**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM10-Q**

 

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

 

**For the Quarterly PeriodEnded     March 31, 2006**

 

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

 

**COMMUNITY VALLEY BANCORP**

(Exact name of registrantas specified in its charter)

 

| **California**                                                   |   | **0-31525**               |   | **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) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

 

Yes  ý  No  o

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Exchange ActRule 12-b-2.

 
| Large accelerated filer | o | Accelerated filer | o | Non-accelerated filer | ý |
|-------------------------|---|-------------------|---|-----------------------|--------|

 

Indicate by check mark whether the registrant is ashell company (as defined in Exchange Act Rule 12b-2. Yes  o  No  ý

 

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

 

No par value Common Stock — 7,465,073 sharesoutstanding at May 12, 2006.

 

 

----

 

PART 1-FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

 

COMMUNITY VALLEY BANCORP

CONDENSED CONSOLIDATEDBALANCE SHEET

 
| **(In thousands except share  data)**                                                                                                                             | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|------------------------|------------|
| ASSETS                                                                                                                                                            | ** ** | ** **          | ** ** | ** **             | ** ** |
|                                                                                                                                                              | ** ** | ** **          | ** ** | ** **             | ** ** |
| Cash  and due from banks                                                                                                                                          |       | $                   | 16,635     |                   | $          | 18,988 |   |
| Federal  funds sold                                                                                                                                               |       | 9,735               |       | 29,015                 |       |
| Total  cash and cash equivalents                                                                                                                                  |       | 26,370              |       | 48,003                 |       |
|                                                                                                                                                              |       |                |       |                   |       |
| Interest-bearing  deposits in banks                                                                                                                               |       | 5,348               |       | 6,636                  |       |
| Investment securities  (market value of $6,587 at March 31, 2006 and $6,676 at December 31, 2005)                                                                 |       | 6,587               |       | 6,676                  |       |
| Loans  held for sale, at lower of cost or market                                                                                                                  |       | 3,547               |       | 2,197                  |       |
| Loans, less allowance  for loan losses of $4,961 at March 31, 2006 and $4,716 at December 31, 2005                                                                |       | 434,872             |       | 401,221                |       |
| Premises  and equipment, net                                                                                                                                      |       | 11,343              |       | 11,221                 |       |
| Accrued  interest receivable and other assets                                                                                                                     |       | 18,414              |       | 18,823                 |       |
| Total  assets                                                                                                                                                     |       | $                   | 506,481    |                   | $          | 494,777 |   |
|                                                                                                                                                              |       |                |       |                   |       |
| LIABILITIES  AND SHAREHOLDERS’ EQUITY                                                                                                                        |       |                |       |                   |       |
|                                                                                                                                                              |       |                |       |                   |       |
| Deposits:                                                                                                                                                         |       |                |       |                   |       |
| Non-interest bearing                                                                                                                                              |       | $                   | 81,705     |                   | $          | 83,336 |   |
| Interest bearing                                                                                                                                                  |       | 363,128             |       | 350,682                |       |
| Total deposits                                                                                                                                                    |       | 444,833             |       | 434,018                |       |
|                                                                                                                                                              |       |                |       |                   |       |
| Notes  payable                                                                                                                                                    |       | 954                 |       | 1,782                  |       |
|                                                                                                                                                              |       |                |       |                   |       |
| Junior  subordinated debentures                                                                                                                                   |       | 8,248               |       | 8,248                  |       |
|                                                                                                                                                              |       |                |       |                   |       |
| Accrued  interest payable and other liabilities                                                                                                                   |       | 9,312               |       | 9,174                  |       |
|                                                                                                                                                              |       |                |       |                   |       |
| Total liabilities                                                                                                                                                 |       | 463,347             |       | 453,222                |       |
|                                                                                                                                                              |       |                |       |                   |       |
| Commitments  and contingencies                                                                                                                                    |       |                |       |                   |       |
|                                                                                                                                                              |       |                |       |                   |       |
| Shareholders’  equity:                                                                                                                                       |       |                |       |                   |       |
| Common stock – no par  value; 20,000,000 shares authorized; outstanding – 7,443,673 shares at March  31, 2006 and 7,408,047 shares at December 31, 2005 |       | 9,243               |       | 9,051                  |       |
| Unallocated ESOP shares  (181,839 shares at March 31, 2006 and 185,051 shares at December 31, 2005, at  cost)                                                     |       | (1,373              | )          | (1,391                 | )          |
|                                                                                                                                                              |       |                |       |                   |       |
| Retained earnings                                                                                                                                                 |       | 35,285              |       | 33,908                 |       |
|                                                                                                                                                              |       |                |       |                   |       |
| Accumulated other  comprehensive loss, net of taxes                                                                                                               |       | (21                 | )          | (13                    | )          |
|                                                                                                                                                              |       |                |       |                   |       |
| Total shareholders’  equity                                                                                                                                  |       | 43,134              |       | 41,555                 |       |
| Total  liabilities and shareholders’ equity                                                                                                                  |       | $                   | 506,481    |                   | $          | 494,777 |   |

 

See Notes to Unaudited Condensed ConsolidatedFinancial Statements

 

2

----

 

COMMUNITY VALLEY BANCORP

CONDENSED CONSOLIDATEDSTATEMENT OF INCOME

 

(Unaudited)in thousands, except per share data)

For the3 months ended March 31,

 
|                                                  |   | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------------------------|--------|----------|------------|----------|------------|
|                                                  |   |     |       |     |       |
| Interest  income:                                     |   |     |       |     |       |
| Interest and fees on  loans                           |   | $        | 8,941      |     | $          | 6,688 |   |
| Interest on federal  funds sold                       |   | 205      |       | 232      |       |
| Interest on deposits in  banks                        |   | 56       |       | 60       |       |
| Interest and dividends  on investment securities:     |   |     |       |     |       |
| Taxable                                               |   | 50       |       | 47       |       |
| Exempt from Federal  income taxes                     |   | 16       |       | 25       |       |
|                                                  |   |     |       |     |       |
| Total interest income                                 |   | 9,268    |       | 7,052    |       |
|                                                  |   |     |       |     |       |
| Interest  expense:                                    |   |     |       |     |       |
| Interest on deposits                                  |   | 1,539    |       | 1,003    |       |
| Interest on junior  subordinated debentures           |   | 170      |       | 131      |       |
| Interest on note  payable                             |   | 18       |       | 11       |       |
| Total interest expense                                |   | 1,727    |       | 1,145    |       |
|                                                  |   |     |       |     |       |
| Net interest income  before provision for loan losses |   | 7,541    |       | 5,907    |       |
|                                                  |   |     |       |     |       |
| Provision  for loan losses                            |   | 225      |       | 225      |       |
| Net interest income  after provision for loan losses  |   | 7,316    |       | 5,682    |       |
|                                                  |   |     |       |     |       |
| Non-interest  income                                  |   | 1,483    |       | 1,636    |       |
|                                                  |   |     |       |     |       |
| Non-interest  expenses:                               |   |     |       |     |       |
| Salaries and employee  benefits                       |   | 3,688    |       | 3,036    |       |
| Occupancy                                             |   | 317      |       | 281      |       |
| Furniture and equipment                               |   | 456      |       | 391      |       |
| Other expense                                         |   | 1,299    |       | 1,166    |       |
| Total non-interest  expense                           |   | 5,760    |       | 4,874    |       |
|                                                  |   |     |       |     |       |
| Income before provision  for income taxes             |   | 3,039    |       | 2,444    |       |
|                                                  |   |     |       |     |       |
| Provision  for income taxes                           |   | 1,290    |       | 990      |       |
|                                                  |   |     |       |     |       |
| Net income                                            |   | $        | 1,749      |     | $          | 1,454 |   |
|                                                  |   |     |       |     |       |
| Basic  earnings per share                             |   | $        | .24        |     | $          | .20 |   |
| Diluted  earnings per share                           |   | $        | .23        |     | $          | .19 |   |
|                                                  |   |     |       |     |       |
| Cash  dividends per share                             |   | $        | .05        |     | $          | .0375 |   |

 

See Notes toUnaudited Condensed Consolidated Financial Statements

 

3

----

 

