**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 September 30, 2005** |
|                                                       |                                                                                                    |
| **o**                                                      | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**COMMUNITY VALLEY BANCORP**

(Exact name of registrant as specified in its charter)

 
| **California**                  | ** ** | **333-85950**            | ** ** | **68-0479553**           |
|---------------------------------|------------|--------------------------|------------|--------------------------|
| (State or other jurisdiction of |       | (Commission File Number) |       | (IRS Employer ID Number) |
| incorporation or organization)  |       |                     |       |                     |

 
| **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 by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

 

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 – 7,389,748 shares outstanding at October 31, 2005.

 

 

----

 

PART 1-FINANCIAL INFORMATION

 

Item 1. FINANCIAL STATEMENTS

 

COMMUNITY VALLEY BANCORP

CONDENSED CONSOLIDATED BALANCE SHEET (Unaudited)

 
| **(In thousands except per share data)**                                                                                                                                                   | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ASSETS                                                                                                                                                                                     |       |                         |       |                        |       |
|                                                                                                                                                                                       |       |                         |       |                        |       |
| Cash and due  from banks                                                                                                                                                                   |       | $                            | 23,995     |                        | $          | 21,778 |   |
| Federal funds  sold                                                                                                                                                                        |       | 24,940                       |       | 46,440                      |       |
| Total cash and cash equivalents                                                                                                                                                            |       | 48,935                       |       | 68,218                      |       |
|                                                                                                                                                                                       |       |                         |       |                        |       |
| Interest-bearing  deposits in banks                                                                                                                                                        |       | 6,636                        |       | 8,715                       |       |
| Investment securities (market value of $8,800 at September 30,  2005 and $6,963 at December 31, 2004)                                                                            |       | 8,817                        |       | 6,961                       |       |
| Loans held for sale at lower of cost or market                                                                                                                                             |       | 2,943                        |       | 1,490                       |       |
| Loans, less allowance for loan losses of $4,644 at September 30,  2005 and $4,381 at December 31, 2004                                                                           |       | 403,537                      |       | 339,174                     |       |
| Premises and equipment, net                                                                                                                                                                |       | 10,988                       |       | 9,027                       |       |
| Accrued interest receivable and other assets                                                                                                                                               |       | 19,342                       |       | 16,091                      |       |
|                                                                                                                                                                                       |       | $                            | 501,198    |                        | $          | 449,676 |   |
|                                                                                                                                                                                       |       |                         |       |                        |       |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                                                                                  |       |                         |       |                        |       |
|                                                                                                                                                                                       |       |                         |       |                        |       |
| Deposits:                                                                                                                                                                                  |       |                         |       |                        |       |
| Non-interest bearing                                                                                                                                                                       |       | $                            | 94,113     |                        | $          | 80,793 |   |
| Interest bearing                                                                                                                                                                           |       | 346,487                      |       | 318,266                     |       |
| Total deposits                                                                                                                                                                             |       | 440,600                      |       | 399,059                     |       |
|                                                                                                                                                                                       |       |                         |       |                        |       |
| Employee stock ownership plan (ESOP) note payable                                                                                                                                          |       | 800                          |       | 833                         |       |
| Junior subordinated debentures                                                                                                                                                             |       | 8,248                        |       | 8,248                       |       |
|                                                                                                                                                                                       |       |                         |       |                        |       |
| Accrued interest payable and other liabilities                                                                                                                                             |       | 11,846                       |       | 7,005                       |       |
|                                                                                                                                                                                       |       |                         |       |                        |       |
| Total liabilities                                                                                                                                                                          |       | 461,494                      |       | 415,145                     |       |
|                                                                                                                                                                                       |       |                         |       |                        |       |
| Commitments and contingencies                                                                                                                                                              |       |                         |       |                        |       |
|                                                                                                                                                                                       |       |                         |       |                        |       |
| Shareholders’ equity:                                                                                                                                                                 |       |                         |       |                        |       |
| Common stock – no par value; 20,000,000 shares  authorized; issued and outstanding – 7,381,748 shares at September 30,  2005 and 7,273,582 shares at December 31, 2004 |       | 8,827                        |       | 7,861                       |       |
| Unallocated ESOP shares (188,209 shares at September 30,  2005 and 179,284 shares at December 31, 2004, at cost)                                                                 |       | (1,409                       | )          | (1,144                      | )          |
|                                                                                                                                                                                       |       |                         |       |                        |       |
| Retained earnings                                                                                                                                                                          |       | 32,282                       |       | 27,802                      |       |
|                                                                                                                                                                                       |       |                         |       |                        |       |
| Accumulated other comprehensive income, net                                                                                                                                                |       | 4                            |       | 12                          |       |
|                                                                                                                                                                                       |       |                         |       |                        |       |
| Total shareholders’ equity                                                                                                                                                            |       | 39,704                       |       | 34,531                      |       |
|                                                                                                                                                                                       |       | $                            | 501,198    |                        | $          | 449,676 |   |

 

See Notes to Unaudited Condensed ConsolidatedFinancial Statements

 

2

----

 

COMMUNITY VALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENT OF INCOME(Unaudited)

 
| ** **                                           | ** ** | **For the periods ended September 30,** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                           | ** ** | **Three months**                             | ** ** | **Nine Months** | ** ** |
| **(In thousands, except per share data)**            | ** ** | **2005**                                     | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Interest income:                                     |       |                                         |       |   |   |   |   |   |   |
| Interest and fees on loans                           |       | $                                            | 8,273      |   | $ | 6,306 |   | $ | 22,252 |   | $ | 17,278 |   |
| Interest on Federal funds sold                       |       | 177                                          |       | 86 |   | 642 |   | 329 |   |
| Interest on deposits in banks                        |       | 60                                           |       | 64 |   | 188 |   | 180 |   |
| Interest and dividends on investment securities:     |       |                                         |       |   |   |   |   |   |   |
| Taxable                                              |       | 43                                           |       | 47 |   | 137 |   | 108 |   |
| Exempt from Federal income taxes                     |       | 27                                           |       | 16 |   | 83 |   | 36 |   |
| Dividends                                            |       | 3                                            |       | 0 |   | 10 |   | 3 |   |
|                                                 |       |                                         |       |   |   |   |   |   |   |
| Total interest income                                |       | 8,583                                        |       | 6,519 |   | 23,312 |   | 17,934 |   |
| Interest expense:                                    |       |                                         |       |   |   |   |   |   |   |
| Interest on deposits                                 |       | 1,231                                        |       | 878 |   | 3,248 |   | 2,605 |   |
| Interest on junior subordinated debentures           |       | 153                                          |       | 112 |   | 428 |   | 315 |   |
| Interest on notes payable                            |       | 21                                           |       | 8 |   | 46 |   | 25 |   |
| Total interest expense                               |       | 1,405                                        |       | 998 |   | 3,722 |   | 2,945 |   |
|                                                 |       |                                         |       |   |   |   |   |   |   |
| Net interest income before provision for loan losses |       | 7,178                                        |       | 5,521 |   | 19,590 |   | 14,989 |   |
| Provision for loan losses                            |       | 225                                          |       | 225 |   | 675 |   | 640 |   |
| Net interest income after provision for loan losses  |       | 6,953                                        |       | 5,296 |   | 18,915 |   | 14,349 |   |
|                                                 |       |                                         |       |   |   |   |   |   |   |
| Non-interest income                                  |       | 1,966                                        |       | 1,366 |   | 5,231 |   | 4,150 |   |
|                                                 |       |                                         |       |   |   |   |   |   |   |
| Non-interest expenses:                               |       |                                         |       |   |   |   |   |   |   |
| Salaries and employee benefits                       |       | 3,096                                        |       | 2,243 |   | 8,920 |   | 6,623 |   |
| Occupancy                                            |       | 326                                          |       | 283 |   | 884 |   | 767 |   |
| Furniture and equipment                              |       | 465                                          |       | 399 |   | 1,295 |   | 1,103 |   |
| Other expense                                        |       | 1,468                                        |       | 1,107 |   | 4,061 |   | 3,076 |   |
| Total non-interest expense                           |       | 5,355                                        |       | 4,032 |   | 15,160 |   | 11,569 |   |
|                                                 |       |                                         |       |   |   |   |   |   |   |
| Income before provision for income taxes             |       | 3,564                                        |       | 2,630 |   | 8,986 |   | 6,930 |   |
|                                                 |       |                                         |       |   |   |   |   |   |   |
| Provision for income taxes                           |       | 1,405                                        |       | 1,036 |   | 3,643 |   | 2,783 |   |
|                                                 |       |                                         |       |   |   |   |   |   |   |
| Net income                                           |       | $                                            | 2,159      |   | $ | 1,594 |   | $ | 5,343 |   | $ | 4,147 |   |
|                                                 |       |                                         |       |   |   |   |   |   |   |
| Basic earnings per share                             |       | $                                            | .30        |   | $ | .22 |   | $ | .75 |   | $ | .58 |   |
| Diluted earnings per share                           |       | $                                            | .28        |   | $ | .21 |   | $ | .70 |   | $ | .55 |   |
|                                                 |       |                                         |       |   |   |   |   |   |   |
| Cash dividends per share                             |       | $                                            | .04        |   | $ | .0375 |   | $ | .1175 |   | $ | .1125 |   |

 

