Table of Contents

 

 

 

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**x****      QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

 

**For the Quarterly PeriodEnded March 31, 2010**

 

**o****         TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGEACT OF 1934**

 

**COMMUNITYVALLEY BANCORP**

(Exact name of registrant as specified in itscharter)

 

| **California**                  | ** ** | **000-51678**            | ** ** | **68-0479553**           |
|---------------------------------|------------|--------------------------|------------|--------------------------|
| (State or other jurisdiction of |       | (Commission File Number) |       | (IRS Employer ID Number) |
| incorporation or organization)  |       |                     |       |                     |

 

| **1360 E. Lassen Avenue, Chico, California** | ** ** | **95973**  |
|----------------------------------------------|------------|------------|
| (Address of principal executive offices)     |       | (Zip code) |

 

**(530) 899-2344**

(Registrant’s telephone number, including area code)

 

 

(Former name, former address and former fiscal year, if changed sincelast report.)

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. Yes  x  No  o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files). Yes o  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 Act Rule 12-b-2.

 

| Large accelerated filer  o |   | Accelerated filer  o |
|--------------------------------------|--------|--------------------------------|
|                                 |   |                           |
| Non-accelerated filer  o   |   | Smaller reporting company x    |

 

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

 

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 – 6,699,603 shares outstanding at May 14, 2010.

 

 

 

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Table of Contents

 

**Table of Contents**

 
| PART I  |   |                                                                                                                             | 3      |
|--------------|--------|----------------------------------------------------------------------------------------------------------------------------------|--------|
|         |   |                                                                                                                             |   |
|         |   | Item  1. Financial Statements (unaudited)                                                                                        | 3      |
|         |   |                                                                                                                             |   |
|         |   | Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations of Community Valley Bancorp | 18     |
|         |   |                                                                                                                             |   |
|         |   | Item 3.  Quantitative and Qualitative Disclosures about Market Risk                                                              | 36     |
|         |   |                                                                                                                             |   |
|         |   | Item 4. Controls  and Procedures                                                                                                 | 38     |
|         |   |                                                                                                                             |   |
| PART II |   |                                                                                                                             | 39     |
|         |   |                                                                                                                             |   |
|         |   | Item 1. Legal  Proceedings                                                                                                       | 39     |
|         |   |                                                                                                                             |   |
|         |   | Item 1A. Risk Factors                                                                                                            | 39     |
|         |   |                                                                                                                             |   |
|         |   | Item 2.  Changes in Securities and Use of Proceeds                                                                               | 39     |
|         |   |                                                                                                                             |   |
|         |   | Item 4.  (Removed and Reserved)                                                                                                  | 39     |
|         |   |                                                                                                                             |   |
|         |   | Item 5. Other  Information                                                                                                       | 39     |
|         |   |                                                                                                                             |   |
|         |   | Item 6. Exhibits                                                                                                                 | 39     |
|         |   |                                                                                                                             |   |
|         |   | Signatures                                                                                                                       | 40     |
|         |   |                                                                                                                             |   |
|         |   | Ex. 31.1. Certification of  CEO Pursuant to Section 302 of the Sarbanes Oxley Act of 2002                                   | 41     |
|         |   |                                                                                                                             |   |
|         |   | Ex. 31.2 Certification of  CFO Pursuant to Section 302 of the Sarbanes Oxley Act of 2002                                    | 42     |
|         |   |                                                                                                                             |   |
|         |   | Ex. 32.1 Certification of  CEO Pursuant to Section 906 of the Sarbanes Oxley Act of 2002                                    | 43     |
|         |   |                                                                                                                             |   |
|         |   | Ex. 32.2 Certification of  CFO Pursuant to Section 906 of the Sarbanes Oxley Act of 2002                                    | 44     |

 

2

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Table of Contents

 

**PART I- FINANCIAL INFORMATION**

**Item 1**

 

**COMMUNITYVALLEY BANCORP**

**CONDENSEDCONSOLIDATED BALANCE SHEET (Unaudited)**

(dollars inthousands, except share data)

 
| ** **                                                                                                                                               | ** ** | **March 31, 2010** | ** ** | **December 31, 2009** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| ASSETS                                                                                                                                                   | ** ** | ** **              | ** ** | ** **                 | ** ** |
| Cash  and due from banks                                                                                                                                 |       | $                       | 13,782     |                       | $          | 12,119 |   |
| Federal  funds sold                                                                                                                                      |       | 45,330                  |       | 46,535                     |       |
| Total  cash & cash equivalents                                                                                                                  |       | 59,112                  |       | 58,654                     |       |
|                                                                                                                                                     |       |                    |       |                       |       |
| Interest-bearing  deposits in banks                                                                                                                      |       | 2,542                   |       | 2,740                      |       |
| Investment  securities (fair value of $4,433 at March 31, 2010, and $5,620 at  December 31, 2009)                                              |       | 4,422                   |       | 5,606                      |       |
| Loans  held for sale at lower of cost or market value                                                                                                    |       | —                  |       | 1,137                      |       |
| Loans,  less allowance for loan losses of $14,979 at March 31, 2010 and $12,975  at December 31, 2009                                          |       | 411,131                 |       | 420,036                    |       |
| Premises  and equipment, net                                                                                                                             |       | 4,632                   |       | 5,271                      |       |
| Other  real estate                                                                                                                                       |       | 10,021                  |       | 13,493                     |       |
| Bank  owned life insurance                                                                                                                               |       | 11,791                  |       | 11,680                     |       |
| Accrued  interest receivable and other assets                                                                                                            |       | 18,537                  |       | 19,845                     |       |
| Total  assets                                                                                                                                            |       | $                       | 522,188    |                       | $          | 538,462 |   |
|                                                                                                                                                     |       |                    |       |                       |       |
| LIABILITIES  AND SHAREHOLDERS’ EQUITY                                                                                                               |       |                    |       |                       |       |
|                                                                                                                                                     |       |                    |       |                       |       |
| Deposits:                                                                                                                                                |       |                    |       |                       |       |
| Non-interest  bearing                                                                                                                                    |       | $                       | 66,808     |                       | $          | 77,340 |   |
| Interest  bearing                                                                                                                                        |       | 419,405                 |       | 420,823                    |       |
| Total  deposits                                                                                                                                          |       | 486,213                 |       | 498,163                    |       |
|                                                                                                                                                     |       |                    |       |                       |       |
| ESOP  note payable                                                                                                                                       |       | 1,084                   |       | 1,122                      |       |
| Junior  subordinated debentures                                                                                                                          |       | 8,248                   |       | 8,248                      |       |
| Accrued  interest payable and other liabilities                                                                                                          |       | 15,209                  |       | 14,977                     |       |
| Total  liabilities                                                                                                                                       |       | 510,754                 |       | 522,510                    |       |
|                                                                                                                                                     |       |                    |       |                       |       |
| Commitments  and contingencies (Note 8)                                                                                                                  |       |                    |       |                       |       |
|                                                                                                                                                     |       |                    |       |                       |       |
| Shareholders’  equity                                                                                                                               |       |                    |       |                       |       |
| Preferred  stock - no par value; 10,000,000 shares authorized; issued and outstanding  -345,647 shares at March 31, 2010 and December 31,2009  |       | 3,313                   |       | 3,313                      |       |
| Common  stock - no par value; 20,000,000 shares authorized; issued and outstanding -  6,699,603 shares at March 31, 2010 and December 31, 2009 |       | 10,174                  |       | 10,186                     |       |
| Unallocated  ESOP shares - 154,593 shares at March 31, 2010 and 160,826 shares at  December 31, 2009 (at cost)                                 |       | (1,553                  | )          | (1,582                     | )          |
| (Accumulated  deficit) retained earnings                                                                                                                 |       | (632                    | )          | 3,908                      |       |
| Accumulated  other comprehensive income, net                                                                                                             |       | 132                     |       | 127                        |       |
| Total  shareholders’ equity                                                                                                                         |       | 11,434                  |       | 15,952                     |       |
| Total  liabilities and shareholders’ equity                                                                                                         |       | $                       | 522,188    |                       | $          | 538,462 |   |

 

See Notes to Unaudited Condensed Consolidated Financial Statements

 

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**COMMUNITYVALLEY BANCORP**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)**

(dollars inthousands, except per share data)

 
| ** **                                                  | ** ** | **For the three months  ended March 31,** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                  | ** ** | **2010**                                       | ** ** | **2009** | ** ** |
|                                                        |       |                                           |       |   |   |
| Interest  income:                                           |       |                                           |       |   |   |
| Interest  and fees on loans                                 |       | $                                              | 5,481      |   | $ | 7,047 |   |
| Interest  on Federal funds sold                             |       | 27                                             |       | 28 |   |
| Interest  on deposits in banks                              |       | 12                                             |       | 24 |   |
| Interest  on investment securities:                         |       |                                           |       |   |   |
| Taxable                                                     |       | 30                                             |       | 55 |   |
| Exempt  from Federal income tax                             |       | 16                                             |       | 16 |   |
| Total  interest income                                      |       | 5,566                                          |       | 7,170 |   |
|                                                        |       |                                           |       |   |   |
| Interest  expense:                                          |       |                                           |       |   |   |
| Interest  expense on deposits                               |       | 918                                            |       | 1,870 |   |
| Interest  expense on junior subordinated debentures         |       | 290                                            |       | 143 |   |
| Interest  expense on notes payable                          |       | 26                                             |       | 78 |   |
| Total  interest expense                                     |       | 1,234                                          |       | 2,091 |   |
| Net  interest income before provision for loan losses       |       | 4,332                                          |       | 5,079 |   |
| Provision  for loan losses                                  |       | 5,289                                          |       | 3,100 |   |
| Net  interest (loss) income after provision for loan losses |       | (957                                           | )          | 1,979 |   |
|                                                        |       |                                           |       |   |   |
| Non-interest  income:                                       |       |                                           |       |   |   |
| Sale  of merchant processing portfolio                      |       | —                                         |       | 2,640 |   |
| Loss  on sale of investment security                        |       | —                                         |       | (172 | ) |
| Other  income                                               |       | 1,908                                          |       | 2,359 |   |
| Total  non-interest income                                  |       | 1,908                                          |       | 4,827 |   |
|                                                        |       |                                           |       |   |   |
| Non-interest  expenses:                                     |       |                                           |       |   |   |
| Salaries  and employee benefits                             |       | 2,993                                          |       | 3,399 |   |
| Occupancy                                                   |       | 697                                            |       | 705 |   |
| Furniture  and equipment                                    |       | 486                                            |       | 649 |   |
| Other  real estate                                          |       | 1,390                                          |       | 61 |   |
| Federal  Deposit Insurance Corporation (FDIC) assessments   |       | 344                                            |       | 333 |   |
| Other  expense                                              |       | 1,827                                          |       | 1,627 |   |
| Total  non-interest expense                                 |       | 7,737                                          |       | 6,774 |   |
|                                                        |       |                                           |       |   |   |
| (Loss)  income before benefit from income taxes             |       | (6,786                                         | )          | 32 |   |
|                                                        |       |                                           |       |   |   |
| Benefit  from income taxes                                  |       | (2,307                                         | )          | (68 | ) |
|                                                        |       |                                           |       |   |   |
| Net  (loss) income                                          |       | (4,479                                         | )          | 100 |   |
| Dividends  on preferred stock                               |       | (61                                            | )          |   |   |
| Net  (loss) income available to common shareholders         |       | $                                              | (4,540     | ) | $ | 100 |   |
|                                                        |       |                                           |       |   |   |
| Basic  (loss) earnings per share                            |       | $                                              | (0.68      | ) | $ | 0.02 |   |
| Diluted  earnings per share                                 |       |                                           |       | 0.02 |   |

 

SeeNotes to Unaudited Condensed Consolidated Financial Statements

 

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**COMMUNITY VALLEY BANCORP**

