ | 239,134 |   | $ | 4,775 |   | 8.10 | % |
| Taxable investment securities                                             |             | 3,277    |         | 28       |               | 3.43 | % | 2,293 |   | 36 |   | 6.37 | % |
| Tax-exempt investment securities (2)                                      |             | 740      |         | 10       |               | 5.42 | % | 1,090 |   | 19 |   | 7.07 | % |
| Federal funds sold                                                        |             | 49,618   |         | 122      |               | 0.99 | % | 59,866 |   | 182 |   | 1.23 | % |
| Investments in time deposits                                              |             | 8,247    |         | 58       |               | 2.82 | % | 4,678 |   | 41 |   | 3.55 | % |
| Total earning assets                                                      |             | 340,739  |         | $        | 5,575              |   | 6.56 | % | 307,061 |   | $ | 5,053 |   | 6.67 | % |
| Cash & due from banks                                                 |             | 13,202   |         |     |               |   |   | 13,901 |   |   |   |   |   |
| Other assets                                                              |             | 36,168   |         |     |               |   |   | 14,668 |   |   |   |   |   |
| Average total assets                                                      |             | $        | 390,109      |     |               |   |   |   | $ | 335,630 |   |   |   |   |   |
|                                                                      |             |     |         |     |               |   |   |   |   |   |   |   |   |
| **Liabilities & Shareholders’ Equity**                           |             |     |         |     |               |   |   |   |   |   |   |   |   |
| Interest bearing liabilities:                                             |             |     |         |     |               |   |   |   |   |   |   |   |   |
| NOW & MMDA                                                            |             | $        | 166,728      |     | $                  | 302 |   | 0.73 | % | $ | 136,902 |   | $ | 358 |   | 1.06 | % |
| Savings                                                                   |             | 25,894   |         | 32       |               | 0.50 | % | 20,530 |   | 37 |   | .73 | % |
| Time deposits                                                             |             | 84,712   |         | 544      |               | 2.58 | % | 84,496 |   | 618 |   | 2.97 | % |
| Other borrowings                                                          |             | 8,811    |         | 110      |               | 5.01 | % | 8,734 |   | 138 |   | 6.41 | % |
| Total interest bearing liabilities                                        |             | 286,145  |         | $        | 988                |   | 1.38 | % | 250,662 |   | $ | 1,151 |   | 1.86 | % |
|                                                                      |             |     |         |     |               |   |   |   |   |   |   |   |   |
| Demand deposits                                                           |             | 65,129   |         |     |               |   |   | 54,605 |   |   |   |   |   |
| Other liabilities                                                         |             | 8,045    |         |     |               |   |   | 4,073 |   |   |   |   |   |
| Total liabilities                                                         |             | 359,319  |         |     |               |   |   | 309,340 |   |   |   |   |   |
| Shareholders’ equity                                                 |             | 30,790   |         |     |               |   |   | 26,290 |   |   |   |   |   |
| Average liabilities and equity                                            |             | $        | 390,109      |     |               |   |   |   | $ | 335,630 |   |   |   |   |   |
| Net interest income & margin (3)                                      |             |     |         | 4,587    |               | 5.40 | % |   |   | $ | 3,902 |   | 5.15 | % |

 

----

(1)                                  Loan interestincludes loan fees of $532,000 and $480,000 during the three months endedMarch 31, 2004 and March 31, 2003, respectively.

(2)                                  Does not includetaxable-equivalent adjustments that primarily relate to income on certainsecurities that is exempt from federal income taxes.

(3)                                  Net interest marginis computed by dividing net interest income by total average earning assets.

(4)                                  Average yield iscalculated based on actual days in quarter (91 for March 31, 2004 and 90for March 31, 2003) and annualized to actual days in year (366 for 2004and 365 for 2003).

 

10

----

 

Table Three sets forth asummary of the changes in interest income and interest expense from changes inaverage asset and liability balances (volume) and changes in average interestrates.  On a year to date basis throughMarch 31, 2004 net interest income has increased $685,000 over the same timeperiod in 2003.  Interest income fromearning assets has increased by $522,000. Changes in the volume of earningassets, primarily loans, have resulted in an increase in interest income of$811,000 while interest income from changes in rates has decreased by $289,000.  Interest expense for the first three monthsof 2004 is $163,000 less than the same time period in 2003.  Changes in the volume of interest bearingliabilities, primarily the stabilization of balances in certificates of depositand the increase in balances of demand deposits, as well as the addition ofinterest expense related to the subordinated debentures, have resulted in a netincrease of interest expense of $92,000. Decreases in average rates paid, primarily on certificates of depositand demand deposits have resulted in an interest expense reduction of $255,000.