COMMUNITY VALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENT OF CHANGES INSHAREHOLDERS’ EQUITY

(In thousands except shares and per share data)

 
| ** **                                                                  | ** ** | ** **       | ** ** | ** ** | ** ** | ** **      | ** ** | ** **        | ** ** | **Accumulated**        | ** ** | ** **        | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------|------------|------------------|------------|------------|------------|-----------------|------------|-------------------|------------|------------------------|------------|-------------------|------------|------------|------------|
| ** **                                                                  | ** ** | ** **       | ** ** | ** ** | ** ** | ** **      | ** ** | ** **        | ** ** | **Other**              | ** ** | ** **        | ** ** | ** ** | ** ** |
| ** **                                                                  | ** ** | ** **       | ** ** | ** ** | ** ** | **Unallocated** | ** ** | ** **        | ** ** | **Comprehensive**      | ** ** | ** **        | ** ** | ** ** | ** ** |
|                                                                        |       | **Common Stock** | ** ** | **ESOP**   | ** ** | **Retained**    | ** ** | **Income (loss)** | ** ** | **Shareholders’** | ** ** | **Comprehensive** | ** ** |
| ** **                                                                  |       | **Shares**       |       | **Amount** |       | **Shares**      |       | **Earnings**      |       | **Net of Taxes**       |       | **Equity**        |       | **Income** |       |
|                                                                        |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Balance,  January 1, 2005                                                   |       | 7,273,582        |       | $          | 7,862      |            | $          | (1,144            | )          | $                      | 27,802     |              | $          | 11         |       | $ | 34,531 |   |   |   |
|                                                                        |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Comprehensive  income                                                       |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Net income                                                                  |       |             |       |       |       |            |       | 7,198             |       |                   |       | 7,198             |       | $          | 7,198      |   |
| Other comprehensive  loss,                                                  |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Net change in unrealized  gains on available-for-sale investment securities |       |             |       |       |       |            |       |              |       | $                      | (24        | )                 | (24        | )          | (24        | ) |
| Total comprehensive  income                                                 |       |             |       |       |       |            |       |              |       |                   |       |              |       | $          | 7,174      |   |
|                                                                        |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Exercise of stock  options and related tax benefit                          |       | 134,465          |       | 1,039      |       |            |       |              |       |                   |       | 1,039             |       |       |       |
| Amortization of stock  compensation – ESOP shares                      |       |             |       | 150        |       | 101             |       |              |       |                   |       | 251               |       |       |       |
| Shares  acquired or redeemed by ESOP                                        |       |             |       |       |       | (348            | )          |              |       |                   |       | (348              | )          |       |       |
| Cash  dividends- $.16 per share                                             |       |             |       |       |       |            |       | (1,092            | )          |                   |       | (1,092            | )          |       |       |
|                                                                        |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Balance,  December 31, 2005                                                 |       | 7,408,047        |       | 9,051      |       | (1,391          | )          | 33,908            |       | (13                    | )          | 41,555            |       |       |       |
|                                                                        |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Comprehensive  income                                                       |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Net income                                                                  |       |             |       |       |       |            |       | 1,749             |       |                   |       | 1,749             |       | $          | 1,749      |   |
| Other comprehensive  loss:                                                  |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Net change in unrealized  loss on available-for-sale Investment securities  |       |             |       |       |       |            |       |              |       | (9                     | )          | (9                | )          | (9         | )          |
|                                                                        |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Total comprehensive  income                                                 |       |             |       |       |       |            |       |              |       |                   |       |              |       | $          | 1,740      |   |
|                                                                        |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Exercise of stock  options and related tax benefit                          |       | 35,626           |       | 122        |       |            |       |              |       |                   |       | 122               |       |       |       |
| Amortization of stock  compensation – ESOP shares                      |       |             |       | 27         |       | 19              |       |              |       |                   |       | 46                |       |       |       |
| Stock-based  compensation expense                                           |       |             |       | 43         |       |            |       |              |       |                   |       |              |       |       |       |
| Cash  dividends declared - $0.04 per share                                  |       |             |       |       |       |            |       | (372              | )          |                   |       | (274              | )          |       |       |
|                                                                        |       |             |       |       |       |            |       |              |       |                   |       |              |       |       |       |
| Balance,  March 31, 2006                                                    |       | 7,443,673        |       | $          | 9,243      |            | $          | (1,372            | )          | $                      | 35,285     |              | $          | (22        | )          | $ | 43,134 |   |   |   |

 

See Notes to Unaudited Condensed ConsolidatedFinancial Statements

 

4

----

 

COMMUNITYVALLEY BANCORP

CONSOLIDATEDSTATEMENT OF CASH FLOWS(Unaudited**)**

 

(Inthousands)

 

For thethree months ended March 31,

 
| ** **                                                                                  | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|---------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                                                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash flows from  operating activities:                                                      |       |       |       |       |       |
| Net income                                                                                  |       | $          | 1,749      |       | $          | 1,454 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:          |       |       |       |       |       |
| Provision for loan  losses                                                                  |       | 225        |       | 225        |       |
| Deferred loan  origination costs, net                                                       |       | (62        | )          | (182       | )          |
| Depreciation and  amortization, net                                                         |       | 397        |       | 296        |       |
| Net increase in loans  held for sale                                                        |       | (1,350     | )          | (1,987     | )          |
| Increase in cash  surrender value of bank-owned life insurance, net                         |       | (77        | )          | (68        | )          |
| Non-cash compensation  expense associated with the ESOP                                     |       | 46         |       | 46         |       |
| Share based  compensation expense associated with the stock options                         |       | 43         |       |       |       |
| Decrease (increase) in  accrued interest receivable and other assets                        |       | 507        |       | (909       | )          |
| Increase (decrease) in  accrued interest payable and other liabilities                      |       | 82         |       | (105       | )          |
|                                                                                        |       |       |       |       |       |
| Net cash provided by  operating activities                                                  |       | 1,560      |       | (1,230     | )          |
|                                                                                        |       |       |       |       |       |
| Cash flows from  investing activities:                                                      |       |       |       |       |       |
|                                                                                        |       |       |       |       |       |
| Net decrease (increase)  in interest-bearing deposits in banks                              |       | 1,288      |       | (99        | )          |
| Proceeds from principal  payments on available-for-sale investment securities               |       | 6          |       |       |       |
| Proceeds from principal  payments, called or matured held-to-maturity investment securities |       | 68         |       | 115        |       |
| Purchase of  available-for-sale investment securities                                       |       |       |       | (999       | )          |
| Purchase of  held-to-maturity investment securities                                         |       |       |       | (995       | )          |
| Purchases of premises  and equipment                                                        |       | (519       | )          | (1,450     | )          |
| Proceeds from sale of  premises and equipment                                               |       |       |       | (500       | )          |
| Net increase in loans                                                                       |       | (33,835    | )          | (5,193     | )          |
|                                                                                        |       |       |       |       |       |
| Net cash (used in)  investing activities                                                    |       | (32,992    | )          | (9,121     | )          |
|                                                                                        |       |       |       |       |       |
| Cash flows from  financing activities:                                                      |       |       |       |       |       |
|                                                                                        |       |       |       |       |       |
| Net (decrease) increase  in demand, interest-bearing and savings deposits                   |       | $          | (4,624     | )          | $          | 12,760 |   |
| Net increase (decrease)  in time deposits                                                   |       | 15,439     |       | (4,960     | )          |
| Repayment of ESOP note  payable                                                             |       | (28        | )          | (33        | )          |
| Payment of cash  dividends                                                                  |       | (296       | )          | (273       | )          |
| Proceeds from exercise  of stock options                                                    |       | 108        |       | 101        |       |
| Payment of note payable                                                                     |       | (800       | )          |       |       |
|                                                                                        |       |       |       |       |       |
| Net cash provided by  financing activities                                                  |       | 9,799      |       | 7,595      |       |
|                                                                                        |       |       |       |       |       |
| Decrease in cash and  cash equivalents                                                      |       | (21,633    | )          | (2,757     | )          |
|                                                                                        |       |       |       |       |       |
| Cash and cash  equivalents at beginning of year                                             |       | 48,003     |       | 68,218     |       |
|                                                                                        |       |       |       |       |       |
| Cash and cash  equivalents at end of period                                                 |       | $          | 26,370     |       | $          | 65,462 |   |

 

See Notes to Unaudited Condensed ConsolidatedFinancial Statements

 

5

----

 

**CommunityValley Bancorp and Subsidiaries**

 

NOTES TO UNAUDITEDCONDENSED 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”) andthe instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly,certain information and footnote disclosures required by accounting principlesgenerally accepted in the United States of America for annual financialstatements are not included herein. In the opinion of management, alladjustments (which consist solely of normal recurring accruals) considerednecessary for a fair presentation of the results for the interim periodspresented have been included. These interim consolidated financial statementsshould be read in conjunction with the financial statements and related notescontained in the Company’s 2005 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 (the “Bank”) and CVBInsurance Agency, LLC. All significant inter-company balances and transactionshave been eliminated in consolidation. The Company has also established awholly-owned unconsolidated subsidiary, Community Valley Bancorp Trust I (the“Trust”), a Delaware statutory business trust, formed for the sole purpose ofissuing trust preferred securities. The results of operations for thethree-month period ended March 31, 2006 may not necessarily be indicative ofthe operating results for the full year 2006.

 

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. No single customer accounts for more than 10% ofthe revenues of the Company or the Bank.

 

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.

 

2. EARNINGS PER SHARE COMPUTATION

 

Basicearnings per share are computed by dividing net income by the weighted averagecommon shares outstanding for the period (7,249,509 shares for the three monthperiod ended March 31, 2006 and 7,109,974 shares for the three month periodended March 31, 2005). Diluted earnings per share reflect the potentialdilution that could occur if outstanding stock options were exercised using thetreasury stock method. Diluted earnings per share is computed by dividing netincome by the weighted average common shares outstanding for the period plusthe dilutive effect of options (398,311 shares for the three-month period endedMarch 31, 2006 and 476,176 shares for the three-month period ended March 31,2005). Earnings per share are retroactively adjusted for stock splits anddividends for all periods presented. During the periods covered the Company hadno stock options that were considered anti-dilutive.

 

3. COMPREHENSIVE INCOME

 

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

 

6

----

 

## **4. STOCK–BASED COMPENSATION**

 

TheCompany issues stock options under two stock-based compensation plans, theCommunity Valley Bancorp 1997 and 2000 Stock Option Plans. The plans requirethat the option price may not be less than the fair market value of the stockat the date the option is granted, and that the stock must be paid in full atthe time the option is exercised. The options expire on a date determined bythe Board of Directors, but not later than ten years from the date of grant. Thevesting period is determined by the Board of Directors and is generally overfive years; however, nonstatutory options granted during 1997 vested immediately.Under the 1997 plan, 261,264 shares of common stock remain reserved forissuance to employees and directors, and the related options are exercisableuntil their expiration. However, no new options will be granted under theseplans. Under the Company’s 2000 stock option plan, 619,737 shares of commonstock remain reserved for issuance to employees and directors, of which 74,677shares are available for future grants.