See Notes to Unaudited CondensedConsolidated Financial Statements

 

3

----

 

COMMUNITY VALLEY BANCORP

CONDENSED CONSOLIDATEDSTATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

 
| ** **                                                                        | ** ** | ** **       | ** ** | ** ** | ** ** | ** **      | ** ** | ** **        | ** ** | **Accumulated**        | ** ** | ** **        | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------|------------|------------|------------|-----------------|------------|-------------------|------------|------------------------|------------|-------------------|------------|------------|------------|
| ** **                                                                        | ** ** | ** **       | ** ** | ** ** | ** ** | **Unallocated** | ** ** | ** **        | ** ** | **Other**              | ** ** | **Total**         | ** ** | ** ** | ** ** |
| ** **                                                                        | ** ** | **Common Stock** | ** ** | **ESOP**   | ** ** | **Retained**    | ** ** | **Comprehensive** | ** ** | **Shareholders’** | ** ** | **Comprehensive** | ** ** |
| **(In thousands, except per share data)**                                         | ** ** | **Shares**       | ** ** | **Amount** | ** ** | **Shares**      | ** ** | **Earnings**      | ** ** | **Income**             | ** ** | **Equity**        | ** ** | **Income** | ** ** |
|                                                                              |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Balance, January 1, 2004                                                     |       | 7,243,648        |       | $          | 7,271      |            | $          | (1,070            | )          | $                      | 23,746     |              | $          | 2          |       | $ | 29,949 |   |   |   |
|                                                                              |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Comprehensive income:                                                             |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Net income                                                                        |       |             |       |       |       |            |       | 5,609             |       |                   |       | 5,609             |       | $          | 5,609      |   |
| Other comprehensive income, net of tax                                            |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| 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                                                              |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Net income                                                                        |       |             |       |       |       |            |       | 5,343             |       |                   |       | 5,343             |       | $          | 5,343      |   |
| Other comprehensive loss, net of taxes:                                           |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Net change in unrealized gain (loss) on  available-for-sale investment securities |       |             |       |       |       |            |       |              |       | (8                     | )          | (8                | )          | (8         | )          |
|                                                                              |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Total comprehensive income                                                        |       |             |       |       |       |            |       |              |       |                   |       |              |       | $          | 5,335      |   |
| Exercise of stock options and related tax benefit                                 |       | 108,166          |       | 843        |       |            |       |              |       |                   |       | 843               |       |       |       |
| Amortization of stock compensation - ESOP shares                                  |       |             |       | 123        |       | (265            | )          |              |       |                   |       | (142              | )          |       |       |
| Cash dividends $0.12 per share                                                    |       |             |       |       |       |            |       | (863              | )          |                   |       | (863              | )          |       |       |
|                                                                              |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Balance, September 30, 2005                                                  |       | 7,381,748        |       | $          | 8,827      |            | $          | (1,409            | )          | $                      | 32,282     |              | $          | 4          |       | $ | 39,704 |   |   |   |

 

See Notes to Unaudited Condensed ConsolidatedFinancial Statements

 

4

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COMMUNITY VALLEY BANCORP

CONDENSED CONSOLIDATEDSTATEMENT OF CASH FLOWS     (Unaudited**)**

 

(In thousands)

 
| **For the nine months ended September 30,**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                               |       |     |       |     |       |
| Cash flows from  operating activities:                                             |       |     |       |     |       |
| Net income                                                                         |       | $        | 5,343      |     | $          | 4,146 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |     |       |     |       |
| Provision for loan losses                                                          |       | 675      |       | 640      |       |
| Deferred loan origination costs, net                                               |       | 47       |       | 59       |       |
| Depreciation and amortization, net                                                 |       | 1,140    |       | 999      |       |
| Gain on disposition of Bank premises and equipment                                 |       | (20      | )          |     |       |
| Net (increase) decrease in loans held for sale                                     |       | (1,453   | )          | 711      |       |
| Increase in cash surrender value of bank-owned life  insurance                     |       | (217     | )          | (335     | )          |
|                                                                               |       |     |       |     |       |
| Non-cash compensation expense associated with the  ESOP                            |       | 205      |       | 135      |       |
| (Increase) decrease in accrued interest receivable  and other assets               |       | (1,188   | )          | 1,259    |       |
| Increase in accrued interest payable and other  liabilities                        |       | 3,406    |       | 829      |       |
|                                                                               |       |     |       |     |       |
| Net cash provided by operating activities                                          |       | 7,938    |       | 8,443    |       |
|                                                                               |       |     |       |     |       |
| Cash flows from  investing activities:                                             |       |     |       |     |       |
|                                                                               |       |     |       |     |       |
| Decrease (increase) in interest-bearing deposits in  banks                         |       | 2,079    |       | (1,682   | )          |
| Proceeds from called available-for-sale investment securities                      |       | 1,000    |       | 300      |       |
| Proceeds from called held-to-maturity investment  securities                       |       |     |       | 1,598    |       |
| Proceeds from matured held-to-maturity investment  securities                      |       | 106      |       | 130      |       |
| Proceeds from principal payments of held-to-maturity  investment securities        |       | 280      |       | 310      |       |
| Purchases of held-to-maturity investment securities                                |       | (1,234   | )          | (1,012   | )          |
| Purchase of available-for-sale investment securities                               |       | (2,008   | )          | (4,148   | )          |
| Purchases of premises and equipment                                                |       | (3,149   | )          | (1,454   | )          |
| Proceeds from sale of premises and equipment                                       |       | 54       |       |     |       |
| Purchase of bank-owned life insurance                                              |       | (1,450   | )          |     |       |
| Investment in ATM program                                                          |       |     |       | (9,989   | )          |
|                                                                               |       |     |       |     |       |
| Net increase in loans                                                              |       | (64,682  | )          | (70,319  | )          |
| Net cash used in investing activities                                              |       | (69,004  | )          | (76,277  | )          |
|                                                                               |       |     |       |     |       |
| Cash flows from financing activities:                                              |       |     |       |     |       |
|                                                                               |       |     |       |     |       |
| Net increase in demand, interest-bearing and savings  deposits                     |       | $        | 27,750     |     | $          | 21,109 |   |
| Net increase in time deposits                                                      |       | 13,791   |       | 11,195   |       |
| Proceeds from loans                                                                |       | 800      |       |     |       |
| Repayment of ESOP loan, net                                                        |       | (170     | )          | (110     | )          |
| Proceeds from ESOP loan                                                            |       | 348      |       |     |       |
| Purchase of unallocated ESOP shares                                                |       | (348     | )          |     |       |
| Payment of cash dividends                                                          |       | (841     | )          | (817     | )          |
| Cash paid for fractional shares                                                    |       |     |       | (6       | )          |
| Proceeds from the exercise of stock options                                        |       | 453      |       | 259      |       |
| Repurchase of common stock                                                         |       |     |       | (502     | )          |
|                                                                               |       |     |       |     |       |
| Net cash provided by financing activities                                          |       | 41,783   |       | 31,128   |       |
|                                                                               |       |     |       |     |       |
| Decrease in cash and cash equivalents                                              |       | (19,283  | )          | (36,708  | )          |
|                                                                               |       |     |       |     |       |
| Cash and cash  equivalents at beginning of year                                    |       | 68,218   |       | 76,810   |       |
|                                                                               |       |     |       |     |       |
| Cash and cash  equivalents at end of period                                        |       | $        | 48,935     |     | $          | 40,102 |   |

 

See Notes to Unaudited Condensed ConsolidatedFinancial Statements

 

5

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**Community Valley Bancorp andSubsidiaries**

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

1.  BASIS OF PRESENTATION

 

Theaccompanying unaudited condensed consolidated financial statements of CommunityValley Bancorp and subsidiaries (the “Company”) have been prepared pursuant tothe rules and regulations of the Securities Exchange Commission (the “SEC”)and the instructions to Form 10-Q and Article 10 of Regulation S-X.Accordingly, certain information and footnote disclosures required byaccounting principles generally accepted in the United States of America forannual financial statements are not include herein. In the opinion ofmanagement, all adjustments (which consist solely of normal recurring accruals)considered necessary for a fair presentation of the results for the interimperiods presented have been included. These interim consolidated financial statements should be read inconjunction with the financial statements and related notes contained in theCompany’s 2004 Annual Report to Shareholders on Form 10-K.

 

Thecondensed consolidated financial statements include the accounts of the Companyand its wholly owned subsidiaries, Butte Community Bank and CVB InsuranceAgency, LLC. All significant inter-company balances and transactions have beeneliminated in consolidation. The Company has also established a wholly-ownedunconsolidated subsidiary, Community Valley Bancorp Trust I (the “Trust”), aDelaware statutory business trust, for the purpose of issuing trust preferredsecurities. The results of operations for the three and nine-month period endedSeptember 30, 2005 may not necessarily be indicative of the operatingresults for the full year 2005.

 

Managementhas determined 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 andassumptions affect the reported amounts of assets and liabilities at the dateof the financial statements and the reported amounts of revenues and expensesduring 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 and per share information has beenretroactively adjusted to reflect the stock split.