 

**TableThree:  Analysis of Volume and RateChanges on Net Interest Income and Expenses (Unaudited)**

 

(In thousands) Three MonthsEnded March 31, 2004 over 2003

 

Increase (decrease) due tochange in:

 
|                                 |   | **Volume** |   | **Rate (3)** |   | **Net Change** |   |
|--------------------------------------|--------|------------|--------|--------------|--------|----------------|--------|
| Interest-earning assets:             |   |       |   |         |   |           |   |
| Net loans (1)                        |   | $          | 800    |         | $      | (218           | )      | $ | 582 |   |
| Taxable investment securities        |   | 16         |   | (24          | )      | (8             | )      |
| Tax exempt investment securities (2) |   | (6         | )      | (3           | )      | (9             | )      |
| Federal funds sold                   |   | (31        | )      | (29          | )      | (60            | )      |
| Investment in time deposits          |   | 32         |   | (15          | )      | 17             |   |
| Total                                |   | 811        |   | (289         | )      | 522            |   |
|                                 |   |       |   |         |   |           |   |
| Interest-bearing liabilities:        |   |       |   |         |   |           |   |
| NOW and MMDA deposits                |   | 79         |   | (135         | )      | (56            | )      |
| Savings deposits                     |   | 10         |   | (15          | )      | (5             | )      |
| Time deposits                        |   | 2          |   | (76          | )      | (74            | )      |
| Other borrowings                     |   | 1          |   | (29          | )      | (28            | )      |
| Total                                |   | 92         |   | (255         | )      | (163           | )      |
| Interest differential                |   | $          | 719    |         | $      | 34             |   | $ | 685 |   |

 

----

(1)               The average balance of non-accruingloans is immaterial as a percentage of total loans and, as such, has beenincluded in net 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 beenincluded in the rate variance.

 

11

----

 

## **Provision for LoanLosses**

 

The Company provided $225,000 for loan and lease losses for the firstquarter of 2004 as compared to $150,000 for the first quarter of 2003.  Net loan recoveries of $10,000 for the threemonths ended March 31, 2004 compared to $3,000 in charge-offs for thethree months ended March 31, 2003.

 

## **Non-interestIncome**

## ** **

Table Four below provides a summary of the components of noninterestincome for the periods indicated (dollars in thousands):

 

**TableFour:  Components of Noninterest Income(Unaudited)**

 
| **Three Months Ended March 31,** |   | **2004** |   | **% of Avg.  Assets** |   | **2003** |   | **% of Avg.  Assets** |   |
|---------------------------------------|--------|----------|--------|-----------------------|--------|----------|--------|-----------------------|--------|
|                                  |   |     |   |                  |   |     |   |                  |   |
| Service charges on deposit accounts   |   | $        | 453    |                  | 0.47   | %        | $      | 258                   |   | 0.31 | % |
| Loan servicing fees                   |   | 92       |   | 0.09                  | %      | 100      |   | 0.12                  | %      |
| Fees - alternative investment sales   |   | 137      |   | 0.14                  | %      | 20       |   | 0.02                  | %      |
| Merchant fee income                   |   | 84       |   | 0.09                  | %      | 106      |   | 0.13                  | %      |
| Gain on the sale of loans             |   | 246      |   | 0.25                  | %      | 493      |   | 0.59                  | %      |
| Other                                 |   | 217      |   | 0.22                  | %      | 206      |   | 0.25                  | %      |
|                                  |   |     |   |                  |   |     |   |                  |   |
| Total non-interest income             |   | $        | 1,229  |                  | 1.26   | %        | $      | 1,183                 |   | 1.42 | % |

## ** **

## **Non-interest income was up $46,000(3.9%) to $1,229,000 for the three months ended March 31, 2004 as comparedto $1,183,000 for the three months ended March 31, 2003.  The major reason for the increases innon-interest income were from fees realized from service charges on depositaccounts (up 75.6%), and fees from alternative investment sales commissions (up585%).  The increase in service chargeincome was the result of additional deposit accounts opened during the firstquarter and fees resulting from the overdraft privilege deposit productimplemented in August of 2003. The Investment Department, which sellsthird-party mutual funds and annuities, experienced an increase in fees due toan increase in sales during the first quarter. Loan servicing income and gains on the sale of loans declined as aresult of fewer loans being sold on the secondary market through FNMA (FannieMae) as many customers of the Company had already taken advantage of the lowlevels in mortgage financing rates during 2003.**

 

12

----

 