**CONDENSED CONSOLIDATED STATEMENT OF CHANGES INSHAREHOLDERS’ EQUITY (Unaudited)**

 (In thousands,except number of shares)

 
| ** **                                                                  | ** ** | **Preferred  Stock** | ** ** | **Common  Stock** | ** ** | **Unallocated** | ** ** | **Retained  Earnings  (Accumulated** | ** ** | **Accumu-  lated Other  Compre-  hensive** | ** ** | **Total  Shareholders’** | ** **   | **Comprehensive** | ** ** |
|-----------------------------------------------------------------------------|------------|----------------------|------------|-------------------|------------|-----------------|------------|--------------------------------------|------------|--------------------------------------------|------------|-------------------------------|--------------|-------------------|------------|
| ** **                                                                  | ** ** | **Shares**           | ** ** | **Amount**        | ** ** | **Shares**      | ** ** | **Amount**                           | ** ** | **ESOP  shares**                           | ** ** | **Deficit)**                  | ** **   | **Income**        | ** ** | **Equity** | ** ** | **Loss** | ** ** |
| Balance,  January 1, 2009                                              |       | —               |       | $                 | —     |            | 6,699,553  |                                 | $          | 10,147                                     |       | $                             |  (1,438 | )                 | $          | 31,416 |   | $ | 14 |   | $ | 40,139 |   |   |   |
|                                                                        |       |                 |       |              |       |            |       |                                 |       |                                       |       |                          |         |              |       |   |   |   |   |
| Comprehensive  loss                                                         |       |                 |       |              |       |            |       |                                 |       |                                       |       |                          |         |              |       |   |   |   |   |
| Net  loss                                                                   |       |                 |       |              |       |            |       |                                 |       |                                       |       | (27,508                       | )            |              |       | (27,508 | ) | $ | (27,508 | ) |
| Other  comprehensive income                                                 |       |                 |       |              |       |            |       |                                 |       |                                       |       |                          |         |              |       |   |   |   |   |
| Net  change in unrealized gains on available-for-sale investment securities |       |                 |       |              |       |            |       |                                 |       |                                       |       |                          |         | 113               |       | 113 |   | 113 |   |
| Total  comprehensive loss                                                   |       |                 |       |              |       |            |       |                                 |       |                                       |       |                          |         |              |       |   |   | $ | (27,395 | ) |
|                                                                        |       |                 |       |              |       |            |       |                                 |       |                                       |       |                          |         |              |       |   |   |   |   |
| Exercise  of stock options and related tax benefit                          |       |                 |       |              |       | 50              |       | —                               |       |                                       |       |                          |         |              |       | — |   |   |   |
| Amortization  of stock compensation-ESOP shares                             |       |                 |       |              |       |            |       | (16                                  | )          | 72                                         |       |                          |         |              |       | 56 |   |   |   |
| Shares  acquired or redeemed by  ESOP                                  |       |                 |       |              |       |            |       |                                 |       | (216                                       | )          |                          |         |              |       | (216 | ) |   |   |
| Sale  of Stock - Preferred A                                                |       | 240,000              |       | 1,200             |       |            |       |                                 |       |                                       |       |                          |         |              |       | 1,200 |   |   |   |
| Sale  of Stock - Preferred B                                                |       | 105,647              |       | 2,113             |       |            |       |                                 |       |                                       |       |                          |         |              |       | 2,113 |   |   |   |
| Stock-based  compensation expense                                           |       |                 |       |              |       |            |       | 55                                   |       |                                       |       |                          |         |              |       | 55 |   |   |   |
| Balance,  December 31, 2009                                            |       | 345,647              |       | 3,313             |       | 6,699,603       |       | 10,186                               |       | (1,582                                     | )          | 3,908                         |         | 127               |       | 15,952 |   |   |   |
|                                                                        |       |                 |       |              |       |            |       |                                 |       |                                       |       |                          |         |              |       |   |   |   |   |
| Comprehensive  loss                                                         |       |                 |       |              |       |            |       |                                 |       |                                       |       |                          |         |              |       |   |   |   |   |
| Net  loss                                                                   |       |                 |       |              |       |            |       |                                 |       |                                       |       | (4,479                        | )            |              |       | (4,479 | ) | $ | (4,479 | ) |
| Other  comprehensive income                                                 |       |                 |       |              |       |            |       |                                 |       |                                       |       |                          |         |              |       |   |   |   |   |
| Net  change in unrealized gains on available-for-sale investment securities |       |                 |       |              |       |            |       |                                 |       |                                       |       |                          |         | 5                 |       | 5 |   | 5 |   |
| Total  comprehensive loss                                                   |       |                 |       |              |       |            |       |                                 |       |                                       |       |                          |         |              |       |   |   | $ | (4,474 | ) |
|                                                                        |       |                 |       |              |       |            |       |                                 |       |                                       |       |                          |         |              |       |   |   |   |   |
| Amortization  of stock compensation-ESOP shares                             |       |                 |       |              |       |            |       | (20                                  | )          | 29                                         |       |                          |         |              |       | 9 |   |   |   |
| Preferred  stock cumulative dividends- $.08 per share                       |       |                 |       |              |       |            |       |                                 |       |                                       |       | (61                           | )            |              |       | (61 | ) |   |   |
| Stock-based  compensation expense                                           |       |                 |       |              |       |            |       | 8                                    |       |                                       |       |                          |         |              |       | 8 |   |   |   |
| Balance,  March 31, 2010                                               |       | 345,647              |       | $                 | 3,313      |            | 6,699,603  |                                 | $          | 10,174                                     |       | $                             | (1,553       | )                 | $          | (632 | ) | $ | 132 |   | $ | 11,434 |   |   |   |

 

SeeNotes to Unaudited Condensed Consolidated Financial Statements

 

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**COMMUNITYVALLEY BANCORP**

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

(In thousands)

 
| ** **                                                                                | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                | ** ** | **March 31,**     | ** ** |
| ** **                                                                                | ** ** | **2010**               | ** ** | **2009** | ** ** |
| Cash  flows from operating activities:                                                    |       |                   |       |   |   |
| Net  (loss) income                                                                        |       | $                      | (4,479     | ) | $ | 100 |   |
| Adjustments  to reconcile net (loss) income to net cash provided by operating activities: |       |                   |       |   |   |
| Provision  for loan losses                                                                |       | 5,289                  |       | 3,100 |   |
| Decrease  in deferred loan origination fees                                               |       | (35                    | )          | (141 | ) |
| Depreciation  and amortization, net                                                       |       | 342                    |       | 490 |   |
| (Loss)  gain on disposition of Bank premises and equipment                                |       | 306                    |       | (14 | ) |
| Loss  on write-down of other real estate                                                  |       | 969                    |       | 564 |   |
| Gain  on sale of other real estate                                                        |       | (69                    | )          | — |   |
| Net  decrease (increase) in loans held for sale                                           |       | 1,137                  |       | (2,098 | ) |
| Increase  in cash surrender value of bank-owned life insurance, net                       |       | (110                   | )          | (111 | ) |
| Non-cash  compensation expense associated with the ESOP                                   |       | 9                      |       | 19 |   |
| Stock  based compensation                                                                 |       | 8                      |       | 16 |   |
| Loss  on sale of investment security                                                      |       | —                 |       | 172 |   |
| Decrease  in accrued interest receivable and other assets                                 |       | 1,304                  |       | 1,066 |   |
| Increase  (decrease) in accrued interest payable and other liabilities                    |       | 171                    |       | (345 | ) |
| Net  cash provided by operating activities                                                |       | 4,842                  |       | 2,818 |   |
|                                                                                      |       |                   |       |   |   |
| Cash  flows from investing activities:                                                    |       |                   |       |   |   |
| Increase  in interest-bearing deposits in banks                                           |       | 198                    |       | 693 |   |
| Proceeds  from matured or called available-for-sale investment securities                 |       | 1,000                  |       | 2,000 |   |
| Proceeds  from principal payments on available-for-sale investment securities             |       | 158                    |       | 54 |   |
| Proceeds  from matured or called held-to-maturity investment securities                   |       | 1,000                  |       | 88 |   |
| Proceeds  from principal payments on held-to-maturity investment securities               |       | 35                     |       | 76 |   |
| Purchase  of available-for-sale investment securities                                     |       | (1,000                 | )          | (1,000 | ) |
| Purchase  of held-to-maturity investment securities                                       |       | —                 |       | (996 | ) |
| Purchases  of premises and equipment                                                      |       | (12                    | )          | (105 | ) |
| Proceeds  from sale of premises and equipment                                             |       | 3                      |       | 20 |   |
| Proceeds  from sale of other real estate                                                  |       | 4,322                  |       | 176 |   |
| Premiums  paid for life insurance policies                                                |       | (1                     | )          | — |   |
| Net  decrease in loans                                                                    |       | 1,901                  |       | 1,564 |   |
| Net  cash provided by investing activities                                                |       | 7,604                  |       | 2,570 |   |
|                                                                                      |       |                   |       |   |   |
| Cash  flows from financing activities:                                                    |       |                   |       |   |   |
| Net  decrease in demand, interest-bearing and savings deposits                            |       | (438                   | )          | (4,908 | ) |
| Net  (decrease) increase in time deposits                                                 |       | (11,512                | )          | 13,807 |   |
| Repayment  of ESOP note payable                                                           |       | (38                    | )          | (39 | ) |
| Proceeds  from ESOP note payable                                                          |       | —                 |       | 217 |   |
| Purchase  of ESOP shares                                                                  |       | —                 |       | (217 | ) |
| Proceeds  from exercise of stock options                                                  |       | —                 |       | 1 |   |
| Net  cash (used in) provided by financing activities                                      |       | (11,988                | )          | 8,861 |   |
|                                                                                      |       |                   |       |   |   |
| Increase  in cash and cash equivalents                                                    |       | 458                    |       | 14,249 |   |
|                                                                                      |       |                   |       |   |   |
| Cash  and cash equivalents at beginning of year                                           |       | 58,654                 |       | 58,348 |   |
|                                                                                      |       |                   |       |   |   |
| Cash  and cash equivalents at end of period                                               |       | $                      | 59,112     |   | $ | 72,597 |   |

 

SeeNotes to Unaudited Condensed Consolidated Financial Statements

 

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Community Valley Bancorp

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

**1. BASIS OF PRESENTATION**

 

Theaccompanying unaudited condensed consolidated financial statements of CommunityValley Bancorp and subsidiaries (the “Company”) have been prepared pursuant tothe rules and regulations of the Securities and Exchange Commission (the “SEC”)and the instructions to Form 10-Q and Article 10 of Regulation S-X.Accordingly, certain information and footnote disclosures required byaccounting principles generally accepted in the United States of America (GAAP)for annual financial statements are not included herein, however the Companybelieves that the disclosures made are adequate to make the information notmisleading. In the opinion of management, all adjustments (which consist solelyof normal recurring adjustments) considered necessary for a fair presentationof the results for the interim periods presented have been included. Theseinterim consolidated financial statements should be read in conjunction withthe financial statements and related notes contained in the Company’s 2009Annual 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 BCB InsuranceAgency, LLC. All significant inter-company balances and transactions have beeneliminated in consolidation. The Company also has a wholly-owned unconsolidatedsubsidiary, Community Valley Bancorp Trust II (the “Trust”), a Delawarestatutory business trust, formed for the sole purpose of issuing trustpreferred securities. The results of operations for the three-month periodended March 31, 2010 may not necessarily be indicative of the operatingresults for the full year 2010.

 

Managementhas determined that because 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 the condensed consolidated financial statements in conformitywith accounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions.  These estimatesand assumptions affect the reported amounts of assets and liabilities at thedate of the financial statements and the reported amounts of revenues andexpenses during the reporting period.  Actual results could differ fromthese estimates.

