**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

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

 

**For the Quarterly Period Ended        June 30, 2005**

 

**o****  TRANSITION REPORT PURSUANT TO SECTION 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 its charter)

 

| **California**                                                | ** ** | **68-0479553**           |
|---------------------------------------------------------------|------------|--------------------------|
| (State or other jurisdiction ofincorporation 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 reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes     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’s classes of common stock, as of the latest practicable date:

 

No par value Common Stock – 7,357,808 shares outstanding at July 31, 2005.

 

 

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PART 1-FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

 

COMMUNITY VALLEY BANCORP

CONDENSED CONSOLIDATED BALANCE SHEET (Unaudited)

 
| **(In thousands except per share  data)**                                                                                                                                   | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
| ASSETS                                                                                                                                                                      |       |               |       |                   |       |
| Cash and due from banks                                                                                                                                                     |       | $                  | 20,775     |                   | $          | 21,778 |   |
| Federal funds sold                                                                                                                                                          |       | 14,125             |       | 46,440                 |       |
| Total cash and cash equivalents                                                                                                                                             |       | 34,900             |       | 68,218                 |       |
|                                                                                                                                                                        |       |               |       |                   |       |
| Interest-bearing deposits in banks                                                                                                                                          |       | 8,418              |       | 8,715                  |       |
| Investment securities (market value of  $7,635 at June 30, 2005 and $6,963 at December 31, 2004)                                                                            |       | 7,643              |       | 6,961                  |       |
| Loans held for sale, at lower of cost or  market                                                                                                                            |       | 3,445              |       | 1,490                  |       |
| Loans, less allowance for loan losses of  $4,825 at June 30, 2005 and $4,381 at December 31, 2004                                                                           |       | 385,295            |       | 339,174                |       |
| Premises and equipment, net                                                                                                                                                 |       | 10,909             |       | 9,027                  |       |
| Accrued interest receivable and other  assets                                                                                                                               |       | 19,163             |       | 16,091                 |       |
|                                                                                                                                                                        |       | $                  | 469,773    |                   | $          | 449,676 |   |
|                                                                                                                                                                        |       |               |       |                   |       |
| LIABILITIES  AND SHAREHOLDERS’ EQUITY                                                                                                                                  |       |               |       |                   |       |
|                                                                                                                                                                        |       |               |       |                   |       |
| Deposits:                                                                                                                                                                   |       |               |       |                   |       |
| Non-interest bearing                                                                                                                                                        |       | $                  | 93,523     |                   | $          | 80,793 |   |
| Interest bearing                                                                                                                                                            |       | 321,225            |       | 318,266                |       |
| Total deposits                                                                                                                                                              |       | 414,748            |       | 399,059                |       |
|                                                                                                                                                                        |       |               |       |                   |       |
| Employee stock ownership plan (ESOP) note  payable                                                                                                                          |       | 1,566              |       | 833                    |       |
| Junior subordinated debenture                                                                                                                                               |       | 8,248              |       | 8,248                  |       |
|                                                                                                                                                                        |       |               |       |                   |       |
| Accrued interest payable and other  liabilities                                                                                                                             |       | 7,369              |       | 7,005                  |       |
|                                                                                                                                                                        |       |               |       |                   |       |
| Total liabilities                                                                                                                                                           |       | 431,932            |       | 415,145                |       |
|                                                                                                                                                                        |       |               |       |                   |       |
| Commitments and contingencies                                                                                                                                               |       |               |       |                   |       |
|                                                                                                                                                                        |       |               |       |                   |       |
| Shareholders’ equity:                                                                                                                                                  |       |               |       |                   |       |
| Common stock – no par value; 20,000,000  shares authorized; issued and outstanding – 7,356,108 shares at June 30, 2005  and 7,273,582 shares at December 31, 2004 |       | 8,535              |       | 7,861                  |       |
| Unallocated ESOP shares (172,718 shares at  June 30, 2005 and 179,284 shares at December 31, 2004, at cost)                                                                 |       | (1,107             | )          | (1,144                 | )          |
|                                                                                                                                                                        |       |               |       |                   |       |
| Retained earnings                                                                                                                                                           |       | 30,417             |       | 27,802                 |       |
|                                                                                                                                                                        |       |               |       |                   |       |
| Accumulated other comprehensive (loss)  income, net of taxes                                                                                                                |       | (4                 | )          | 12                     |       |
|                                                                                                                                                                        |       |               |       |                   |       |
| Total shareholders’ equity                                                                                                                                             |       | 37,841             |       | 34,531                 |       |
|                                                                                                                                                                        |       | $                  | 469,773    |                   | $          | 449,676 |   |

 

See Notes to Unaudited Condensed ConsolidatedFinancial Statements

 

2

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COMMUNITY VALLEY BANCORP

CONDENSEDCONSOLIDATED STATEMENT OF INCOME(Unaudited)

 
| ** **                                                       | ** ** | **For the periods ended June 30,** | ** ** |
|------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                       | ** ** | **Three months**                   | ** ** | **Six Months** | ** ** |
| **(In thousands, except per share  data)**                       | ** ** | **2005**                           | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                       | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest income:                                                 |       |                               |       |   |   |   |   |   |   |
| Interest and fees on loans                                       |       | $                                  | 7,291      |   | $ | 5,615 |   | $ | 13,979 |   | $ | 10,972 |   |
| Interest on Federal funds sold                                   |       | 233                                |       | 121 |   | 465 |   | 243 |   |
| Interest on deposits in banks                                    |       | 68                                 |       | 58 |   | 128 |   | 116 |   |
| Interest and dividends on investment  securities:                |       |                               |       |   |   |   |   |   |   |
| Taxable                                                          |       | 47                                 |       | 33 |   | 94 |   | 61 |   |
| Exempt from Federal income taxes                                 |       | 31                                 |       | 10 |   | 56 |   | 20 |   |
| Dividends                                                        |       | 7                                  |       | 3 |   | 7 |   | 3 |   |
|                                                             |       |                               |       |   |   |   |   |   |   |
| Total interest income                                            |       | 7,677                              |       | 5,840 |   | 14,729 |   | 11,415 |   |
| Interest expense:                                                |       |                               |       |   |   |   |   |   |   |
| Interest on deposits                                             |       | 1,012                              |       | 849 |   | 2,017 |   | 1,727 |   |
| Interest on junior subordinated debentures                       |       | 143                                |       | 102 |   | 274 |   | 203 |   |
| Interest on ESOP note payable                                    |       | 14                                 |       | 8 |   | 25 |   | 17 |   |
| Total interest expense                                           |       | 1,169                              |       | 959 |   | 2,316 |   | 1,947 |   |
|                                                             |       |                               |       |   |   |   |   |   |   |
| Net interest income before provision for  loan losses            |       | 6,508                              |       | 4,881 |   | 12,413 |   | 9,468 |   |
|                                                             |       |                               |       |   |   |   |   |   |   |
| Provision for loan losses                                        |       | 225                                |       | 190 |   | 450 |   | 415 |   |
| Net interest income after provision for  loan losses             |       | 6,283                              |       | 4,691 |   | 11,963 |   | 9,053 |   |
|                                                             |       |                               |       |   |   |   |   |   |   |
| Non-interest income                                              |       | 1,629                              |       | 1,554 |   | 3,265 |   | 2,783 |   |
|                                                             |       |                               |       |   |   |   |   |   |   |
| Non-interest expense:                                            |       |                               |       |   |   |   |   |   |   |
| Salaries and employee benefits                                   |       | 2,788                              |       | 2,101 |   | 5,824 |   | 4,380 |   |
| Occupancy                                                        |       | 277                                |       | 245 |   | 558 |   | 484 |   |
| Furniture and equipment                                          |       | 439                                |       | 311 |   | 830 |   | 664 |   |
| Other expense                                                    |       | 1,430                              |       | 1,092 |   | 2,594 |   | 2,008 |   |
| Total non-interest expense                                       |       | 4,934                              |       | 3,749 |   | 9,806 |   | 7,536 |   |
|                                                             |       |                               |       |   |   |   |   |   |   |
| Income before provision for income taxes                         |       | 2,978                              |       | 2,496 |   | 5,422 |   | 4,300 |   |
|                                                             |       |                               |       |   |   |   |   |   |   |
| Provision for income taxes                                       |       | 1,248                              |       | 1,031 |   | 2,238 |   | 1,747 |   |
|                                                             |       |                               |       |   |   |   |   |   |   |
| Net income                                                       |       | $                                  | 1,730      |   | $ | 1,465 |   | $ | 3,184 |   | $ | 2,553 |   |
|                                                             |       |                               |       |   |   |   |   |   |   |
| Basic earnings per share                                         |       | $                                  | .24        |   | $ | .21 |   | $ | .45 |   | $ | .36 |   |
| Diluted earnings per share                                       |       | $                                  | .23        |   | $ | .19 |   | $ | .42 |   | $ | .34 |   |
|                                                             |       |                               |       |   |   |   |   |   |   |
| Cash dividends per share of issued and outstanding  common stock |       | $                                  | .04        |   | $ | .0375 |   | $ | .0775 |   | $ | .075 |   |

 

See Notes to Unaudited Condensed ConsolidatedFinancial Statements

 

3

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COMMUNITY VALLEY BANCORP

CONSOLIDATED STATEMENT OF CHANGES INSHAREHOLDERS’ EQUITY

(Unaudited)