**Non-interest Expense**

 

Non-interest expense increased $567,000(17.6%) to $3,787,000 in the first quarter of 2004 versus $3,220,000 in thefirst quarter of 2003.  On a quarterover quarter basis, full time equivalent employees increased by 23.  Salary and employee benefits increased$141,000 (6.6%) resulting from normal cost of living raises, commissions paidto Butte Community Bank’s Real Estate Loan agents and staffing additions madeduring the year as the Company continues to grow and implement the newtechnology acquired during the year. Benefit costs and employer taxes increased commensurate with thesalaries.    On a quarter over quarterbasis, occupancy expenses were higher by $67,000 (39%).  This increase in costs is associated withthe opening of the North Paradise office and the construction of the NorthChico office and relocation of the Magalia office in 2003, and is related tobuilding depreciation, utilities, janitorial services and property taxes.   Fixed asset expense was $373,000 in thefirst quarter of 2004 compared to $240,000 in the same period of 2003,representing a 55.4% increase.   Thisincrease relates to technology upgrades made to our core banking systems andthe furniture fixtures and equipment needed to open the three offices mentionedabove. Other expenses increased $226,000 (33.7%) in the first quarter of 2004versus the first quarter of 2003.   Thisincrease was attributed to higher telephone, postage and insurance costs aswell as increased advertising and promotion costs associated with the newoffices.

 

**Provision for IncomeTaxes**

 

The effective tax rate for the first quarter of 2004 was 39.7%, versus39.5% for the same period in 2003.

 

**Balance SheetAnalysis**

 

The Company’s total assets were $397,700,000 at March 31, 2004 ascompared to $386,723,000 at December 31, 2003, representing an increase of2.8%.  The average balance of totalassets for the three months ended March 31, 2004 was $390,109,000, whichrepresents an increase of $54,479,000 (16.2%) over the $335,630,000 during thethree-month period ended March 31, 2003.

 

## **Loans**

## ** **

The Company concentrates its lending activities in the followingprincipal areas: 1) commercial; 2) real estate; 3) residential real estate andreal estate construction (both commercial and residential); 4) agriculture; and5) consumer loans.  Commercial andresidential real estate loans are generally secured by improved property, withoriginal maturities of 3-10 years.  AtMarch 31, 2004, these principal areas accounted for approximately 20%,44%, 20%, 8% and 8%, respectively, of the Company’s loan portfolio.    The mix at December 31, 2003 was 20%,42%, 23%, 8% 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 ($2,743,000 or 5.1%), consumer($319,000 or 1.5%), commercial and residential real estate ($10,127,000 or 8.8%)and agricultural loans ($2,495,000 or 12%) and decreases in real estateconstruction ($5,892,000 or 9.3%). Table Five below summarizes the composition of the loan portfolio as ofMarch 31, 2004 and December 31, 2003.

 

13

----

 

**Table Five: LoanPortfolio Composition (Unaudited)**

 
| **(In thousands)**        |   | **March 31,  2004** |    | **December 31,  2003** |   |
|---------------------------|--------|--------------------------|---------|-----------------------------|--------|
| Commercial                |   | $                        | 56,819  |                        | $      | 54,076 |   |
| Real estate:              |   |                     |    |                        |   |
| Mortgage                  |   | 125,039                  |    | 114,912                     |   |
| Construction              |   | 57,304                   |    | 63,196                      |   |
|                      |   |                     |    |                        |   |
| Agriculture               |   | 23,315                   |    | 20,820                      |   |
| Consumer                  |   | 22,166                   |    | 21,847                      |   |
| Total loans               |   | 284,643                  |    | 274,851                     |   |
| Allowance for loan losses |   | (3,822                   | )       | (3,587                      | )      |
| Deferred loan fees, net   |   | (907                     | )       | (1,033                      | )      |
| Total net loans           |   | $                        | 279,914 |                        | $      | 270,231 |   |

 

The majority of the Company’s loans aredirect loans made to individuals and local businesses.  The Company relies substantially on localpromotional activity and personal contacts by bank officers, directors andemployees to compete with other financial institutions.  The Company makes loans to borrowers whoseapplications include a sound purpose and a viable primary repayment source,generally supported by a secondary source of repayment.

 

Commercial loans consist of credit lines foroperating needs, loans for equipment purchases, working capital, and variousother business loan products.  Consumerloans include a range of traditional consumer loan products such as personallines of credit and loans to finance purchases of autos, boats, recreationalvehicles, mobile homes and various other consumer items.  Construction loans are generally composed ofcommitments to customers within the Company’s service area for construction ofboth commercial properties and custom and semi-custom single-family residences.  Other real estate loans consist primarily ofloans 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,and almonds.  In general, except in thecase of loans with SBA or FMHA guarantees, the Company does not make long-termmortgage loans; however, Butte Community Bank has a residential lendingdivision to assist customers in securing most forms of longer termsingle-family mortgage financing.