 

OnJanuary 1, 2006, the Company adopted Statement of Financial AccountingStandards (“SFAS”) No. 123(R), “Share-Based Payments,” which addresses theaccounting for stock-based payment transactions. SFAS No. 123(R)eliminates the ability to account for stock-based compensation transactionsusing the intrinsic value method under Accounting Principles Board Opinion(“APB”) No. 25, “Accounting for Stock Issued to Employees,” and insteadgenerally requires that such transactions be accounted for using a fair-valuebased method. The Company has elected the modified prospective transition methodas permitted under SFAS No. 123(R), and accordingly prior periods have notbeen restated to reflect the impact of SFAS No. 123(R). The modifiedprospective transition method requires that stock-based compensation expense berecorded for all new and unvested stock options that are ultimately expected tovest as the requisite service is rendered beginning on January 1, 2006.Stock-based compensation for awards granted prior to January 1, 2006 isbased upon the grant-date fair value of such compensation as determined underthe pro forma provisions of SFAS No. 123, “Accounting for Stock-BasedCompensation.” The Company issues new shares of common stock upon the exerciseof stock options.

 

TheCompany uses a Black-Scholes option valuation model to determine the fair valueof stock-based compensation under SFAS No. 123(R), consistent with thatused for pro forma disclosures under SFAS No. 123. The Black-Scholes modelincorporates various assumptions including the expected term of awards,volatility of stock price, risk-free rates of return and dividend yield. Theexpected term of an award is generally no less than the option vesting periodand is based on the Company’s historical experience. Expected volatility isbased upon the historical volatility of the Company’s stock price. Therisk-free interest rate is approximated using rates available on U.S. Treasurysecurities with a remaining term equal to the option’s expected life.

 

SFAS123(R) requires the cash flows resulting from the tax benefits resulting fromtax deductions in excess of the compensation cost recognized for those options(excess tax benefits) to be classified as a cash flow from financing in thestatement of cash flows. These excess tax benefits were not significant for theCompany.

 

TheCompany recorded an incremental $43 thousand ($38 thousand after tax) ofstock-based compensation expense during the three months ended March 31,2006 as a result of the adoption of SFAS No. 123(R). As a result, therewas not a significant impact on the provision for income taxes on the basic ordiluted earnings per share. SFAS No. 123(R), *Share-BasedPayment*, requires the fair value method of accounting for stockoptions whereby compensation expense will be recognized based on the computedfair value of the options on the grant date for stock options granted on orafter the effective date of the standard, January 1, 2006. Certain pro formadisclosures of the expense recognition provisions of Statement No. 123 arerequired for periods prior to implementation of the standard for companies,such as Community Valley Bancorp, which used the intrinsic-value method foraccounting for stock options, and are as follows:

 

7

----

 
| ** **                                                                                                                               |   | **March 31, 2005** |   |
|------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|--------|
|                                                                                                                                     |   |               |   |
| Net  earnings as reported                                                                                                                |   | $                  | 1,454  |   |
|                                                                                                                                     |   |               |   |
| Deduct: Total  stock-based compensation expense determined under the fair value based method  for all awards, net of related tax effects |   | $                  | (87    | ) |
|                                                                                                                                     |   |               |   |
| Pro  forma net income                                                                                                                    |   | $                  | 1,367  |   |
|                                                                                                                                     |   |               |   |
| Basic  earnings per share - as reported                                                                                                  |   | $                  | 0.20   |   |
| Basic  earnings per share - pro forma                                                                                                    |   | $                  | 0.19   |   |
|                                                                                                                                     |   |               |   |
| Diluted  earnings per share - as reported                                                                                                |   | $                  | 0.19   |   |
| Diluted  earnings per share - pro forma                                                                                                  |   | $                  | 0.18   |   |

 

Thefair value of the options granted during the three months ended March 31, 2006and 2005 are noted below and are based on the following assumptions:

 
| ** **                                                      | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                      | ** ** | **March 31, 2006**     | ** ** | **March 31, 2005** | ** ** |
|                                                            |       |                   |       |   |   |
| Expected  Volatility                                            |       | 33.08                  | %          | 41.00 | % |
| Risk-free  interest rate                                        |       | 4.50                   | %          | 4.00 | % |
| Expected  Option Life                                           |       | 7.5 years              |       | 10 years |   |
| Weighted  average fair value of options granted during the year |       | $                      | 3.67       |   | $ | 7.50 |   |
|                                                                 |            |                        |            |  |  |  |  |

 

Stockoption activity for the interim 2006 and 2005 period is summarized as follows:

 
| **2006**                                              | ** ** | **Number of  Stock Options  Outstanding** | ** ** | **Exercise  Price  Range** | ** **     | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Contractual  Life** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------|------------|----------------------------|----------------|----------------------------------------|------------|------------------------------------------|------------|
|                                                  |       |                                      |       |                       |           |                                   |       |                                     |       |
| Outstanding  at January 1                             |       | 841,950                                   |       | $                          | 2.30 to $14.75 |                                   | $          | 5.74                                     |       |   |   |
| Exercised                                             |       | (35,626)                                  |       | $                          | 2.23 to $7.50  |                                   | $          | 3.04                                     |       |   |   |
| Granted                                               |       | 4,000                                     |       | $                          | 15.40          |                                   | $          | 15.40                                    |       |   |   |
| Cancelled  or expired                                 |       | (4,000)                                   |       | $                          | 14.75          |                                   | $          | 14.75                                    |       |   |   |
|                                                  |       |                                      |       |                       |           |                                   |       |                                     |       |
| Outstanding  at March 31                              |       | 806,324                                   |       | $                          | 2.30 to $15.40 |                                   | $          | 5.79                                     |       | 3.5 years |   |
| Options vested or  expected to vest at March 31, 2006 |       | 791,493                                   |       | $                          | 2.30 to $15.40 |                                   | $          | 5.68                                     |       | 3.6 years |   |
| Exercisable  at March 31                              |       | 676,378                                   |       | $                          | 2.30 to $15.40 |                                   | $          | 4.67                                     |       | 2.8 years |   |

 

8

----

 
| **2005**                  | ** ** | **Number of  Stock Options  Outstanding** | ** ** | **Exercise Price  Range** | ** **      | **Weighted  Average  Exercise  Price** | ** ** |
|---------------------------|------------|-------------------------------------------|------------|---------------------------|-----------------|----------------------------------------|------------|
|                      |       |                                      |       |                      |            |                                   |       |
| Outstanding  at January 1 |       | 966,028                                   |       | $                         | 1.02 to $13.88  |                                   | $          | 5.22 |   |
| Exercised                 |       | 26,768                                    |       | $                         | 1.02 to $7.50   |                                   | $          | 3.75 |   |
| Granted                   |       | 20,000                                    |       | $                         | 13.25 to $13.75 |                                   | $          | 14.05 |   |
| Cancelled  or expired     |       |                                      |       |                      |            |                                   |       |
|                      |       |                                      |       |                      |            |                                   |       |
| Outstanding  at March 31  |       | 959,260                                   |       | $                         | 2.30 to $13.75  |                                   | $          | 5.45 |   |
| Exercisable  at March 31  |       | 826,829                                   |       | $                         | 2.30 to $13.75  |                                   | $          | 4.75 |   |

 

Thetotal fair value of the shares that vested during the quarter ended March 31,2006 was $64,264 The aggregate intrinsic value is calculated as the differencebetween the exercise price of the underlying awards and the quoted price of theCompany’s common stock for options that were in-the-money at March 31, 2006. Theintrinsic value of options outstanding, options vested or expected to vest, andexercisable relating to the above stock option plan was $8.0 million, $7.9million and $7.4 million, respectively, as of March 31, 2006. During the threemonths ended March 31, 2006 and 2005, the aggregate intrinsic value of optionsexercised relating to the above stock option plan was $372,000 and $186,000,respectively.

 

Asrequired by SFAS 123 (R), management made an estimate of expected forfeituresand is recognizing compensation costs only for those equity awards expected tovest. Management has estimated the forfeiture rate to be approximately 2% forthe remaining non-vested options.

 

AtMarch 31, 2006, the total compensation cost related to non-vested stock optionawards granted to employees under the Company’s stock option plans but not yetrecognized was $1.1 million. Stock option compensation expense is recognized ona straight-line basis over the vesting period of the option. This cost isexpected to be recognized over a weighted average remaining period of 3.4 yearsand will be adjusted for subsequent changes in estimated forfeitures.

 

5. COMMITMENTS ANDCONTINGENCIES

 

TheCompany is party to claims and legal proceedings arising in the ordinary courseof business. In the opinion of the Company’s management, the amount of ultimateliability with respect to such proceedings will not have a material adverseeffect on the financial condition or result of operations of the Company takenas a whole.

 

In thenormal course of business, there are various outstanding commitments to extendcredit which are not reflected in the financial statements, including loancommitments of $194,635,000 and $200,693,000 and stand-by

 

9

----

 

letters of credit of $6,409,000 and $4,895,000 atMarch 31, 2006 and December 31, 2005, respectively.