(In thousands except number of shares)

 
| ** **                                                                  | ** ** | ** **       | ** ** | ** ** | ** ** | ** **      | ** ** | ** **        | ** ** | **Accumulated**        | ** ** | ** **        | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------|------------|------------------|------------|------------|------------|-----------------|------------|-------------------|------------|------------------------|------------|-------------------|------------|------------|------------|
| ** **                                                                  | ** ** | ** **       | ** ** | ** ** | ** ** | **Unallocated** | ** ** | ** **        | ** ** | **Other**              | ** ** | ** **        | ** ** | ** ** | ** ** |
| ** **                                                                  | ** ** | **Common Stock** | ** ** | **ESOP**   | ** ** | **Retained**    | ** ** | **Comprehensive** | ** ** | **Shareholders’** | ** ** | **Comprehensive** | ** ** |
| ** **                                                                  | ** ** | **Shares**       | ** ** | **Amount** | ** ** | **Shares**      | ** ** | **Earnings**      | ** ** | **Income (loss)**      | ** ** | **Equity**        | ** ** | **Income** | ** ** |
|                                                                        |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Balance, January 1, 2004                                                    |       | 7,243,648        |       | $          | 7,271      |            | $          | (1,070            | )          | $                      | 23,746     |              | $          | 2          |       | $ | 29,949 |   |   |   |
|                                                                        |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Comprehensive income (Note 3):                                              |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Net income                                                                  |       |             |       |       |       |            |       | 5,609             |       |                   |       | 5,609             |       | $          | 5,609      |   |
| Other comprehensive income, net of taxes                                    |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Net change in unrealized gains on  available-for-sale investment securities |       |             |       |       |       |            |       |              |       | 10                     |       | 10                |       | 10         |       |
| Total comprehensive income                                                  |       |             |       |       |       |            |       |              |       |                   |       |              |       | $          | 5,619      |   |
| Exercise of stock options and related tax  benefit                          |       | 68,404           |       | 532        |       |            |       |              |       |                   |       | 532               |       |       |       |
| Amortization of stock compensation - ESOP  shares                           |       |             |       | 104        |       | 76              |       |              |       |                   |       | 180               |       |       |       |
| Shares acquired or redeemed by ESOP                                         |       |             |       |       |       | (150            | )          |              |       |                   |       | (150              | )          |       |       |
| Cash dividends - $.15 per share                                             |       |             |       |       |       |            |       | (1,091            | )          |                   |       | (1,091            | )          |       |       |
| Cash in lieu of fractional shares in  four-for-three stock split            |       |             |       | (6         | )          |            |       |              |       |                   |       | (6                | )          |       |       |
| Repurchase and retirement of common stock                                   |       | (38,470          | )          | (40        | )          |            |       | (462              | )          |                   |       | (502              | )          |       |       |
| Balance, December 31, 2004                                                  |       | 7,273,582        |       | 7,861      |       | (1,144          | )          | 27,802            |       | 12                     |       | 34,531            |       |       |       |
|                                                                        |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Comprehensive income (Note 3):                                              |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Net income                                                                  |       |             |       |       |       |            |       | 3,184             |       |                   |       | 3,184             |       | $          | 3,184      |   |
| Other comprehensive loss, net of taxes:                                     |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Net change in unrealized loss on  available-for-sale investment securities  |       |             |       |       |       |            |       |              |       | (17                    | )          | (17               | )          | (17        | )          |
|                                                                        |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Total comprehensive income                                                  |       |             |       |       |       |            |       |              |       |                   |       |              |       | $          | 3,167      |   |
| Exercise of stock options and related tax  benefit                          |       | 82,526           |       | 619        |       |            |       |              |       |                   |       | 619               |       |       |       |
| Amortization of stock compensation - ESOP  shares                           |       |             |       | 55         |       | 37              |       |              |       |                   |       | 92                |       |       |       |
| Cash  dividends - $.08 per share                                            |       |             |       |       |       |            |       | (568              | )          |                   |       | (568              | )          |       |       |
|                                                                        |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Balance, June 30, 2005                                                      |       | 7,356,108        |       | $          | 8,535      |            | $          | (1,107            | )          | $                      | 30,418     |              | $          | (5         | )          | $ | 37,841 |   |   |   |

 

SeeNotes to Unaudited Condensed Consolidated Financial Statements

 

4

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COMMUNITYVALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENT OF CASHFLOWS    (Unaudited**)**

 
| **(In thousands)**                                                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| **For the six months ended June  30,**                                             | ** ** | **2005**   | ** ** | **2004**   | ** ** |
| ** **                                                                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash flows from operating activities:                                              |       |       |       |       |       |
| Net income                                                                         |       | $          | 3,184      |       | $          | 2,553 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |       |       |       |       |
| Provision for loan losses                                                          |       | 450        |       | 415        |       |
| (Decrease) increase in deferred loan  origination costs, net                       |       | (66        | )          | 23         |       |
| Depreciation, amortization and accretion,  net                                     |       | 736        |       | 646        |       |
| Gain on disposition of Bank premises and  equipment                                |       | (20        | )          |       |       |
| Net (decrease) increase in loans held for  sale                                    |       | (1,955     | )          | 834        |       |
| Increase in cash surrender value of  bank-owned life insurance                     |       | (146       | )          | (250       | )          |
| Non-cash compensation expense associated  with the ESOP                            |       | 91         |       | 90         |       |
| (Increase) decrease in accrued interest  receivable and other assets               |       | (1,170     | )          | 1,387      |       |
| Increase in accrued interest payable and other  liabilities                        |       | 344        |       | 647        |       |
|                                                                               |       |       |       |       |       |
| Net cash provided by operating activities                                          |       | 1,447      |       | 6,345      |       |
|                                                                               |       |       |       |       |       |
| Cash flows from investing activities:                                              |       |       |       |       |       |
|                                                                               |       |       |       |       |       |
| Decrease (increase) in interest-bearing  deposits in banks                         |       | 297        |       | (1,088     | )          |
| Purchase of available-for-sale investment  securities                              |       | (999       | )          |       |       |
| Proceeds from matured or called  available-for-sale investment securities          |       | 1,000      |       | 300        |       |
| Proceeds from matured or called  held-to-maturity investment securities            |       | 100        |       | 380        |       |
| Proceeds from principal payments of  held-to-maturity investment securities        |       | 195        |       | 150        |       |
| Purchase of held-to-maturity investment securities                                 |       | (995       | )          | (1,012     | )          |
| Purchases of premises and equipment                                                |       | (2,638     | )          | (1,448     | )          |
| Proceeds from sale of premises and  equipment                                      |       | 31         |       | 323        |       |
| Premiums paid for bank owned life insurance                                        |       | (1,450     | )          |       |       |
| Net increase in loans                                                              |       | (46,505    | )          | (34,336    | )          |
|                                                                               |       |       |       |       |       |
| Net cash used in investing activities                                              |       | (50,964    | )          | (36,731    | )          |
|                                                                               |       |       |       |       |       |
| Cash flows from financing activities:                                              |       |       |       |       |       |
|                                                                               |       |       |       |       |       |
| Net increase in demand, interest-bearing  and savings deposits                     |       | $          | 14,119     |       | $          | 22,737 |   |
| Net increase in time deposits                                                      |       | 1,570      |       | 2,384      |       |
| Proceeds from loans                                                                |       | 800        |       |       |       |
| Repayments of ESOP note payable                                                    |       | (67        | )          | (73        | )          |
| Payment of cash dividends                                                          |       | (547       | )          | (544       | )          |
| Cash paid for fractional shares                                                    |       |       |       | (6         | )          |
| Proceeds from exercise of stock options                                            |       | 324        |       | 210        |       |
| Repurchase of common stock                                                         |       |       |       | (324       | )          |
|                                                                               |       |       |       |       |       |
| Net cash provided by financing activities                                          |       | 16,199     |       | 24,384     |       |
|                                                                               |       |       |       |       |       |
| Decrease in cash and cash equivalents                                              |       | (33,318    | )          | (6,002     | )          |
|                                                                               |       |       |       |       |       |
| Cash and cash equivalents at beginning of  year                                    |       | 68,218     |       | 76,810     |       |
|                                                                               |       |       |       |       |       |
| Cash and cash equivalents at end of period                                         |       | $          | 34,900     |       | $          | 70,808 |   |

 

SeeNotes to Unaudited Condensed Consolidated Financial Statements

 

5

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**Community Valley Bancorp and Subsidiaries**

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

1.   BASIS OFPRESENTATION

 

The accompanyingunaudited condensed consolidated financial statements of Community ValleyBancorp and subsidiaries (the “Company”) have been prepared pursuant to therules and regulations of the Securities Exchange Commission (the “SEC”) and theinstructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly,certain information and footnote disclosures required by accounting principlesgenerally accepted in the United States of America for annual financialstatements are not include herein. In the opinion of management, alladjustments (which consist solely of normal recurring accruals) considerednecessary for a fair presentation of the results for the interim periodspresented have been included.  Theseinterim consolidated financial statements should be read in conjunction withthe financial statements and related notes contained in the Company’s 2004Annual Report to Shareholders on Form 10-K.

 

The condensedconsolidated financial statements include the accounts of the Company and itswholly owned subsidiaries, Butte Community Bank and CVB Insurance Agency, LLC.All significant inter-company balances and transactions have been eliminated inconsolidation. The Company has also established a wholly-owned unconsolidatedsubsidiary, Community Valley Bancorp Trust I (the “Trust”), a Delawarestatutory business trust, for the purpose of issuing trust preferredsecurities. The results of operations for the three and six-month period endedJune 30, 2005 may not necessarily be indicative of the operating results for thefull year 2005.

 

Management hasdetermined that since all of the commercial banking products and servicesoffered by the Company are available in each branch of the bank, all branchesare located within the same economic environment and management does notallocate resources based on the performance of different lending or transactionactivities, it is appropriate to aggregate the Bank branches and report them asa single operating segment.

 

Thepreparation of consolidated financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assetsand liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period.  Actual results could differ from theseestimates.

 

On April 13, 2005,the Board of Directors of the Company declared a two-for-one stock spliteffective May 16, 2005 for shareholders of record on May 2, 2005. All share andper share information has been retroactively adjusted to reflect the stocksplit.

 

2.  EARNINGS PER SHARE COMPUTATION

 

Basic earnings per share are computed by dividing net income by the weighted average common shares outstanding for the period (7,148,463 and 7,129,218 shares for the three and six month periods ended June 30, 2005 and 7,111,582 and 7,096,504 shares for the three and six month periods ended June 30, 2004).  Diluted earnings per share reflect the potential dilution that could occur if outstanding stock options were exercised using the treasury stock method.   Diluted earnings per share is computed by dividing net income by the weighted average common shares outstanding for the period plus the dilutive effect of options (457,823 and 464,186 shares for the three and six month periods ended June 30, 2005 and 390,440 and 372,790 shares for the three and  six month periods ended June 30, 2004).  During the periods covered the Company had no stock options that were considered anti-dilutive.

 

6

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3. COMPREHENSIVE INCOME

 

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

 

## **4.** STOCK –BASEDCOMPENSATION

 

The Company issues stock options under three stock-based compensationplans, the Community Valley Bancorp 1991, 1997 and 2000 Stock OptionPlans.  The Company accounts for these plansunder the recognition and measurement principles of APB Opinion No. 25, *Accounting for Stock Issued to Employees*, and relatedInterpretations.  No stock-basedcompensation cost is reflected in net income, as all options granted underthese plans had an exercise price equal to the market value of the underlyingcommon stock on the date of grant.

 

The following table illustrates the effect on net income and earningsper share if the Company had applied the fair value recognition provisions ofFASB Statement No. 123, *Accounting for Stock-BasedCompensation*, to stock-based employee compensation.

 

Pro forma adjustments to the Company’sconsolidated net earnings and earnings per share are disclosed during theperiods in which the options become vested.