 

## **Risk Elements**

## ** **

The Company assesses and manages credit riskon an ongoing basis through a total credit culture that emphasizes excellentcredit quality, extensive internal monitoring and established formal lendingpolicies.  Additionally, the Companycontracts with an outside loan review consultant to periodically review theexisting loan portfolio.  Management believesits ability to identify and assess risk and return characteristics of theCompany’s loan portfolio is critical for profitability and growth.  Management strives to continue its emphasison credit quality in the loan approval process, active credit administrationand regular monitoring.  With this inmind, management has designed and implemented a comprehensive loan review andgrading system that functions to continually assess the credit risk inherent inthe loan portfolio.

 

Ultimately, underlying trends in economic andbusiness cycles may influence credit quality. The Company’s business is concentrated in the Butte and Sutter CountyArea. The economy of these two counties is diversified with professionalservices, manufacturing, agriculture and real estate investment andconstruction.

 

14

----

 

Special emphasis is placed within thecommunities in which the Company has offices (Chico, Paradise, Magalia,Oroville and Yuba City).  The Companyalso maintains loan production offices in the cities of Citrus Heights andRedding.  Single-family residentialconstruction is the primary lending product from the Citrus Heights locationserving the greater Sacramento area. Small Business Administration (SBA) loans and other commercial lendingis the focus in Redding.

 

The Company has significant extensions ofcredit and commitments to extend credit that are secured by real estate.  The ultimate repayment of these loans isgenerally dependent on personal or business cash flows or the sale orrefinancing of the real estate.  TheCompany monitors the effects of current and expected market conditions andother factors on the collectability of real estate loans.  The more significant factors managementconsiders involve the following:  lease,absorption and sale rates; real estate values and rates of return; operatingexpenses; inflation; and sufficiency of collateral independent of the realestate including, in limited instances, personal guarantees.

 

In extending credit and commitments toborrowers, the Company generally requires collateral and/or guarantees assecurity.  The repayment of such loansis expected to come from cash flow or from proceeds from the sale of selectedassets of the borrowers.  The Company’srequirement for collateral and/or guarantees is determined on a case-by-casebasis in connection with management’s evaluation of the creditworthiness of theborrower.  Collateral held varies butmay include accounts receivable, inventory, property, plant and equipment,income-producing properties, residences and other real property.  The Company secures its collateral byperfecting its security interest in business assets, obtaining deeds of trust,or outright possession among other means.

 

## **In management’s judgment, aconcentration exists in real estate loans, which represented approximately 64.1%of the Company’s loan portfolio at March 31, 2004, which reflects animprovement from the 64.8% concentration level at December 31, 2003.  Management believes the concentration tohave no more than the normal risk of collectability; however, a substantialdecline in the economy in general, or a decline in real estate values in theCompany’s primary market areas in particular, could have an adverse impact onthe collectability of these loans and require an increase in the provision forloan losses which could adversely affect the Company’s future prospects,results of operations, profitability and stock price.  Management believes that its lending policies and underwritingstandards will tend to minimize losses in an economic downturn; however, thereis no assurance 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 a significantmajority 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, PastDue and Restructured Loans**

## ** **

Management generally places loans on nonaccrual status when they become90 days past due, unless the loan is well secured and in the process ofcollection.  Loans are charged off when,in the opinion of management, collection appears unlikely.

 

Table Six below sets forth nonaccrual loans as of March 31, 2004and December 31, 2003.  There wereno loans past due 90 days or more and still accruing interest at March 31,2004 or December 31, 2003.

 

15

----

 

**Table Six: Non-Performing Loans (Unaudited)**

 
| **(In thousands)**         |   | **March 31,  2004** |   | **December 31,  2003** |   |
|----------------------------|--------|--------------------------|--------|-----------------------------|--------|
| Nonaccrual:                |   |                     |   |                        |   |
| Commercial                 |   | 36                       |   | 46                          |   |
| Real estate                |   | 79                       |   |                        |   |
| Consumer and other         |   | 10                       |   | 8                           |   |
| Total non-performing loans |   | $                        | 125    |                        | $      | 54 |   |
|                            |        |                          |        |                             |        |  |  |

 

At March 31, 2004, non-performing loans were .04% of totalloans.  The recorded investments inloans that were considered to be impaired totaled three loans with balances of$125,000 at March 31, 2004 and two loans with balances of $54,000 atDecember 31, 2003.  One of thethree impaired loans shown for March 31, 2004 has a U.S. Government guaranteefor 80% of the loan balance.  Theguarantee is for $29,000.  The remainingtwo loans have a very low potential for loss. There were no loan concentrations in excess of 10% of total loans nototherwise disclosed as a category of loans as of March 31, 2004 orDecember 31, 2003.  Management isnot aware of any potential problem loans, which were accruing and current atMarch 31, 2004, where serious doubt exists as to the ability of theborrower to comply with the present repayment terms.