 

**2. REGULATORY MATTERS**

 

Effective May 11,2010, in connection with the Bank’s regularly scheduled 2010 Joint FDIC andCalifornia Department of Financial Institutions (“DFI”) examination, the Bankentered into a Consent Order (“Order”) with the FDIC and the DFI.  The FDIC and DFI in the Consent Order, whichsupersedes the Memorandum of Understanding (MOU) that was entered into betweenthe Bank and the FDIC and DFI in April 2009, order certain actions to betaken by the Bank including among others:

 

·                  Having and retaining qualified management;

·                  Obtaining an independent study of themanagement and personnel structure of the Bank within 180 days of the date ofthe Order to determine whether the Bank is staffed by qualified individualscommensurate with its size and risk profile to ensure the safe and profitableoperation of the Bank;

·                  Within 90 days of the date of the Order,increasing and maintaining the Bank’s Tier 1 capital to a level such that itsleverage ratio is at least 10% and its total risk-based capital is at least13%;

·                  Not paying cash dividends or making any otherpayments to its shareholder without the prior written consent of the FDIC andDFI;

·                  Reducing or eliminating certain classifiedassets within 180 days of the date of the Order;

·                  Within 30 days of the date of the Order,revising or developing, adopting and implementing a comprehensive policy fordetermining the adequacy of the allowance for loan losses, and increasing andmaintaining its allowance for loan losses to be compliant with suchcomprehensive policy;

·                  With certain exceptions, not extending anyadditional credit to or for the benefit of any borrower who has a loan that hasbeen charged off or classified;

 

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·                  Within 90 days of the date of the Order,revising or developing, adopting and implementing written lending andcollection policies to provide effective guidance and control over the Bank’slending function as satisfactory to the FDIC and DFI;

·                  Within 90 days of the date of the Order,revising or developing, adopting and implementing a written plan forsystematically reducing its concentration of construction and land loans to becompliant with banking laws and bank regulatory agency guidance;

·                  Within 90 days of the date of the Order,revising or developing, adopting and implementing a written liquidity and fundsmanagement policy that adequately addresses liquidity needs and appropriatelyreduces its reliance on non-core funding sources as satisfactory to the FDICand DFI;

·                  Within 30 days of the date of the Order,revising or developing, adopting and implementing a written plan addressingretention of profits, reducing overhead expenses, and setting forth acomprehensive budget for 2010 as satisfactory to the FDIC and DFI;

·                  Within 180 days of the date of the Order,revising or developing, adopting and implementing a written three yearstrategic plan as satisfactory to the FDIC and DFI;

·                  Not establishing any new branches or otheroffices of the Bank without the prior consent of the FDIC and DFI;

·                  Complying with the banking laws andregulations on brokered deposits, and within 60 days of the date of the Order,submiting to the FDIC and DFI a written plan for eliminating its reliance onbrokered deposits; and

·                  Within 30 days of the end of each quarterfollowing the date of the Order, furnish written progress reports to the FDICand DFI.

 

As of March 31,2010, the Bank’s Tier 1 capital to average assets ratio was 3.5% and totalrisk-based capital ratio was 5.2%.

 

Effective July 30,2009, the Company entered into a Memorandum of Understanding with the FederalReserve Bank of San Francisco (FRB) to not declare or pay any dividends, makeany payments of principal or interest on trust preferred securities, or makeany other capital distributions without the prior written approval of the FRB;to not incur, increase or renew any exiting debt or guarantee any debt withoutthe prior written approval of the FRB; to comply with certain notice provisionsin the case of any new director or senior executive officer; and to comply withany legal restrictions regarding indemnification and severance payments toinstitution-affiliated parties without written approval from the FRB andconcurrence from the FDIC.

 

While management believesthat progress has been made in addressing certain of the requirements set forthin the Consent Order and Memorandum of Understanding, the Board of Directorsand management are committed to putting the necessary resources and plans inplace to become fully compliant within the timelines as set forth above.

 

*Regulatory Capital Guidelines*

 

Federal bank regulatory agencies use capital adequacyguidelines in the examination and regulation of bank holding companies andbanks. The guidelines are “risk-based,” meaning that they are designed to makecapital requirements more sensitive to differences in risk profiles among banksand bank holding companies.  Regulationsalso include additional capital categories for all depository institutionsunder the regulatory framework for prompt corrective action which establish aframework of supervisory actions for insured depository institutions that arenot adequately capitalized.  For thosedepository institutions that fail to meet these minimum capital requirements,certain mandatory, and possibly additional discretionary, actions by regulatorsare initiated that can have a direct material effect on the Bank.  These quantitative measures are establishedby regulation and require that minimum amounts and ratios of total and Tier 1capital to risk-weighted assets and of Tier 1 capital to average assets bemaintained.  Capital amounts andclassification are also subject to qualitative judgments by the regulatorsabout components, risk weightings and other factors.

 

*Prompt Corrective Action*

 

Underthe Supervisory Prompt Correction Action Directive received from the FDIC on May 3,2010, the Bank is required to file a capital restoration plan and is subject toamong other things, recapitalization of the Bank, refraining from accepting,renewing or rolling over any brokered deposits; restricting the interest ratesthat the Bank pays on deposits to comply with rate restrictions in certain FDICRules and Regulations; ensuring that average total assets during anycalendar quarter do not exceed average total assets during the precedingcalendar quarter; refraining from making any capital distributions or dividendpayments to its parent or paying any bonuses or increased compensation to anydirector or officer of the Bank without prior written approval from the FDIC;retaining qualified senior executive officers; restrictions on access to theFederal Reserve’s discount window; and being prohibited from opening newbranches and from relocating, selling or disposing of any existing brancheswithout the approval of the FDIC.

 

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Under the prompt corrective action guidelines, adepository institution is assigned to one of five capital categories dependingon its total risk-based capital ratio, Tier 1 risk-based capital ratio, andleverage ratio, together with certain subjective factors. The categories are “wellcapitalized,” “adequately capitalized,” “undercapitalized,” “significantlyundercapitalized,” and “critically undercapitalized.” Institutions that aredeemed to be undercapitalized, depending on the category to which they areassigned, are subject to certain mandatory supervisory corrective actions.  The Bank’s total capital to risk-weightedassets ratio dropped below 6.0% as of March 31, 2010, therefore, the Bank isconsidered “significantly undercapitalized” for purposes of the promptcorrection action regulations.

 

Certain minimum ratios under the provisions of theprompt corrective action guidelines and the actual capital ratios of theCompany and the Bank at March 31, 2010, are set forth in the table below:

** **
| ** **                      | ** ** | **Requirements for the********Bank Under the Prompt  Corrective Action Provisions to  be:** | ** ** | ** **            | ** ** | ** ** | ** ** |
|---------------------------------|------------|---------------------------------------------------------------------------------------------|------------|-----------------------|------------|------------|------------|
| ** **                      | ** ** | **Adequately  Capitalized**                                                                 | ** ** | **Well  Capitalized** | ** ** | **Bank**   | ** ** | **Company** | ** ** |
| Tier 1 leverage capital ratio   |       | 4.0                                                                                         | %          | 5.0                   | %          | 3.5        | %          | 2.0 | % |
| Tier 1 risk-based capital ratio |       | 4.0                                                                                         | %          | 6.0                   | %          | 4.0        | %          | 2.2 | % |
| Total risk-based capital ratio  |       | 8.0                                                                                         | %          | 10.0                  | %          | 5.2        | %          | 5.4 | % |

 

Under the Consent Order discussed above, the Bank isrequired to raise its Tier 1 leverage capital ratio to 10% and its risk basedcapital ratio to 13% which are higher than the level for being categorized as “WellCapitalized.”

 

**3. GOING CONCERN CONSIDERATIONS**

 

The accompanyingconsolidated financial statements have been prepared assuming the Company willcontinue as a going concern which contemplates the realization of assets andthe discharge of liabilities in the normal course of business for theforeseeable future. We have determined that significant additional sources ofliquidity and capital will be required for us to continue operations through2010 and beyond. We estimate that to increase the Bank’s leverage ratio to10%, we will need at least $33,900,000 of new Tier 1 capital. Additional lossesin subsequent quarters will increase the capital needs necessary to meet therequirement. We have engaged financial advisors to assist the Company in itsefforts to raise additional capital, sell assets, and explore other strategicalternatives to address our current and expected liquidity and capitaldeficiencies. However, there can be no assurance that the Company will be ableto maintain sufficient liquidity or to raise additional capital to satisfyregulatory requirements and meet obligations as they occur. As described aboveunder “Regulatory Matters” in Note 2, the Company and the Bank did not meeteither the minimum regulatory capital requirements or the leverage ratiorequirement of 10% outlined in the Memorandum of Understanding and the ConsentOrder signed May 11, 2010 which superseded the Memorandum ofUnderstanding. As such, the Company is considered undercapitalized and the Bankhas been categorized as significantly undercapitalized under the PromptCorrective Action Directive received on May 3, 2010.  The accompanying financial statements do notreflect the impact of the conditions included in the Consent Order and PromptCorrective Action Directive discussed above. Further, the regulators arecontinually monitoring liquidity and capital adequacy and evaluating theCompany’s ability to continue to operate in a safe and sound manner. The Bank’sregulators could, if deemed warranted, take further actions, including theassumption of control of the Bank, to protect the interests of depositorsinsured by the FDIC. The uncertainty regarding the Company’s ability to obtainadditional capital, improve asset quality and meet future liquidityrequirements raises substantial doubt about the Company’s ability to continueas a going concern.

 

While considerable risks to the Company’s futurefinancial performance exist, management believes the Company is capable ofresponding to these risks and carrying on operations while it implements itsstrategic plan and pursues opportunities with respect to augmenting capital. Ifsuccessfully implemented, the Company’s capital plan will address its near-termcapital resources and liquidity needs. However, there can be no guarantee thatany restructuring or recapitalization plan will be successfully implemented.

 

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**4. ALLOWANCE FOR LOAN LOSSES**

 

The allowance for loan losses is established through aprovision for loan losses which is charged to expense. Additions to theallowance for loan losses are expected to maintain the adequacy of the totalallowance after loan losses and loan growth. The allowance for loan losses ismaintained to provide for losses related to impaired loans and other lossesthat can be reasonably expected to occur in the normal course of business. Thedetermination of the allowance for loan losses is based on estimates made bymanagement to include consideration of the character of the loan portfolio,specifically identified problem loans, potential losses inherent in theportfolio taken as a whole and economic conditions in the Company’s servicearea.

 

A loan is considered impaired when, based on currentinformation and events, it is probable that the Company will be unable tocollect all amounts due (including both principal and interest) in accordancewith the contractual terms of the loan agreement. An impaired loan is measuredbased on the present value of expected future cash flows discounted at the loan’seffective interest rate or, as a practical matter, at the loan’s observablemarket price or the fair value of collateral if the loan is collateraldependent. Interest income on impaired loans, if appropriate, is recognized ona cash basis.

 

Classified loans and loans determined to be impairedare evaluated by management for specific risk of loss. In addition, a reservefactor is assigned to currently performing loans based on management’sassessment of the following for each identified loan type: (1) inherentcredit risk, (2) historical losses and, (3) where the Company has notexperienced losses, the loss experience of peer banks. These estimates areparticularly susceptible to changes in the economic environment and marketconditions.

 

The Company’s Board of Directors reviews the adequacyof the allowance for loan losses at least quarterly, to include considerationof the relative risks in the portfolio and current economic conditions. Theallowance for loan losses is adjusted based on that review if, in the judgmentof the Board of Directors and management, changes are warranted. The allowancefor loan losses at March 31, 2010 and 2009 reflects management’s estimateof possible losses in the portfolio.

 

Changes in theallowance for loan losses were as follows:

 
| ** **                                | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|
| ** **                                | ** ** | **2010**                          | ** ** | **2009** | ** ** |
| ** **                                | ** ** | ** **                        | ** ** | ** ** | ** ** |
| Balance,  beginning of year               |       | $                                 | 12,975,000 |   | $ | 7,826,000 |   |
| Provision  charged/credited to operations |       | 5,289,000                         |       | 3,152,000 |   |
| Losses charged  to allowance              |       | (3,530,000                        | )          | (2,282,000 | ) |
| Recoveries                                |       | 245,000                           |       | 1,000 |   |
|                                      |       |                              |       |   |   |
| Balance, end of  year                     |       | $                                 | 14,979,000 |   | $ | 8,697,000 |   |

 

At March 31, 2010 and December 31, 2009, impaired loanstotaled $63,254,000 and $54,123,000, respectively. Specific reserves recordedtotaled $3,751,000 on impaired loans totaling $23,392,000 at March 31,2010 and specific reserves recorded totaled $4,045,000 on impaired loanstotaling $20,146,000 at December 31, 2009. The remaining impaired loansdid not require a specific reserve at March 31, 2010 or December 31,2009. Interest recognized for cash payments received on impaired loans was $90,000 for the quarter ending March 31,2010 and was not significant for the quarter ending March 31, 2009. At March 31,2010 and December 31, 2009, the Company had $424,000 committed to lendadditional funds to borrowers whose loans were restructured.

 

At March 31, 2010 and December 31, 2009, nonaccrual loanstotaled $57,457,000 and $51,075,000, respectively. Interest foregone onnonaccrual loans totaled $917,000 and $340,000 for the quarters ended March,31, 2010 and 2009, respectively. There were no loans greater than ninety dayspast due still accruing interest at March 31, 2010 and December 31,2009. Interest recognized for cash payments received on nonaccrual loans wasnot significant for the quarters ended March 31, 2010 and 2009.