 

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 (7,183,171 and 7,147,502 shares for the three and nine month periods ended September 30, 2005 and 7,121,806 and 7,104,938 shares for the three and nine month periods ended September 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 (441,510 and 456,626 shares for the three and nine month periods ended September 30, 2005 and 460,384 and 495,586 shares for the three and nine month periods ended September 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 other 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 –BASED COMPENSATION**

 

TheCompany issues stock options under three stock-based compensation plans, theCommunity Valley Bancorp 1991, 1997 and 2000 Stock Option Plans.  The Company accounts for these plans underthe 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.

 

Thefollowing table illustrates the effect on net income and earnings per share ifthe Company had applied the fair value recognition provisions of FASB StatementNo. 123, *Accounting for Stock-Based Compensation*,to stock-based employee compensation.

 

Proforma adjustments to the Company’s consolidated net earnings and earnings pershare are disclosed during the periods in which the options become vested.

 
| ** **                                                                                                                               | ** ** | **Three Months Ended**       | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| **(In thousands, except per share  data)**                                                                                               | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
|                                                                                                                                     |       |                         |       |   |   |
| Net income as reported                                                                                                                   |       | $                            | 2,159      |   | $ | 1,594 |   |
| Deduct: Total stock-based  compensation expense determined under the fair value based method for all  awards, net of related tax effects |       | (90                          | )          | (71 | ) |
|                                                                                                                                     |       |                         |       |   |   |
| Pro forma net income                                                                                                                     |       | $                            | 2,069      |   | $ | 1,523 |   |
|                                                                                                                                     |       |                         |       |   |   |
| Basic earnings per share - as  reported                                                                                                  |       | $                            | 0.30       |   | $ | 0.22 |   |
|                                                                                                                                     |       |                         |       |   |   |   |   |
| Basic earnings per share - pro  forma                                                                                                    |       | $                            | 0.29       |   | $ | 0.21 |   |
|                                                                                                                                     |       |                         |       |   |   |   |   |
| Diluted earnings per share -  as reported                                                                                                |       | $                            | 0.28       |   | $ | 0.21 |   |
|                                                                                                                                     |       |                         |       |   |   |   |   |
| Diluted earnings per share -  pro forma                                                                                                  |       | $                            | 0.27       |   | $ | 0.20 |   |

 

7

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| ** **                                                                                                                               | ** ** | **Nine Months Ended**        | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                                                                               | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
|                                                                                                                                     |       |                         |       |   |   |
| Net earnings as reported                                                                                                                 |       | $                            | 5,343      |   | $ | 4,147 |   |
| Deduct: Total stock-based  compensation expense determined under the fair value based method for all  awards, net of related tax effects |       | (267                         | )          | (214 | ) |
|                                                                                                                                     |       |                         |       |   |   |
| Pro forma net income                                                                                                                     |       | $                            | 5,076      |   | $ | 3,933 |   |
|                                                                                                                                     |       |                         |       |   |   |
| Basic earnings per share - as  reported                                                                                                  |       | $                            | .75        |   | $ | .58 |   |
|                                                                                                                                     |       |                         |       |   |   |   |   |
| Basic earnings per share - pro  forma                                                                                                    |       | $                            | .71        |   | $ | .56 |   |
|                                                                                                                                     |       |                         |       |   |   |
| Diluted earnings per share -  as reported                                                                                                |       | $                            | .70        |   | $ | .55 |   |
|                                                                                                                                     |       |                         |       |   |   |   |   |
| Diluted earnings per share -  pro forma                                                                                                  |       | $                            | .67        |   | $ | .52 |   |

 
| ** **                                                      | ** ** | **Nine Months Ended**       | ** ** |
|-----------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                      | ** ** | **September 30, 2005** | ** ** | **September 30, 2004** | ** ** |
| Dividend yield  (not applicable)                                |       | .81                         | %          | 1.37 | % |
| Expected volatility                                             |       | 58                          | %          | 86 | % |
|                                                            |       |                        |       |   |   |
| Risk-free interest rate                                         |       | 4.0                         | %          | 4.07 | % |
|                                                            |       |                        |       |   |   |
| Expected option life                                            |       | 10 years                    |       | 10 years |   |
|                                                            |       |                        |       |   |   |
| Weighted average  fair value of options granted during the year |       | $                           | 5.81       |   | $ | 9.51 |   |
|                                                                 |            |                             |            |  |  |  |  |

 

8

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## **5.  COMMITMENTS AND CONTINGENCIES**

 

The Company is party to claims and legal proceedingsarising in the ordinary course of business. In the opinion of the Company’smanagement, the amount of ultimate liability with respect to such proceedingswill not have a material adverse effect on the financial condition or result ofoperations of the Company taken as a whole.

 

In the normal course of business, there are variousoutstanding commitments to extend credit which are not reflected in thefinancial statements, including loan commitments of $184,489,000 and$148,921,000 and stand-by letters of credit of $6,902,000 and $4,649,000 at September 30,2005 and December 31, 2004, respectively.

 

Of the loan commitments outstanding at September 30,2005, $119,953,000 are real estate construction loan commitments that areexpected to fund within the next twelve months. The remaining commitmentsprimarily relate to revolving lines of credit or other commercial loans, andmany of these are expected to expire without being drawn upon. Therefore, thetotal commitments do not necessarily represent future cash requirements. Eachloan commitment and the amount and type of collateral obtained, if any, areevaluated on an individual basis. Collateral held varies, but may include realproperty, bank deposits, debt or equity securities or business assets.

 

Stand-byletters of credit are conditional commitments written to guarantee theperformance of a customer to a third party. These guarantees are primarilyrelated to the purchases of inventory by commercial customers and are typicallyshort-term in nature. Credit risk is similar to that involved in extending loancommitments to customers and accordingly, evaluation and collateralrequirements similar to those for loan commitments are used.  The fair value of the liability related tothese stand-by letters of credit, which represents the fees received forissuing the guarantees, was not significant at September 30, 2005 and December 31,2004.  The Company recognizes these feesas revenues over the term of the commitment or when the commitment is used.

 

## **6. NEW ACCOUNTING PRONOUNCEMENTS**

 

Share-Based Payments

 

In December 2004the FASB issued Statement Number 123 (revised 2004) (FAS 123 (R)), *Share-Based Payments*. FAS 123 (R) requires all entities to recognize compensation expense inan amount equal to the fair value of share-based payments such as stock optionsgranted to employees.  In April 2005,the Securities and Exchange Commission adopted a rule that defers thecompliance 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 effectthat FAS 123 (R) will have, but believes that the effect will be consistentwith its previous pro forma disclosures.

 

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

 

Thefollowing is Community Valley Bancorp’s (the “Company”) management’s discussionand analysis of the significant changes in balance sheet accounts for September 30,2005 and December 31, 2004 and income and expense accounts for the threeand nine month periods ended September 30, 2005 and 2004. The discussionis designed to provide a better understanding of significant trends related tothe Company’s financial condition, results of operations, liquidity, capitalresources and interest rate 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.

 

9

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## **GeneralDevelopment of Business**

 

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

 

TheCompany owns 100% of the issued and outstanding common shares of ButteCommunity Bank.  Butte Community Bank wasincorporated and commenced business in Paradise and Oroville, California in1990.  Butte Community Bank operatesthirteen full service offices within its primary service areas of Butte,Sutter, Yuba, Tehama, and Shasta Counties. The Bank also maintains Loan Production Offices in Citrus Heights and Gridley.Butte Community Bank’s primary business is serving the commercial banking needsof small to mid-sized businesses and consumers within those counties.  Butte Community Bank accepts checking andsavings deposits, offers money market deposit accounts and certificates ofdeposit, makes secured and unsecured commercial, secured real estate, and otherinstallment and term loans and offers other customary 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*

 

TheCompany’s significant accounting principles are described in Note 1 of theconsolidated financial statements in the Company’s 2004 Annual Report toShareholders on Form 10-K and are essential to understanding Management’sDiscussion and Analysis of Results of Operations and Financial Condition.Community Valley Bancorp’s annual consolidated financial statements areprepared in accordance with accounting principles generally accepted in theUnited States of America (GAAP). The financial information contained within ourstatements is, to a significant extent, financial information that is based onmeasures of the financial effects of transactions and events that have alreadyoccurred. Some of the Company’s accounting principles require significantjudgment to estimate values of assets or liabilities. In addition, certainaccounting principles require significant judgment in applying the complexaccounting principles to transactions to determine the most appropriatetreatment. The following is a summary of the more judgmental and complexaccounting estimates and principles.

 

*Allowance for Loan Losses (ALL)*

 

Theallowance for loan losses is management’s best estimate of the probable lossesthat may be sustained in our loan portfolio. The allowance is based on twobasic principles of accounting:  (1) SFAS No.5 which requires thatlosses be accrued when they are probable of occurring and estimable and (2) SFASNo. 114, which requires that losses be accrued on impaired loans based onthe differences between the value of collateral, present value of future cashflows or values that are observable in the secondary market and the loanbalance.

 

10

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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”).

 

Additionalfactors include concentrations of borrowers, industries, geographical sectors,loan product, 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.

 

Forindividually impaired loans, SFAS No. 114 provides guidance on theacceptable methods to measure impairment. Specifically, SFAS No. 114states that when a loan is impaired, the Company should measure impairmentbased on the present value of expected future principal and interest cash flowsdiscounted at the loan’s effective interest rate, except that as a practicalexpedient, a creditor may measure impairment based on a loan’s observablemarket price or the fair value of collateral, if the loan is collateraldependent. When developing the estimate of future cash flows for a loan, theCompany considers all available information reflecting past events and currentconditions, including the effect of existing environmental factors.