 

Of theloan commitments outstanding at March 31, 2006, $115,153,000 are real estateconstruction loan commitments that are expected to fund within the next twelvemonths. The remaining commitments primarily relate to revolving lines of creditor other commercial loans, and many of these are expected to expire withoutbeing drawn upon. Therefore, the total commitments do not necessarily representfuture cash requirements. Each loan commitment and the amount and type ofcollateral obtained, if any, are evaluated on an individual basis. Collateralheld varies, but may include real property, bank deposits, debt or equitysecurities 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 ofthe liability related to these stand-by letters of credit, which represents thefees received for issuing the guarantees, was not significant at March 31, 2006and December 31, 2005. The Company recognizes these fees as revenues over theterm of the commitment or when the commitment is used.

 

## **6. NEWACCOUNTING PRONOUNCEMENTS**

## ** **

*Accounting for Servicing of Financial Assets*

 

InMarch 2006, the Financial Accounting Standards Board (FASB) issued StatementNo. 156 (SFAS 156), *Accounting for Servicingof Financial Assets — An Amendment of FASB Statement No. 140.*SFAS156 requires that a servicing asset or liability be recognized each time acontract to service a financial asset is entered into, requires that allseparately recognized servicing assets and servicing liabilities be initiallymeasured at fair value, if practicable, and permits the subsequent measurementof servicing assets and servicing liabilities based on the amortization methodor the fair value measurement method. SFAS 156 also permits a one-timereclassification of available-for-sale securities to trading securitiesprovided that the available-for-sale securities are identified in some manneras offsetting the entity’s exposure to changes in the fair value of servicingassets or servicing liabilities that a servicer elects to are subsequentlymeasured at fair value. SFAS 156 will become effective as of the beginning ofthe first fiscal year that begins after September 15, 2006. Earlier adoption ispermitted at the beginning of an entity’s fiscal year provided the entity hasnot yet issued financial statements, including interim financial statements,for any period of that fiscal year.

 

TheCompany should apply the requirements for recognition and initial measurementof servicing assets and servicing liabilities prospectively to all transactionsafter the effective date entered into on or after January 1, 2007  SFAS 156 permits a one-time reclassificationof available-for-sale securities to trading securities provided that they areidentified in some manner as offsetting the entity’s exposure to changes infair value of servicing assets or servicing liabilities that a servicer electsto subsequently measure at fair value. The provisions of SFAS 156 are effectiveas of the beginning of the first fiscal year that begins after September 15,2006. Management has not completed its evaluation of the impact that SFAS 156will have but believes that the effect on the Company’s financial position andresults of operations will not be material.

 

10

----

 

**Item 2. MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF COMMUNITY VALLEYBANCORP**

 

Thefollowing is Community Valley Bancorp’s (the “Company”) management’s discussionand analysis of the significant changes in balance sheet accounts for March 31,2006 and December 31, 2005 and income and expense accounts for the three-monthperiod ended March 31, 2006 and 2005. The discussion is designed to provide abetter understanding of significant trends related to the Company’s financialcondition, results of operations, liquidity, capital resources and interestrate sensitivity.

 

Inaddition to the historical information contained herein, this report on Form10-Q contains certain forward-looking statements. The reader of this reportshould understand that all such forward-looking statements are subject tovarious uncertainties and risks that could affect their outcome. The Company’sactual results could differ materially from those suggested by such forward-lookingstatements. Factors that could cause or contribute to such differences include,but are not limited to, variances in the actual versus projected growth inassets, return on assets, loan losses, expenses, rates charged on loans andearned 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 itssubsidiaries, changes in the regulatory environment, changes in businessconditions and inflation, changes in securities markets, data processingproblems, a decline in real estate values in the Company’s market area,  the effects of terrorism, including the eventsof September 11, 2001 and thereafter, and the conduct of the war on terrorismby the United States and its allies, as well as other factors. This entirereport should be read putting such forward-looking statements in context.

 

## **General Development of Business**

 

CommunityValley Bancorp (the “Company”) is a financial holding company (FHC”) registeredand authorized to engage in the activities permitted under the Bank HoldingCompany Act of 1956, as amended. The Company was incorporated under the laws ofthe State of California in 2002 and elected to change to a FHC in 2004. As afinancial holding company, the Company is subject to the Federal HoldingCompany Act and to supervision by the board of Governors of the Federal ReserveSystem (“FRB”). Its principal office is located at 2041 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 was incorporated and commenced business inParadise and Oroville, California in 1990. Butte Community Bank operatesthirteen full service offices within its service areas of Butte, Sutter, Yuba,Tehama, Shasta, and Colusa Counties. The Bank also maintains Loan ProductionOffices in Citrus Heights and Gridley. Butte Community Bank’s primary businessis serving the commercial banking needs of small to mid-sized businesses andconsumers within those counties. Butte Community Bank accepts checking andsavings deposits, offers money market deposit accounts and certificates of deposit,makes secured and unsecured commercial, secured real estate, and otherinstallment and term loans and offers other customary banking services.

 

OnDecember 19, 2002, the Company formed a wholly-owned unconsolidated subsidiary,Community Valley Bancorp Trust I (the “Trust”), a Delaware statutory businesstrust, for the purpose of issuing trust preferred securities.

 

OnDecember 1, 2004, the Company formed a wholly-owned subsidiary, CVB InsuranceAgency LLC for the purpose of providing insurance related services.

 

11

----

 

**Critical Accounting Policies**

 

*General*

 

TheCompany’s significant accounting principles are described in Note 1 of theconsolidated financial statements in the Company’s 2005 Annual Report to Shareholderson Form 10-K and are essential to understanding Management’s Discussion andAnalysis of Results of Operations and Financial Condition. Community ValleyBancorp’s annual consolidated financial statements are prepared in accordancewith accounting principles generally accepted in the United States of America(GAAP). The financial information contained within our statements is, to asignificant extent, financial information that is based on measures of thefinancial effects of transactions and events that have already occurred. Someof the Company’s accounting principles require significant judgment to estimatevalues of assets or liabilities. In addition, certain accounting principlesrequire significant judgment in applying the complex accounting principles totransactions to determine the most appropriate treatment. The following is asummary of the more judgmental and complex accounting estimates and principles.

 

*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 that lossesbe accrued when they are probable of occurring and estimable and (2) SFAS No. 114,which requires that losses be accrued on impaired loans based on thedifferences between the value of collateral, present value of future cash flowsor values that are observable in the secondary market and the loan balance. TheCompany performs periodic and systematic detailed evaluations of its lendingportfolio to identify and estimate the inherent risks and assess the overallcollectibility. These evaluations include general conditions such as theportfolio composition, size and maturities of various segmented portions of theportfolio such as secured, unsecured, construction, and Small BusinessAdministration (“SBA”).

 

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 collateral dependent.When developing the estimate of future cash flows for a loan, the Companyconsiders 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 discount rates. Servicing assets are amortized over the estimated life of the relatedloan.  I/O strips are not significant at March 31, 2006.  These

 

12

----

 

prepayment and discount rates were based on currentmarket conditions and historical performance of the various pools of servicedloans.  If actual prepayments with respect to sold loans occur morequickly than projected the carrying value of the servicing assets may have tobe adjusted through a charge to earnings.

 

*Stock-Based Compensation*

 

OnJanuary 1, 2006, the Company adopted Statement of Financial AccountingStandards No. 123(R), *Share Based Payment*(“SFAS123(R)”) using the modified prospective transition method. Prior periods havenot been restated to reflect the impact of SFAS No. 123(R). Prior to adoptionof this statement, the Company accounted for its share-based employeecompensation plans under the recognition and measurement provisions of APBOpinion No. 25, Accounting*for Stock-BasedCompensation* and no stock-based compensation expense was recorded*.*As a result of adopting this statementthe Company will recognize stock-based compensation expense for all preexistingnon-vested stock options and all new stock option grants that are expected tovest as the requisite service is rendered. See Note 4 to the CondensedConsolidated Financial Statements for additional information related toimplementation of SFAS 123(R).

 

*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 Statementsin the Company’s 2005 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.

 

**Overview**

 

TheCompany recorded net income of $1,749,000 for the quarter ended March 31, 2006,which was a 20% increase from the $1,454,000 reported for the same period of2005. Diluted earnings per share for the first quarter of 2006 were $0.23,compared to the $0.19 recorded in the first quarter of 2005. The annualizedreturn on average equity (ROAE) and annualized return on average assets (ROAA)for the first quarter of 2006 were 16.61% and 1.42%, respectively, as comparedto 16.61% and 1.31%, respectively, for the same period in 2005. The primaryreason for the increase in net income was due to significant growth in averageearning assets and the increase in the net interest margin, as a result of thepositive effect of the rising interest rate environment. These increases wereoffset by higher interest expense from growth in the levels of the averageinterest bearing deposit balances and increases in the rates paid, andincreases non-interest expenses, primarily in salaries and benefits.

 

Totalassets of the Company increased by $11,704,000 2.4% from $494,777,000 atDecember 31, 2005 to $506,481,000 at March 31, 2006. Net loans increased to$438,419,000, up $35,001,000, 8.7% from the ending balances on December 31,2005. Deposit balances at March 31, 2006 increased to $444,833,000 up$10,815,000 2.5% from December 31, 2005.