 

## **Allowance for LoanLosses Activity**

## ** **

The provision for loan losses is based upon management’s evaluation ofthe adequacy of the existing allowance for loans outstanding. This allowance isincreased by provisions charged to expense and recoveries and is reduced byloan charge-offs. Management determines an appropriate provision based upon theinteraction of three primary factors: (1) loan portfolio growth, (2) acomprehensive grading and review formula for total loans outstanding, and (3)estimated inherent credit risk in the portfolio.

 

Management establishes general reserve factors for loans based upon anassessment of a credit risk by loan type and loan grade. These reserve factors,which are based on historical loss information, may be adjusted for significantcommercial and real estate loans that are individually evaluated by managementfor specific risk of loss.  In addition,reserve factors ranging from 0.25% to 2.50% are assigned to currentlyperforming loans that are not otherwise graded as Special Mention, Substandardor Doubtful.  These factors are assignedbased on management’s assessment of the following for each identified loantype: (1) inherent credit risk, (2) historical losses and, (3) where theCompany has not experienced losses, historical losses experienced by peerbanks.    Finally, a residual componentis maintained to cover uncertainties that could affect management’s estimate ofprobable losses.  This residualcomponent of the allowance reflects a margin of imprecision inherent in theunderlying assumptions used to estimate losses in specifically graded loans andexpected losses in the performing portfolio.

 

The Loan Committee of the Bank reviews the adequacy of the allowancefor loan losses at least quarterly to include consideration of the relativerisks in the portfolio and current economic conditions.  The allowance is adjusted based on thatreview if, in the judgment of the loan committee and management, changes arewarranted.  The allowance for loanlosses totaled $3,822,000 or 1.35% of loans net of deferred fees atMarch 31, 2004 and $3,587,000 or 1.31% at December 31, 2003.  Net recoveries to average loans were .004%for the first quarter of 2004. Net charge-offs through the first three monthsof 2003 were .0013% of average loans.

 

16

----

 

Table Seven below summarizes, for the periods indicated, the activityin the allowance for loan losses.

 

**TableSeven: Allowance for Loan Losses (Unaudited)**

 
|                                                                      |   | **Three  Months  Ended  March 31,** |    |
|---------------------------------------------------------------------------|--------|------------------------------------------|---------|
| **(In thousands, except for  percentages)**                               |   | **2004**                                 |    | **2003** |   |
|                                                                      |   |                                     |    |   |   |
| Average loans outstanding                                                 |   | $                                        | 234,060 |   | $ | 239,134 |   |
|                                                                      |   |                                     |    |   |   |
| Allowance for possible loan losses at  beginning of period                |   | $                                        | 3,587   |   | $ | 3,007 |   |
|                                                                      |   |                                     |    |   |   |
| Loans charged off:                                                        |   |                                     |    |   |   |
| Commercial                                                                |   | —                                   |    |   |   |
| Real estate                                                               |   | —                                   |    | — |   |
| Consumer                                                                  |   | (7                                       | )       | (3 | ) |
| Total                                                                     |   | (7                                       | )       | (3 | ) |
| Recoveries of loans previously charged off:                               |   |                                     |    |   |   |
| Commercial                                                                |   | —                                   |    | — |   |
| Real estate                                                               |   | —                                   |    | — |   |
| Consumer                                                                  |   | 17                                       |    |   |   |
| Total                                                                     |   | 17                                       |    |   |   |
| Net loan charge offs                                                      |   | 10                                       |    | (3 | ) |
|                                                                      |   |                                     |    |   |   |
| Additions to allowance charged to operating  expenses                     |   | 225                                      |    | 150 |   |
| Allowance for loan losses at end of period                                |   | $                                        | 3,822   |   | $ | 3,154 |   |
| Ratio of net charge-offs to average loans  outstanding                    |   | .004                                     | %       | -.001 | % |
| Provision for possible loan losses to  average loans outstanding          |   | .081                                     | %       | .063 | % |
| Allowance for loan losses to loans net of  deferred fees at end of period |   | 1.35                                     | %       | 1.34 | % |