 

**5. (LOSS) EARNINGS PER SHARE COMPUTATION**

 

Basic(loss) earnings per share are computed by dividing net (loss) income availableto common shareholders by the weighted average common shares outstanding forthe period (6,538,777 shares for the three month period ended March 31,2010 and 6,557,505 shares for the three month period ended March 31,2009). Diluted earnings per share reflect the potential dilution that couldoccur if outstanding stock options were exercised using the treasury stockmethod. Diluted earnings per share is 

 

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computedby dividing net income available to common shareholders by the weighted averagecommon shares outstanding for the period plus the dilutive effect of options(zero shares for the three month periods ended March 31, 2010 and2009).  As of March 31, 2009, 325,381outstanding stock options were “out of the money”; that is, the option pricewas higher than the market price so these shares were not used in thecalculation of earnings per share as they are considered antidilutive.  In addition, diluted earnings per share arenot presented when a loss occurs because the conversion of potential commonstock is anti-dilutive.

 

**6. COMPREHENSIVE (LOSS) INCOME**

 

Comprehensive(loss) income is reported in addition to net (loss) income for all periodspresented. Comprehensive (loss) income is made up of net (loss) income plusother comprehensive income or loss. The Company’s only source of comprehensiveincome or loss is changes in unrealized gains or losses, net of taxes, onavailable-for-sale securities, adjusted for the effect of realized gains orlosses on available-for-sale securities, net of taxes. Comprehensive loss was$(4,474,000) for the three month period ended March 31, 2010 compared tocomprehensive income of $178,000 for the same period in 2009.

 

**7. STOCK - BASED COMPENSATION**

 

The Company issues stock options under onestock-based compensation plan, the Community Valley Bancorp 2000 Stock OptionPlan. The plan requires that the option price may not be less than the fairmarket value of the stock at the date the option is granted, and that the stockmust be paid in full at the time the option is exercised. The options expire ona date determined by the Board of Directors, but not later than ten years fromthe date of grant. The vesting period is determined by the Board of Directorsand is generally over five years. Under the Company’s 2000 stock option plan,259,981 shares of common stock remain reserved for issuance to employees anddirectors. There are 178,862 additional shares available for future grants.

 

Stockoption activity for the interim 2010 period is summarized below:

 
| **2010**                                             | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|------------------------------------------------------|------------|------------|------------|---------------------------------------|------------|------------------------------------------|------------|---------------------------------|------------|
| Outstanding  at January 1                       |       | 311,751    |       | $                                     | 4.25       |                                     | 2.3 years  |                            | $          | — |   |
| Cancelled/Expired                                    |       | (51,770    | )          | $                                     | 3.75       |                                     |       |                            |       |   |
| Outstanding  at March 31                        |       | 259,981    |       | $                                     | 8.68       |                                     | 2.5 years  |                            | $          | — |   |
| Options  vested or expected to vest at March 31 |       | 254,781    |       | $                                     | 8.51       |                                     | 2.4 years  |                            | $          | — |   |
| Exercisable  at March 31                        |       | 251,781    |       | $                                     | 8.40       |                                     | 2.4 years  |                            | $          | — |   |

 

**8. COMMITMENTS AND CONTINGENCIES**

 

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 results of operations of the Company takenas a whole.

 

Inthe normal course of business, there are various outstanding commitments toextend credit which are not reflected in the financial statements, includingloan commitments of $95,570,000 and $110,890,000 and stand-by letters of creditof $4,136,000 and $4,387,000 at March 31, 2010 and December 31, 2009,respectively.

 

Ofthe loan commitments outstanding at March 31, 2010, $16,727,000 are realestate construction loan commitments that are not expected to fund within thenext twelve months due to the current downturn in the real estate market. Theremaining commitments primarily relate to revolving lines of credit or othercommercial loans, and many of these are expected to expire without being drawnupon. Therefore, the total commitments do not necessarily represent future cashrequirements. Each loan commitment and the amount and type of collateralobtained, if any, are evaluated on an individual basis. Collateral held varies,but may include real property, bank deposits, debt or equity securities orbusiness assets.

 

AtMarch 31, 2010, the Company had $424,000, which is included in theoutstanding commitments, committed to lend additional funds to borrowers whoseloans were restructured.

 

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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 31,2010 and December 31, 2009. The Company recognizes these fees as revenuesover the term of the commitment or when the commitment is used.

 

## **9.  INCOME TAXES**

##  

The Company filesits income tax returns on a consolidated basis with its subsidiaries. Theallocation of income tax expense (benefit) represents each entity’sproportionate share of the consolidated provision (benefit) for income taxes.

 

The Company accounts for income taxes under the assetand liability method. Under the asset and liability method, deferred tax assetsand liabilities are recognized for the future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases. Deferred tax assets andliabilities are measured using currently enacted tax rates applied to suchtaxable income in the years in which those temporary differences are expectedto be recovered or settled. The effect on deferred tax assets and liabilitiesof a change in tax rates is recognized in income in the period that includesthe enactment date. If future income should prove non-existent or less than theamount of deferred tax assets within the tax years to which they may beapplied, the asset may not be realized and net income will be reduced. The Companyonly recognizes tax positions that meet the more likely than not recognitionthreshold that the tax position will be sustained in a tax examination.

 

A comprehensive model isused for recognizing, measuring, presenting and disclosing in the financialstatements tax positions taken or expected to be taken on a tax return.  A tax position is recognized as a benefitonly if it is “more likely than not” that the tax position would be sustainedin a tax examination, with a tax examination being presumed to occur.  The amount recognized is the largest amountof tax benefit that is greater than 50% likely of being realized onexamination.  For tax positions notmeeting the “more likely than not” test, no tax benefit is recorded.

 

If Management determines, based on available evidenceat the time, that it is more likely than not that some portion or all of theCompany’s deferred tax assets will not be realized, then a valuation allowanceagainst the deferred tax asset is established. In evaluating the likelihood ofrealizing the benefit of the deferred tax asset, Management estimates futuretaxable income based on Management’s business plans and ongoing tax planningstrategies against which the deferred tax asset may be applied. This processinvolves significant judgment about assumptions that are subject to revisionfrom period to period based on changes in tax laws or variances between theCompany’s projected operating performance and the Company’s actual results andother factors. A valuation allowance for deferred tax assets is establishedthrough an expense recorded in the statement of operations.

 

For the three years ended December 31, 2009, 2008and 2007, the Company is in a cumulative pretax loss position. For purposes ofestablishing a deferred tax valuation allowance, this cumulative pretax lossposition is considered significant, objective evidence that the Company’sdeferred tax assets may not be realizable in the future. The cumulative pretaxloss position was caused primarily by the significant amount of loan lossprovision and other real estate expense taken in 2009. As a result of theselosses and the losses recognized in the current quarter, a valuation allowancewas recorded on substantially all of the Company’s net deferred tax assets at March 31,2010 and December 31, 2009. Due to continued deteriorating marketconditions, the Company has determined that there is not sufficient additionalpositive evidence to support the realization of its net deferred tax assets.However, a current tax receivable can be realized from the carryback of the2010 projected net operating loss. Net operating loss carrybacks for the yearending December 31, 2010 are limited to the $4.1 million in taxes paid for the2008 tax year.

 

The amount ofdeferred tax assets considered realizable is subject to adjustment in futureperiods. Management will continue to monitor all available evidence related tothe Company’s ability to utilize its net deferred tax assets. The Company’sincome tax expense in future periods will be increased or reduced to the extentof offsetting increases or decreases to the Company’s net deferred tax assetvaluation allowance.

 

****10.  NOTE PAYABLE AND OTHER BORROWING ARRANGEMENTS****

 

The ESOP obtained financingthrough a $1,300,000 unsecured line of credit from another financialinstitution with the Company acting as the guarantor. The note has a variableinterest rate, based on an independent index, and a maturity date of October 16,2016. The interest rate was 5.75% at March 31, 2010. The balance on theline of credit totaled $1,084,000 and $1,122,000 at March 31, 2010****and December 31,2009, respectively.****

 

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Tomeet unanticipated funding requirements, the Bank obtained a line of creditwith the Federal Reserve Bank of San Francisco (FRB), with a borrowing capacityof $9,665,000 at May 4, 2010. This line is collateralized by agricultureloans and commercial real estate loans with a carrying value of $22,210,000.

 

## **11.INVESTMENT SECURITIES**

##  

The amortized cost andestimated fair value of available-for-sale investment securities at March 31,2010 and December 31, 2009 consisted of the following (dollars inthousands):

 

Available for Sale

 
| ** **                                        | ** ** | **March 31, 2010** | ** ** |
|---------------------------------------------------|------------|-------------------------|------------|
| ** **                                        | ** ** | **Amortized  Cost**     | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair Value** | ** ** |
| Debt  securities:                                 |       |                    |       |   |   |   |   |   |   |
| U.S.  Government agencies                         |       | $                       | 2,648      |   | $ | 118 |   | $ | — |   | $ | 2,766 |   |
| Obligations  of states and political subdivisions |       | 1,358                   |       | 104 |   | — |   | 1,462 |   |
|                                              |       | $                       | 4,006      |   | $ | 222 |   | $ | — |   | $ | 4,228 |   |

 
| ** **                                        | ** ** | **December 31, 2009** | ** ** |
|---------------------------------------------------|------------|----------------------------|------------|
| ** **                                        | ** ** | **Amortized  Cost**        | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair Value** | ** ** |
| Debt  securities:                                 |       |                       |       |   |   |   |   |   |   |
| U.S.  Government agencies                         |       | $                          | 2,807      |   | $ | 131 |   | $ | — |   | $ | 2,938 |   |
| Obligations  of states and political subdivisions |       | 1,358                      |       | 81 |   | — |   | 1,439 |   |
|                                              |       | $                          | 4,165      |   | $ | 212 |   | $ | — |   | $ | 4,377 |   |

 

Net unrealizedgains on available-for-sale investment securities totaling $222,000 and$212,000 were recorded, net of $90,000 and $85,000 in tax expenses, asaccumulated other comprehensive income within shareholders’ equity for 2010 and2009, respectively. There were no sales or transfers of available-for-saleinvestment securities for the periods ended March 31, 2010 and 2009.

 

The amortized cost andestimated fair value of held-to-maturity investment securities at March 31,2010 and December 31, 2009 consisted of the following (dollars inthousands):

 

Held to Maturity

 
| ** **                | ** ** | **March 31, 2010** | ** ** |
|---------------------------|------------|-------------------------|------------|
| ** **                | ** ** | **Amortized  Cost**     | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair Value** | ** ** |
| Debt  securities:         |       |                    |       |   |   |   |   |   |   |
| U.S.  Government agencies |       | $                       | 194        |   | $ | 11 |   | $ | — |   | $ | 205 |   |
|                           |            |                         |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                | ** ** | **December 31, 2009** | ** ** |
|---------------------------|------------|----------------------------|------------|
| ** **                | ** ** | **Amortized  Cost**        | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair Value** | ** ** |
| Debt  securities:         |       |                       |       |   |   |   |   |   |   |
| U.S.  Government agencies |       | $                          | 1,229      |   | $ | 14 |   | $ | — |   | $ | 1,243 |   |
|                           |            |                            |            |  |  |  |  |  |  |  |  |  |  |

 

There were nosales or transfers of held-to-maturity investment securities for the periodsended March 31, 2010 and 2009.

 

There were noinvestment securities with unrealized losses at March 31, 2010 and December 31,2009.

 

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Investmentsecurities with amortized costs totaling $2,358,000 and $3,445,000 and fairvalues totaling $2,459,000 and $3,446,000 were pledged to secure publicdeposits and treasury, tax and loan accounts at March 31, 2010 and December 31,2009, respectively.