 

(In thousands, except per share data)

 

** **
| ** **                                                                                                                               | ** ** | **Three  Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                                                               | ** ** | **June 30, 2005**       | ** ** | **June 30, 2004** | ** ** |
|                                                                                                                                     |       |                    |       |   |   |
| Net income as reported                                                                                                                   |       | $                       | 1,730      |   | $ | 1,465 |   |
| Deduct: Total stock-based  compensation expense determined under the fair value based method for all  awards, net of related tax effects |       | (89                     | )          | (76 | ) |
|                                                                                                                                     |       |                    |       |   |   |
| Pro forma net income                                                                                                                     |       | $                       | 1,641      |   | $ | 1,389 |   |
|                                                                                                                                     |       |                    |       |   |   |
| Basic earnings per share - as  reported                                                                                                  |       | $                       | 0.24       |   | $ | 0.21 |   |
| Basic earnings per share - pro  forma                                                                                                    |       | $                       | 0.23       |   | $ | 0.20 |   |
|                                                                                                                                     |       |                    |       |   |   |
| Diluted earnings per share - as  reported                                                                                                |       | $                       | 0.23       |   | $ | 0.19 |   |
| Diluted earnings per share -  pro forma                                                                                                  |       | $                       | 0.22       |   | $ | 0.18 |   |

 
| ** **                                                                                                                               | ** ** | **Six  Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                               | ** ** | **June 30, 2005**     | ** ** | **June 30, 2004** | ** ** |
|                                                                                                                                     |       |                  |       |   |   |
| Net earnings as reported                                                                                                                 |       | $                     | 3,184      |   | $ | 2,553 |   |
| Deduct: Total stock-based  compensation expense determined under the fair value based method for all  awards, net of related tax effects |       | (177                  | )          | (149 | ) |
|                                                                                                                                     |       |                  |       |   |   |
| Pro forma net income                                                                                                                     |       | $                     | 3,007      |   | $ | 2,404 |   |
|                                                                                                                                     |       |                  |       |   |   |
| Basic earnings per share - as  reported                                                                                                  |       | $                     | 0.45       |   | $ | 0.36 |   |
| Basic earnings per share - pro  forma                                                                                                    |       | $                     | 0.42       |   | $ | 0.34 |   |
|                                                                                                                                     |       |                  |       |   |   |
| Diluted earnings per share - as  reported                                                                                                |       | $                     | 0.42       |   | $ | 0.34 |   |
| Diluted earnings per share -  pro forma                                                                                                  |       | $                     | 0.40       |   | $ | 0.32 |   |

 

7

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The fair value ofeach option granted during the periods indicated was estimated on the date ofgrant using an option pricing model with the following assumptions.

 
| ** **                                                      | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                      | ** ** | **June 30, 2005**    | ** ** | **June 30, 2004** | ** ** |
| Dividend yield                                                  |       | .97                  | %          | 1.15 | % |
|                                                            |       |                 |       |   |   |
| Expected volatility                                             |       | 29.27                | %          | 70.51 | % |
|                                                            |       |                 |       |   |   |
| Risk-free interest rate                                         |       | 4.00                 | %          | 4.02 | % |
|                                                            |       |                 |       |   |   |
| Expected option life                                            |       | 6.5 years            |       | 10 years |   |
|                                                            |       |                 |       |   |   |
| Weighted average fair value of options  granted during the year |       | $                    | 6.91       |   | $ | 4.24 |   |
|                                                                 |            |                      |            |  |  |  |  |

 

There were 8,000 and 10,000 options granted for the three-month and six-month periods ended June 30, 2005, and 10,000 and 13,000 options granted for the three-month and six-month periods ended June 30, 2004.

 

5. COMMITMENTS AND CONTINGENCIES

 

The Company is party toclaims and legal proceedings arising in the ordinary course of business. In theopinion of the Company’s management, the amount of ultimate liability withrespect to such proceedings will not have a material adverse effect on thefinancial condition or result of operations of the Company taken as a whole.

 

In the normal course ofbusiness, there are various outstanding commitments to extend credit which arenot reflected in the financial statements, including loan commitments of$167,919,000 and $148,921,000 and letters of credit of $3,915,000 and$4,649,000 at June 30, 2005 and December 31, 2004, respectively.

 

Of the loan commitmentsoutstanding at June 30, 2005, $102,193,000 are real estate construction loancommitments that are expected to fund within the next twelve months. Theremaining commitments primarily relate to revolving lines of credit or othercommercial loans, and many of these are expected to expire without being drawnupon. Therefore, the total commitments do not necessarily represent future cashrequirements. Each loan commitment and the amount and type of collateralobtained, if any, are evaluated on an individual basis. Collateral held varies,but may include real property, bank deposits, debt or equity securities orbusiness assets.

 

Stand-by letters of creditare conditional commitments written to guarantee the performance of a customerto a third party. These guarantees are primarily related to the purchases ofinventory by commercial customers and are typically short-term in nature.Credit risk is similar to that involved in extending loan commitments tocustomers and accordingly, evaluation and collateral requirements similar tothose for loan commitments are used. The fair value of the liability related tothese standby letters of credit, which represents the fees received for issuingthe guarantees, was not significant at June 30, 2005 and December 31,2004.  The Company recognizes these feesas revenues over the term of the commitment or when the commitment is used.

 

8

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6. NEW ACCOUNTING PRONOUNCEMENTS

 

Share-Based Payments

 

In December 2004 the FASB issued Statement Number 123 (revised 2004) (FAS 123 (R)), *Share-Based Payments*.  FAS 123 (R) requires all entities to recognize compensation expense in an amount equal to the fair value of share-based payments such as stock options granted to employees.  In April 2005, the Securities and Exchange Commission adopted a rule that defers the compliance date of FAS 123(R) from the first reporting period beginning after June 15, 2005 to the first fiscal year beginning after June 15, 2005, January 1, 2006 for the Company. Management has not completed its evaluation of the effect that FAS 123 (R) will have, but believes that the effect will be consistent with its previous pro forma disclosures.

 

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

 

The following isCommunity Valley Bancorp’s (the “Company”) management’s discussion and analysisof the significant changes in balance sheet accounts for June 30, 2005 andDecember 31, 2004 and income and expense accounts for the three and six monthperiods ended June 30, 2005 and 2004. The discussion is designed to provide abetter understanding of significant trends related to the Company’s financialcondition, results of operations, liquidity, capital resources and interestrate sensitivity.

 

In addition to the historical information contained herein, this report on Form 10-Q contains certain forward-looking statements.  The reader of this report should understand that all such forward-looking statements are subject to various uncertainties and risks that could affect their outcome.   The Company’s actual results could differ materially from those suggested by such forward-looking statements.  Factors that could cause or contribute to such differences include, but are not limited to, variances in the actual versus projected growth in assets, return on assets, loan losses, expenses, rates charged on loans and earned on securities investments, rates paid on deposits, competition effects, fee and other noninterest income earned, general economic conditions, nationally, regionally and in the operating market areas of the Company and its subsidiaries, changes in the regulatory environment, changes in business conditions and inflation, changes in securities markets, data processing problems, a decline in real estate values in the Company’s market area,  the effects of terrorism, including the events of September 11, 2001 and thereafter, and the conduct of the war on terrorism by the United States and its allies, as well as other factors. This entire report should be read putting such forward-looking statements in context.

 

## **General Development ofBusiness**

 

The Company is afinancial holding company (“FHC”) registered and authorized to engage in theactivities permitted under the Bank Holding Company Act of 1956, as amended.The Company was incorporated under the laws of the State of California in 2002and elected to change to a FHC in 2004.   As a financial holding company, the Company is subject to the FederalHolding Company Act and to supervision by the board of Governors of the FederalReserve System (“FRB”).** **Its principal office is located at2041 Forest Avenue, Chico, California 95928 and its telephone number is (530)899-2344.

 

The Company owns100% of the issued and outstanding common shares of Butte Community Bank.  Butte Community Bank was incorporated andcommenced business in Paradise and Oroville, California in 1990.  Butte Community Bank operates twelve fullservice offices within its primary service areas of Butte, Sutter, Yuba andTehama Counties.  The Bank also maintainsLoan Production Offices in Citrus Heights and Redding. Another Loan ProductionOffice was opened in the City of Gridley in July of 2005.  Butte Community Bank’s primary business isserving the commercial banking needs of small to mid-sized businesses andconsumers within those counties.

 

9

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Butte CommunityBank accepts checking and savings deposits, offers money market depositaccounts and certificates of deposit, makes secured and unsecured commercial,secured real estate, and other installment and term loans and offers othercustomary banking services.

 

On December 19,2002 the Company formed a wholly-owned unconsolidated subsidiary, CommunityValley Bancorp Trust I (the “Trust”), a Delaware statutory business trust, forthe purpose of issuing trust preferred securities.

 

On December 1,2004, the Company formed a wholly-owned subsidiary, CVB Insurance Agency LLCfor the purpose of providing insurance related services.

 

**CriticalAccounting Policies**

 

*General*

 

The Company’ssignificant accounting principles are described in Note 1 of the consolidatedfinancial statements in the Company’s 2004 Annual Report to Shareholders onForm 10-K and are essential to understanding Management’s Discussion andAnalysis of Results of Operations and Financial Condition. Community ValleyBancorp’s annual consolidated financial statements are prepared in accordancewith accounting principles generally accepted in the United States of America(GAAP). The financial information contained within our statements is, to asignificant extent, financial information that is based on measures of thefinancial effects of transactions and events that have already occurred. Someof the Company’s accounting principles require significant judgment to estimatevalues of assets or liabilities. In addition, certain accounting principlesrequire significant judgment in applying the complex accounting principles totransactions to determine the most appropriate treatment. The following is asummary of the more judgmental and complex accounting estimates and principles.

 

*Allowancefor Loan Losses (ALL)*

 

The allowance forloan losses is management’s best estimate of the probable losses that may besustained in our loan portfolio. The allowance is based on two basic principlesof accounting:  (1) SFAS No.5 which requires that losses be accruedwhen they are probable of occurring and estimable and (2) SFAS No. 114,which requires that losses be accrued on impaired loans based on thedifferences between the value of collateral, present value of future cash flowsor values that are observable in the secondary market and the loan balance. TheCompany performs periodic and systematic detailed evaluations of its lendingportfolio to identify and estimate the inherent risks and assess the overallcollectibility. These evaluations include general conditions such as theportfolio composition, size and maturities of various segmented portions of theportfolio such as secured, unsecured, construction, and Small BusinessAdministration (“SBA”).

 

Additional factorsinclude concentrations of borrowers, industries, geographical sectors, loanproduct, loan classes and collateral types, volume and trends of loandelinquencies and non-accrual, criticized and classified assets and trends inthe aggregate in significant credits identified as watch list items. There areseveral components to the determination of the adequacy of the ALL. Each ofthese components is determined based upon estimates that can and do change whenthe actual events occur. The Company estimates the SFAS No. 5 portion ofthe ALL based on the segmentation of its portfolio. For those segments thatrequire an ALL, the Company estimates loan losses on a monthly basis based uponits ongoing loan review process and analysis of loan performance. The Companyfollows a systematic and consistently applied approach to select the mostappropriate loss measurement methods and support its conclusions and rationalewith written documentation. One method of estimating loan losses for groups ofloans is through the application of loss rates to the groups’ aggregate loanbalances. Such rates typically reflect historical loss experience for eachgroup of loans, adjusted for relevant economic factors over a defined period oftime. The Company evaluates and modifies its loss estimation model as needed toensure that the resulting loss estimate is consistent with GAAP.