 

It is the policy of management to maintainthe allowance for loan losses at a level adequate for known and inherent risksin the portfolio.  Based on informationcurrently available to analyze inherent credit risk, including economic factors,overall credit quality, historical delinquencies and a history of actualcharge-offs, management believes that the provision for loan losses and theallowance are prudent and adequate.  TheCompany generally makes monthly allocations to the allowance for loanlosses.  The budgeted allocation isbased on estimates of loss risk and loan growth.  Adjustments may be made based on differences from estimated loangrowth, the types of loans constituting this growth, changes in risk ratingswithin the portfolio, and general economic conditions.  However, no prediction of the ultimate levelof loans charged off in future years can be made with any certainty.

 

**Other Real Estate**

 

At March 31, 2004 and December 31, 2003, the Company did nothave any other real estate (“ORE”) properties.

 

17

----

 

## **Deposits**

## ** **

At March 31, 2004, total deposits were $351,835,000 representingan increase of $9,324,000 (2.7%) over the December 31, 2003 balance of$342,511,000.

 

## **Capital Resources**

## ** **

The current and projected capital position of the Company and theimpact of capital plans and long-term strategies are reviewed regularly bymanagement. The Company’s capital position represents the level of capitalavailable to support continued operations and expansion.

 

The Board of Directors of the Company authorized the payment of a cashdividend of $.075 per share on January 23, 2003, April 24, 2003, andJuly 25, 2003, $.075 per share on October 24, 2003 and $.075 pershare on January 23, 2004.  The paymentof dividends in the future is subject to the discretion of the Board ofDirectors of the Company and will depend on earnings, the financial conditionof the Company and other relevant factors. The per share amounts have been retroactively restated for the Company’s4 for 3 stock split approved by the Board of Directors on February 17,2004.

 

The Company and its subsidiary Bank are subject to certain regulationsissued by the Board of Governors of the Federal Reserve System and the FDICwhich require maintenance of certain levels of capital.  At March 31, 2004, shareholders’ equitywas $31,054,000, representing an increase of $1,105,000 (3.7%) from $29,949,000at December 31, 2003.  The Bank’sratio of total risk-based capital to risk adjusted assets was 12.0% atMarch 31, 2004 compared to 12.1% at December 31, 2003.  Tier 1 risk-based capital to risk-adjustedassets was 10.8% at March 31, 2004 and 10.9% at December 31, 2003.

 

Table Eight below lists the Company and the Bank capital ratios atMarch 31, 2004 and December 31, 2003, as well as the minimum ratiosrequired under regulatory definitions of capital adequacy. 

 

**Table Eight: Capital Ratios (Unaudited)**

 
| **Capital to Risk-Adjusted Assets** |   | **At  March 31,  2004** |   | **At  December 31,  2003** |   | **Minimum  Regulatory Requirement** |   |
|-------------------------------------|--------|------------------------------|--------|---------------------------------|--------|-------------------------------------|--------|
| **Company**                         |   |                         |   |                            |   |                                |   |
|                                |   |                         |   |                            |   |                                |   |
| Leverage ratio                      |   | 9.9                          | %      | 9.9                             | %      | 4.0                                 | %      |
|                                |   |                         |   |                            |   |                                |   |
| Tier 1 Risk-Based Capital           |   | 12.2                         | %      | 12.2                            | %      | 4.0                                 | %      |
|                                |   |                         |   |                            |   |                                |   |
| Total Risk-Based Capital            |   | 13.4                         | %      | 13.3                            | %      | 8.0                                 | %      |
|                                |   |                         |   |                            |   |                                |   |
| **Bank**                            |   |                         |   |                            |   |                                |   |
|                                |   |                         |   |                            |   |                                |   |
| Leverage ratio                      |   | 8.9                          | %      | 8.8                             | %      | 4.0                                 | %      |
|                                |   |                         |   |                            |   |                                |   |
| Tier 1 Risk-Based Capital           |   | 10.8                         | %      | 10.9                            | %      | 4.0                                 | %      |
|                                |   |                         |   |                            |   |                                |   |
| Total Risk-Based Capital            |   | 12.0                         | %      | 12.1                            | %      | 8.0                                 | %      |

 

Capital ratios are reviewed on a regular basis to ensure that capitalexceeds the prescribed regulatory minimums and is adequate to meet future needs.  All ratios are in excess of the regulatorydefinition of “Minimum” at March 31, 2004 and December 31, 2003.  The Bank was considered “well-capitalized”by regulatory standards, at March 31, 2004 and December 31, 2003.