 

## **12.FAIR VALUE MEASUREMENTS**

##  

The carrying amounts and estimated fair values of the Company’sfinancial instruments are as follows (dollars in thousands):

 
| ** **                                                  | ** ** | **March 31, 2010** | ** ** | **December 31, 2009** | ** ** |
|-------------------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| ** **                                                  | ** ** | **Carrying  Amount**    | ** ** | **Fair Value**             | ** ** | **Carrying  Amount** | ** ** | **Fair Value** | ** ** |
| Financial  assets:                                          |       |                    |       |                       |       |   |   |   |   |
| Cash  and due from banks                                    |       | $                       | 13,782     |                       | $          | 13,782 |   | $ | 12,119 |   | $ | 12,119 |   |
| Federal  Funds sold                                         |       | 45,330                  |       | 45,330                     |       | 46,535 |   | 46,535 |   |
| Interest-bearing  deposits in banks                         |       | 2,542                   |       | 2,549                      |       | 2,740 |   | 2,742 |   |
| Loans  held for sale                                        |       | —                  |       | —                     |       | 1,137 |   | 1,137 |   |
| Investment  securities                                      |       | 4,422                   |       | 4,433                      |       | 5,606 |   | 5,620 |   |
| Loans                                                       |       | 411,131                 |       | 419,835                    |       | 420,036 |   | 426,724 |   |
| Other  investments                                          |       | 960                     |       | 960                        |       | 985 |   | 985 |   |
| Accrued  interest receivable                                |       | 1,846                   |       | 1,846                      |       | 2,380 |   | 2,380 |   |
| Cash  surrender value of Bank owned life insurance policies |       | 11,791                  |       | 11,791                     |       | 11,680 |   | 11,680 |   |
| Loan  servicing assets                                      |       | 3,377                   |       | 3,377                      |       | 3,463 |   | 3,463 |   |
|                                                        |       |                    |       |                       |       |   |   |   |   |
| Financial  liabilities:                                     |       |                    |       |                       |       |   |   |   |   |
| Deposits                                                    |       | $                       | 486,213    |                       | $          | 486,648 |   | $ | 498,163 |   | $ | 500,337 |   |
| Note  payable                                               |       | 1,084                   |       | 1,084                      |       | 1,122 |   | 1,122 |   |
| Junior  subordinated debentures                             |       | 8,248                   |       | 6,900                      |       | 8,248 |   | 6,787 |   |
| Accrued  interest payable                                   |       | 423                     |       | 423                        |       | 346 |   | 346 |   |

 

Estimated fairvalues are disclosed for financial instruments for which it is practicable toestimate fair value. These estimates are made at a specific point in time basedon relevant market data and information about the financial instruments. Theseestimates do not reflect any premium or discount that could result fromoffering the Company’s entire holdings of a particular financial instrument forsale at one time, nor do they attempt to estimate the value of anticipatedfuture business related to the instruments. In addition, the tax ramificationsrelated to the realization of unrealized gains and losses can have asignificant effect on fair value estimates and have not been considered in anyof these estimates.

 

Because no marketexists for a significant portion of the Company’s financial instruments, fairvalue estimates are based on judgments regarding current economic conditions,risk characteristics of various financial instruments and other factors. Theseestimates are subjective in nature and involve uncertainties and matters ofsignificant judgment and therefore cannot be determined with precision. Changesin assumptions could significantly affect the fair values presented.

 

The followingmethods and assumptions were used by the Company to estimate the fair value ofits financial instruments at March 31, 2010 and December 31, 2009:

 

Cash and cashequivalents: Cashand cash equivalents include cash and due from banks and Federal funds soldwhere the carrying amount is estimated to be fair value.

 

Interest-bearingdeposits in banks:The fair values of interest-bearing deposits in banks are estimated bydiscounting their future cash flows using rates at each reporting date forinstruments with similar remaining maturities offered by comparable financialinstitutions.

 

Investmentsecurities: Forinvestment securities, fair values are based on quoted market prices, whereavailable. If quoted market prices are not available, fair values are estimatedusing quoted market prices for similar securities and indications of valueprovided by brokers.

 

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Loans: Fair values of loans held for sale areestimated using quoted market prices for similar loans or the amount thatpurchasers have committed to purchase the loans. For variable-rate loans thatreprice frequently with no significant change in credit risk, fair values arebased on carrying values.  The fairvalues for other loans are estimated using discounted cash flow analyses, usinginterest rates offered at each reporting date for loans with similar terms toborrowers of comparable creditworthiness adjusted for the allowance for loanlosses. The carrying amount of accrued interest receivable approximates its fairvalue.

 

Other investments: Other investments includenon-marketable equity securities. The carrying value of these investmentsapproximates their fair value.

 

Bank owned lifeinsurance policies:The fair values of life insurance policies are based on cash surrender valuesat each reporting date provided by the insurers.

 

Loan servicingassets: The fairvalue of loan servicing assets is determined by an independent third party. Thevaluation model takes into consideration discounted cash flows using current interestrates and prepayment speeds for each type of underlying asset being serviced.

 

Deposits: The fair values of time deposits arebased on the discounted value of contractual cash flows using discount ratesequal to the interest rates offered at each reporting date by the Bank for timedeposits with similar maturities. The fair values of deposits that have nostated maturities are based on the carrying amounts reported in the balancesheet.

 

Note payable: The ESOP note payable reprice is basedupon an independent index. The carrying amount of the note payable approximatesits fair value.

 

Juniorsubordinated debentures: The fair value of the junior subordinated debentures was determinedbased on the current market for like-kind instruments of a similar maturity andstructure.

 

Commitments toextend credit and standby letters of credit: Commitments to extend credit are primarily forvariable rate loans and standby letters of credit. The fair value ofcommitments are estimated using the fees currently charged to enter intosimilar agreements and are not significant and, therefore, not included in theabove table.

 

Thefollowing tables present information about the Company’s assets and liabilitiesmeasured at fair value on a recurring and non recurring basis as of March 31,2010 and December 31, 2009.

 

*RecurringBasis*

 

Assets andliabilities measured at fair value on a recurring basis are as follows (dollarsin thousands):

 
| ** **                                | ** ** | **March 31,  2010** | ** ** |
|-------------------------------------------|------------|--------------------------|------------|
| ** **                                | ** ** | ** **               | ** ** | **Quoted  Prices in** | ** ** | **Other** | ** ** | **Significant** | ** ** |
| ** **                                | ** ** | ** **               | ** ** | **Active  Markets for** | ** ** | **Observable** | ** ** | **Unobservable** | ** ** |
| ** **                                | ** ** | ** **               | ** ** | **Identical  Assets** | ** ** | **Inputs** | ** ** | **Inputs** | ** ** |
| **Description**                           | ** ** | **Fair  Value**          | ** ** | **(Level  1)** | ** ** | **(Level  2)** | ** ** | **(Level  3)** | ** ** |
| Investment  securities available-for-sale |       | $                        | 4,228      |   | $ | — |   | $ | 4,228 |   | $ | — |   |
|                                           |            |                          |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                      | ** ** | **December 31,  2009** | ** ** |
|-------------------------------------------------|------------|-----------------------------|------------|
| ** **                                      | ** ** | ** **                  | ** ** | **Quoted  Prices in** | ** ** | **Other** | ** ** | **Significant** | ** ** |
| ** **                                      | ** ** | ** **                  | ** ** | **Active  Markets for** | ** ** | **Observable** | ** ** | **Unobservable** | ** ** |
| ** **                                      | ** ** | ** **                  | ** ** | **Identical  Assets** | ** ** | **Inputs** | ** ** | **Inputs** | ** ** |
| **Description**                                 | ** ** | **Fair  Value**             | ** ** | **(Level  1)** | ** ** | **(Level  2)** | ** ** | **(Level  3)** | ** ** |
| Investment  securities  available-for-sale |       | $                           | 4,377      |   | $ | — |   | $ | 4,377 |   | $ | — |   |
|                                                 |            |                             |            |  |  |  |  |  |  |  |  |  |  |

 

Fair values forinvestment securities are based on quoted market prices for similar instrumentsin active markets.

 

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*Non-recurringBasis*

 

Assets measured atfair value on a non-recurring basis are summarized below (dollars inthousands):

 
| ** **                                                    | ** ** | **March 31,  2010** | ** ** | **Total  Losses**       | ** ** |
|---------------------------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| ** **                                                    | ** ** | ** **               | ** ** | **Quoted  Prices in**   | ** ** | **Other** | ** ** | **Significant** | ** ** | **For  the Three** | ** ** |
| ** **                                                    | ** ** | ** **               | ** ** | **Active  Markets for** | ** ** | **Observable** | ** ** | **Unobservable** | ** ** | **Months  Ended** | ** ** |
| ** **                                                    | ** ** | ** **               | ** ** | **Identical  Assets**   | ** ** | **Inputs** | ** ** | **Inputs** | ** ** | **March 31,** | ** ** |
| **Description**                                               | ** ** | **Fair  Value**          | ** ** | **(Level  1)**          | ** ** | **(Level  2)** | ** ** | **(Level  3)** | ** ** | **2010** | ** ** |
| Impaired  loans                                               |       | $                        | 44,693     |                    | $          | — |   | $ | 27,379 |   | $ | 17,314 |   | $ | 10,480 |   |
| Real  estate owned                                            |       | 10,021                   |       | —                  |       | 10,021 |   | — |   | 969 |   |
| Total  assets measured at fair value on a non-recurring basis |       | $                        | 54,714     |                    | $          | — |   | $ | 37,400 |   | $ | 17,314 |   | $ | 11,449 |   |

 
| ** **                                                    | ** ** | **December 31,  2009** | ** ** | **Total  Losses**       | ** ** |
|---------------------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| ** **                                                    | ** ** | ** **                  | ** ** | **Quoted  Prices in**   | ** ** | **Other** | ** ** | **Significant** | ** ** | **For  the Twelve** | ** ** |
| ** **                                                    | ** ** | ** **                  | ** ** | **Active  Markets for** | ** ** | **Observable** | ** ** | **Unobservable** | ** ** | **Months  Ended** | ** ** |
| ** **                                                    | ** ** | ** **                  | ** ** | **Identical  Assets**   | ** ** | **Inputs** | ** ** | **Inputs** | ** ** | **December 31,** | ** ** |
| **Description**                                               | ** ** | **Fair  Value**             | ** ** | **(Level  1)**          | ** ** | **(Level  2)** | ** ** | **(Level  3)** | ** ** | **2009** | ** ** |
| Impaired  loans                                               |       | $                           | 37,962     |                    | $          | — |   | $ | 34,548 |   | $ | 3,414 |   | $ | 13,473 |   |
| Real  estate owned                                            |       | 13,493                      |       | —                  |       | 13,493 |   | — |   | 5,528 |   |
| Total  assets measured at fair value on a non-recurring basis |       | $                           | 51,455     |                    | $          | — |   | $ | 48,041 |   | $ | 3,414 |   | $ | 19,001 |   |

 

***Impaired Loans*****— Impaired loans, carried at fair value, which aremeasured for impairment using the fair value of the collateral for collateraldependent loans, had a carrying amount of $44,693,000 which included a specificreserve of $3,751,000. At December 31, 2009, impaired loans carried atfair value had a carrying amount of $37,962,000, which included a specificreserve of $4,045,000. Impaired loans are measured at an observable marketprice, if available, or at the fair value of the loans collateral, if the loanis collateral dependent. The fair value of the loan’s collateral is determinedby appraisals or independent valuation which is then adjusted for the cost relatedto liquidation of the collateral. When the fair value of the loan’s collateralis based on an observable market price or current appraised value, the Companyclassifies the fair value of the impaired loans as a nonrecurring valuationwithin level 2 of the valuation hierarchy. When the Company measures impairmentusing anything but an observable market price or a current appraised value,such loans would be classified within level 3 of the valuation hierarchy.

 

***Real Estate Owned*******— The fair value of real estate owned is basedprimarily on the values obtained through current property appraisals which useobservable data.

 

**13. NEWACCOUNTING PRONOUNCEMENTS**

 

*Accountingfor Transfers of Financial Assets*

 

In June 2009, the FASB issued ASC Topic 860 (previously SFAS No. 166),*Accounting for Transfers of FinancialAssets, an amendment of SFAS No. 140.*This standard amends thederecognition accounting and disclosure guidance included in previously issuedstandards. This standard eliminates the exemption from consolidation forqualifying special-purpose entities (SPEs) and also requires a transferor toevaluate all existing qualifying SPEs to determine whether they must beconsolidated in accordance with ASC Topic 810. This standard also provides morestringent requirements for derecognition of a portion of a financial asset andestablishes new conditions for reporting the transfer of a portion of afinancial asset as a sale. This standard did not have an impact on the Company’sfinancial condition, results of operations, cash flows or disclosures.

 

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*Transfersand Servicing*

 

In December 2009, the FASB issued Accounting Standards Update(ASU) No. 2009-16, *Transfers andServicing (ASC Topic 860): Accounting for Transfers of Financial Assets,*whichupdates the derecognition guidance in ASC Topic 860 for previously issued SFAS No. 166.This update reflects the Board’s response to issues entities have encounteredwhen applying ASC 860, including: (1) requires that all arrangements madein connection with a transfer of financial assets be considered in thederecognition analysis, (2) clarifies when a transferred asset isconsidered legally isolated from the transferor, (3) modifies therequirements related to a transferee’s ability to freely pledge or exchangetransferred financial assets, and (4) provides guidance on when a portionof a financial asset can be derecognized. This standard did not have an impacton the Company’s financial condition, results of operations, cash flows ordisclosures.