 

13

----

 

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

 

**Table One: Components of Net Income**

 
| ** **                                                       | ** ** | **Three months ended  March 31,** | ** ** |
|------------------------------------------------------------------|------------|-----------------------------------|------------|
| **(In thousands, except  percentages)**                          | ** ** | **2006**                          | ** ** | **2005** | ** ** |
|                                                             |       |                              |       |   |   |
| Net interest  income                                             |       | $                                 | 7,541      |   | $ | 5,907 |   |
| Provision  for loan losses                                       |       | (225                              | )          | (225 | ) |
| Non-interest  income                                             |       | 1,483                             |       | 1,636 |   |
| Non-interest  expense                                            |       | (5,760                            | )          | (4,874 | ) |
| Provision  for income taxes                                      |       | (1,290                            | )          | (990 | ) |
|                                                             |       |                              |       |   |   |
| Net income                                                       |       | $                                 | 1,749      |   | $ | 1,454 |   |
|                                                             |       |                              |       |   |   |
| Average  total assets (In millions)                              |       | $                                 | 498.2      |   | $ | 449.8 |   |
| Net income  (annualized) as a percentage of average total assets |       | 1.42                              | %          | 1.31 | % |

 

**Results ofOperations**

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

 

Net interest incomerepresents the excess of interest and fees earned on interest earning assets(loans, securities, federal funds sold and investments in time deposits) overthe interest paid on deposits and borrowed funds.  Net interest margin is net interest incomeexpressed as a percentage of average earning assets.

 

The Company’s net interestmargin was 6.77% for the three months ended March 31, 2006 and 5.97% for thethree months ended March 31, 2005.  Netinterest income increased $1,634,000 (27.7%) for the first quarter of 2006compared to the same period in 2005.  Theprimary reason for this increase was the growth in average loans of $73,792,000over the same period in 2005 along with the overall positive impact of therising interest rate environment.

 

The averagebalances of interest bearing liabilities of $359,188,000 were $34,208,000(10.5%) higher in the first quarter of 2006 versus the same quarter in2005.  As interest bearing balancesincreased, rates paid on these liabilities increased by 52 basis points on aquarter over quarter basis.  As a result,interest expense was $582,000 (50.8%) higher in the first quarter versus thesame period in 2005.

 

Table Two,Analysis of Net Interest Margin and Table Three, Analysis of Volume and RateChanges on Net Interest Income and Expenses, are provided to enable the readerto understand the components and past trends of the Company’s interest incomeand expense.  Table Two provides ananalysis of net interest margin setting forth average assets, liabilities andshareholders’ equity; interest income earned and interest expense paid andaverage rates earned and paid; and the net interest margin.

 

14

----

 

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

 
| ** **                                                           | ** ** | **2006**         | ** ** | **2005**     | ** ** |
|----------------------------------------------------------------------|------------|------------------|------------|--------------|------------|
| **Three Months Ended March 31,  (In thousands, except percentages)** | ** ** | **Avg  Balance** | ** ** | **Interest** | ** ** | **Avg  Yield (4)** | ** ** | **Avg  Balance** | ** ** | **Interest** | ** ** | **Avg  Yield (4)** | ** ** |
| ** **                                                           | ** ** | ** **       | ** ** | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Assets:**                                                          |       |             |       |         |       |   |   |   |   |   |   |   |   |
| Earning  assets                                                      |       |             |       |         |       |   |   |   |   |   |   |   |   |
| Loans (1)                                                            |       | $                | 421,695    |         | $          | 8,941 |   | 8.60 | % | $ | 347,903 |   | $ | 6,688 |   | 7.80 | % |
| Taxable investment securities                                        |       | 5,207            |       | 50           |       | 3.89 | % | 6,047 |   | 47 |   | 3.25 | % |
| Tax-exempt investment securities (2)                                 |       | 1,380            |       | 16           |       | 4.70 | % | 2,041 |   | 25 |   | 4.91 | % |
| Federal  funds sold                                                  |       | 17,473           |       | 205          |       | 4.76 | % | 36,348 |   | 232 |   | 2.59 | % |
| Interest  bearing deposits in banks                                  |       | 5,844            |       | 56           |       | 3.89 | % | 8,715 |   | 60 |   | 2.79 | % |
| Total  earning assets                                                |       | 451,599          |       | $            | 9,268      |   | 8.32 | % | 401,054 |   | $ | 7,052 |   | 7.05 | % |
| Cash &  due from banks                                           |       | 16,037           |       |         |       |   |   | 12,751 |   |   |   |   |   |
| Other assets                                                         |       | 30,570           |       |         |       |   |   | 36,002 |   |   |   |   |   |
| Average  total assets                                                |       | $                | 498,206    |         |       |   |   |   | $ | 449,807 |   |   |   |   |   |
|                                                                 |       |             |       |         |       |   |   |   |   |   |   |   |   |
| **Liabilities  & Shareholders’ Equity**                     |       |             |       |         |       |   |   |   |   |   |   |   |   |
| Interest  bearing liabilities:                                       |       |             |       |         |       |   |   |   |   |   |   |   |   |
| NOW & MMDA                                                       |       | $                | 186,927    |         | $          | 425 |   | 0.92 | % | $ | 181,032 |   | $ | 270 |   | 0.60 | % |
| Savings                                                              |       | 36,770           |       | 44           |       | 0.49 | % | 34,721 |   | 42 |   | .49 | % |
| Time deposits                                                        |       | 126,280          |       | 1,070        |       | 3.44 | % | 100,168 |   | 691 |   | 2.81 | % |
| Other borrowings                                                     |       | 9,211            |       | 188          |       | 8.28 | % | 9,058 |   | 142 |   | 6.36 | % |
| Total  interest bearing liabilities                                  |       | 359,188          |       | $            | 1,727      |   | 1.95 | % | 324,980 |   | $ | 1,145 |   | 1.43 | % |
|                                                                 |       |             |       |         |       |   |   |   |   |   |   |   |   |
| Demand  deposits                                                     |       | 87,958           |       |         |       |   |   | 82,263 |   |   |   |   |   |
| Other  liabilities                                                   |       | 8,354            |       |         |       |   |   | 7,070 |   |   |   |   |   |
| Total  liabilities                                                   |       | 455,500          |       |         |       |   |   | 414,313 |   |   |   |   |   |
| Shareholders’  equity                                           |       | 42,706           |       |         |       |   |   | 35,494 |   |   |   |   |   |
| Average  liabilities and equity                                      |       | $                | 498,206    |         |       |   |   |   | $ | 449,807 |   |   |   |   |   |
| Net interest  income & margin (3)                                |       |             |       | 7,541        |       | 6.77 | % |   |   | $ | 5,907 |   | 5.97 | % |

 

----

(1)                    Loan interest includes loan fees of $617,000and $616,000 during the three months ended March 31, 2006 and March 31, 2005,respectively.

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

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

(4)                    Average yield is calculated based on actualdays in quarter (90 for March 31, 2006 and 90 for March 31, 2005) andannualized to actual days in year (365 for 2006 and 2005).

 

15

----

 

Table Three sets forth asummary of the changes in interest income and interest expense from changes inaverage asset and liability balances (volume) and changes in average interestrates.  On a quarter over quarter basisfor the period ending March 31, 2006 net interest income has increased$1,634,000 over the same time period in 2005. Interest income from earning assets has increased by $2,216,000. Changesin the volume of earning assets, primarily loans, have resulted in an increasein interest income of $1,419,000 while interest income from changes in rateshas increased by $834,000.  Changes inthe volume of interest bearing liabilities, primarily the increase in balancesof interest bearing demand deposits and time deposits, has resulted in a netincrease of interest expense of $582,000.

 

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

 
| **(In thousands) Three Months Ended March 31, 2006  over 2005** | ** ** | ** ** | ** ** | ** **   | ** ** | ** **     | ** ** |
|-----------------------------------------------------------------|------------|------------|------------|--------------|------------|----------------|------------|
| **Increase (decrease) due to change in:**                       | ** ** | **Volume** | ** ** | **Rate (3)** | ** ** | **Net Change** | ** ** |
| **Interest-earning assets:**                                    | ** ** | ** ** | ** ** | ** **   | ** ** | ** **     | ** ** |
| Net loans (1)                                                   |       | $          | 1,419      |         | $          | 834            |       | $ | 2,253 |   |
| Taxable investment securities                                   |       | (7         | )          | 8            |       | 3              |       |
| Tax exempt investment securities (2)                            |       | (8         | )          | (1           | )          | (9             | )          |
| Federal funds sold                                              |       | (120       | )          | 93           |       | (27            | )          |
| Interest bearing deposits in banks                              |       | (20        | )          | 16           |       | (4             | )          |
| Total                                                           |       | 1,264      |       | 950          |       | 2,216          |       |
|                                                            |       |       |       |         |       |           |       |
| Interest-bearing  liabilities:                                  |       |       |       |         |       |           |       |
| NOW and MMDA deposits                                           |       | 9          |       | 146          |       | 155            |       |
| Savings deposits                                                |       | 2          |       | 0            |       | 2              |       |
| Time deposits                                                   |       | 181        |       | 196          |       | 379            |       |
| Other borrowings                                                |       | 2          |       | 44           |       | 46             |       |
| Total                                                           |       | 194        |       | 386          |       | 582            |       |
| Interest  differential                                          |       | $          | 1,070      |         | $          | 564            |       | $ | 1,634 |   |
|                                                                 |            |            |            |              |            |                |            |  |  |  |  |

 

----

(1)                    The average balance of non-accruing loans isnot significant as a percentage of total loans and, as such, has been includedin net loans.