 

18

----

 

**Item 3. Quantitative and Qualitative Disclosures about Market Risk**

 

**Market RiskManagement**

 

*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.

 

The Board of Directors has overallresponsibility for the interest rate risk management policies.  The Bank has an Asset and LiabilityManagement Committee (ALCO) that establishes and monitors guidelines to controlthe sensitivity of earnings to changes in interest rates.

 

*Asset/Liability Management*.  Activities involved in asset/liabilitymanagement include, but are not limited to, lending, accepting and placingdeposits, investing in securities, using trust preferred securities andborrowings.  Interest rate risk is theprimary market risk associated with asset/liability management.  Sensitivity of earnings to interest ratechanges arises when yields on assets change in a different time period or in adifferent amount from that of interest costs on liabilities.  To mitigate interest rate risk, thestructure of the balance sheet is managed with the goal that movements ofinterest rates on assets and liabilities are correlated and contributes toearnings even in periods of volatile interest rates.  The asset/liability management policy sets limits on theacceptable amount of variance in net interest margin and market value of equityunder changing interest environments. The Company uses simulation models to forecast earnings, net interestmargin and market value of equity.

 

Simulation of earnings is the primary toolused to measure the sensitivity of earnings to interest rate changes.  Using computer-modeling techniques, theCompany is able to estimate the potential impact of changing interest rates onearnings.  A balance sheet forecast isprepared monthly using inputs of actual loans, securities and interest bearingliability (i.e. deposits/borrowings) positions as the beginning base.  The forecast balance sheet is processedagainst seven interest rate scenarios. These scenarios include a 100, 200 and 300 basis point rising rateforecast, a flat rate forecast and a 100, 200 and 300 basis point falling rateforecast which take place within a one year time frame.  The net interest income is measured duringthe year assuming a gradual change in rates over the twelve-month horizon.  The Company’s net interest income, asforecast below, was modeled utilizing a forecast balance sheet projected frombalances as of the date indicated.

 

Table Nine below summarizes the effect on netinterest income (NII) of a ±200 basis point change in interest rates asmeasured against a constant rate (no change) scenario.  The results shown in Table nine for the twoperiods, fall within the parameters of the Bank’s policy for interest raterisk.

 

**TableNine:  Interest Rate Risk Simulation ofNet Interest as of March 31, 2004 and December 31, 2003 (Unaudited)**

 
| **(In thousands)**                      |   | **$ Change  in NII  from Current   12 Month Horizon   March 31, 2004** |   | **$ Change  in NII  from Current   12 Month Horizon   December 31, 2003** |   |
|-----------------------------------------|--------|-----------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------|--------|
| Variation from a constant rate scenario |   |                                                                        |   |                                                                           |   |
| +200bp                                  |   | $                                                                           | 355    |                                                                           | $      | 286 |   |
| - 200bp                                 |   | $                                                                           | 375    |                                                                           | $      | 714 |   |

## ** **

## **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.**

## ** **

19

----

 

## **Inflation**

## ** **

The impact of inflation on a financial institution differssignificantly from that exerted on manufacturing, or other commercial concerns,primarily because its assets and liabilities are largely monetary.  In general, inflation primarily affects theCompany and it subsidiaries through its effect on market rates of interest,which affects the Company’s ability to attract loan customers.  Inflation affects the growth of total assetsby increasing the level of loan demand, and potentially adversely affectscapital adequacy because loan growth in inflationary periods can increase atrates higher than the rate capital grows through retention of earnings, whichmay be generated in the future.  Inaddition to its effects on interest rates, inflation increases overall operatingexpenses.  Inflation has not had amaterial effect upon the results of operations of the Company and itssubsidiaries during the periods ended March 31, 2004, and 2003.

 

**Liquidity**

 

Liquidity management refers to the Company’s ability to provide fundson an ongoing basis to meet fluctuations in deposit levels as well as thecredit needs and requirements of its clients. Both assets and liabilities contribute to the Company’s liquidityposition.  Federal funds lines,short-term investments and securities, and loan repayments contribute to liquidity,along with deposit increases, while loan funding and deposit withdrawalsdecrease liquidity.  The Companyassesses the likelihood of projected funding requirements by reviewinghistorical funding patterns, current and forecasted economic conditions andindividual client funding needs. Commitments to fund loans at March 31, 2004 and December 31,2003 were approximately $131,387,000 and $141,308,000, respectively.  Such loans relate primarily to revolvinglines of credit and other commercial loans, and to real estate constructionloans.