 

*FairValue Measurements*

 

In January 2010, the FASB issued ASU 2010-06, *Fair Value Measurements and Disclosures*(“Topic820”)*: Improving Disclosures about FairValue Measurements*(“ASU 10-06”). ASU 10-06 revises two disclosurerequirements concerning fair value measurements and clarifies two others. Itrequires separate presentation of significant transfers into and out of Levels1 and 2 of the fair value hierarchy and disclosure of the reasons for suchtransfers. It also requires the presentation of purchases, sales, issuances andsettlements within Level 3 on a gross basis rather than a net basis. Theamendments also clarify that disclosures should be disaggregated by class ofasset or liability and that disclosures about inputs and valuation techniquesshould be provided for both recurring and non-recurring fair valuemeasurements. The Company’s disclosures about fair value measurements are presentedin Note 12: Fair Value Measurements. These new disclosure requirements wereadopted by the Company during the current period, with the exception of therequirement concerning gross presentation of Level 3 activity, which iseffective for fiscal years beginning after December 15, 2010.  Withrespect to the portions of this ASU that were adopted during the currentperiod, the adoption of this standard did not have a material impact on theCompany’s financial position, results of operations, cash flows, ordisclosures.  Management does not believe that the adoption of theremaining portion of this ASU will have a material impact on the Company’sfinancial position, results of operation, cash flows, or disclosures.

 

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

 

Thefollowing is Community Valley Bancorp’s (the “Company”) management’s discussionand analysis of the significant changes in balance sheet accounts between March 31,2010 and December 31, 2009 and income and expense accounts for the threemonth periods ended March 31, 2010 and 2009. The discussion is designed toprovide a better understanding of significant trends related to the Company’sfinancial condition, results of operations, liquidity, capital resources andinterest rate sensitivity.

 

Inaddition to the historical information contained herein, this report on Form 10-Qcontains certain forward-looking statements. The reader of this report shouldunderstand that all such forward-looking statements are subject to variousuncertainties and risks that could affect their outcome. The Company’s actualresults 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 events of September 11, 2001 andthereafter, and the conduct of the war on terrorism by the United States andits allies, as well as other factors. This entire report should be read puttingsuch forward-looking statements in context.

 

**General Development of Business**

 

TheCompany is a financial holding company (“FHC”) registered and authorized toengage in the activities permitted under the Bank Holding Company Act of 1956,as amended. The Company was incorporated under the laws of the State ofCalifornia in 2002 and elected to change to a FHC in 2004. As a financialholding company, the Company is subject to the Federal Holding Company Act andto supervision by the board of Governors of the Federal Reserve System (“FRB”).Its principal office is located at 1360 E. Lassen Avenue, Chico, California95973 and its telephone number is (530) 899-2344.

 

TheCompany owns 100% of the issued and outstanding common shares of ButteCommunity Bank (the “Bank”). The Bank was incorporated and commenced businessin Paradise and Oroville, California in 1990. The Bank operates fourteen fullservice offices within its service areas of Butte, Sutter, Yuba, Tehama,Shasta, and Colusa Counties. Butte Community Bank’s primary business is servingthe commercial banking needs of small to mid-sized businesses and consumerswithin those counties. Butte Community Bank accepts checking and savingsdeposits, 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 1, 2004, the Company formed a wholly-owned subsidiary, CVBInsurance Agency LLC for the purpose of providing insurance related services.  The name was subsequently changed to ButteCommunity Insurance Agency LLC in April 2006.

 

OnJuly 10, 2007 the Company formed a wholly-owned unconsolidated subsidiary,Community Valley Bancorp Trust II (the “Trust”), a Delaware statutory businesstrust, for the purpose of issuing trust preferred securities.

 

**ConsentOrder**

 

Effective May 11,2010, in connection with the Bank’s regularly scheduled 2010 Joint FDIC andCalifornia Department of Financial Institutions (“DFI”) examination, the Bankentered into a Consent Order (“Order”) with the FDIC and the DFI.  The FDIC and DFI in the Consent Order, whichsupersedes the Memorandum of Understanding (MOU) that was entered into betweenthe Bank and the FDIC and DFI in April 2009, order certain actions to be takenby the Bank including among others:

 

·                  Having and retaining qualified management;

·                  Obtaining an independent study of themanagement and personnel structure of the Bank within 180 days of the date ofthe Order to determine whether the Bank is staffed by qualified individualscommensurate with its size and risk profile to ensure the safe and profitableoperation of the Bank;

·                  Within 90 days of the date of the Order,increasing and maintaining the Bank’s Tier 1 capital to a level such that itsleverage ratio is at least 10% and its total risk-based capital is at least13%;

 

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·                  Not paying cash dividends or making any otherpayments to its shareholder without the prior written consent of the FDIC andDFI;

·                  Reducing or eliminating certain classifiedassets within 180 days of the date of the Order;

·                  Within 30 days of the date of the Order,revising or developing, adopting and implementing a comprehensive policy fordetermining the adequacy of the allowance for loan losses, and increasing andmaintaining its allowance for loan losses to be compliant with suchcomprehensive policy;

·                  With certain exceptions, not extending anyadditional credit to or for the benefit of any borrower who has a loan that hasbeen charged off or classified;

·                  Within 90 days of the date of the Order,revising or developing, adopting and implementing written lending andcollection policies to provide effective guidance and control over the Bank’slending function as satisfactory to the FDIC and DFI;

·                  Within 90 days of the date of the Order,revising or developing, adopting and implementing a written plan forsystematically reducing its concentration of construction and land loans to becompliant with banking laws and bank regulatory agency guidance;

·                  Within 90 days of the date of the Order,revising or developing, adopting and implementing a written liquidity and fundsmanagement policy that adequately addresses liquidity needs and appropriatelyreduces its reliance on non-core funding sources as satisfactory to the FDICand DFI;

·                  Within 30 days of the date of the Order,revising or developing, adopting and implementing a written plan addressingretention of profits, reducing overhead expenses, and setting forth acomprehensive budget for 2010 as satisfactory to the FDIC and DFI;

·                  Within 180 days of the date of the Order,revising or developing, adopting and implementing a written three yearstrategic plan as satisfactory to the FDIC and DFI;

·                  Not establishing any new branches or otheroffices of the Bank without the prior consent of the FDIC and DFI;

·                  Complying with the banking laws andregulations on brokered deposits, and within 60 days of the date of the Order,submiting to the FDIC and DFI a written plan for eliminating its reliance onbrokered deposits; and

·                  Within 30 days of the end of each quarterfollowing the date of the Order, furnish written progress reports to the FDICand DFI.

 

As of March 31,2010, the Bank’s Tier 1 capital to average assets ratio was 3.5% and totalrisk-based capital ratio was 5.2%.

 

Effective July 30,2009, the Company entered into a Memorandum of Understanding with the FederalReserve Bank of San Francisco (FRB) to not declare or pay any dividends, makeany payments of principal or interest on trust preferred securities, or makeany other capital distributions without the prior written approval of the FRB;to not incur, increase or renew any exiting debt or guarantee any debt withoutthe prior written approval of the FRB; to comply with certain notice provisionsin the case of any new director or senior executive officer; and to comply withany legal restrictions regarding indemnification and severance payments toinstitution-affiliated parties without written approval from the FRB andconcurrence from the FDIC.

 

While management believesthat progress has been made in addressing certain of the requirements set forthin the Consent Order and Memorandum of Understanding, the Board of Directorsand management are committed to putting the necessary resources and plans inplace to become fully compliant within the timelines as set forth above.

 

**Regulatory CapitalGuidelines**

 

Federal bank regulatory agencies use capital adequacyguidelines in the examination and regulation of bank holding companies andbanks.  The guidelines are “risk-based,”meaning that they are designed to make capital requirements more sensitive todifferences in risk profiles among banks and bank holding companies.Regulations also include additional capital categories for all depositoryinstitutions under the regulatory framework for prompt corrective action whichestablish a framework of supervisory actions for insured depositoryinstitutions that are not adequately capitalized.  For those depository institutions that failto meet these minimum capital requirements, certain mandatory, and possiblyadditional discretionary, actions by regulators are initiated that can have adirect material effect on the Bank. These quantitative measures are establishedby regulation and require that minimum amounts and ratios of total and Tier 1capital to risk-weighted assets and of Tier 1 capital to average assets bemaintained.  Capital amounts andclassification are also subject to qualitative judgments by the regulatorsabout components, risk weightings and other factors.

 

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**Prompt CorrectiveAction**

 

Under the Supervisory PromptCorrection Action Directive received from the FDIC on May 3, 2010, theBank is required to file a capital restoration plan and is subject to amongother things, recapitalization of the Bank, refraining from accepting, renewingor rolling over any brokered deposit; restricting the interest rates that theBank pays on deposits to comply with rate restrictions in certain FDIC Rules andRegulations; ensuring that average total assets during any calendar quarter donot exceed average total assets during the preceding calendar quarter;refraining from making any capital distributions or dividend payments to itsparent or paying any bonuses or increased compensation to any director orofficer of the Bank without prior written approval from the FDIC; retainingqualified senior executive officers; restrictions on access to the FederalReserve’s discount window; and being prohibited from opening new branches andfrom relocating, selling or disposing of any existing branches without theapproval of the FDIC.

 

Under the prompt corrective action guidelines, adepository institution is assigned to one of five capital categories dependingon its total risk-based capital ratio, Tier 1 risk-based capital ratio, andleverage ratio, together with certain subjective factors. The categories are “wellcapitalized,” “adequately capitalized,” “undercapitalized,” “significantlyundercapitalized,” and “critically undercapitalized.” Institutions that aredeemed to be undercapitalized, depending on the category to which they areassigned, are subject to certain mandatory supervisory corrective actions.  The Bank’s total capital to risk-weightedassets ratio dropped below 6.0% as of March 31, 2010, therefore, the Bank isconsidered “significantly undercapitalized” for purposes of the promptcorrection action regulations.

 

Certain minimum ratios under the provisions of theprompt corrective action guidelines and the actual capital ratios of theCompany and the Bank at March 31, 2010, are set forth in the table below:

** **
| ** **                      | ** ** | **Requirements for the********Bank Under the Prompt  Corrective Action Provisions to  be:** | ** ** | ** **            | ** ** | ** ** | ** ** |
|---------------------------------|------------|---------------------------------------------------------------------------------------------|------------|-----------------------|------------|------------|------------|
| ** **                      | ** ** | **Adequately  Capitalized**                                                                 | ** ** | **Well  Capitalized** | ** ** | **Bank**   | ** ** | **Company** | ** ** |
| Tier 1 leverage capital ratio   |       | 4.0                                                                                         | %          | 5.0                   | %          | 3.5        | %          | 2.0 | % |
| Tier 1 risk-based capital ratio |       | 4.0                                                                                         | %          | 6.0                   | %          | 4.0        | %          | 2.2 | % |
| Total risk-based capital ratio  |       | 8.0                                                                                         | %          | 10.0                  | %          | 5.2        | %          | 5.4 | % |

 

Under the Consent Order discussed above, the Bank isrequired to raise its Tier 1 leverage capital ratio to 10% and its risk basedcapital ratio to 13% which are higher than the level for being categorized as “WellCapitalized.”

 

**Going Concern Considerations**

 

The accompanyingconsolidated financial statements have been prepared assuming the Company willcontinue as a going concern which contemplates the realization of assets andthe discharge of liabilities in the normal course of business for theforeseeable future.   We have determinedthat significant additional sources of liquidity and capital will be requiredfor us to continue operations through 2010 and beyond.  We estimate thatto increase the Bank’s leverage ratio to 10%, we will need at least $33,900,000of new Tier 1 capital. Additional losses in subsequent quarters will increasethe capital needs necessary to meet the requirement. We have engaged financialadvisors to assist the Company in its efforts to raise additional capital, sellassets, and explore other strategic alternatives to address our current andexpected liquidity and capital deficiencies. However, there can be no assurancethat the Company will be able to maintain sufficient liquidity or to raiseadditional capital to satisfy regulatory requirements and meet obligations asthey occur. As described above under “Consent Order,” “Regulatory CapitalGuidelines” and “Prompt Corrective Action”, the Company and the Bank did not meeteither the minimum regulatory capital requirements or the leverage ratiorequirement of 10% outlined in the Memorandum of Understanding and the ConsentOrder signed May 11, 2010 which superseded the Memorandum ofUnderstanding. As such, the Company is considered undercapitalized and the Bankhas been categorized as significantly undercapitalized under the PromptCorrective Action Directive received on May 3, 2010. The accompanyingfinancial statements do not reflect the impact of the conditions included inthe Consent Order and Prompt Corrective Action Directive discussed above.Further, the regulators are continually monitoring liquidity and capitaladequacy and evaluating the Company’s ability to continue to operate in a safeand sound manner. The Bank’s regulators could, if deemed warranted, takefurther actions, including the assumption of control of the Bank, to protectthe interests of depositors insured by the FDIC. The uncertainty regarding theCompany’s ability to obtain additional capital, improve asset quality and meetfuture liquidity requirements raises substantial doubt about the Company’sability to continue as a going concern.