 

10

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For individuallyimpaired loans, SFAS No. 114 provides guidance on the acceptable methodsto measure impairment. Specifically, SFAS No. 114 states that when a loanis impaired, the Company should measure impairment based on the present valueof expected future principal and interest cash flows discounted at the loan’seffective interest rate, except that as a practical expedient, a creditor maymeasure impairment based on a loan’s observable market price or the fair valueof collateral, if the loan is collateral dependent. When developing theestimate of future cash flows for a loan, the Company considers all availableinformation reflecting past events and current conditions, including the effectof existing environmental factors.

 

*LoanSales and Servicing*

 

The Companyoriginates government guaranteed loans and mortgage loans that may be sold inthe secondary market.  The amounts of gains recorded on sales of loans andthe initial recording of servicing assets and interest only (I/O) strips isbased on the estimated fair values of the respective components.  Inrecording the initial value of the servicing assets and the fair value of theI/O strips receivable, the Company uses estimates which are made based onmanagement’s expectations of future prepayment and discount rates. Servicing assets are amortized over the estimated life of the relatedloan.  I/O strips are not significant at June 30, 2005.  Theseprepayment and discount rates were based on current market conditions andhistorical performance of the various pools of serviced loans.  If actualprepayments with respect to sold loans occur more quickly than projected thecarrying value of the servicing assets may have to be adjusted through a chargeto earnings.

 

*Stock-BasedCompensation*

 

The Company usesthe intrinsic value based method for measuring compensation cost related tostock options. Under the intrinsic value based method, compensation cost is theexcess, if any, of the quoted market price of the stock at grant date over theamount an employee must pay to acquire the stock. This cost is amortized on astraight-line basis over the vesting period of the options granted. The Companyapplies Accounting Principles Board Opinion (“APB”) No. 25 *Accounting for Stock Issued to Employees*andrelated interpretations in accounting for stock options.  No compensationcost has been recorded in the accompanying financial statements because alloptions have been granted at an exercise price of no less than the fair marketvalue at date of grant.  The Company will be required to implement FAS123(R) beginning January 2006.  Under123(R) the Company will recognize compensation expense in an amount equal tothe fair value of share-based payments such as stock options granted toemployees.  Management has no completedits evaluation of the effect that FAS 123(R) will have, but believes that theeffect will be consistent with its previous pro forma disclosures.

 

*Revenuerecognition*

 

The Company’sprimary source of revenue is interest income, which is the difference betweenthe interest income it receives on interest-earning assets and the interestexpense it pays on interest-bearing liabilities, and (ii) fee income,which includes fees earned on deposit services, income from SBA lending,electronic-based cash management services, mortgage brokerage fee income andmerchant credit card processing services. Interest income is recorded on anaccrual basis. Note 1 to the Consolidated Financial Statements in the Company’s2004 Annual Report to Shareholders on Form 10-K offers an explanation of theprocess for determining when the accrual of interest income is discontinued onan impaired loan.

 

*IncomeTaxes*

 

The Companyaccounts for income taxes under the asset and liability method. Under the assetand liability method, deferred tax assets and liabilities are recognized forthe future tax consequences attributable to differences between the financialstatement carrying amounts of existing assets and liabilities and their respectivetax bases. Deferred tax assets and liabilities are measured using currentlyenacted tax rates applied to such taxable income in the years in which thosetemporary differences are expected to be recovered or settled. The effect ondeferred tax assets and liabilities of a change in tax rates is recognized inincome in the period that includes the enactment date. If future income shouldprove non-existent or less than the amount of deferred tax assets within thetax years to which they may be applied, the asset may not be realized and ournet income will be reduced.

 

11

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*StockSplit*

 

On April 13, 2005,the Board of Directors of the Company declared a two-for-one stock spliteffective May 16, 2005 for shareholders of record on May 2, 2005.  All share and per share information has beenretroactively adjusted to reflect the stock split.

 

**Overview**

 

The Company recorded net income of $1,730,000 for the quarter ended June 30, 2005, which was an 18% increase from the $1,465,000 reported for the same period of 2004.  Diluted earnings per share for the second quarter of 2005 were $0.23, compared to the $0.19 recorded in the second quarter of 2004. The annualized return on average equity (ROAE) and the return on average assets (ROAA) for the second quarter of 2005 were 18.63% and 1.49%, respectively, as compared to 18.45% and 1.43%, respectively, for the same period in 2004.

 

Net income for the six months ended June 30, 2005 was $3,184,000 which was a 24.7% increase from the $2,553,000 recorded in the first six months of 2004.   Diluted earnings per share for the first six months of 2005 were $0.42, compared to the $0.34 recorded for the first six months of 2004. The annualized return on average equity (ROAE) and the return on average assets (ROAA) for the first six months of 2005 were 17.27% and 1.39%, respectively, as compared to 17.62% and 1.39%, respectively, for the same period in 2004.  The primary reason for the increase in net income was the growth in earning assets the company experienced through the opening of four new branch offices during 2004 and 2005.

 

Total assets of the Company increased by $20,097,000 or (4.5%) from December 31, 2004 to $469,773,000 at June 30, 2005.  Net loans totaled $388,740,000, up $48,076,000 (14.1%) from the ending balances on December 31, 2004.  Deposit balances at June 30, 2005 totaled $414,748,000, up $15,689,000 (3.9%) from December 31, 2004.

 

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

 

**Table One:  Components of Net Income**

 
| ** **                                                       | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                       | ** ** | **June 30,**           | ** ** | **June 30,**         | ** ** |
| **(In thousands, except  percentages)**                          | ** ** | **2005**               | ** ** | **2004**             | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                             |       |                   |       |                 |       |   |   |   |   |
| Net interest income                                              |       | $                      | 6,508      |                 | $          | 4,881 |   | $ | 12,413 |   | $ | 9,468 |   |
| Provision for loan losses                                        |       | (225                   | )          | (190                 | )          | (450 | ) | (415 | ) |
| Non-interest income                                              |       | 1,629                  |       | 1,554                |       | 3,265 |   | 2,783 |   |
| Non-interest expense                                             |       | (4,934                 | )          | (3,749               | )          | (9,806 | ) | (7,536 | ) |
| Provision for income taxes                                       |       | (1,248                 | )          | (1,031               | )          | (2,238 | ) | (1,747 | ) |
|                                                             |       |                   |       |                 |       |   |   |   |   |
| Net income                                                       |       | $                      | 1,730      |                 | $          | 1,465 |   | $ | 3,184 |   | $ | 2,553 |   |
|                                                             |       |                   |       |                 |       |   |   |   |   |
| Average total assets (In millions)                               |       | $                      | 466.0      |                 | $          | 413.0 |   | $ | 457.9 |   | $ | 401.6 |   |
| Net income (annualized) as a percentage of  average total assets |       | 1.49                   | %          | 1.43                 | %          | 1.39 | % | 1.27 | % |

 

12

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**Resultsof Operations**

 

## **Net Interest Income andNet Interest Margin**

 

Net interestincome represents the excess of interest and fees earned on interest earningassets (loans, securities, federal funds sold and investments in 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 netinterest margin was 6.18% for the three months ended June 30, 2005 and 6.06%for the six month period ending June 30, 2005 compared to 5.42% for the sameperiods in the prior year.   Net interestincome increased $1,627,000 (33%) for the second quarter of 2005 compared tothe same period in 2004.  Net interestincome increased $2,945,000 (31%) for the six months ended June 30, 2005 overthe same period in 2004.   The primaryreason for this increase was the increase in average loans of $74,904,000 and72,021,000 for the second quarter and first six months of 2005 over the sameperiods in 2004 along with the overall positive impact of the rising interestrate environment as well as increases in loan fees associated with the growth.

 

The averagebalances of interest bearing liabilities were $30,346,000 (10.2%) higher in thesecond quarter of 2005 versus the same quarter in 2004.  Even though the interest bearing balancesincreased, rates paid on these liabilities only increased 13 basis points on aquarter over quarter basis.  As a result,interest expense was $210,000 (21.9%) higher in the second quarter of 2005compared to versus the prior year period. The average balances of interest bearing liabilities were $35,456,000(12.1%) higher in the six-month period ended June 30, 2005 versus the sameperiod in 2004.  Rates paid on interestbearing liabilities only increased 9 basis points compared to the six monthperiod ended June 30, 2004.  Managementwas able to keep deposit interest rates low because there was excess liquidityin the form of overnight fed funds available to match the loan growth.  It is anticipated that deposit interest ratespaid in the third and fourth quarter may rise in order to continue funding theongoing loan demand.

 

Table Two,Analysis of Net Interest Margin on Earning Assets, and Table Three, Analysis ofVolume and Rate Changes on Net Interest Income and Expenses, are provided toenable the reader to understand the components and past trends of the Company’sinterest income and expense.

 

Table Twoprovides an analysis of net interest margin setting forth average assets,liabilities and shareholders’ equity; interest income earned and interestexpense paid and average rates earned and paid; and the net interest margin.

 

13

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**TableTwo:  Analysis of Net Interest Margin onEarning Assets**