 

*Loan Sales and Servicing*

 

TheCompany originates government guaranteed loans and mortgage loans that may besold in the secondary market.  The amounts of gains recorded on sales ofloans and the initial recording of servicing assets and interest only (I/O)strips is based on the estimated fair values of the respectivecomponents.  In recording the initial value of the servicing assets andthe fair value of the I/O strips receivable, the Company uses estimates whichare based on management’s expectations of future prepayments and discountrates.  Servicing assets are amortized over the estimated life of therelated loan.  I/O strips are not significant at September 30, 2005. These prepayment 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-Based Compensation*

 

The Companyuses the intrinsic value based method for measuring compensation cost relatedto stock options. Under the intrinsic value based method, compensation cost isthe excess, if any, of the quoted market price of the stock at grant date overthe amount an employee must pay to acquire the stock. This cost is amortized ona straight-line basis over the vesting period of the options granted. TheCompany applies 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.

 

11

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*Revenue recognition*

 

TheCompany’s primary source of revenue is interest income, which is the differencebetween the interest income it receives on interest-earning assets and theinterest expense it pays on interest-bearing liabilities, and (ii) feeincome, which includes fees earned on deposit services, income from SBAlending, electronic-based cash management services, mortgage brokerage feeincome and merchant credit card processing services. Interest income isrecorded on an accrual basis. Note 1 to the Consolidated Financial Statements inthe Company’s 2004 Annual Report to Shareholders on Form 10-K offers anexplanation of the process for determining when the accrual of interest incomeis discontinued on an impaired loan.

 

*Income Taxes*

 

TheCompany accounts for income taxes under the asset and liability method. Underthe asset and liability method, deferred tax assets and liabilities arerecognized for the future tax consequences attributable to differences betweenthe financial statement carrying amounts of existing assets and liabilities andtheir respective tax bases. Deferred tax assets and liabilities are measuredusing currently enacted tax rates applied to such taxable income in the yearsin which those temporary differences are expected to be recovered or settled.The effect on deferred tax assets and liabilities of a change in tax rates isrecognized in income in the period that includes the enactment date. If futureincome should prove non-existent or less than the amount of deferred tax assetswithin the tax years to which they may be applied, the asset may not berealized and our net income will be reduced.

 

**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 shareinformation has been retroactively adjusted to reflect the stock split.

 

**Overview**

 

The Company recorded net income of $2,159,000 for the quarter ended September 30, 2005, which was a 35.4% increase from the $1,594,000 reported for the same period of 2004.  Diluted earnings per share for the third quarter of 2005 were $0.28, compared to the $0.21 recorded in the third quarter of 2004.  The annualized return on average equity (ROAE) and the return on average assets (ROA) for the third quarter of 2005 were 21.82% and 1.73%, respectively, as compared to 19.18% and 1.51%, respectively, for the same period in 2004.

 

Net income for the nine months ended September 30, 2005 was $5,343,000 (up 28.8%) compared to the $4,147,000 recorded in the first nine months of 2004.   Diluted earnings per share for the first nine months of 2005 were $0.70, compared to the $0.55 recorded in the same period of 2004.  The annualized ROAE and ROA for the first nine months of 2005 were 19.14% and 1.52%, respectively, as compared to 17.30% and 1.35%, respectively, for the same period in 2004. The primary reasons for the increase in net income for both the third quarter and the first nine months of 2005 was the growth in the net interest margin, as a result of the overall positive effect of the rising interest rate environment, and in the growth in earning assets the Company experienced through the opening of five new branch offices during 2004 and 2005, offset by increased non-interest expenses.

 

Total assets of the Company increased by $51,522,000 or (11.5%) from December 31, 2004 to $501,198,000 at September 30, 2005.  Net loans totaled $406,480,000, up $64,816,000 (19%) from the ending balances on December 31, 2004.  Deposit balances at September 30, 2005 totaled $440,600,000, up $41,451,000 (10.4%) from December 31, 2004.

 

12

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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  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| **(In thousands, except percentages)**                           | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                       | ** ** | ** **                                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net interest  income                                             |       | $                                          | 7,178      |                                      | $          | 5,521 |   | $ | 19,590 |   | $ | 14,989 |   |
| Provision for  loan losses                                       |       | (225                                       | )          | (225                                      | )          | (675 | ) | (640 | ) |
| Non-interest  income                                             |       | 1,966                                      |       | 1,366                                     |       | 5,231 |   | 4,150 |   |
| Non-interest  expense                                            |       | (5,355                                     | )          | (4,032                                    | )          | (15,160 | ) | (11,569 | ) |
| Provision for  income taxes                                      |       | (1,405                                     | )          | (1,036                                    | )          | (3,643 | ) | (2,783 | ) |
|                                                             |       |                                       |       |                                      |       |   |   |   |   |
| Net income                                                       |       | $                                          | 2,159      |                                      | $          | 1,594 |   | $ | 5,343 |   | $ | 4,147 |   |
|                                                             |       |                                       |       |                                      |       |   |   |   |   |
| Average total  assets (In millions)                              |       | $                                          | 495.1      |                                      | $          | 421.1 |   | $ | 470.3 |   | $ | 408.1 |   |
| Net income (annualized) as a percentage of average  total assets |       | 1.73                                       | %          | 1.51                                      | %          | 1.52 | % | 1.35 | % |

 

**Resultsof Operations**

 

## **NetInterest Income and Net Interest Margin**

 

Netinterest income represents the excess of interest and fees earned on interestearning assets (loans, securities, federal funds sold and investments in timedeposits) over the interest paid on deposits and borrowed funds.  Net interest margin is net interest incomeexpressed as a percentage of average earning assets.

 

TheCompany’s net interest margin was 6.45% for the three months ended September 30,2005 and 6.22% for the nine month period ending September 30, 2005 up from5.86% and 5.58% for the same periods in the prior year.  Net interest income increased $1,657,000 (30%)for the third quarter of 2005 compared to the same period in 2004.  Net interest income increased $4,602,000 (30.7%)for the nine months ended September 30, 2005 over the same period in 2004.  The primary reason for this increase was the increasein average loans of $71,256,000 and 71,929,000 for the third quarter and firstnine months of 2005 over the same periods in 2004 along with the overallpositive impact of the rising interest rate environment and increases in loanfees associated with the growth.

 

Theaverage balances of interest bearing liabilities were $41,650,000 (13.7%)higher in the third quarter of 2005 versus the same quarter in 2004. Rates paidon these liabilities also increased 31 basis points on a quarter over quarterbasis.  As a result, interest expense was$407,000 (40.78%) higher in the third quarter of 2005 versus the prior yearperiod.  The average balances of interestbearing liabilities were $37,483,000 (12.7%) higher in the nine-month periodended September 30, 2005 versus the same period in 2004.  Rates paid on interest bearing liabilities onlyincreased 16 basis points compared to the nine month period ended September 30,2004.  As a result, interest expense was$777,000 (26.38%) higher in the first nine months of 2005 versus the sameperiod in the prior year.  It isanticipated that deposit interest rates paid in the fourth quarter may need toincrease in order to continue funding the ongoing loan demand.

 

13

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TableTwo, Analysis of Net Interest Margin, and Table Three, Analysis of Volume andRate Changes on Net Interest Income and Expenses, are provided to enable thereader to understand the components and past trends of the Company’s interestincome and expense.  Table Two providesan analysis of net interest margin setting forth average assets, liabilitiesand shareholders’ equity; interest income earned and interest expense paid andaverage rates earned and paid; and the net interest margin.

 