 

While considerable risks to the Company’s futurefinancial performance exist, management believes the Company is capable ofresponding to these risks and carrying on operations while it implements itsstrategic plan and pursues opportunities with respect to augmenting capital. Ifsuccessfully implemented, the Company’s capital plan will address its near-termcapital resources and liquidity needs. However, there can be no guarantee thatany restructuring or recapitalization plan will be successfully implemented.

 

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**Critical Accounting Policies**

 

*General*

 

TheCompany’s significant accounting principles are described in Note 1 of theconsolidated financial statements in the Company’s 2009 Annual Report toShareholders on Form 10-K and are essential to understanding Management’sDiscussion and Analysis of Results of Operations and Financial Condition.Community Valley Bancorp’s annual consolidated financial statements areprepared in accordance with accounting principles generally accepted in theUnited States of America (GAAP). The financial information contained within ourstatements is, to a significant extent, financial information that is based onmeasures of the financial effects of transactions and events that have alreadyoccurred. Some of the Company’s accounting principles require significantjudgment to estimate values of assets or liabilities. In addition, certainaccounting principles require significant judgment in applying the complexaccounting principles to transactions to determine the most appropriatetreatment. The following is a summary of the more judgmental and complexaccounting estimates and principles.

 

*Allowance for Loan Losses (ALL)*

 

Theallowance for loan losses is management’s best estimate of the probable lossesthat may be sustained in our loan portfolio. The allowance is based on twobasic principles of accounting:  (1) ASC 450 which requires thatlosses be accrued when they are probable of occurring and estimable and (2) ASC310 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 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 that are evaluated include concentrations of borrowers, industries,geographical sectors, loan product, loan classes and collateral types, volumeand trends of loan delinquencies and non-accrual loans, criticized andclassified assets and trends in the aggregate in significant credits identifiedas watch list items. There are several components to the determination of theadequacy of the ALL. Each of these components is determined based uponestimates that can and do change when the actual events occur. The Companyestimates the ASC 450 portion of the ALL based on the segmentation of itsportfolio. The Company estimates loan losses on a monthly basis based upon itsongoing 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. The primary method used in estimating loan lossesfor groups of loans is through the application of loss rates to the groups’aggregate loan balances. Such rates typically reflect historical lossexperience for each group of loans, adjusted for relevant economic factors,over a rolling twelve month period. The Company evaluates and modifies its lossestimation model as needed to ensure that the resulting loss estimate isconsistent with GAAP.

 

Forindividually impaired loans, the Company follows the guidance in ASC 310 on theacceptable methods to measure impairment. Specifically, when a loan isimpaired, the Company measures impairment based on the present value ofexpected future principal and interest cash flows discounted at the loan’seffective interest rate, except that as a practical expedient, the Company maymeasure impairment based on a loan’s observable market price or the fair valueof collateral, if the loan is collateral dependent. When developing theestimate of future cash flows for a loan, the Company considers all availableinformation reflecting past events and current conditions, including the effectof existing environmental factors.

 

*Loan Sales and Servicing*

 

TheCompany originates government guaranteed loans and mortgage loans that may besold in the secondary market.  The amount 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 fair value of the servicing assetsand the fair value of the I/O strips receivable, the Company uses estimateswhich are based on management’s expectations of future prepayments and discountrates.  Servicing assets are amortized over the estimated life of therelated loan.  I/O strips are not significant at March 31,2010.  These prepayment and discount rates are based on current marketconditions 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.

 

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*Stock-BasedCompensation*

 

Compensation costis recognized for all share-based payments over the requisite service periodsof the awards based on the grant-date fair value of the options determinedusing the Black-Scholes-Merton based option valuation model.  Critical assumptions that are assessed incomputing the fair value of share-based payments include stock pricevolatility, expected dividend rates, the risk free interest rate and theexpected lives of such options. Compensation cost recorded is net of estimatedforfeitures expected to occur prior to vesting. See Note 7 to the UnauditedCondensed Consolidated Financial Statements for additional information relatedto stock-based compensation.

 

*Impairment of Investment Securities*

 

Investmentsecurities are evaluated for other-than-temporary impairment on at least aquarterly basis and more frequently when economic or market conditions warrantsuch an evaluation to determine whether a decline in their value belowamortized cost is other than temporary. Management utilizes criteria such asthe magnitude and duration of the decline, the financial condition of theissuer, rating agency changes related to the issuer’s securities and the intentand ability of the Bank to retain its investment in the issues for a period oftime sufficient to allow for an anticipated recovery in fair value, in additionto the reasons underlying the decline, to determine whether the loss in valueis other than temporary. The term “other than temporary” is not intended toindicate that the decline is permanent, but indicates that the prospects for anear-term recovery of value is not necessarily favorable, or that there is alack of evidence to support a realizable value equal to or greater than the carryingvalue of the investment. Once a decline in value is determined to be other-than-temporary andmanagement has the ability and intent to hold the security to a forecastedrecovery of cost, only the portion of the impairment loss representing creditexposure would be recognized as a charge to earnings, with the balancerecognized as a charge to other comprehensive loss.  If management intendsto sell the security or it is more likely than not that it will be required tosell the security before recovering its forecasted cost, the entire impairmentloss would be recognized as a charge to earnings.

 

*Revenue Recognition*

 

TheCompany’s primary sources of revenue are net interest income, which is thedifference between the interest income it receives on interest-earning assetsand the interest expense it pays on interest-bearing liabilities, and feeincome, which includes fees earned on deposit services, income from sales andservicing of SBA loans, electronic-based cash management services, and mortgagebrokerage fee income. Interest income is recorded on an accrual basis. However,when, in the opinion of management, loans are considered to be impaired and thefuture collectibility of interest and principal is in serious doubt, loans areplaced on nonaccrual status and the accrual of interest income is suspended.Any interest accrued but unpaid is charged against income. Payments receivedare applied to reduce principal to the extent necessary to ensure collection.Subsequent payments on these loans, or payments received on nonaccrual loansfor which the ultimate collectibility of principal is not in doubt, are appliedfirst to earned but unpaid interest and then to principal.

 

*Income Taxes*

 

The Company accounts forincome taxes under the asset and liability method. Under the asset andliability method, deferred tax assets and liabilities are recognized for thefuture tax consequences attributable to differences between the financialstatement carrying amounts of existing assets and liabilities and theirrespective tax bases. Deferred tax assets and liabilities are measured usingcurrently enacted tax rates applied to such taxable income in the years inwhich those temporary differences are expected to be recovered or settled. Theeffect on deferred tax assets and liabilities of a change in tax rates isrecognized in income in the period that includes the enactment date. If futureincome should prove non-existent or less than the amount of net deferred taxassets within the tax years to which they may be applied, the asset may not berealized and our net income will be reduced.

 

If Management determines,based on available evidence at the time, that it is more likely than not thatsome portion or all of the Company’s deferred tax assets will not be realized,then a valuation allowance against the deferred tax asset is established. Inevaluating the likelihood of realizing the benefit of the deferred tax asset,Management estimates future taxable income based on Management’s business plansand ongoing tax planning strategies against which the deferred tax asset may beapplied. This process involves significant judgment about assumptions that aresubject to revision from period to period based on changes in tax laws orvariances between the Company’s projected operating performance and theCompany’s actual results and other factors. A valuation allowance for deferredtax assets is established through an expense recorded in the statement ofoperations.

 

The Company recognizesonly tax positions that meet the more likely than not recognition thresholdthat the tax position would be sustained in a tax examination were recognizedor continue to be recognized.

 

Whentax returns are filed, it is highly certain that some positions taken would besustained upon examination by the taxing authorities, while others are subjectto uncertainty about the merits of the position taken or the amount of theposition that would be ultimately sustained.  The benefit of a tax position isrecognized in the financial statements in the period during which, based on allavailable evidence, management believes it is more likely than not that theposition will be sustained upon examination, including the resolution ofappeals or litigation processes, if any.  Tax positions taken are notoffset or aggregated with other positions.  Tax positions that meet themore-likely-than-not recognition threshold are measured as the largest amountof tax benefit that is more than 50 percent likely of being realized uponsettlement with the applicable taxing authority.  The

 

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portion of the benefitsassociated with tax positions taken that exceeds the amount measured asdescribed above is reflected as a liability for unrecognized tax benefits inthe accompanying balance sheet along with any associated interest and penaltiesthat would be payable to the taxing authorities upon examination. Interest expense and penalties associated with unrecognized tax benefits areclassified as income tax expense in the consolidated statement of income.

 

*FairValue*

 

Managementutilizes a hierarchical disclosure framework associated with the level ofobservable pricing scenarios for measuring assets and liabilities at fairvalue. The degree of judgment utilized in measuring the fair value of assetsand liabilities generally correlates to the level of the observable pricingscenario. Assets and liabilities with readily available active quoted prices orfor which fair value can be measured from actively quoted prices generally willhave a higher degree of observable pricing and a lesser degree of judgmentutilized in measuring fair value. Conversely, assets and liabilities rarely tradedor not quoted will generally have little or no observable pricing and a higherdegree of judgment utilized in measuring fair value. Observable pricingscenarios are impacted by a number of factors, including the type of asset orliability, whether the asset or liability is new to the market and not yetestablished and the characteristics specific to the transaction.

 

**Overview**

 

TheCompany recorded a net loss of $(4,479,000) for the quarter ended March 31,2010, compared to net income of $100,000 reported for the same period of 2009.Basic (loss) earnings per share available to common shareholders for the firstquarter of 2010 were ($0.68), compared to the $0.02 recorded in the firstquarter of 2009. The annualized return on average equity (ROAE) and annualizedreturn on average assets (ROAA) for the first quarter of 2010 were (127.90)%and (3.49)%, respectively, as compared to 1.00% and .07%, respectively, for thesame period in 2009. The primary reasons for the loss for the first quarterended March 31, 2010 are the increase in the level of the provision forloan losses, increase in other real estate expenses, and a decline in netinterest income and non interest income. This waspartially mitigated by the decrease in non interest expense and the recognitionof an increased income tax benefit in the current quarter.

 

Weexperienced a compression of the net interest margin of 13 basis points asyields on earning assets decreased 65 basis points while rates paid on interestbearing liabilities decreased 64 basis points. The compression is a directresult of increased nonaccrual loans at March 31, 2010 compared to thesame period in 2009.

 

Totalassets of the Company decreased by $16,274,000 or 3.0% from $538,462,000 at December 31,2009 to $522,188,000 at March 31, 2010. Net loans decreased to$411,131,000, down $8,905,000 or 2.1% from December 31, 2009. Depositbalances at March 31, 2010 decreased to $486,213,000, down $11,950,000 or2.4% from December 31, 2009.  Premises and equipment decreased to $4,632,000, down $639,000 or 12.1%.Other real estate decreased to $10,021,000, down $3,472,000 or 25.7% as aresult of the Company’s diligent efforts to sell these properties.  Shareholders’ equity decreased to$11,434,000, down $4,518,000 from year end 2009.