** **
| ** **                                      | ** ** | **2005**         | ** ** | **2004**     | ** ** |
|-------------------------------------------------|------------|------------------|------------|--------------|------------|
| **Three Months Ended June 30,**                 | ** ** | **Avg  Balance** | ** ** | **Interest** | ** ** | **Avg  Yield (4)** | ** ** | **Avg  Balance** | ** ** | **Interest** | ** ** | **Avg  Yield (4)** | ** ** |
| **(In thousands, except percentages)**          |       |             |       |         |       |   |   |   |   |   |   |   |   |
| **Assets:**                                     |       |             |       |         |       |   |   |   |   |   |   |   |   |
| Earning assets                                  |       |             |       |         |       |   |   |   |   |   |   |   |   |
| Loans (1)                                       |       | $                | 373,520    |         | $          | 7,291 |   | 7.83 | % | $ | 298,616 |   | $ | 5,615 |   | 7.56 | % |
| Taxable investment securities                   |       | 5,779            |       | 54           |       | 3.75 | % | 3,897 |   | 36 |   | 3.41 | % |
| Tax-exempt investment securities (2)            |       | 2,430            |       | 31           |       | 5.12 | % | 705 |   | 10 |   | 5.71 | % |
| Federal funds sold                              |       | 32,112           |       | 233          |       | 2.91 | % | 49,979 |   | 121 |   | 0.97 | % |
| Interest bearing deposits in banks              |       | 8,701            |       | 68           |       | 3.13 | % | 8,863 |   | 58 |   | 2.63 | % |
| Total earning assets                            |       | 422,542          |       | 7,677        |       | 7.29 | % | 362,060 |   | 5,840 |   | 6.49 | % |
| Cash & due from banks                       |       | 24,688           |       |         |       |   |   | 26,486 |   |   |   |   |   |
| Other assets                                    |       | 18,771           |       |         |       |   |   | 24,489 |   |   |   |   |   |
| Average total assets                            |       | $                | 466,001    |         |       |   |   |   | $ | 413,036 |   |   |   |   |   |
|                                            |       |             |       |         |       |   |   |   |   |   |   |   |   |
| **Liabilities & Shareholders’ Equity** |       |             |       |         |       |   |   |   |   |   |   |   |   |
| Interest bearing liabilities:                   |       |             |       |         |       |   |   |   |   |   |   |   |   |
| NOW & MMDA                                  |       | $                | 181,326    |         | 266        |   | 0.59 | % | $ | 174,829 |   | 263 |   | 0.61 | % |
| Savings                                         |       | 36,611           |       | 44           |       | 0.48 | % | 27,993 |   | 34 |   | 0.49 | % |
| Time deposits                                   |       | 100,359          |       | 702          |       | 2.81 | % | 85,638 |   | 552 |   | 2.59 | % |
| Other borrowings                                |       | 9,292            |       | 157          |       | 6.78 | % | 8,782 |   | 110 |   | 5.04 | % |
| Total interest bearing liabilities              |       | 327,588          |       | 1,169        |       | 1.43 | % | 297,242 |   | 959 |   | 1.30 | % |
|                                            |       |             |       |         |       |   |   |   |   |   |   |   |   |
| Demand deposits                                 |       | 92,691           |       |         |       |   |   | 77,678 |   |   |   |   |   |
| Other liabilities                               |       | 8,474            |       |         |       |   |   | 6,174 |   |   |   |   |   |
| Total liabilities                               |       | 428,753          |       |         |       |   |   | 381,094 |   |   |   |   |   |
| Shareholders’ equity                       |       | 37,248           |       |         |       |   |   | 31,942 |   |   |   |   |   |
| Average liabilities and equity                  |       | $                | 466,001    |         |       |   |   |   | $ | 413,036 |   |   |   |   |   |
| Net interest income & margin (3)            |       |             |       | $            | 6,508      |   | 6.18 | % |   |   | $ | 4,881 |   | 5.42 | % |

 

----

(1)   Loaninterest includes loan fees of $610,000 and $499,000 during the three monthsended June 30, 2005 and June 30, 2004 respectively.

(2)   Doesnot include taxable-equivalent adjustments that primarily relate to income oncertain securities that are exempt from federal income taxes.

(3)   Netinterest margin is computed by dividing net interest income by total averageearning assets.

(4)   Averageyield is calculated based on actual days in quarter (91 for June 30, 2005 andJune 30, 2004) and annualized to actual days in year (365 for 2005 and 366 for2004).

 

14

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| ** **                                      | ** ** | **2005**         | ** ** | **2004**     | ** ** |
|-------------------------------------------------|------------|------------------|------------|--------------|------------|
| **Six Months Ended June 30,**                   | ** ** | **Avg  Balance** | ** ** | **Interest** | ** ** | **Avg  Yield (4)** | ** ** | **Avg  Balance** | ** ** | **Interest** | ** ** | **Avg  Yield (4)** | ** ** |
| **(In thousands, except percentages)**          |       |             |       |         |       |   |   |   |   |   |   |   |   |
| **Assets:**                                     |       |             |       |         |       |   |   |   |   |   |   |   |   |
| Earning assets                                  |       |             |       |         |       |   |   |   |   |   |   |   |   |
| Loans (1)                                       |       | $                | 360,762    |         | $          | 13,979 |   | 7.81 | % | $ | 288,741 |   | $ | 10,972 |   | 7.64 | % |
| Taxable investment securities                   |       | 5,913            |       | 101          |       | 3.44 | % | 3,619 |   | 61 |   | 3.39 | % |
| Tax-exempt investment securities (2)            |       | 2,236            |       | 56           |       | 5.05 | % | 725 |   | 20 |   | 5.55 | % |
| Federal funds sold                              |       | 35,091           |       | 465          |       | 2.67 | % | 49,783 |   | 243 |   | 0.98 | % |
| Interest bearing deposits in banks              |       | 8,741            |       | 128          |       | 2.95 | % | 8,555 |   | 119 |   | 2.73 | % |
| Total earning assets                            |       | 412,743          |       | 14,729       |       | 7.20 | % | 351,423 |   | 11,415 |   | 6.51 | % |
| Cash & due from banks                       |       | 18,720           |       |         |       |   |   | 25,979 |   |   |   |   |   |
| Other assets                                    |       | 26,424           |       |         |       |   |   | 24,211 |   |   |   |   |   |
| Average total assets                            |       | $                | 457,887    |         |       |   |   |   | $ | 401,613 |   |   |   |   |   |
|                                            |       |             |       |         |       |   |   |   |   |   |   |   |   |
| **Liabilities & Shareholders’ Equity** |       |             |       |         |       |   |   |   |   |   |   |   |   |
| Interest bearing liabilities:                   |       |             |       |         |       |   |   |   |   |   |   |   |   |
| NOW & MMDA                                  |       | $                | 181,114    |         | 536        |   | .60 | % | $ | 170,603 |   | 564 |   | .66 | % |
| Savings                                         |       | 35,620           |       | 86           |       | .49 | % | 26,942 |   | 68 |   | .51 | % |
| Time deposits                                   |       | 101,304          |       | 1,395        |       | 2.78 | % | 85,175 |   | 1,095 |   | 2.59 | % |
| Other borrowings                                |       | 9,175            |       | 299          |       | 6.57 | % | 9,037 |   | 220 |   | 4.90 | % |
| Total interest bearing liabilities              |       | 327,213          |       | 2,316        |       | 1.43 | % | 291,757 |   | 1,947 |   | 1.34 | % |
|                                            |       |             |       |         |       |   |   |   |   |   |   |   |   |
| Demand deposits                                 |       | 87,178           |       |         |       |   |   | 73,406 |   |   |   |   |   |
| Other liabilities                               |       | 7,125            |       |         |       |   |   | 5,074 |   |   |   |   |   |
| Total liabilities                               |       | 421,516          |       |         |       |   |   | 370,237 |   |   |   |   |   |
| Shareholders’ equity                       |       | 36,371           |       |         |       |   |   | 31,376 |   |   |   |   |   |
| Average liabilities and equity                  |       | $                | 457,887    |         |       |   |   |   | $ | 401,613 |   |   |   |   |   |
| Net interest income & margin (3)            |       |             |       | 12,413       |       | 6.06 | % |   |   | 9,468 |   | 5.42 | % |
|                                                 |            |                  |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)   Loaninterest includes loan fees of $1,226,000 and $1,031,000 during the six monthsended June 30, 2005 and June 30, 2004, respectively.

(2)   Doesnot include taxable-equivalent adjustments that primarily relate to income oncertain securities that is exempt from federal income taxes.

(3)   Net interestmargin is computed by dividing net interest income by total average earningassets.

(4)   Averageyield is calculated based on actual days in period (181 for June 30, 2005 and182 days for June 30, 2004) and annualized to actual days in year (365 for 2005and 366 for 2004).

 

15

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Table Threesets forth a summary of the changes in interest income and interest expensefrom changes in average asset and liability balances (volume) and changes inaverage interest rates.  On a quarterover quarter basis for the period ending June 30, 2005 net interest income hasincreased $1,627,000 over the same time period in 2004.  Interest income from earning assets hasincreased by $1,837,000. Changes in the volume of earning assets, primarilyloans, have resulted in an increase in interest income of $1,410,000 while interestincome from changes in rates has increased by $427,000.  Interest expense for the second quarter of2005 was $210,000 more than the same time period in 2004.  Changes in the volume of interest bearingliabilities, primarily the increase in balances of time deposits, has resultedin a net increase of interest expense of $121,000.  Increases in average rates paid, primarily ontime deposits and junior subordinated debentures have resulted in an interestexpense increase of $89,000.   On ayear-to-date basis through June 30, 2005, net interest income has increased$2,945,000 over the same period in 2004. Interest income from earning assets has increased by $3,314,000.  Changes in the volume of earning assets,primarily loans, have resulted in an increase in interest income of $2,742,000while interest income from changes in rates has increased by $572,000.  Interest expense for the six month period was$369,000 more than the same time period in 2004.  Changes in the volume of interest bearingliabilities, primarily the increase in balances of time deposits, have resultedin a net increase of interest expense of $267,000.  Increases in average rates paid, primarily ontime deposits and junior subordinated debentures have resulted in an interestexpense increase of $102,000.

 

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

 

(Inthousands) Three Months Ended June 30, 2005 over 2004

 
| **Increase (decrease) due to  change in:** | ** ** | **Volume** | ** ** | **Rate (3)** | ** ** | **Net Change** | ** ** |
|--------------------------------------------|------------|------------|------------|--------------|------------|----------------|------------|
| Interest-earning assets:                   |       |       |       |         |       |           |       |
| Net loans (1)                              |       | $          | 1,412      |         | $          | 264            |       | $ | 1,676 |   |
| Taxable investment securities              |       | 17         |       | 1            |       | 18             |       |
| Tax exempt investment securities (2)       |       | 25         |       | (4           | )          | 21             |       |
| Federal funds sold                         |       | (43        | )          | 155          |       | 112            |       |
| Investment in time deposits                |       | (1         | )          | 11           |       | 10             |       |
| Total                                      |       | 1,410      |       | 427          |       | 1,837          |       |
|                                       |       |       |       |         |       |           |       |
| Interest-bearing liabilities:              |       |       |       |         |       |           |       |
| NOW & MMDA                             |       | 10         |       | (7           | )          | 3              |       |
| Savings deposits                           |       | 10         |       | 0            |       | 10             |       |
| Time deposits                              |       | 95         |       | 55           |       | 150            |       |
| Other borrowings                           |       | 6          |       | 41           |       | 47             |       |
| Total                                      |       | 121        |       | 89           |       | 210            |       |
| Interest differential                      |       | $          | 1,289      |         | $          | 338            |       | $ | 1,627 |   |

 

----

(1)   Theaverage balance of non-accruing loans is immaterial as a percentage of totalloans and, as such, has been included in net loans.

(2)   Doesnot include taxable-equivalent adjustments that primarily relate to income oncertain securities that is exempt from federal income taxes.

(3)   Therate/volume variance has been included in the rate variance.