**TableTwo:  Analysis of Net Interest Margin**

 
| ** **                                           | ** ** | **2005**         | ** ** | **2004**     | ** ** |
|------------------------------------------------------|------------|------------------|------------|--------------|------------|
| **Three Months Ended  September 30,**           | ** ** | **Avg  Balance** | ** ** | **Interest** | ** ** | **Avg  Yield (4)** | ** ** | **Avg  Balance** | ** ** | **Interest** | ** ** | **Avg  Yield (4)** | ** ** |
| **(In thousands, except  percentages)**              |
| **Assets:**                                          |       |             |       |         |       |   |   |   |   |   |   |   |   |
| Earning assets                                       |       |             |       |         |       |   |   |   |   |   |   |   |   |
| Loans (1)                                            |       | $                | 405,419    |         | $          | 8,273 |   | 8.10 | % | $ | 334,154 |   | $ | 6,306 |   | 7.51 | % |
| Taxable  investment securities                       |       | 5,640            |       | 46           |       | 3.24 | % | 5,529 |   | 47 |   | 3.31 | % |
| Tax-exempt  investment securities (2)                |       | 2,372            |       | 27           |       | 4.52 | % | 1,219 |   | 16 |   | 5.22 | % |
| Federal funds  sold                                  |       | 20,287           |       | 177          |       | 3.46 | % | 24,784 |   | 86 |   | 1.38 | % |
| Interest bearing  deposits in banks                  |       | 7,751            |       | 60           |       | 3.07 | % | 9,305 |   | 64 |   | 2.74 | % |
| Total earning assets                                 |       | 441,470          |       | 8,583        |       | 7.71 | % | 374,991 |   | 6,519 |   | 6.91 | % |
| Cash & due from banks                       |       | 18,829           |       |         |       |   |   | 27,040 |   |   |   |   |   |
| Other assets                                         |       | 34,759           |       |         |       |   |   | 19,118 |   |   |   |   |   |
| Average total assets                                 |       | $                | 495,058    |         |       |   |   |   | $ | 421,149 |   |   |   |   |   |
|                                                 |       |             |       |         |       |   |   |   |   |   |   |   |   |
| **Liabilities & Shareholders’ Equity** |       |             |       |         |       |   |   |   |   |   |   |   |   |
| Interest bearing liabilities:                        |       |             |       |         |       |   |   |   |   |   |   |   |   |
| NOW &  MMDA                                 |       | $                | 183,817    |         | 322        |   | 0.69 | % | $ | 175,330 |   | 262 |   | 0.59 | % |
| Savings                                              |       | 38,587           |       | 49           |       | 0.50 | % | 31,172 |   | 37 |   | 0.47 | % |
| Time deposits                                        |       | 113,202          |       | 860          |       | 3.01 | % | 88,377 |   | 579 |   | 2.61 | % |
| Other borrowings                                     |       | 9,907            |       | 174          |       | 6.97 | % | 8,984 |   | 120 |   | 5.31 | % |
| Total interest bearing liabilities                   |       | 345,513          |       | 1,405        |       | 1.61 | % | 303,863 |   | 998 |   | 1.31 | % |
| Demand deposits                                      |       | 97,123           |       |         |       |   |   | 77,711 |   |   |   |   |   |
| Other liabilities                                    |       | 13,169           |       |         |       |   |   | 6,512 |   |   |   |   |   |
| Total liabilities                                    |       | 455,805          |       |         |       |   |   | 388,086 |   |   |   |   |   |
| Shareholders’ equity                            |       | 39,253           |       |         |       |   |   | 33,063 |   |   |   |   |   |
| Average liabilities and equity                       |       | $                | 495,058    |         |       |   |   |   | $ | 421,129 |   |   |   |   |   |
|                                                 |       |             |       |         |       |   |   |   |   |   |   |   |   |
| Net interest income & margin (3)            |       |             |       | $            | 7,178      |   | 6.45 | % |   |   | $ | 5,521 |   | 5.86 | % |

 

----

(1)   Loaninterest includes loan fees of $636,000 and $628,000 during the three monthsended September 30, 2005 and September 30, 2004 respectively.

(2)   Does notinclude 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 (92 for September 30,2005 and September 30, 2004) and annualized to actual days in year (365for 2005 and 366 for 2004).

 

14

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| ** **                                           | ** ** | **2005**         | ** ** | **2004**     | ** ** |
|------------------------------------------------------|------------|------------------|------------|--------------|------------|
| **Nine Months Ended  September 30,**            | ** ** | **Avg  Balance** | ** ** | **Interest** | ** ** | **Avg  Yield (4)** | ** ** | **Avg  Balance** | ** ** | **Interest** | ** ** | **Avg  Yield (4)** | ** ** |
| **(In thousands, except percentages)**               |
| **Assets:**                                          |       |             |       |         |       |   |   |   |   |   |   |   |   |
| Earning assets                                       |       |             |       |         |       |   |   |   |   |   |   |   |   |
| Loans (1)                                            |       | $                | 374,231    |         | $          | 22,252 |   | 7.94 | % | $ | 302,302 |   | $ | 17,278 |   | 7.63 | % |
| Taxable  investment securities                       |       | 5,771            |       | 147          |       | 3.40 | % | 4,260 |   | 111 |   | 3.45 | % |
| Tax-exempt  investment securities (2)                |       | 2,281            |       | 83           |       | 4.85 | % | 889 |   | 36 |   | 5.41 | % |
| Federal funds  sold                                  |       | 30,066           |       | 642          |       | 2.85 | % | 41,407 |   | 329 |   | 1.06 | % |
| Interest bearing  deposits in banks                  |       | 8,410            |       | 188          |       | 2.99 | % | 8,806 |   | 180 |   | 2.73 | % |
| Total earning assets                                 |       | 420,759          |       | 23,312       |       | 7.38 | % | 357,664 |   | 17,934 |   | 6.70 | % |
| Cash & due from banks                       |       | 21,692           |       |         |       |   |   | 26,339 |   |   |   |   |   |
| Other assets                                         |       | 27,821           |       |         |       |   |   | 24,095 |   |   |   |   |   |
|                                                 |       | $                | 470,272    |         |       |   |   |   | $ | 408,098 |   |   |   |   |   |
|                                                 |       |             |       |         |       |   |   |   |   |   |   |   |   |
| **Liabilities & Shareholders’ Equity** |       |             |       |         |       |   |   |   |   |   |   |   |   |
| Interest bearing liabilities:                        |       |             |       |         |       |   |   |   |   |   |   |   |   |
| NOW &  MMDA                                 |       | $                | 181,894    |         | 858        |   | 0.63 | % | $ | 172,296 |   | 828 |   | 0.64 | % |
| Savings                                              |       | 36,624           |       | 135          |       | 0.49 | % | 28,353 |   | 103 |   | 0.49 | % |
| Time deposits                                        |       | 105,296          |       | 2,255        |       | 2.87 | % | 86,242 |   | 1,674 |   | 2.59 | % |
| Other borrowings                                     |       | 9,419            |       | 474          |       | 6.75 | % | 8,859 |   | 340 |   | 5.13 | % |
| Total interest bearing liabilities                   |       | 333,233          |       | 3,722        |       | 1.50 | % | 295,750 |   | 2,945 |   | 1.33 | % |
| Demand deposits                                      |       | 90,493           |       |         |       |   |   | 73,506 |   |   |   |   |   |
| Other liabilities                                    |       | 9,214            |       |         |       |   |   | 6,910 |   |   |   |   |   |
| Total liabilities                                    |       | 432,940          |       |         |       |   |   | 376,166 |   |   |   |   |   |
| Shareholders’ equity                            |       | 37,332           |       |         |       |   |   | 31,932 |   |   |   |   |   |
| Demand deposits                                      |       | $                | 470,272    |         |       |   |   |   | $ | 408,098 |   |   |   |   |   |
|                                                 |       |             |       |         |       |   |   |   |   |   |   |   |   |
| Net interest income & margin (3)            |       |             |       | 19,590       |       | 6.22 | % |   |   | 14,989 |   | 5.58 | % |
|                                                      |            |                  |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)          Loan interest includesloan fees of $1,826,000 and $1,659,000 during the nine months endedSeptember 30, 2005 and September 30, 2004, respectively.

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

(3)          Net interest margin iscomputed by dividing net interest income by total average earning assets.

(4)          Average yield iscalculated based on actual days in period (273 for September 30, 2005 and274 days for September 30, 2004) and annualized to actual days in year(365 for 2005 and 366 for 2004).

 

15

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Table Three sets forth a summary of the changes ininterest income and interest expense from changes in average asset andliability balances (volume) and changes in average interest rates.  On a quarter over quarter basis for theperiod ending September 30, 2005 net interest income has increased$1,657,000 over the same time period in 2004. Interest income from earning assets has increased by $2,064,000. Changesin the volume of earning assets, primarily loans, have resulted in an increasein interest income of $1,338,000 while interest income from changes in rateshas increased by $726,000.  Interestexpense for the third quarter of 2005 was $407,000 more than the same timeperiod in 2004.  Changes in the volume ofinterest bearing liabilities, primarily the increase in balances of timedeposits, has resulted in a net increase of interest expense of $197,000.  Increases in average rates paid, primarily ontime deposits and junior subordinated debentures have resulted in an interestexpense increase of $210,000.  On ayear-to-date basis through September 30, 2005, net interest income hasincreased $4,601,000 over the same time period in 2004.  Interest income from earning assets hasincreased by $5,378,000.  Changes in thevolume of earning assets, primarily loans, have resulted in an increase ininterest income of $4,128,000 while interest income from changes in rates hasincreased by $1,250,000.  Interestexpense for the nine month period was $777,000 more than the same time periodin 2004.  Changes in the volume ofinterest bearing liabilities, primarily the increase in balances of timedeposits, have resulted in a net increase of interest expense of $469,000.  Increases in average rates paid, primarily ontime deposits and junior subordinated debentures have resulted in an interestexpense increase of $308,000.