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

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

 

16

----

 

## **Non-interest Income**

 

Table Four below provides asummary of the components of noninterest income for the periods indicated(dollars in thousands):

 

**TableFour:  Components of Noninterest Income**

 

Three Months Ended March 31,

 
| ** **                           | ** ** | **2006** | ** ** | **% of Avg.  Assets** | ** ** | **2005** | ** ** | **% of Avg.  Assets** | ** ** |
|--------------------------------------|------------|----------|------------|-----------------------|------------|----------|------------|-----------------------|------------|
|                                 |       |     |       |                  |       |     |       |                  |       |
| Service  charges on deposit accounts |       | $        | 578        |                  | 0.46       | %        | $          | 539                   |       | 0.48 | % |
| Loan  servicing fees                 |       | 104      |       | 0.08                  | %          | 98       |       | 0.09                  | %          |
| Fees -  alternative investment sales |       | 69       |       | 0.15                  | %          | 159      |       | 0.14                  | %          |
| Merchant fee  income                 |       | 88       |       | 0.07                  | %          | 78       |       | 0.07                  | %          |
| Gain on the  sale of loans           |       | 356      |       | 0.29                  | %          | 473      |       | 0.42                  | %          |
| Other                                |       | 288      |       | 0.26                  | %          | 289      |       | 0.26                  | %          |
| Total non-interest income            |       | $        | 1,483      |                  | 1.27       | %        | $          | 1,636                 |       | 1.46 | % |

 

Non-interestincome declined by $153,000 (10.3%) to $1,483,000 for the three months endedMarch 31, 2006 as compared to $1,636,000 for the three months ended March 31,2005.  Increases in non-interest incomewere realized in fees from service charges (up 7.2%), loan servicing fees (up6.1%), and merchant fee income (up 12.8%) for the three months ended March 31,2006 as compared to March 31, 2005. Decreases were in fees from alternative investment sales (down 56.6%),gains on the sale of loans (down 24.7%) and other income (down .35%) Theincrease in service charge income was the result of additional deposit accountsopened during the first quarter throughout our system of branches.  Loan servicing fees increased as the volumeof loans sold in the secondary market for which the Company retains servicingrights increased.  The AlternativeInvestment Department, which sells third-party mutual funds and annuities,experienced a decrease in fees due to a decline in sales during the firstquarter.  Gains on sales of loans intothe secondary market decreased compared to the prior year as the loans sold byour Government and Mortgage Lending Divisions were of lesser total value.

 

17

----

 

**Non-interestExpense**

 

Non-interest expenseincreased $886,000 (18.2%) to $5,760,000 in the first quarter of 2006 versus$4,874,000 in the first quarter of 2005. Salary and employee benefits increased $652,000 (21.5%) resulting fromnormal cost of living raises, commissions paid to Butte Community Bank’s RealEstate Loan agents and staffing additions made during the year as the Companycontinues to grow.  On a quarter overquarter basis, full time equivalent employees increased by 20 to 239(9.1%).  Benefit costs and employer taxesincreased commensurate with the salaries.  On a quarter over quarter basis, occupancyexpenses were higher by $36,000 (12.8%). This increase in costs is associated with building leases, utilities,janitorial services and property taxes.  Furnitureand equipment expense was $456,000 in the first quarter of 2006 compared to$391,000 in the same period of 2005, representing a 16.6% increase.  This increase relates to the depreciationrecorded on the purchase of new technology software and hardware. Otherexpenses increased $135,000 (11.6%) in the first quarter of 2006 versus thefirst quarter of 2005.  This increase wasattributed to higher telephone, postage and insurance costs as well asincreased advertising and promotion costs.

** **

**Provisionfor Loan Losses**

 

The Company provided$225,000 for loan losses for the first quarter of 2006 and 2005.  There were no net loan charge-offs for thefirst quarter of 2006 as charge-offs of $1 thousand were offset by recoveriesfor the same amount.  Net charge-offs forthe period ended March 31, 2005 were $1 thousand. Management assesses its loanquality on a monthly basis to maintain an adequate allowance for loanlosses.  The Company’s loan portfoliocomposition, non-performing assets and allowance for loan losses are furtherdiscussed under the Balance Sheet Analysis section below.

** **

**Provisionfor Income Taxes**

 

The effective tax rate forthe first quarter of 2006 was 42.5%, versus 40.5% for the same period in2005.  The increase in the tax provisionwas due to the Company having fewer tax exempt municipal bonds in the firstquarter of 2006 than the same period in 2005.

** **

**BalanceSheet Analysis**

 

The Company’s total assetswere $506,481,000 at March 31, 2006 up $11,704,000 (2.4%) from $494,777,000 atDecember 31, 2005.  On a year over yearbasis, the average balance of total assets for the three months ended March 31,2006 was $498,206,000, which represents an increase of $48,402,000 (10.8%) overthe $449,807,000 during the three-month period ended March 31, 2005.

 

**Loans**

 

The Company concentrates itslending activities in the following principal areas: 1) commercial; 2) realestate mortgage; 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 March 31, 2006, theseprincipal areas accounted for approximately 17%, 43%, 26%, 5% and 9%,respectively, of the Company’s loan portfolio.  The mix at December 31, 2005 was 15%, 43%,27%, 6% and 9%.  Continuing strongeconomic activity in the Company’s market area, new borrowers developed throughthe Company’s marketing efforts and credit lines expanded to existingborrowers, offset by normal loan pay-downs and payoffs, resulted in netincreases in loan balances from December 31, 2005 for commercial loans of$13,113,000 or (21.4%), consumer loans of $3,640,000 or (10.0%), commercial andresidential real estate loans of $16,104,000 or (9.3%) real estate constructionloans of $1,787,000 or (1.6%), and a decrease in agricultural loans of $809,000or (3.4%).  Table Five below summarizesthe composition of the loan portfolio as of March 31, 2006 and December 31,2005.

 

18

----

 

**Table Five:Loan Portfolio Composition**

 
| ** **                 | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|----------------------------|------------|---------------|------------|------------------|------------|
| **(In thousands)**         | ** ** | **2006**      | ** ** | **2005**         | ** ** |
| Commercial                 |       | $             | 74,275     |             | $          | 61,162 |   |
| Real estate:               |       |          |       |             |       |
| Mortgage                   |       | 189,553       |       | 173,449          |       |
| Construction               |       | 112,917       |       | 111,130          |       |
|                       |       |          |       |             |       |
| Agriculture                |       | 23,994        |       | 24,803           |       |
| Consumer                   |       | 40,141        |       | 36,501           |       |
| Total loans                |       | 440,880       |       | 407,045          |       |
| Allowance  for loan losses |       | (4,961        | )          | (4,716           | )          |
| Deferred  loan fees, net   |       | (1,047        | )          | (1,108           | )          |
| Total net  loans           |       | $             | 434,872    |             | $          | 401,221 |   |

 

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

 

Commercial loans consist ofcredit lines for operating needs, loans for equipment purchases, workingcapital, and various other business loan products.  Consumer loans include a range of traditionalconsumer loan products such as personal lines of credit and loans to financepurchases of autos, boats, recreational vehicles, mobile homes and variousother consumer items.

 

Real estate constructionloans are generally composed of commitments to customers within the Company’sservice area for construction of both commercial properties and custom andsemi-custom single-family residences. Other real estate loans consist primarily of loans secured by firsttrust deeds on commercial and residential properties typically with maturitiesfrom 3 to 10 years and original loan to value ratios generally from 65% to80%.  Agriculture loans consist primarilyof crop loans to farmers of peaches, prunes, walnuts, and almonds.  In general, except in the case of loans withSBA or FMHA guarantees, the Company does not make long-term mortgage loans;however, Butte Community Bank has a residential lending division to assistcustomers in securing most forms of longer term single-family mortgagefinancing.

 

**RiskElements**

 

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

 

Ultimately, underlyingtrends in economic and business cycles may influence credit quality.  The Company’s business is concentrated in theButte, Sutter and Shasta County areas. The economy of these three counties isdiversified with professional services, manufacturing, agriculture and real estateinvestment and construction.

 

19

----

 

Special emphasis is placedwithin the communities in which the Company has offices (Chico, Paradise,Magalia, Oroville, Yuba City, Red Bluff, Marysville, Colusa, Corning andRedding).  The Company also maintainsloan production offices in the cities of Citrus Heights and Gridley.  Single-family residential construction is theprimary lending product from the Citrus Heights location serving the greaterSacramento area.  The primary focus ofthe loan production office in Gridley is commercial and agricultural loans.

 

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

 

In extending credit andcommitments to borrowers, the Company generally requires collateral and/orguarantees as security.  The repayment ofsuch loans is expected to come from cash flow or from proceeds from the sale ofselected assets of the borrowers.  TheCompany’s requirement for collateral and/or guarantees is determined on acase-by-case basis in connection with management’s evaluation of thecreditworthiness of the borrower. Collateral held varies but may include accounts receivable, inventory,property, plant and equipment, income-producing properties, residences andother real property.  The Company securesits collateral by perfecting its security interest in business assets,obtaining deeds of trust, or outright possession among other means.

 

## **In management’s judgment, a concentration exists in realestate loans, which represented approximately 68.6% of the Company’s loanportfolio at March 31, 2006, which is slightly less, on a percentage basis,than the 69.9% concentration level at December 31, 2005.  Management believes the concentration to haveno more than the normal risk of collectability; however, a substantial declinein the economy in general, or a decline in real estate values in the Company’sprimary market areas in particular, could have an adverse impact on thecollectability of these loans and require an increase in the provision for loanlosses which could adversely affect the Company’s future prospects, results ofoperations, profitability and stock price. Management believes that its lending policies and underwriting standardswill tend to minimize losses in an economic downturn; however, there is noassurance that losses will not occur under such circumstances.  The Company’s loan policies and underwritingstandards include, but are not limited to, the following: (1) maintaining athorough understanding of the Company’s service area and originating asignificant majority of its loans within that area, (2) maintaining a thoroughunderstanding of borrowers’ knowledge, capacity, and market position in theirfield of expertise, (3) basing real estate loan approvals not only on marketdemand for the project, but also on the borrowers’ capacity to support theproject financially in the event it does not perform to expectations (whethersale or income performance), and (4) maintaining conforming and prudent loan tovalue and loan to cost ratios based on independent outside appraisals andongoing inspection and analysis by the Company’s lending officers.**

 

**Nonaccrual,Past Due and Restructured Loans**

 

Management generally placesloans on nonaccrual status when they become 90 days past due, unless the loanis well secured and in the process of collection.  Loans are charged off when, in the opinion ofmanagement,

collection appears unlikely.