 

16

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

 

(In thousands) Six Months EndedJune 30, 2005 over 2004

 
| **Increase (decrease) due to  change in:** | ** ** | **Volume** | ** ** | **Rate (3)** | ** ** | **Net Change** | ** ** |
|--------------------------------------------|------------|------------|------------|--------------|------------|----------------|------------|
| Interest-earning assets:                   |       |       |       |         |       |           |       |
| Net loans (1)                              |       | $          | 2,729      |         | $          | 278            |       | $ | 3,007 |   |
| Taxable investment securities              |       | 40         |       | (3           | )          | 37             |       |
| Tax exempt investment securities (2)       |       | 42         |       | (6           | )          | 36             |       |
| Federal funds sold                         |       | (72        | )          | 294          |       | 222            |       |
| Investment in time deposits                |       | 3          |       | 9            |       | 12             |       |
| Total                                      |       | 2,742      |       | 572          |       | 3,314          |       |
|                                       |       |       |       |         |       |           |       |
| Interest-bearing liabilities:              |       |       |       |         |       |           |       |
| NOW & MMDA                             |       | 35         |       | (63          | )          | (28            | )          |
| Savings deposits                           |       | 22         |       | (4           | )          | 18             |       |
| Time deposits                              |       | 207        |       | 93           |       | 300            |       |
| Other borrowings                           |       | 3          |       | 76           |       | 79             |       |
| Total                                      |       | 267        |       | 102          |       | 369            |       |
| Interest differential                      |       | $          | 2,475      |         | $          | 470            |       | $ | 2,945 |   |

 

----

(1)   Theaverage balance of non-accruing loans is immaterial as a percentage of totalloans and, as such, has been included in net loans.

(2)   Doesnot include taxable-equivalent adjustments that primarily relate to income oncertain securities that is exempt from federal income taxes.

(3)   Therate/volume variance has been included in the rate variance.

 

17

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## **Non-interest Income**

 

Table Four belowprovides a summary of the components of noninterest income for the periodsindicated (dollars in thousands) (percent of assets annualized):

 

**Table Four: Components of Noninterest Income (Unaudited)  **

 
| **Three Months Ended June 30,**     | ** ** | **2005** | ** ** | **% of Avg.  Assets** | ** ** | **2004** | ** ** | **% of Avg.  Assets** | ** ** |
|-------------------------------------|------------|----------|------------|-----------------------|------------|----------|------------|-----------------------|------------|
|                                |       |     |       |                  |       |     |       |                  |       |
| Service charges on deposit accounts |       | $        | 604        |                  | .52        |     | $          | 511                   |       | .49 |   |
| Loan servicing fees                 |       | 104      |       | .09                   |       | 94       |       | .09                   |       |
| Fees - alternative investment sales |       | 176      |       | .15                   |       | 93       |       | .09                   |       |
| Merchant fee income                 |       | 108      |       | .09                   |       | 78       |       | .08                   |       |
| Gain on sale of loans               |       | 341      |       | .29                   |       | 543      |       | .52                   |       |
| Other                               |       | 296      |       | .25                   |       | 235      |       | .23                   |       |
|                                |       |     |       |                  |       |     |       |                  |       |
| Total non-interest income           |       | $        | 1,629      |                  | 1.39       |     | $          | 1,554                 |       | 1.50 |   |

 
| **Six Months Ended June 30,**       | ** ** | **2005** | ** ** | **% of Avg.  Assets** | ** ** | **2004** | ** ** | **% of Avg.  Assets** | ** ** |
|-------------------------------------|------------|----------|------------|-----------------------|------------|----------|------------|-----------------------|------------|
|                                |       |     |       |                  |       |     |       |                  |       |
| Service charges on deposit accounts |       | $        | 1,143      |                  | .50        |     | $          | 964                   |       | .48 |   |
| Loan servicing fees                 |       | 200      |       | .09                   |       | 186      |       | .09                   |       |
| Fees - alternative investment sales |       | 335      |       | .15                   |       | 230      |       | .11                   |       |
| Merchant fee income                 |       | 186      |       | .08                   |       | 162      |       | .08                   |       |
| Gain on sale of loans               |       | 814      |       | .36                   |       | 788      |       | .39                   |       |
| Other                               |       | 587      |       | .26                   |       | 453      |       | .23                   |       |
|                                |       |     |       |                  |       |     |       |                  |       |
| Total non-interest income           |       | $        | 3,265      |                  | 1.44       |     | $          | 2,783                 |       | 1.38 |   |

 

## **Non-interest income was up $75,000(4.8%) to $1,629,000 for the three months ended June 30, 2005 as compared to$1,554,000 for the three months ended June 30, 2004.    Increases in non-interest income wererealized in fees from service charges (up 18.2%), loan servicing (up 10.6%),fees from alternative investment sales (up 89.2%), merchant processing fees (up38.5%) and other (up 26%).**

 

## **Gains on sales of loans declined asa result of fewer loans being sold on the secondary market through ourGovernment Lending and Mortgage Lending Divisions as many customers of theCompany had already taken advantage of the low levels in mortgage financingrates during 2004.**

 

## **The increase in service chargeincome was the result of additional deposit accounts opened during the secondquarter and fees resulting from the overdraft privilege deposit product.  The Investment Department, which sellsthird-party mutual funds and annuities, experienced an increase in fees due toan increase in sales during the second quarter.**

 

18

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For the six monthsended June 30, 2005, non-interest income was up $482,000 (17.3%) to $3,265,000as compared to the $2,783,000 total for the six months ended June 30,2004.   All of the components ofnon-interest income showed gains. Increases were realized in service charges on deposit accounts (up18.6%), loan servicing (up 7.5%), alternative investment sales (up 45.7%),merchant fee income (up 14.8%), gain on sale of loans (up 3.3%), and other (up29.6%).  Gains on sales of loansincreased year over year as our Government Lending Division sold more loans toSBA and the USDA B&I programs in the second quarter of 2005 than the sameperiod in 2004.

 

**Non-interestExpense**

 

Non-interestexpense increased $1,185,000 (31.6%) to $4,934,000 in the second quarter of2005 versus $3,749,000 in the second quarter of 2004.  Much of the increase in non-interest expensecan be attributed to the opening of the Red Bluff, Marysville and Colusaoffices in 2004 and the opening of the Corning office in March of 2005.  On a quarter over quarter basis, full timeequivalent employees increased by 7. Salary and employee benefits increased $687,000 (32.7%) resulting fromnormal cost of living raises, commissions paid to Butte Community Bank’s RealEstate Loan agents and staffing additions made during the year as the Companycontinues to grow. Benefit costs and employer taxes increased commensurate withthe salaries.    On a quarter overquarter basis, occupancy expenses were higher by $32,000 (13%) which is relatedto building depreciation, utilities, janitorial services and propertytaxes.   Furniture and equipment expensewas $439,000 in the second quarter of 2005 compared to $311,000 in the sameperiod of 2004, representing a 41.2% increase.  This increase relates to the additional depreciation on the furniturefixtures and equipment needed to open the four offices mentioned above.  Other expenses increased $338,000 (31%) inthe second quarter of 2005 versus the second quarter of 2004.   This increase was attributed to highertelephone, postage and insurance costs as well as increased advertising andpromotion costs associated with the new offices.

 

Non-interestexpense increased $2,270,000 for the six month period ended June 30, 2005 to$9,806,000 versus $7,536,000 for the same period in 2004.  As with the quarter over quarter totals thesix month numbers are also reflective of the new offices opened in 2004 and2005 as discussed above.  Salaries andbenefits increased by $1,444,000 (33%) due to cost of living raises addedbenefit costs and employer taxes associated with the staffing additions madeduring the year as the Company continues to grow. On a year over year basis,full time equivalent employees increased by 37 to 226.   Occupancy expense was up $74,000 (15.3%)from the first six months of 2004 to the first six months of 2005.  Furniture and equipment expense was up166,000 (25.0%).    Other expensesincreased by $586,000 (29.2%).   Thisincrease was attributed to higher telephone, postage and insurance costs aswell as increased advertising and promotion costs associated with the newoffices.

 

## **Provision for Loan Losses**

 

The Companyprovided $225,000 for loan losses for the second quarter of 2005 as compared to$190,000 for the second quarter of 2004. Net loan charge-offs for the three months ended June 30, 2005 were$5,000 as compared to $1,000 in net recoveries for the three months ended June30, 2004.   For the first six months of2004, the Company made provisions for loan losses of $450,000.   This compares to the provision for loanlosses of $415,000 for the first six months of 2004.  Net loan charge-offs for the six months endedJune 30, 2005 were $6,000 as compared to net recoveries of $11,000 for the sixmonths ended June 30, 2004.  Managementassesses its loan quality on a monthly basis to maintain an adequate allowancefor loan losses.  The Company’s loanportfolio composition, non-performing assets and allowance for loan losses arefurther discussed under the Balance Sheet Analysis section below.

 

**Provisionfor Income Taxes**

 

The effective taxrate for the second quarter and first six months of 2005 was 41.9% and 41.3%,versus 41.3% and 40.6%, for the same period in 2004.

 

19

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**BalanceSheet Analysis**

 

The Company’stotal assets were $469,773,000 at June 30, 2005 as compared to $449,676,000 atDecember 31, 2004, representing an increase of 4.5%.  The average balance of total assets for thesix months ended June 30, 2005 was $457,887,000, which represents an increaseof $56,273,000 (14.0%) over the $401,613,000 during the six-month period endedJune 30, 2004.

 

## **Loans**

 

The Companyconcentrates its lending activities in the following principal areas: 1)commercial; 2) real estate; 3) residential real estate and real estateconstruction (both commercial and residential); 4) agriculture; and 5) consumerloans.  Commercial and residential realestate loans are generally secured by improved property, with originalmaturities of 3-10 years.  At June 30,2005, these principal areas accounted for approximately 16%, 45%, 25%, 7% and8%, respectively, of the Company’s loan portfolio.    The mix at December 31, 2004 was 17%, 43%,26%, 6% 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 ($3,705,000 or 6.3%),residential real estate ($24,845,000 or 16.9%), real estate construction($9,385,000 or 10.4%), agricultural loans ($4,100,000 or 18.5%), and consumer($4,463,000 or 17.0%).  These changes arereflective of the overall growth in loans and consistent with the Company’shistory of increased real estate construction activity during the summermonths.  Table Five below summarizes thecomposition of the loan portfolio as of June 30, 2005 and December 31, 2004.

 

**TableFive: Loan Portfolio Composition**

 
| ** **                | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------|------------|--------------|------------|------------------|------------|
| **(In thousands)**        | ** ** | **2005**     | ** ** | **2004**         | ** ** |
| Commercial                |       | $            | 62,367     |             | $          | 58,662 |   |
| Real estate:              |       |         |       |             |       |
| Mortgage                  |       | 171,721      |       | 146,876          |       |
| Construction              |       | 100,028      |       | 90,643           |       |
|                      |       |         |       |             |       |
| Agriculture               |       | 26,277       |       | 22,177           |       |
| Consumer                  |       | 30,682       |       | 26,219           |       |
| Total loans               |       | 391,075      |       | 344,577          |       |
| Allowance for loan losses |       | (4,825       | )          | (4,381           | )          |
| Deferred loan fees, net   |       | (955         | )          | (1,022           | )          |
| Total net loans           |       | $            | 385,295    |             | $          | 339,174 |   |

 

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

 

Commercialloans consist of credit lines for operating needs, loans for equipmentpurchases, working capital, and various other business loan products.  Consumer loans include a range of traditionalconsumer loan products such as personal lines of credit and loans to financepurchases of autos, boats, recreational vehicles, mobile homes and variousother consumer items.