 

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

(In thousands) Three Months Ended September 30, 2005 over 2004

Increase (decrease) due to change in:

 
| ** **                            | ** ** | **Volume** | ** ** | **Rate (3)** | ** ** | **Net Change** | ** ** |
|---------------------------------------|------------|------------|------------|--------------|------------|----------------|------------|
| Interest-earning assets:              |       |       |       |         |       |           |       |
| Net loans (1)                         |       | $          | 1,349      |         | $          | 618            |       | $ | 1,967 |   |
| Taxable  investment securities        |       | 1          |       | (2           | )          | (1             | )          |
| Tax exempt  investment securities (2) |       | 15         |       | (4           | )          | 11             |       |
| Federal funds  sold                   |       | (16        | )          | 107          |       | 91             |       |
| Interest bearing  deposits in banks   |       | (11        | )          | 7            |       | (4             | )          |
| Total                                 |       | 1,338      |       | 726          |       | 2,064          |       |
| Interest-bearing liabilities:         |       |       |       |         |       |           |       |
| NOW &  MMDA                  |       | 13         |       | 47           |       | 60             |       |
| Savings deposits                      |       | 9          |       | 3            |       | 12             |       |
| Time deposits                         |       | 163        |       | 118          |       | 281            |       |
| Other borrowings                      |       | 12         |       | 42           |       | 54             |       |
| Total                                 |       | 197        |       | 210          |       | 407            |       |
| Interest differential                 |       | $          | 1,141      |         | $          | 516            |       | $ | 1,657 |   |

 

----

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

(2)  Does notinclude 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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**Table Three:  Analysis of Volume and Rate Changes on NetInterest Income and Expenses**

(In thousands)Nine Months Ended September 30, 2005 over 2004

Increase (decrease) dueto change in:

 
| ** **                            | ** ** | **Volume** | ** ** | **Rate (3)** | ** ** | **Net Change** | ** ** |
|---------------------------------------|------------|------------|------------|--------------|------------|----------------|------------|
| Interest-earning assets:              |       |       |       |         |       |           |       |
| Net loans (1)                         |       | $          | 4,137      |         | $          | 837            |       | $ | 4,974 |   |
| Taxable  investment securities        |       | 38         |       | (2           | )          | 36             |       |
| Tax exempt  investment securities (2) |       | 52         |       | (5           | )          | 47             |       |
| Federal funds  sold                   |       | (91        | )          | 404          |       | 313            |       |
| Investment in  time deposits          |       | (8         | )          | 16           |       | 8              |       |
| Total                                 |       | 4,128      |       | 1,250        |       | 5,378          |       |
|                                  |       |       |       |         |       |           |       |
| Interest-bearing liabilities:         |       |       |       |         |       |           |       |
| Demand deposits                       |       | 45         |       | (15          | )          | 30             |       |
| Savings deposits                      |       | 30         |       | 2            |       | 32             |       |
| Time deposits                         |       | 371        |       | 210          |       | 581            |       |
| Other borrowings                      |       | 23         |       | 111          |       | 134            |       |
| Total                                 |       | 469        |       | 308          |       | 777            |       |
| Interest differential                 |       | $          | 3,659      |         | $          | 942            |       | $ | 4,601 |   |

 

----

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

(2)  Does notinclude 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-interestIncome**

 

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

 

**Table Four: Components of Noninterest Income**

 
| **Three Months Ended  September 30,** | ** ** | **2005** | ** ** | **% of Avg.  Assets** | ** ** | **2004** | ** ** | **% of Avg.  Assets** | ** ** |
|--------------------------------------------|------------|----------|------------|-----------------------|------------|----------|------------|-----------------------|------------|
|                                       |       |     |       |                  |       |     |       |                  |       |
| Service charges on deposit accounts        |       | $        | 606        |                  | .49        |     | $          | 575                   |       | .55 |   |
| Loan servicing fees                        |       | 110      |       | .09                   |       | 103      |       | .10                   |       |
| Fees - alternative investment sales        |       | 91       |       | .07                   |       | 85       |       | .08                   |       |
| Merchant fee income                        |       | 101      |       | .08                   |       | 81       |       | .08                   |       |
| Gain on the sale of loans                  |       | 770      |       | .62                   |       | 255      |       | .24                   |       |
| Other                                      |       | 288      |       | .23                   |       | 267      |       | .25                   |       |
|                                       |       |     |       |                  |       |     |       |                  |       |
| Total  non-interest income                 |       | $        | 1,966      |                  | 1.58       |     | $          | 1,366                 |       | 1.30 |   |

## ** **

| **Nine Months Ended  September 30,** | ** ** | **2005** | ** ** | **% of Avg.  Assets** | ** ** | **2004** | ** ** | **% of Avg.  Assets** | ** ** |
|-------------------------------------------|------------|----------|------------|-----------------------|------------|----------|------------|-----------------------|------------|
|                                      |       |     |       |                  |       |     |       |                  |       |
| Service charges on deposit accounts       |       | $        | 1,749      |                  | .50        |     | $          | 1,359                 |       | .50 |   |
| Loan servicing fees                       |       | 310      |       | .09                   |       | 289      |       | .09                   |       |
| Fees - alternative investment sales       |       | 426      |       | .12                   |       | 315      |       | .10                   |       |
| Merchant fee income                       |       | 287      |       | .08                   |       | 243      |       | .08                   |       |
| Gain on the sale of loans                 |       | 1,584    |       | .45                   |       | 1,043    |       | .34                   |       |
| Other                                     |       | 875      |       | .25                   |       | 721      |       | .24                   |       |
|                                      |       |     |       |                  |       |     |       |                  |       |
| Total  non-interest income                |       | $        | 5,231      |                  | 1.49       |     | $          | 4,150                 |       | 1.36 |   |

 

Non-interest income was up $600,000 (43.7%) to $1,966,000for the three months ended September 30, 2005 as compared to $1,366,000for the three months ended September 30, 2004.  Increases in non-interest income wererealized in fees from service charges (up 5.39%), loan servicing fees (up6.8%), fees from alternative investment sales (up 7.1%), merchant processingfees (up 24.7%), gain on sale of loans (up 202%) and other (up 7.1%).

 

The increase in service charge income was the resultof additional deposit accounts opened during the third quarter and feesresulting from the overdraft privilege deposit product.  Loan servicing fees were up slightly as theportfolio of serviced loans in our Government Lending Departmentincreased.  The Investment Department,which sells third-party mutual funds and annuities, experienced an increase infees due to an increase in sales during the third quarter.  Merchant fee income was up due to largervolumes of electronic transactions being processed for our merchantcustomers.  The gain on sale of loans hadthe largest increase of the non-interest income items as the level of governmentguaranteed loans were sold into the secondary market increased.

 

18

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For the nine months ended September 30, 2005,non-interest income was up $1,080,000 (26%) to $5,231,000 as compared to the $4,150,000total for the nine months ended September 30, 2004.  All of the components of non-interest incomeshowed gains.  Increases were realized inservice charges on deposit accounts (up 28.7%), loan servicing (up 7.3%),alternative investment sales (up 35.2%), merchant fee income (up 18.1%), gainon sale of loans (up 51.9%), and other (up 21.2%).

 

**Non-interestExpense**

 

Non-interest expense increased $1,323,000 (32.8%) to $5,355,000 in the thirdquarter of 2005 versus $4,032,000 in the third quarter of 2004.  Much of the increase in non-interest expensecan be attributed to the opening of the Colusa office in December 2004, andthe Corning and Redding offices in March and September of 2005respectively.  Salary and employeebenefits increased $853,000 (38%) resulting from normal cost of living raises,commissions paid to Butte Community Bank’s Real Estate Loan agents and staffingadditions made during the year as the Company continues to grow. Benefit costsand employer taxes increased commensurate with the salaries.  On a quarter over quarter basis, occupancyexpenses were higher by $43,000 (15.2%) which is related to buildingdepreciation, utilities, janitorial services and property taxes.  Furniture and equipment expense was $465,000in the third quarter of 2005 compared to $399,000 in the same period of 2004,representing a 16.5% increase.  Thisincrease relates to the depreciation for the furniture, fixtures and equipmentneeded for the three offices mentioned above. Other expenses increased $361,000 (32.6%) in the third quarter of 2005versus the third quarter of 2004.  Thisincrease was attributed to higher telephone, postage and insurance costs aswell as increased advertising and promotion costs associated with the newoffices.

 

Non-interest expense for the nine month period ended September 30,2005 increased $3,591,000 (31.0%) to $15,160,000 versus $11,569,000 for thesame period in 2004.  As with the quarterover quarter totals the nine month numbers are also reflective of the newoffices opened in 2004 and 2005 as stated above.  Salaries and benefits increased by $2,297,000(34.7%) due to cost of living raises added benefit costs and employer taxesassociated with the staffing additions made during the year as the Companycontinues to grow. On a year over year basis, full time equivalent employeesincreased by 35 to 230.  Occupancy expensewas up $117,000 (15.3%) from the first nine months of 2004 to the first ninemonths of 2005.  Furniture and equipmentexpense was up 192,000 (17.4%).  Otherexpenses increased by $986,000 (32.1%). This increase was attributed to higher telephone, postage and insurancecosts as well as increased advertising and promotion costs associated with thenew offices.

 

## **Provisionfor Loan Losses**

 

The Company provided$225,000 for loan losses for the third quarter of 2005 which was the sameamount as the third quarter of 2004.  Netloan charge-offs for the three months ended September 30, 2005 was $2,000as compared to $5,000 in net charge-offs for the three months ended September 30,2004.  For the first nine months of 2005,the Company made provisions for loan losses of $675,000.  This compares to the provision for loanlosses of $640,000 for the first nine months of 2004.  Net loan charge-offs for the nine monthsended September 30, 2005 was $9,000 as compared to net recoveries of $6,000for the nine months ended September 30, 2004.  Management assesses its loan quality on amonthly basis to maintain an adequate allowance for loan losses.  The Company’s loan portfolio composition,non-performing assets and allowance for loan losses are further discussed underthe Balance Sheet Analysis section below.