 

Table Six below sets forthnonaccrual loans as of March 31, 2006 and December 31, 2005.  There were no loans past due 90 days or moreand still accruing interest at March 31, 2006 or December 31, 2005.

 

20

----

 

**TableSix:  Non-Performing Loans**

 
| ** **                  | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------|------------|---------------|------------|------------------|------------|
| **(In thousands)**          | ** ** | **2006**      | ** ** | **2005**         | ** ** |
| Nonaccrual:                 |       |          |       |             |       |
| Commercial                  |       | 0             |       |             |       |
| Real estate                 |       | 1,502         |       |             |       |
| Consumer and other          |       | 9             |       | 9                |       |
| Total  non-performing loans |       | $             | 1,511      |             | $          | 9 |   |
|                             |            |               |            |                  |            |  |  |

 

At March 31,2006, there were two non-performing loans which were considered to beimpaired.  One is a real estate securedgovernment guaranteed loan for $1,502,000 of which the unguaranteed portionrepresenting the Company’s exposure is $300,000.  The property is in foreclosure and managementdoes not foresee a loss from this loan. The other loan is a consumer loan on an automobile which the Company hasrepossessed and currently has for sale. There was no specific valuation allowance on these impaired loans. Therewere no loan concentrations in excess of 10% of total loans not otherwisedisclosed as a category of loans as of March 31, 2006 or December 31,2005.  Management is not aware of anypotential problem loans, which were accruing and current at March 31, 2006,where serious doubt exists as to the ability of the borrower to comply with thepresent repayment terms.

 

**Allowancefor Loan Losses Activity**

 

We employ asystematic methodology for determining the allowance for loan losses thatincludes a monthly review process and monthly adjustment of the allowance. Our process 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 (eitherindividually or in pools).  While this methodology utilizes historical andother objective information, the establishment of the allowance for loan lossesand the classification of loans are, to some extent, based on management’sjudgment and experience.

 

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

 

Qualitativefactors include the general economic environment in our markets and, in particular,the state 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.

 

Ourmethodology is, and has been, consistently followed.  However, as we addnew products, increase in complexity, and expand our geographic coverage, weexpect to enhance our methodology to keep pace with the size and complexity ofthe loan portfolio.  On an ongoing basis we engage outside firms toindependently assess our methodology, and to perform independent credit reviewsof our loan portfolio.  The FDIC and the California Department of FinancialInstitutions review the allowance for loan losses as an integral part of theexamination processes.  Management believes that our current methodologyis appropriate given our size and level of complexity.  Further,management believes that the allowance for loan losses is adequate as of March31, 2006 to cover known and inherent risks in the loan portfolio. However, fluctuations in credit quality, or changes in economic conditions orother factors could cause management to increase or decrease the allowance forloan losses as necessary.

 

21

----

 

The Board ofDirectors of the Bank reviews the adequacy of the allowance for loan losses atleast quarterly to include consideration of the relative risks in the portfolioand current economic conditions.  Theallowance is adjusted based on that review if, in the judgment of the loancommittee and management, changes are warranted.  The allowance for loan losses totaled$4,961,000 or 1.13% of total loans at March 31, 2006 and $4,716,000 or 1.16% atDecember 31, 2005.  There were no netcharge-offs for the quarter ended March 31, 2006.

 

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

 

**TableSeven: Allowance for Loan Losses**

 
| ** **                                                                | ** ** | **Three Months  Ended  March 31,** | ** ** |
|---------------------------------------------------------------------------|------------|------------------------------------|------------|
| **(In thousands, except for  percentages)**                               | ** ** | **2006**                           | ** ** | **2005** | ** ** |
|                                                                      |       |                               |       |   |   |
| Average  loans outstanding                                                |       | $                                  | 421,695    |   | $ | 347,903 |   |
|                                                                      |       |                               |       |   |   |
| Allowance  for possible loan losses at beginning of period                |       | $                                  | 4,716      |   | $ | 4,000 |   |
|                                                                      |       |                               |       |   |   |
| Loans  charged off:                                                       |       |                               |       |   |   |
| Commercial                                                                |       | —                             |       |   |   |
| Real estate                                                               |       | —                             |       | — |   |
| Consumer                                                                  |       | (1                                 | )          | (1 | ) |
| Total                                                                     |       | (1                                 | )          | (1 | ) |
| Recoveries  of loans previously charged off:                              |       |                               |       |   |   |
| Commercial                                                                |       | —                             |       | — |   |
| Real estate                                                               |       | —                             |       | — |   |
| Consumer                                                                  |       | 1                                  |       |   |   |
| Total                                                                     |       | 1                                  |       |   |   |
| Net loan  charge offs                                                     |       | 0                                  |       | (1 | ) |
|                                                                      |       |                               |       |   |   |
| Additions to  allowance charged to operating expenses                     |       | 225                                |       | 225 |   |
| Allowance for unfunded loan commitments                                   |       | 20                                 |       |   |   |
| Allowance for loan losses at end of period                                |       | $                                  | 4,961      |   | $ | 4,224 |   |
|                                                                      |       |                               |       |   |   |
| Ratio of net  charge-offs to average loans outstanding                    |       | .000                               | %          | .000 | % |
| Provision for possible loan losses to  average loans outstanding          |       | .053                               | %          | .065 | % |
| Allowance for loan losses to loans net of  deferred fees at end of period |       | 1.14                               | %          | 1.23 | % |

 

It is the policy ofmanagement to maintain the allowance for loan losses at a level adequate forknown and inherent risks in the portfolio. Based on information currently available to analyze inherent creditrisk, including economic factors, overall credit quality, historical delinquenciesand a history of actual charge-offs, management believes that the provision forloan losses and the allowance are adequate. The Company generally makes monthly allocations to the allowance forloan losses.  The budgeted allocation isbased on estimates of loss risk and loan growth.  Adjustments may be made based on differencesfrom estimated loan growth, the types of loans constituting this growth,changes in risk ratings within the portfolio, and general economic conditions.  However, no prediction of the ultimate levelof loans charged off in future years can be made with any certainty.

 

22

----

 

**Other RealEstate**

 

At March 31, 2006 andDecember 31, 2005, the Company did not have any other real estate (“ORE”)properties.

 

**Deposits**

 

At March 31, 2006, totaldeposits were $444,833,000 representing an increase of $10,815,000 (2.5%) overthe December 31, 2005 balance of $434,018,000. This increase is concentrated in interest bearing checking accounts andcertificates of deposit.  In order to keepup with the rapid growth in loans during the first quarter, rates oncertificates of deposit were raised to encourage depositors to move theirmaturing funds from other institutions to the Bank.  Non-interest bearing deposits decreased by$1.6 million partly due to the reduction in deposits from a title companycustomer as activity in the real estate market have slowed.

 

**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 ofthe Company authorized the payment of a cash dividend of $.0375 per share onJanuary 28, 2005, April 22, 2005, $0.04 per share on July 29, 2005, October 28,2005 and January 27, 2006 and $0.05 per share on April 28, 2006.  The payment of dividends in the future issubject to the discretion of the Board of Directors of the Company and willdepend on earnings, the financial condition of the Company and other relevantfactors.

 

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 March31, 2006, shareholders’ equity was $43,134,000, representing an increase of$1,579,000 (3.8%) from $41,555,000 at December 31, 2005.  The increase is primarily the result of theexercise of stock options and net income from the period offset by the stockbased compensation expense recorded and cash dividends discussed above.  The Bank’s ratio of total risk-based capitalto risk adjusted assets was 10.6% at March 31, 2006 compared to 11.3% at December31, 2005.  Tier 1 risk-based capital torisk-adjusted assets was 9.5% at March 31, 2006 and 10.1% at December 31, 2005.

 

Table Eight below lists theCompany’s and the Bank’s capital ratios at March 31, 2006 and December 31,2005, as well as the minimum ratios required under regulatory definitions ofcapital adequacy.

 

23

----

 

**TableEight: Capital Ratios**

 
| **Capital to Risk-Adjusted Assets** | ** ** | **At March 31,  2006** | ** ** | **At December 31, 2005** | ** ** | **Minimum  Regulatory Requirement** | ** ** |
|-------------------------------------|------------|------------------------|------------|--------------------------|------------|-------------------------------------|------------|
| ** **                          | ** ** | ** **             | ** ** | ** **               | ** ** | ** **                          | ** ** |
| **Company**                         | ** ** |                   |       |                     |       |                                |       |
| Leverage ratio                      | ** ** | 10.3                   | %          | 9.8                      | %          | 4.0                                 | %          |
|                                | ** ** |                   |       |                     |       |                                |       |
| Tier 1 Risk-Based Capital           |       | 10.8                   | %          | 11.4                     | %          | 4.0                                 | %          |
|                                |       |                   |       |                     |       |                                |       |
| Total Risk-Based Capital            |       | 11.8                   | %          | 12.5                     | %          | 8.0                                 | %          |
| ** **                          |       |                   |       |                     |       |                                |       |
| **Bank**                            |       |                   |       |                     |       |                                |       |
| ** **                          |       |                   |       |                     |       |                                |       |
| Leverage ratio                      |       | 9.2                    | %          | 8.8                      | %          | 4.0                                 | %          |
|                                |       |                   |       |                     |       |                                |       |
| Tier 1 Risk-Based Capital           |       | 9.5                    | %          | 10.1                     | %          | 4.0                                 | %          |
|                                |       |                   |       |                     |       |                                |       |
| Total Risk-Based Capital            |       | 10.6                   | %          | 11.3                     | %          | 8.0                                 | %          |

 

Capital ratios are reviewedon a regular basis to ensure that capital exceeds the prescribed regulatoryminimums and is adequate to meet future needs. All ratios are in excess of the regulatory definition of “Minimum” atMarch 31, 2006 and December 31, 2005. The Bank was considered “well-capitalized” by regulatory standards, atMarch 31, 2006 and December 31, 2005.