 

Realestate construction loans are generally composed of commitments to customerswithin the Company’s service area for construction of both commercialproperties and custom and semi-custom single-family residences.

 

20

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Real estate mortgage loans consist primarily of loans secured by firsttrust deeds on commercial and residential properties typically with maturitiesfrom 3 to 10 years and original loan to value ratios generally from 65% to 80%.

 

Agriculture loans consist primarily of crop loans to farmers ofpeaches, prunes, walnuts, and almonds. In general, except in the case of loans with SBA or FMHA guarantees, theCompany does not make long-term mortgage loans; however, Butte Community Bankhas a residential lending division to assist customers in securing most formsof longer term single-family mortgage financing.

 

## **Risk Elements**

 

The Company assesses and manages credit risk on an ongoing basisthrough a total credit culture that emphasizes excellent credit quality,extensive internal monitoring and established formal lending policies.  Additionally, the Company contracts with anoutside loan review consultant to periodically review the existing loanportfolio.  Management believes itsability to identify and assess risk and return characteristics of the Company’sloan 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 and business cycles mayinfluence credit quality.  The Company’sbusiness is concentrated in the Butte, Sutter and Shasta County Areas. Theeconomy of these three counties is diversified with professional services,manufacturing, agriculture and real estate investment and construction.

 

Special emphasis is placed within the communities in which the Companyhas offices (Chico, Paradise, Magalia, Oroville, Yuba City, Red Bluff, andMarysville, Colusa and Corning).  TheCompany also maintains loan production offices in the cities of Citrus Heightsand Redding, and as of July 18, 2005 in the city of Gridley.  Single-family residential construction is theprimary lending product from the Citrus Heights location serving the greaterSacramento area.  The primary focus ofthe loan production office in Redding is commercial loans with an emphasis onSBA and other government loan programs. The Gridley location will concentrate on agricultural and commerciallending.

 

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

 

In extending credit and commitments to borrowers, the Company generallyrequires collateral and/or guarantees as security.  The repayment of such loans is expected tocome from cash flow or from proceeds from the sale of selected assets of theborrowers.  The Company’s requirement forcollateral and/or guarantees is determined on a case-by-case basis inconnection with management’s evaluation of the creditworthiness of theborrower.  Collateral held varies but mayinclude 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.

 

## **Inmanagement’s judgment, a concentration exists in real estate loans, whichrepresented approximately 70.5% of the Company’s loan portfolio at June 30,2005, which is a slight increase from the 70.0% concentration level at December31, 2004.  Management believes theconcentration to have no more than the normal risk of**

 

21

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## **collectability;however, a substantial decline in the economy in general, or a decline in realestate values in the Company’s primary market areas in particular, could havean adverse impact on the collectability of these loans and require an increasein the provision for loan losses which could adversely affect the Company’sfuture prospects, results of operations, profitability and stock price.  Management believes that its lending policiesand underwriting standards will tend to minimize losses in an economicdownturn; however, there is no assurance that losses will not occur under suchcircumstances.**

## ** **

## **TheCompany’s loan policies and underwriting standards include, but are not limitedto, the following: (1) maintaining a thorough understanding of the Company’sservice area and originating a significant majority of its loans within thatarea, (2) maintaining a thorough understanding of borrowers’ knowledge,capacity, and market position in their field of expertise, (3) basing realestate loan approvals not only on market demand for the project, but also onthe borrowers’ capacity to support the project financially in the event it doesnot perform to expectations (whether sale or income performance), and (4)maintaining conforming and prudent loan to value and loan to cost ratios basedon independent outside appraisals and ongoing inspection and analysis by theCompany’s lending officers.**

## ** **

## **Nonaccrual, Past Due and Restructured Loans**

## ** **

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

 

TableSix below sets forth nonaccrual loans as of June 30, 2005 and December 31,2004.  There were no loans past due 90days or more and still accruing interest at June 30, 2005 or December 31, 2004.

 

**TableSix:  Non-Performing Loans (Unaudited)**

 
| ** **                  | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------|------------|--------------|------------|------------------|------------|
| **(In thousands)**          | ** ** | **2005**     | ** ** | **2004**         | ** ** |
| Nonaccrual:                 |       |         |       |             |       |
| Agricultural                |       | 0            |       | 17               |       |
| Commercial                  |       | 0            |       |             |       |
| Real estate                 |       | 0            |       | 84               |       |
| Consumer and other          |       | 0            |       |             |       |
| Total  non-performing loans |       | $            | 0          |             | $          | 101 |   |
|                             |            |              |            |                  |            |  |  |

 

At June 30, 2005, there were no non-performing loans. The recordedinvestments in loans that were considered to be impaired totaled $101,000 atDecember 31, 2004.  These loans weresubsequently brought current as to all past due interest and principle and werereturned to accrual status as management believes the loans arecollectable.  There were no loanconcentrations in excess of 10% of total loans not otherwise disclosed as acategory of loans as of June 30, 2005 or December 31, 2004.  Management is not aware of any potentialproblem loans, which were accruing and current at June 30, 2005, where seriousdoubt exists as to the ability of the borrower to comply with the presentrepayment terms.

 

22

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## **Allowance for Loan Losses Activity**

## ** **

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

 

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

 

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

 

Ourmethodology is, and has been, consistently followed.  However, as we addnew products, increase in complexity, and expand our geographic coverage, weexpect to enhance our methodology to keep pace with the size and complexity ofthe loan portfolio.  On an ongoing basis we engage outside firms to independentlyassess our methodology, and to perform independent credit reviews of our loanportfolio.  The FDIC and the California Department of FinancialInstitutions review the allowance for loan losses as an integral part of theexamination processes.  Management believes that our current methodologyis appropriate given our size and level of complexity.  Further,management believes that the allowance for loan losses is adequate as of June30, 2005 to cover known and inherent risks in the loan portfolio. However, fluctuations in credit quality, or changes in economic conditions orother factors could cause management to increase or decrease the allowance forloan losses as necessary.

 

The Boardof Directors of the Bank reviews the adequacy of the allowance for loan lossesat least quarterly to include consideration of the relative risks in theportfolio and current economic conditions. The allowance is adjusted based on that review if, in the judgment ofthe loan committee and management, changes are warranted.  The allowance for loan losses totaled$4,825,000 or 1.23% of total loans at June 30, 2005 and $4,381,000 or 1.27% atDecember 31, 2004.  Net charge-offs toaverage loans for the second quarter were .01% and year to date through June30, 2005 are .01%.

 

23

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Table Seven below summarizes, for the periodsindicated, the activity in the allowance for loan losses

 

**Table Seven: Allowance for Loan Losses (Unaudited)**

 
| ** **                                                                | ** ** | **Three Months  Ended  June 30,** | ** ** | **Six Months  Ended  June 30,** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------|------------|---------------------------------|------------|
| **(In thousands, except for  percentages)**                               | ** ** | **2005**                          | ** ** | **2004**                        | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                      |       |                              |       |                            |       |   |   |   |   |
| Average  loans outstanding                                                |       | $                                 | 373,520    |                            | $          | 298,616 |   | $ | 360,762 |   | $ | 288,741 |   |
|                                                                      |       |                              |       |                            |       |   |   |   |   |
| Allowance for possible loan losses at  beginning of period                |       | $                                 | 4,605      |                            | $          | 3,822 |   | $ | 4,381 |   | $ | 3,587 |   |
|                                                                      |       |                              |       |                            |       |   |   |   |   |
| Loans  charged off:                                                       |       |                              |       |                            |       |   |   |   |   |
| Commercial                                                                |       | (5                                | )          |                            |       | (5 | ) |   |   |
| Real estate                                                               |       |                              |       |                            |       |   |   |   |   |
| Consumer                                                                  |       |                              |       |                            |       | (1 | ) | (7 | ) |
| Total                                                                     |       | (5                                | )          |                            |       | (6 | ) | (7 | ) |
| Recoveries of loans previously charged off:                               |       |                              |       |                            |       |   |   |   |   |
| Commercial                                                                |       |                              |       |                            |       |   |   | 14 |   |
| Real estate                                                               |       |                              |       |                            |       |   |   |   |   |
| Consumer                                                                  |       |                              |       | 1                               |       |   |   | 4 |   |
| Total                                                                     |       |                              |       | 1                               |       |   |   | 18 |   |
| Net loan  recoveries/charge-offs                                          |       | (5                                | )          | 1                               |       | (6 | ) | 11 |   |
|                                                                      |       |                              |       |                            |       |   |   |   |   |
| Additions to allowance charged to operating  expenses                     |       | 225                               |       | 190                             |       | 450 |   | 415 |   |
| Allowance for loan losses at end of period                                |       | $                                 | 4,825      |                            | $          | 4,013 |   | $ | 4,825 |   | $ | 4,013 |   |
| Ratio of net charge-offs to average loans  outstanding                    |       | .00                               | %          | .00                             | %          | .00 | % | .00 | % |
| Provision for possible loan losses to  average loans outstanding          |       | .06                               | %          | .06                             | %          | .12 | % | .14 | % |
| Allowance for loan losses to loans net of  deferred fees at end of period |       | 1.25                              | %          | 1.30                            | %          | 1.25 | % | 1.30 | % |

 

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

 

24

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**Other Real Estate**

 

AtJune 30, 2005 and December 31, 2004, the Company did not have any other realestate (“ORE”) properties.

 

## **Deposits**

## ** **

AtJune 30, 2005, total deposits were $414,748,000 representing an increase of$15,689,000 (3.9%) over the December 31, 2004 balance of $399,059,000.  Non interest bearing deposits comprised$12,730,000 of this increase.

 

## **Capital Resources**

## ** **

Thecurrent and projected capital position of the Company and the impact of capitalplans and long-term strategies are reviewed regularly by management. TheCompany’s capital position represents the level of capital available to supportcontinued operations and expansion.

 

The Board of Directors of the Company authorized the payment of a cashdividend of $.0375 per share on January 23, 2004, April 23, 2004, and July 23,2004, $.0375 per share on October 22, 2004, January 28, 2005 and $.04 per shareon June 21, 2005.  The per share amountshave been retroactively restated for the Company’s 2 for 1 stock split whichwas distributed on May 16, 2005.  Thepayment of 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.