 

The Company’s sources of liquidity consist ofcash and due from correspondent banks, overnight funds sold to correspondentbanks, unpledged marketable investments and loans held for sale.  On March 31, 2004, consolidated liquidassets totaled $83 million or 20.9% of total assets compared to $80.1 millionor 20.7% of total assets on December 31, 2003.  In addition to liquid assets, the Company maintains short-termlines of credit in the amount of $6,000,000 with correspondent banks.  There were no borrowings outstanding underthese arrangements at March 31, 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 maintaina balanced position of liquid assets to volatile and cyclical deposits.

 

Liquidity is also affected by portfolio maturities and the effect ofinterest rate fluctuations on the marketability of both assets andliabilities.  The Company can sell anyof its unpledged securities held in the available-for-sale category to meet liquidityneeds.

 

## **Off-Balance SheetItems**

## ** **

The Company has certain ongoing commitments under operatingleases.  These commitments do notsignificantly impact operating results. As of March 31, 2004 andDecember 31, 2003, commitments to extend credit and letters of credit werethe only 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.  Loancommitments and letters of credit were $131,387,000 and $141,308,000 atMarch 31, 2004 and December 31, 2003, respectively.  As a percentage of net loans, theseoff-balance sheet items represent 46.9% and 52.3%, respectively.

 

20

----

 

**Other Matters**

 

**Controls and Procedures**

 

(a)Disclosure Controls and Procedures: An evaluation of the Company’s disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-15(e) and15d-15(e)) was carried out under the supervision and with the participation ofthe Company’s Chief Executive Officer, Chief Financial Officer and othermembers of the Company’s senior management as of the end of the Company’sfiscal quarter ended March 31, 2004. The Company’s Chief Executive Officerand Chief Financial Officer concluded that the Company’s disclosure controlsand procedures as currently in effect are effective in ensuring that theinformation required to be disclosed by the Company in the reports it files orsubmits under the Exchange Act is (i) accumulated and communicated to theCompany’s management (including the Chief Executive Officer and Chief FinancialOfficer) to allow timely decisions regarding required disclosure, and (ii)recorded, processed, summarized and reported within the time periods specifiedin the Commission’s rules and forms.

 

(b)Internal Control Over Financial Reporting: An evaluation of any changes in theCompany’s internal control over financial reporting (as defined in Exchange ActRules 13a-15(f) and 15d-15(f)), that occurred during the Company’s fiscalquarter ended March 31, 2004, was carried out under the supervision andwith the participation of the Company’s Chief Executive Officer, ChiefFinancial Officer and other members of the Company’s senior management. TheCompany’s Chief Executive Officer and Chief Financial Officer concluded that nochange identified in connection with such evaluation has materially affected,or is reasonably likely to materially affect, the Company’s internal controlover financial reporting.

 

## **PART II – OTHER INFORMATION**

 

Item 1.  Legal Proceedings.

 

None.

 

Item 2.  Changes in Securitiesand Use of Proceeds.

 

None.

 

Item 3.  Defaults Upon SeniorSecurities.

 

None.

 

Item 4.  Submission of Mattersto a Vote of Security Holders.

 

None.

 

Item 5.  Other Information.

 

None

 

21

----

 

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 December 19, 2003, the Company fileda Report on form 8-k announcing a seven and one half cent per share CashDividend for shareholders of record on December 31, 2003, payableJanuary 23, 2004.

 

On February 20, 2004, the Company fileda Report on form 8-k announcing a four-for-three Stock Split for shareholdersof record on March 2, 2004, payable March 26, 2004.

 

On March 26, 2004 the Company filed aReport on form 8-k announcing a seven and one half cent per share Cash Dividendfor shareholders of record on April 6, 2004 payable April 23, 2004.

 

22

----

 

**SIGNATURES**

 

Pursuant to the requirements of the Securities and Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 
|        |   |                               |                       | COMMUNITY VALLEY BANCORP |
|-------------|--------|------------------------------------|----------------------------|--------------------------|
|        |   |                               |                       |
| May 2, 2004 |   |                               | By: /s/ *Keith C. Robbins* |                     |
|        |   |                               |
|        |   | Keith C. Robbins                   |
|        |   |                               |
|        |   | President, Chief Executive Officer |
|        |   |                               |
|        |   |                               |
| May 2, 2004 |   |                               | By*:**/s/  John F. Coger*  |                     |
|        |   |                               |
|        |   | John F. Coger                      |
|        |   |                               |
|        |   | Executive Vice President, CFO      |
|             |        |                                    |                            |                          |  |  |  |

 

23

----