 

**Item3.  Quantitative and Qualitative Disclosuresabout Market Risk**

** **

**Market RiskManagement**

* *

*Overview*.  Market risk is the risk ofloss from adverse changes in market prices and rates.  The Company’s market risk arises primarilyfrom interest rate risk inherent in its loan, investment and deposit portfolios.  The goal for managing the assets andliabilities of the Company is to maximize shareholder value and earnings whilemaintaining a high quality balance sheet without exposing the Company to undueinterest rate risk.

 

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

* *

*Asset/Liability Management*. Activities involved in asset/liability management include, but are notlimited to, lending, accepting and placing deposits, investing in securities,using trust preferred securities and borrowings.  Interest rate risk is the primary market riskassociated with asset/liability management. Sensitivity of earnings to interest rate changes arises when yields onassets change in a different time period or in a different amount from that ofinterest costs on liabilities.  Tomitigate interest rate risk, the structure of the balance sheet is managed withthe goal that movements of interest rates on assets and liabilities arecorrelated and contributes to earnings even in periods of volatile interestrates.  The asset/liability managementpolicy sets limits on the acceptable amount of variance in net interest marginand market value of equity under changing interest environments.  The Company uses simulation models toforecast earnings, net interest margin and market value of equity.

 

Simulation of earnings isthe primary tool used to measure the sensitivity of earnings to interest ratechanges.  Using computer-modelingtechniques, the Company is able to estimate the potential impact of changinginterest rates on earnings.  A balancesheet forecast is prepared monthly using inputs of actual loans, securities andinterest bearing liability (i.e. deposits/borrowings) positions as thebeginning base.  The forecast balancesheet is processed against seven interest rate scenarios.  These scenarios include a 100, 200 and 300 basispoint rising rate forecast, a flat rate forecast and a 100, 200 and 300 basispoint falling rate forecast

 

24

----

 

which take place within a one year timeframe.  The net interest income ismeasured during the year assuming a gradual change in rates over thetwelve-month horizon.  The Company’s netinterest income, as forecast below, was modeled utilizing a forecast balancesheet projected from balances as of the date indicated.

 

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

 

**Table Nine:  Interest Rate RiskSimulation of Net Interest as of March 31, 2006 and December 31, 2005**

 
| **(In thousands)**                       | ** ** | **$ Change in NII  from Current  12 Month Horizon  March 31, 2006** | ** ** | **$ Change in NII  from Current  12 Month Horizon  December 31, 2005** | ** ** |
|------------------------------------------|------------|--------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| Variation  from a constant rate scenario |       |                                                                     |       |                                                                        |       |
| +200bp                                   |       | $                                                                        | 3,498      |                                                                        | $          | 1,732 |   |
| - 200bp                                  |       | $                                                                        | (4,028     | )                                                                           | $          | (2,380 | ) |

 

Assumptions are inherentlyuncertain, and, consequently, the model cannot precisely measure net interestincome or precisely predict the impact of changes in interest rates on netinterest income. Actual results will differ from simulated results due totiming, magnitude and frequency of interest rate changes, as well as changes inmarket conditions 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 inflation on a financialinstitution differs significantly from that exerted on manufacturing, or othercommercial concerns, primarily because its assets and liabilities are largelymonetary.  In general, inflationprimarily affects the Company and it subsidiaries through its effect on marketrates of interest, which affects the Company’s ability to attract loancustomers.  Inflation affects the growthof total assets by increasing the level of loan demand, and potentiallyadversely affects capital adequacy because loan growth in inflationary periodscan increase at rates higher than the rate capital grows through retention ofearnings, which may be generated in the future. In addition to its effects on interest rates, inflation increasesoverall operating expenses.  Inflationhas not had a material effect upon the results of operations of the Company andits subsidiaries during the periods ended March 31, 2006, and 2005.

 

**Liquidity**

 

Liquidity management refersto 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 March 31, 2006 and December 31, 2005 wereapproximately $201,044,000 and $205,588,000, respectively.  Such loans relate primarily to revolvinglines of credit and other commercial loans, and to real estate constructionloans.

 

The Company’s sources ofliquidity consist of cash and due from correspondent banks, overnight fundssold to correspondent banks, unpledged marketable investments and loans heldfor sale.  On March 31, 2006,consolidated liquid assets totaled $31.9 million or 6.3% of total assetscompared to $52.2 million or 10.5% of total assets on December 31, 2005.  In addition to liquid assets, the Companymaintains short-term lines of credit in the amount of $15,000,000 withcorrespondent banks.  There were noborrowings outstanding under these arrangements at March 31, 2006.

 

25

----

 

The Bank also has informalagreements with various other banks to sell participations in loans, ifnecessary.  The Company serves primarilya business and professional customer base and, as such, its deposit base is susceptibleto economic fluctuations.  Accordingly,management strives to maintain a balanced position of liquid assets to volatileand cyclical deposits.

 

Liquidity is also affectedby portfolio maturities and the effect of interest rate fluctuations on themarketability of both assets and liabilities. The Company can sell any of its unpledged securities held in theavailable-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 ofMarch 31, 2006 and December 31, 2005, commitments to extend credit and lettersof credit were the only financial instruments with off-balance sheet risk.  The Company has not entered into any contractsfor financial derivative instruments such as futures, swaps, options or similarinstruments.  Loan commitments andstand-by letters of credit were $201,044,000 and $205,588,000 at March 31, 2006and December 31, 2005, respectively.  Asa percentage of net loans, these off-balance sheet items represent 46.2% and51.2%, respectively.

 

**OtherMatters**

 

**Item4.  Controls and Procedures**

 

(a) Disclosure Controls and Procedures: An evaluation of the Company’sdisclosure 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 participationof the Company’s Chief Executive Officer, Chief Financial Officer and othermembers of the Company’s senior management as of the end of the Company’sfiscal quarter ended March 31, 2006. The Company’s Chief Executive Officer andChief Financial Officer concluded that the Company’s disclosure controls andprocedures as currently in effect are effective in ensuring that theinformation required to be disclosed by the Company in the reports it files orsubmits under the Exchange Act is (i) accumulated and communicated to theCompany’s management (including the Chief Executive Officer and Chief FinancialOfficer) to allow timely decisions regarding required disclosure, and (ii)recorded, processed, summarized and reported within the time periods specifiedin the Commission’s rules and forms.

 

(b) Internal Control Over Financial Reporting: An evaluation of anychanges in the Company’s internal control over financial reporting (as definedin Exchange Act Rules 13a-15(f) and 15d-15(f)), that occurred during theCompany’s fiscal quarter ended March 31, 2006, was carried out under thesupervision 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 concludedthat no change identified in connection with such evaluation has materiallyaffected, or is reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

 

**Item 5. Subsequent Events**

 

On April 14, 2006 the Company announced its acceptance into The NASDAQCapital Market with an expected initial trade date of May 1, 2006.

 

26

----

 

**PART II – OTHER INFORMATION**

 

Item 1. Legal Proceedings.

 

None.

 

Item 1A. Risk Factors

 

In addition to the otherinformation set forth in this report, you should carefully consider the factorsdiscussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-Kfor the year ended December 31, 2005, which could materially affect ourbusiness, financial condition or future results. The risks described in ourAnnual Report on Form 10-K are not the only risks facing our Company.Additional risks and uncertainties not currently known to us or that wecurrently deem to be immaterial also may materially adversely affect ourbusiness, financial condition and/or operating results.”

 

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 Security Holders.

 

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 January 20, 2006 the Company filed a Report on form 8-k announcingthe financial results for 2005.

 

On March 15, 2006, the Company filed a Report on form 8-k announcing a25% increase in the cash dividend to be paid to shareholders of record on March31, 2006, increasing the cash dividend from $0.04 per share to $0.05 per sharepayable April 22, 2005.

 

27

----

 

**SIGNATURES**

 

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

 
|         |   |   | COMMUNITY  VALLEY BANCORP |
|--------------|--------|--------|---------------------------|
|         |   |   |                      |   |
|         |   |   |                      |   |
| May 12, 2006 |   |   |                      |   | By: /s/ *Keith C. Robbins* |   |
|         |   |   |                      |   |
|         |   |   |                      | Keith C.  Robbins |
|         |   |   |                      |
|         |   |   |                      | President,  Chief Executive Officer |
|         |   |   |                      |
|         |   |   |
| May 12, 2006 |   |   |                      | By*: /s/ John F. Coger* |   |
|         |   |   |                      |
|         |   |   |                      | John F. Coger |
|         |   |   |                      |   |
|         |   |   |                      | Executive Vice President,  CFO, COO |
|              |        |        |                           |  |  |  |  |  |

 

28

----