 

TheCompany and its subsidiary Bank are subject to certain regulations issued bythe Board of Governors of the Federal Reserve System and the FDIC which requiremaintenance of certain levels of capital. At June 30, 2005, shareholders’ equity was $37,841,000, representing anincrease of $3,310,000 (9.6%) from $34,531,000 at December 31, 2004.  The increase is primarily the result of thenet income from the period offset by the cash dividends discussed above.  The Bank’s ratio of total risk-based capitalto risk adjusted assets was 10.7% at June 30, 2005 compared to 11.3% atDecember 31, 2004.  Tier 1 risk-basedcapital to risk-adjusted assets was 9.6% at June 30, 2005 and 10.2% at December31, 2004.

 

TableEight below lists the Company and the Bank capital ratios at June 30, 2005 andDecember 31, 2004, as well as the minimum ratios required under regulatory definitionsof capital adequacy.

 

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

 
| **Capital to Risk-Adjusted Assets** | ** ** | **At June 30, 2005** | ** ** | **At December 31,  2004** | ** ** | **Minimum  Regulatory Requirement** | ** ** |
|-------------------------------------|------------|----------------------|------------|---------------------------|------------|-------------------------------------|------------|
| **Company**                         |       |                 |       |                      |       |                                |       |
| Leverage ratio                      |       | 9.9                  | %          | 9.5                       | %          | 4.0                                 | %          |
| Tier 1 Risk-Based Capital           |       | 10.8                 | %          | 11.3                      | %          | 4.0                                 | %          |
| Total Risk-Based Capital            |       | 12.0                 | %          | 12.5                      | %          | 8.0                                 | %          |
| **Bank**                            |       |                 |       |                      |       |                                |       |
| Leverage ratio                      |       | 7.9                  | %          | 8.6                       | %          | 4.0                                 | %          |
| Tier 1 Risk-Based Capital           |       | 8.4                  | %          | 10.2                      | %          | 4.0                                 | %          |
| Total Risk-Based Capital            |       | 10.7                 | %          | 11.3                      | %          | 8.0                                 | %          |

 

25

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Capitalratios are reviewed on a regular basis to ensure that capital exceeds theprescribed regulatory minimums and is adequate to meet future needs.  All ratios are in excess of the regulatorydefinition of “Minimum” at June 30, 2005 and December 31, 2004.  The Bank was considered “well-capitalized” byregulatory standards, at June 30, 2005 and December 31, 2004.

 

**Item 3.  Quantitative and Qualitative Disclosuresabout Market Risk**

 

**Market Risk Management**

 

*Overview*.  Market risk is the risk of loss from adversechanges in market prices and rates.  TheCompany’s market risk arises primarily from interest rate risk inherent in itsloan, investment and deposit portfolios. The goal for managing the assets and liabilities of the Company is tomaximize shareholder value and earnings while maintaining a high qualitybalance sheet without exposing the Company to undue interest rate risk.

 

The Board of Directors has overall responsibility for the interest raterisk management policies.  The Bank hasan Asset and Liability Management Committee (ALCO) that establishes andmonitors guidelines to control the sensitivity of earnings to changes ininterest 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, the structureof the balance sheet is managed with the goal that movements of interest rateson assets and liabilities are correlated and contributes to earnings even inperiods of volatile interest rates.  Theasset/liability management policy sets limits on the acceptable amount ofvariance in net interest margin and market value of equity under changinginterest environments.  The Company usessimulation models to forecast earnings, net interest margin and market value ofequity.

 

Simulation of earnings is the primary tool used to measure thesensitivity 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.

 

26

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Table Nine below summarizes the effect on net interest income (NII) ofa ±200 basis point change in interest rates as measured against a constant rate(no change) scenario.  The results shownin Table nine for the two periods, fall within the parameters of the Bank’spolicy for interest rate risk.

 

**Table Nine: Interest Rate Risk Simulation of Net Interest as of June 30, 2005 andDecember 31, 2004 (Unaudited)**

 
| **(In thousands)**                      | ** ** | **$ Change in NII  from Current  12 Month Horizon  June 30, 2005** | ** ** | **$ Change in NII  from Current  12 Month Horizon  December 31, 2004** | ** ** |
|-----------------------------------------|------------|-------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| Variation from a constant rate scenario |       |                                                                    |       |                                                                        |       |
| +200bp                                  |       | $                                                                       | 1,854      |                                                                        | $          | 1,513 |   |
| - 200bp                                 |       | $                                                                       | (1,490     | )                                                                           | $          | 395 |   |

 

Assumptions are inherently uncertain, and, consequently, the modelcannot precisely measure net interest income or precisely predict the impact ofchanges in interest rates on net interest income. Actual results will differfrom simulated results due to timing, magnitude and frequency of interest ratechanges, as well as changes in market conditions and management strategies whichmight moderate the negative consequences of interest rate deviations. In themodel above, the simulation shows that the Company is asset sensitive over theone-year horizon as increasing rates have a positive impact on net interestincome and declining rates have a negative impact.

 

## **Inflation**

## ** **

Theimpact of inflation on a financial institution differs significantly from thatexerted on manufacturing, or other commercial concerns, primarily because itsassets and liabilities are largely monetary. In general, inflation primarily affects the Company and it subsidiariesthrough its effect on market rates of interest, which affects the Company’sability to attract loan customers. Inflation affects the growth of total assets by increasing the level ofloan demand, and potentially adversely affects capital adequacy because loangrowth in inflationary periods can increase at rates higher than the rate thatcapital grows through retention of earnings, which may be generated in thefuture.  In addition to its effects oninterest rates, inflation increases overall operating expenses.  Inflation has not had a material effect uponthe results of operations of the Company and its subsidiaries during theperiods ended June 30, 2005, and 2004.

 

**Liquidity**

 

Liquiditymanagement refers to the Company’s ability to provide funds on an ongoing basisto meet fluctuations in deposit levels as well as the credit needs andrequirements of its clients.  Both assetsand liabilities contribute to the Company’s liquidity position.  Federal funds lines, short-term investmentsand securities, and loan repayments contribute to liquidity, along with depositincreases, while loan funding and deposit withdrawals decrease liquidity.  The Company assesses the likelihood ofprojected funding requirements by reviewing historical funding patterns,current and forecasted economic conditions and individual client fundingneeds.  Commitments to fund loans at June30, 2005 and December 31, 2004 were approximately $171,834,000 and$153,570,000, respectively.  Such loansrelate primarily to revolving lines of credit and other commercial loans, andto real estate construction loans.

 

The Company’s sources of liquidity consist of cash and due fromcorrespondent banks, overnight funds sold to correspondent banks, unpledgedmarketable investments and loans held for sale. On June 30, 2005, consolidated liquid assets totaled $24.2 million or5.1% of total assets compared to $62.7 million or 13.9% of total assets onDecember 31, 2004.  In addition to liquidassets, the Company maintains short-term lines of credit in the amount of $15,000,000with correspondent banks.  There were noborrowings outstanding under these arrangements at June 30, 2005.

 

27

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The Bank also has informal agreements with various other banks to sellparticipations in loans, if necessary. The Company serves primarily a business and professional customer baseand, as such, its deposit base is susceptible to economic fluctuations.  Accordingly, management strives to maintain abalanced position of liquid assets to volatile and cyclical deposits.

 

Liquidityis also affected by portfolio maturities and the effect of interest ratefluctuations on the marketability of both assets and liabilities.  The Company can sell any of its unpledgedsecurities held in the available-for-sale category to meet liquidity needs.

 

## **Off-Balance Sheet Items**

## ** **

TheCompany has certain ongoing commitments under operating leases.  These commitments do not significantly impactoperating results. As of June 30, 2005 and December 31, 2004, commitments toextend credit and letters of credit were the only financial instruments withoff-balance sheet risk.  The Company hasnot entered into any contracts for financial derivative instruments such asfutures, swaps, options or similar instruments. Loan commitments and letters of credit were $171,834,000 and$153,570,000 at June 30, 2005 and December 31, 2004, respectively.  As a percentage of net loans, theseoff-balance sheet items represent 44.6% and 45.2%, respectively.

 

**Item 4. Controls and Procedures**

 

(a) Disclosure Controls and Procedures: Anevaluation of the Company’s disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e)) was carried out under thesupervision and with the participation of the Company’s Chief ExecutiveOfficer, Chief Financial Officer and other members of the Company’s seniormanagement as of the end of the Company’s fiscal quarter ended June 30, 2005.The Company’s Chief Executive Officer and Chief Financial Officer concludedthat the Company’s disclosure controls and procedures as currently in effectare effective in ensuring that the information required to be disclosed by theCompany in the reports it files or submits under the Exchange Act is (i)accumulated and communicated to the Company’s management (including the ChiefExecutive Officer and Chief Financial Officer) to allow timely decisionsregarding required disclosure, and (ii) recorded, processed, summarized and reportedwithin the time periods specified in the Commission’s rules and forms.

 

(b) Internal Control Over Financial Reporting: Anevaluation of any changes in the Company’s internal control over financialreporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)), thatoccurred during the Company’s fiscal quarter ended June 30, 2005, was carriedout under the supervision and with the participation of the Company’s ChiefExecutive Officer, Chief Financial Officer and other members of the Company’ssenior management. The Company’s Chief Executive Officer and Chief FinancialOfficer concluded that no change identified in connection with such evaluationhas materially affected, or is reasonably likely to materially affect, theCompany’s internal control over financial reporting.

 

28

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## **PART II – OTHER INFORMATION**

## ** **

Item 1.  LegalProceedings.

 

None.

 

Item 2.  Changesin Securities and Use of Proceeds.

 

None.

 

Item 3. Defaults Upon Senior Securities.

 

None.

 

Item 4. Submission of Matters to a Vote of Security Holders.

 

None.

 

Item 5.  OtherInformation.

 

None

 

Item 6.  Exhibits

 

(a)  Exhibits

 

Exhibit

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

 

(b)  Reports on Form 8-K

 

On April 13, 2005 the Company filed a Report on Form 8-k announcing atwo-for-one stock split.

 

On April 19, 2005 the Company filed a Report on Form 8-k announcingfirst quarter earnings for 2005.

 

On April 28, 2005 the Company filed a Report on form 8-k announcing itsintent to file an application to NASDAQ with the intent of listing the sharesof Community Valley Bancorp.

 

29

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**SIGNATURES**

 

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

 
|            |   | COMMUNITY VALLEY BANCORP                          |
|-----------------|--------|---------------------------------------------------|
|            |   |                                              |
| August 10, 2005 |   | By:                                               | /s/ *Keith C. Robbins* |   |
|            |   |                                              |
|            |   | Keith C. Robbins                                  |
|            |   |                                              |
|            |   | President, Chief Executive Officer                |
|            |   |                                              |
|            |   |                                              |
| August 10, 2005 |   | By*:*                                             | */s/ John F. Coger* |   |
|            |   |                                              |
|            |   | John F. Coger                                     |
|            |   | Executive Vice President, Chief Financial Officer |
|            |   | and Chief Operating Officer                       |
|                 |        |                                                   |  |  |  |  |  |

 

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