 

**Provisionfor Income Taxes**

 

The effective taxrate for the third quarter and first nine months of 2005 was 39.4% and 40.5%,versus 39.4% and 40.2%, for the same period in 2004.

 

19

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**BalanceSheet Analysis**

 

The Company’s totalassets were $501,198,000 at September 30, 2005 as compared to $449,676,000at December 31, 2004, representing an increase of 11.5%.  The average balance of total assets for the ninemonths ended September 30, 2005 was $470,272,000, which represents anincrease of $62,174,000 (15.2%) over the $408,098,000 during the nine-monthperiod ended September 30, 2004.

 

## **Loans**

## ** **

The Company concentratesits lending activities in the following principal areas: 1) commercial; 2) realestate; 3) residential real estate and real estate construction (bothcommercial and residential); 4) agriculture; and 5) consumer loans.  Commercial and residential real estate loansare generally secured by improved property, with original maturities of 3-10years.  At September 30, 2005, theseprincipal areas accounted for approximately 16%, 43%, 26%, 7% and 8%,respectively, of the Company’s loan portfolio. The mix at December 31, 2004 was 17%, 43%, 26%, 6% and 8%.  Continuing strong economic activity in theCompany’s market area, new borrowers developed through the Company’s marketingefforts and credit extensions expanded to existing borrowers, offset by normalloan pay-downs and payoffs, resulted in net increases in loan balances forcommercial loans ($6,609,000 or 11%), residential real estate ($28,029,000 or 19.1%),real estate construction ($14,862,000 or 16.4%), agricultural loans ($6,823,000or 30.8%) and consumer ($8,350,000 or 31.8%). These changes in real estate lending are consistent with the Company’shistory of increased real estate activity during the summer months.  Table Five below summarizes the compositionof the loan portfolio as of September 30, 2005 and December 31, 2004.

 

**Table Five: Loan Portfolio Composition**

 
| ** **                | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------|------------|------------------------|------------|-----------------------|------------|
| **(In thousands)**        | ** ** | **2005**               | ** ** | **2004**              | ** ** |
| Commercial                |       | $                      | 65,271     |                  | $          | 58,662 |   |
| Real estate:              |       |                   |       |                  |       |
| Mortgage                  |       | 174,905                |       | 146,876               |       |
| Construction              |       | 105,505                |       | 90,643                |       |
|                      |       |                   |       |                  |       |
| Agriculture               |       | 29,000                 |       | 22,177                |       |
| Consumer                  |       | 34,569                 |       | 26,219                |       |
| Total loans               |       | 409,250                |       | 344,577               |       |
| Allowance for loan losses |       | (4,644                 | )          | (4,381                | )          |
| Deferred loan fees, net   |       | (1,069                 | )          | (1,022                | )          |
| Total net loans           |       | $                      | 403,537    |                  | $          | 339,174 |   |

 

The majority of the Company’s loans are direct loans made toindividuals and local businesses.  TheCompany relies substantially on local promotional activity and personalcontacts by bank officers, directors and employees to compete with otherfinancial institutions.  The Companymakes loans to borrowers whose applications include a sound purpose and a viableprimary repayment source, generally supported by a secondary source ofrepayment.

 

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

 

20

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

 

## **RiskElements**

 

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,Marysville, Colusa, Corning and Redding). The Company also maintains loan production offices in the cities ofCitrus Heights and Gridley. Single-family residential construction is the primarylending product from the Citrus Heights location serving the greater Sacramentoarea.  The primary focus of the loanproduction office in Gridley is commercial and agricultural loans.

 

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.

 

21

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## **Inmanagement’s judgment, a concentration exists in real estate loans, whichrepresented approximately 68.5% of the Company’s loan portfolio at September 30,2005, which is a slight decrease from the 70.0% concentration level at December 31,2004.  Management believes theconcentration to have no more than the normal risk of collectability; however,a substantial decline in the economy in general, or a decline in real estatevalues in the Company’s primary market areas in particular, could have anadverse impact on the collectability of these loans and require an increase inthe provision for loan losses which could adversely affect the Company’s futureprospects, 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.  The Company’s loanpolicies and underwriting standards include, but are not limited to, thefollowing: (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) maintainingconforming and prudent loan to value and loan to cost ratios based onindependent outside appraisals and ongoing inspection and analysis by theCompany’s lending officers.**

 

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

 

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

 

Table Six below setsforth nonaccrual loans as of September 30, 2005 and December 31, 2004.  There were no loans past due 90 days or moreand still accruing interest at September 30, 2005 or December 31, 2004.

 

**Table Six:  Non-Performing Loans**

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

 

At September 30, 2005, there were no non-performingloans. The recorded investments in loans that were considered to be impairedtotaled $101,000 at December 31, 2004. These loans were subsequently brought current as to all past dueinterest and principle and were returned to accrual status as managementbelieves the loans are collectable. There were no loan concentrations in excess of 10% of total loans nototherwise disclosed as a category of loans as of September 30, 2005 or December 31,2004.  Management is not aware of anypotential problem loans, which were accruing and current at September 30,2005, where serious doubt exists as to the ability of the borrower to complywith the present repayment terms.

 

22

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## **Allowancefor Loan Losses Activity**

## ** **

We employ a systematicmethodology for determining the allowance for loan losses that includes amonthly review process and monthly adjustment of the allowance.  Ourprocess includes a periodic review of individual loans that have beenspecifically identified as problem loans or have characteristics which couldlead to impairment, as well as detailed reviews of other loans (either individuallyor in pools).  While this methodology utilizes historical and otherobjective information, the establishment of the allowance for loan losses andthe classification of loans are, to some extent, based on management’s judgmentand experience.

 

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

 

Qualitative factorsinclude the general economic environment in our markets and, in particular, thestate of the agriculture industry and other key industries in the NorthernSacramento Valley.  The way a particular loan might be structured, theextent and nature of waivers of existing loan policies, loan concentrations andthe rate of portfolio growth are other qualitative factors that are considered.

 

Our methodology is, andhas been, consistently followed.  However, as we add new products,increase in complexity, and expand our geographic coverage, we expect toenhance our methodology to keep pace with the size and complexity of the loanportfolio.  On an ongoing basis we engage outside firms to independentlyassess our methodology, and to perform independent credit reviews of our loanportfolio.  The FDIC and the California Department of FinancialInstitutions review the allowance for loan losses as an integral part of theexamination processes.  Management believes that our current methodologyis appropriate given our size and level of complexity.  Further, managementbelieves that the allowance for loan losses is adequate as of September 30,2005 to cover known and inherent risks in the loan portfolio.  However,fluctuations in credit quality, or changes in economic conditions or otherfactors could cause management to increase or decrease the allowance for loanlosses as necessary.

 

The Board of Directors ofthe Bank reviews the adequacy of the allowance for loan losses at leastquarterly to include consideration of the relative risks in the portfolio andcurrent economic conditions.  Theallowance is adjusted based on that review if, in the judgment of the loancommittee and management, changes are warranted.  The allowance for loan losses totaled $4,644,000or 1.14% of total loans at September 30, 2005 and $4,381,000 or 1.27% at December 31,2004.  A separate reserve for unfunded loancommitments was $403,000 and $381,000 as of September 30, 2005 and December 31,2004 respectively.  Net charge-offs toaverage loans for the third quarter and nine months ended September 30,2005 were 0.00%.  Net charge-offs were $3,000for the third quarter of 2005 and $9,000 for the nine months ended September 30,2005.

 

23

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

 

**TableSeven: Allowance for Loan Losses**

 
| ** **                                                                | ** ** | **Three Months  Ended  September 30,** | ** ** | **Nine Months  Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| **(In thousands, except for  percentages)**                               | ** ** | **2005**                                    | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                      |       |                                        |       |                                       |       |   |   |   |   |
| Average loans  outstanding                                                |       | $                                           | 405,419    |                                       | $          | 334,154 |   | $ | 374,231 |   | $ | 302,302 |   |
|                                                                      |       |                                        |       |                                       |       |   |   |   |   |
| Allowance for  possible loan losses at beginning of period                |       | $                                           | 4,825      |                                       | $          | 4,013 |   | $ | 4,381 |   | $ | 3,587 |   |
|                                                                      |       |                                        |       |                                       |       |   |   |   |   |
| Loans charged  off:                                                       |       |                                        |       |                                       |       |   |   |   |   |
| Commercial                                                                |       |                                        |       | (6                                         | )          | (5 | ) | (6 | ) |
| Real estate                                                               |       |                                        |       |                                       |       |   |   |   |   |
| Consumer                                                                  |       | (3                                          | )          | (8                                         | )          | (4 | ) | (15 | ) |
| Total                                                                     |       | (3                                          | )          | (14                                        | )          | (9 | ) | (21 | ) |
| Recoveries of  loans previously charged off:                              |       |                                        |       |                                       |       |   |   |   |   |
| Commercial                                                                |       |                                        |       |                                       |       |   |   | 14 |   |
| Real estate                                                               |       |                                        |       |                                       |       |   |   |   |   |
| Consumer                                                                  |       |                                        |       | 9                                          |       |   |   | 13 |   |
| Total                                                                     |       |                                        |       | (5                                         | )          |   |   | 27 |   |
| Net loan  recoveries (charge-offs)                                        |       | (3                                          | )          | (5                                         | )          | (9 | ) | 6 |   |
|                                                                      |       |                                        |       |                                       |       |   |   |   |   |
| Additions to  allowance charged to operating expenses                     |       | 225                                         |       | 225                                        |       | 675 |   | 640 |   |
| Allowance for  unfunded commitments                                       |       | (403                                        | )          | (381                                       | )          | (403 | ) | (381 | ) |
| Allowance for  loan losses at end of period                               |       | $                                           | 4,644      |                                       | $          | 3,852 |   | 4,644 |   | 3,852 |   |
| Ratio of net  charge-offs to average loans outstanding                    |       | .00                                         | %          | .00                                        | %          | .00 | % | .00 | % |
| Provision for  probable loan losses to average loans outstanding          |       | .06                                         | %          | .07                                        | %          | .18 | % | .20 | % |
| Allowance for  loan losses to loans net of deferred fees at end of period |       | 1.13                                        | %          | 1.13                                       | %          | 1.13 | % | 1.13 | % |

 

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.

 

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**OtherReal Estate**

 

At September 30, 2005and December 31, 2004, the Company did not have any other real estate (“ORE”)properties.

 

## **Deposits**

 

At September 30, 2005,total deposits were $440,600,000 representing an increase of $41,541,000 (10.4%)over the December 31, 2004 balance of $399,059,000.  The new branches in Colusa, Corning andRedding combined have added $18,325,000 through September 30, 2005.

 

## **CapitalResources**

## ** **

The current and projectedcapital position of the Company and the impact of capital plans and long-termstrategies are reviewed regularly by management. The Company’s capital positionrepresents the level of capital available to support continued operations andexpansion.

 

The Board of Directors of the Company authorized thepayment of a cash dividend 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, April 22, 2005, $.04 per share on July 29, 2005 and October 28,2005.  The payment of dividends in thefuture is subject to the discretion of the Board of Directors of the Companyand will depend on earnings, the financial condition of the Company and otherrelevant factors.

 

The Company and itssubsidiary Bank are subject to certain regulations issued by the Board ofGovernors of the Federal Reserve System and the FDIC which require maintenanceof certain levels of capital.  At September 30,2005, shareholders’ equity was $39,704,000, representing an increase of$5,173,000 (15%) 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 September 30, 2005 compared to 11.3%at December 31, 2004.  Tier 1risk-based capital to risk-adjusted assets was 9.4% at September 30, 2005and 10.2% at December 31, 2004.

 

Table Eight below liststhe Company and the Bank capital ratios at September 30, 2005 and December 31,2004, as well as the minimum ratios required under regulatory definitions of capitaladequacy. 

 

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**Table Eight: Capital Ratios**

 
| **Capital to Risk-Adjusted Assets** | ** ** | **At September 30, 2005** | ** ** | **At December 31, 2004** | ** ** | **Minimum Regulatory Requirement** | ** ** |
|-------------------------------------|------------|--------------------------------|------------|-------------------------------|------------|------------------------------------|------------|
| **Company**                         | ** ** | ** **                     | ** ** | ** **                    | ** ** | ** **                         | ** ** |
| Leverage ratio                      |       | 10.0                           | %          | 9.5                           | %          | 4.0                                | %          |
| Tier 1  Risk-Based Capital          |       | 10.7                           | %          | 11.3                          | %          | 4.0                                | %          |
| Total Risk-Based  Capital           |       | 11.8                           | %          | 12.5                     | %          | 8.0                                | %          |
| **Bank**                            |       |                           |       |                          |       |                               |       |
| Leverage ratio                      |       | 8.5                            | %          | 8.6                           | %          | 4.0                                | %          |
| Tier 1  Risk-Based Capital          |       | 9.4                            | %          | 10.2                          | %          | 4.0                                | %          |
| Total Risk-Based  Capital           |       | 10.7                           | %          | 11.3                          | %          | 8.0                                | %          |

 

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

 

**Item3.  Quantitative and QualitativeDisclosures about Market Risk**

 

**MarketRisk 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 rate changesarises 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.

 

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The net interest income is measured during the year assuming a gradualchange in rates over the twelve-month horizon. The Company’s net interest income, as forecast below, was modeledutilizing a forecast balance sheet projected from balances as of the dateindicated.

 

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 September 30,2005 and December 31, 2004**

 
| **(In thousands)**                       | ** ** | **$ Change in NII  from Current  12 Month Horizon  September 30, 2005** | ** ** | **$ Change in NII  from Current  12 Month Horizon  December 31, 2004** | ** ** |
|------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| Variation from a  constant rate scenario |       |                                                                              |       |                                                                             |       |
| +200bp                                   |       | $                                                                                 | 1,696      |                                                                             | $          | 1,513 |   |
| - 200bp                                  |       | $                                                                                 | (1,904     | )                                                                                | $          | 395 |   |

 

Assumptions are inherently uncertain, and,consequently, the model cannot precisely measure net interest income orprecisely predict the impact of changes in interest rates on net interestincome. Actual results will differ from simulated results due to timing,magnitude and frequency of interest rate changes, as well as changes in marketconditions and management strategies which might moderate the negativeconsequences of interest rate deviations. In the model above, the simulationshows that the Company is asset sensitive over the one-year horizon asincreasing rates have a positive impact on net interest income and decliningrates have a negative impact.

 

## **Inflation**

## ** **

The impact of inflationon a financial institution differs significantly from that exerted onmanufacturing, or other commercial concerns, primarily because its assets andliabilities are largely monetary.  Ingeneral, inflation primarily affects the Company and it subsidiaries throughits effect on market rates of interest, which affects the Company’s ability toattract loan customers.  Inflationaffects the growth of total assets by increasing the level of loan demand, andpotentially adversely affects capital adequacy because loan growth in inflationaryperiods can increase at rates higher than the rate that capital grows throughretention of earnings, which may be generated in the future.  In addition to its effects on interest rates,inflation increases overall operating expenses. Inflation has not had a material effect upon the results of operationsof the Company and its subsidiaries during the periods ended September 30,2005, and 2004.

 

**Liquidity**

 

Liquidity managementrefers to the Company’s ability to provide funds on an ongoing basis to meetfluctuations in deposit levels as well as the credit needs and requirements ofits clients.  Both assets and liabilitiescontribute to the Company’s liquidity position. Federal funds lines, short-term investments and securities, and loanrepayments contribute to liquidity, along with deposit increases, while loanfunding 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 andstand-by letters of credit at September 30, 2005 and December 31, 2004were approximately $191,391,000 and $153,570,000, respectively.  Such loans relate primarily to revolvinglines of credit and other commercial loans, and to real estate constructionloans.

 

27

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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 September 30, 2005, consolidated liquid assets totaled $36.6million or 7.3% of total assets compared to $62.7 million or 13.9% of totalassets on December 31, 2004.  Inaddition to liquid assets, the Company maintains short-term lines of credit inthe amount of $15,000,000 with correspondent banks.  There were no borrowings outstanding underthese arrangements at September 30, 2005.

 

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

 

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

 

## **Off-BalanceSheet Items**

## ** **

The Company has certainongoing commitments under operating leases. These commitments do not significantly impact operating results. As of September 30,2005 and December 31, 2004, commitments to extend credit and letters ofcredit were the only financial instruments with off-balance sheet risk.  The Company has not entered into anycontracts for financial derivative instruments such as futures, swaps, optionsor similar instruments.  Loan commitmentsand stand-by letters of credit were $191,391,000 and $153,570,000 at September 30,2005 and December 31, 2004, respectively. As a percentage of net loans, these off-balance sheet items represent47.4% and 45.1%, respectively.

 

**Item4. Controls and Procedures**

 

(a) Disclosure Controls and Procedures: An evaluation of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) was carried out under the supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and other members of the Company’s senior management as of the end of the Company’s fiscal quarter ended September 30, 2005. The Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures as currently in effect are effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is (i) accumulated and communicated to the Company’s management (including the Chief Executive Officer and Chief Financial Officer) to allow timely decisions regarding required disclosure, and (ii) recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms.  (b) Internal Control Over Financial Reporting: An evaluation of any changes in the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)), that occurred during the Company’s fiscal quarter ended September 30, 2004, was carried out under the supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and other members of the Company’s senior management. The Company’s Chief Executive Officer and Chief Financial Officer concluded that no change identified in connection with such evaluation has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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## **PART II — OTHER INFORMATION**

## ** **

Item 1.  Legal Proceedings.

 

None

 

Item 2.  Changes in Securities and Use of Proceeds.

 

None

 

Item 3.  Defaults Upon Senior Securities.

 

None

 

Item 4.  Submission of Matters to a Vote of SecurityHolders.

 

None

 

Item 5.  Other Information.

 

None

 

Item 6.  Exhibits

 

(a)  Exhibits

 

Exhibit

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

 

(b)  Reports on Form 8-K

 

On July 21, 2005, the Company filed a Report onform 8-k issuing a press release announcing earnings for the second quarter of2005.

 

On September 26, 2005 the Company filed a Reporton form 8-k announcing a four cent per share Cash Dividend for shareholders ofrecord on September 30, 2005 payable October 28, 2005.

 

On October 18, 2005 the Company filed a Report onform 8-k issuing a press release announcing earnings for the third quarter of2005.

 

29

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**SIGNATURES**

 

Pursuant to the requirements of the Securities andExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.

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

 

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