 

TableOne below provides a summary of the components of net (loss) income for theperiods indicated:

 

**Table One:  Components of Net (Loss) Income**

 
| ** **                                                              | ** ** | **Three months ended  March 31,** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------------|------------|
| **(In thousands, except  percentages)**                                 | ** ** | **2010**                               | ** ** | **2009** | ** ** |
|                                                                    |       |                                   |       |   |   |
| Net  interest income                                                    |       | $                                      | 4,332      |   | $ | 5,079 |   |
| Provision  for loan losses                                              |       | (5,289                                 | )          | (3,100 | ) |
| Non-interest  income                                                    |       | 1,908                                  |       | 4,827 |   |
| Non-interest  expense                                                   |       | (7,737                                 | )          | (6,774 | ) |
| Benefit  for income taxes                                               |       | 2,307                                  |       | 68 |   |
|                                                                    |       |                                   |       |   |   |
| Net  (loss) income                                                      |       | $                                      | (4,479     | ) | $ | 100 |   |
|                                                                    |       |                                   |       |   |   |
| Average  total assets (in millions)                                     |       | $                                      | 520.6      |   | $ | 594.3 |   |
| Net  (loss) income (annualized) as a percentage of average total assets |       | (3.49                                  | )%         | 0.07 | % |

 

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Duringthese difficult economic times, management has been working diligently toimprove asset quality, reduce the concentration in real estate construction anddevelopment loans, increase and preserve capital and liquidity, and reduceexpenses. The Company successfully reduced real estate construction anddevelopment loans by $34,717,000 from March 31, 2009. In addition, theCompany continues to reduce expenses with recommendations from employees,management, and the Board of Directors. In 2010, the Company will continue tofreeze salaries for the second year, reduce employee benefits effective April 1,2010, suspend directors fees effective March 1, 2010, along withadditional reductions in operating expenses such as office supply costs,travel, advertising and promotion. Further, the Company has plans to eliminateSaturday banking for several Offices. These Offices either have nominalcustomer transactions on Saturday or have another branch within a closeproximity. This will allow for reduced branch costs while increasingproductivity.

 

Managementcontinues to proactively manage credit quality and continues to work with itsborrowers in addressing work out strategies and loan collections.

 

We continue to closely monitor and manage ourliquidity position, understanding that this is of critical importance in thecurrent economic environment. Attracting and retaining customer depositsremains our primary source of liquidity. The Bank will continue to participatein the FDIC voluntary Transaction Account Guarantee (“TAG”) program which isavailable through December 31, 2010. Under this program, noninterestbearing transaction accounts and qualified NOW checking accounts are fullyguaranteed by the FDIC for an unlimited amount of coverage. The coverage underthe TAG program is in addition to, and separate from, the coverage availableunder the FDIC’s general deposit insurance protection.

 

Since December 31, 2008, the Company has beensuccessful in its strategic plan to deleverage the balance sheet. Loans havedecreased by $61,632,000 or 12.5% from December 31, 2008 to December 31,2009 and continued to decrease by $6,936,000 or 1.6% from December 31,2009 to March 31, 2010. Deposits have decreased by $28,322,000 or 5.37%from December 31, 2008 to December 31, 2009 and continued to decreaseby $11,950,000 or 2.4% from December 31, 2009 to March 31, 2010.

 

As of March 31, 2010, the Company’s and the Bank’stotal risk-based capital ratios were less than 6.0%, and therefore, the Bankwas categorized as “significantly undercapitalized” under the federal promptcorrective action regulatory guidelines. In addition, the Bank’s Tier 1leverage capital ratio of 3.5% remains less than the minimum of 10% required bythe terms of the Consent Order described previously. The primary focus of theCompany is to strengthen its capital position by dedicating substantial effortsto raising additional capital. The Company’s Capital Augmentation Committee isworking vigorously with an investment banking firm to assist in raisingcapital. While considerable risks to the Company’s future financial performanceexist, management believes the Company can effectively respond to these risksand carry on operations while it implements its strategic plan and pursuesopportunities with respect to augmenting capital. If successfully implemented,the Company’s capital plan will address its near-term capital resources andliquidity

 

**Resultsof Operations**

 

**Net InterestIncome 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 isnet interest income expressed as a percentage of average earning assets.

 

The Company’s net interest margin was 3.66% for thethree month period ended March 31, 2010 which was down 13 basis pointsfrom 3.79% for the three month period ended March 31, 2009.  Net interest income decreased $747,000(14.71%) for the first quarter of 2010 compared to the same period in2009.  The primary reason for this decrease was the compression of the netinterest margin due to the increase in nonaccrual loans which was partiallymitigated by decreased interest expense.

 

Table Two, Analysis ofNet Interest Margin, sets forth the average daily balances forthe major asset and liability categories, the related income or expense whereapplicable, and the resultant yield or cost attributable to the average earningassets and interest-bearing liabilities. Changes in the average balances and the rates received or paid depend onmarket opportunities, how well the Company has managed interest rate risks,product pricing policy, product mix, and external trends and developments. Thenet interest margin is also adversely impacted by the significant level ofnonaccrual loans during the quarter ended March 31, 2010.

 

TableThree, Analysis of Volume and Rate changes on Net Interest Income, analyzes thechanges in net interest income for the three month period ended March 31,2010 compared to March 31, 2009 that are reported in Table Two.  The analysis shows the impact of volume andrate changes on the major categories of assets and liabilities between theseperiods.  The table explains what portionof the difference or variance in interest income or expense between theseperiods for each major category of assets or liabilities is due to changes inthe balances (volume) or to changes in rates.

 

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Forexample, Table Two shows that interest income from loans for the three monthsended March 31, 2010 decreased by $1,566,000 from $7,047,000 at March 31,2009 to $5,481,000.  The average balanceof loans decreased from $490,644,000 to $427,526,000 and the interest rateearned decreased from 5.82% to 5.20%. Table Three shows the $1,566,000 decrease in interest income from loanswas actually the result of a $906,000 decrease in interest income from thelower balance of loans and a $660,000 decrease from the decrease in yieldsearned in the first quarter of 2010 compared to the same period in 2009.

 

Ashift in the relative size of the major balance sheet categories has an impacton net interest income and net interest margin. For example, to the extent that funds received from maturing or soldsecurities can be repositioned into loans instead of re-invested in securities,earnings increase because of the higher yields received on loans. However,changing the asset mix in this way comes at the price of additional risks thatmust be successfully managed. Additional credit risk is incurred with loanscompared to the very low risk of default loss on securities, and the Companymust carefully monitor the underwriting process to ensure that the benefit ofthe additional interest earned is not offset by additional credit losses.

 

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

 
| ** **                                                                               | ** ** | **2010**             | ** ** | **2009**     | ** ** |
|------------------------------------------------------------------------------------------|------------|----------------------|------------|--------------|------------|
| **Three months ended March 31,  (In thousands, except percentages)** | ** ** | **Avg Balance** | ** ** | **Interest** | ** ** | **Avg Yield  (5)** | ** ** | **Avg Balance** | ** ** | **Interest** | ** ** | **Avg Yield  (5)** | ** ** |
| Assets                                                                                   |       |                 |       |         |       |   |   |   |   |   |   |   |   |
| Earning  assets:                                                                         |       |                 |       |         |       |   |   |   |   |   |   |   |   |
| Loans  (1)(2)                                                                            |       | $                    | 427,526    |         | $          | 5,481 |   | 5.20 | % | $ | 490,644 |   | $ | 7,047 |   | 5.82 | % |
| Taxable  investment securities                                                           |       | 3,048                |       | 30           |       | 3.99 | % | 5,529 |   | 55 |   | 4.05 | % |
| Tax-exempt  investment securities (3)                                                    |       | 1,441                |       | 16           |       | 4.50 | % | 1,370 |   | 16 |   | 4.75 | % |
| Federal  funds sold                                                                      |       | 45,178               |       | 27           |       | 0.24 | % | 45,566 |   | 28 |   | 0.25 | % |
| Interest  bearing deposits in banks                                                      |       | 2,641                |       | 12           |       | 1.84 | % | 2,389 |   | 24 |   | 4.09 | % |
| Total  earning assets                                                                    |       | 479,834              |       | 5,566        |       | 4.70 | % | 545,498 |   | 7,170 |   | 5.35 | % |
| Cash &  due from banks                                                          |       | 12,881               |       |         |       |   |   | 16,541 |   |   |   |   |   |
| Other  assets                                                                            |       | 27,875               |       |         |       |   |   | 32,220 |   |   |   |   |   |
| Average  total assets                                                                    |       | $                    | 520,590    |         |       |   |   |   | $ | 594,259 |   |   |   |   |   |
|                                                                                     |       |                 |       |         |       |   |   |   |   |   |   |   |   |
| Liabilities &  Shareholders’ Equity                                        |       |                 |       |         |       |   |   |   |   |   |   |   |   |
| Interest  bearing liabilities:                                                           |       |                 |       |         |       |   |   |   |   |   |   |   |   |
| NOW &  MMDA                                                                     |       | $                    | 153,062    |         | $          | 123 |   | 0.33 | % | $ | 152,259 |   | $ | 205 |   | 0.55 | % |
| Savings                                                                                  |       | 114,753              |       | 163          |       | 0.58 | % | 108,167 |   | 296 |   | 1.11 | % |
| Time  deposits                                                                           |       | 151,682              |       | 632          |       | 1.69 | % | 196,006 |   | 1,369 |   | 2.84 | % |
| Other  borrowings                                                                        |       | 9,346                |       | 316          |       | 13.71 | % | 13,367 |   | 221 |   | 6.72 | % |
| Total  interest bearing liabilities                                                      |       | 428,843              |       | 1,234        |       | 1.17 | % | 469,799 |   | 2,091 |   | 1.81 | % |
| Demand  deposits                                                                         |       | 72,184               |       |         |       |   |   | 73,518 |   |   |   |   |   |
| Other  liabilities                                                                       |       | 4,730                |       |         |       |   |   | 10,405 |   |   |   |   |   |
| Total  liabilities                                                                       |       | 505,790              |       |         |       |   |   | 553,722 |   |   |   |   |   |
| Shareholders’  equity                                                               |       | 14,833               |       |         |       |   |   | 40,537 |   |   |   |   |   |
| Average  liabilities and equity                                                          |       | $                    | 520,590    |         |       |   |   |   | $ | 594,259 |   |   |   |   |   |
|                                                                                     |       |                 |       |         |       |   |   |   |   |   |   |   |   |
| Net  interest income & margin (4)                                               |       |                 |       | $            | 4,332      |   | 3.66 | % |   |   | $ | 5,079 |   | 3.79 | % |

 

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----

| (1)  Loan interest  includes loan fees of $220,000 and $272,000 during the three months ended  March 31, 2010 and March 31, 2009, respectively.                                                                                                                                                                                                                                                                    |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                                                                                                                                              |
| (2)  Average  non-accrual loan balances of $60.78 million and $17.48 million for the three  months ended March 31, 2010 and March 31, 2009, respectively, are  included in total average loans for purposes of calculating average earning  assets. Average interest foregone on non-accrual loans totaled $807,000 and  $241,000, respectively. Refer to Revenue Recognition under Critical  Accounting Policies. |
|                                                                                                                                                                                                                                                                                                                                                                                                                              |
| (3)  Does not  include taxable-equivalent adjustments that primarily relate to income on  certain securities that are exempt from federal income taxes.                                                                                                                                                                                                                                                                      |
|                                                                                                                                                                                                                                                                                                                                                                                                                              |
| (4)  Net interest  margin is computed by dividing net interest income by total average earning  assets.                                                                                                                                                                                                                                                                                                                      |
|                                                                                                                                                                                                                                                                                                                                                                                                                              |
| (5)  Average yield  is calculated based on actual days in period (90 for March 31, 2010 and  90 for March 31, 2009).                                                                                                                                                                                                                                                                                               |

 

TableThree sets forth a summary of the changes in interest income and interestexpense from changes in average asset and liability balances (volume) andchanges in average interest rates.  On a quarter over quarter basis forthe period ending March 31, 2010, net interest income has decreased$747,000 from the same time period in 2009.  Interest income from earningassets has decreased by $1,604,000. Changes in the volume of earning assets,primarily loans, have resulted in a decrease in interest income of $927,000while interest income has decreased by $677,000 from changes in rates. Interest expense for the first quarter of 2010 was $857,000 less than the sameperiod in 2009.  Decreases in the volumeof interest bearing liabilities have resulted in a decrease of interest expenseof $358,000.  Decreases in average ratespaid on all deposit products have resulted in an interest expense decrease of$499,000.

 

Theaverage balances of interest bearing liabilities of $428,843,000 were $40,956(8.71%) less in the first quarter of 2010 versus the same quarter in2009.  As interest bearing liability balances decreased, rates paid onthese liabilities also decreased by 64 basis points on a quarter over quarterbasis.  As a result of both the decrease in interest rates and the volumeand mix of interest bearing liabilities, interest expense was $857,000 (40.1%)lower in the first quarter of 2010 versus the same period in 2009.

 

As a result of the above, the Company’s net interestmargin declined 13 basis points to 3.66% for the three months ended March 31,2010 from 3.79% for the same period in the prior year.

 

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

** **
| **Three  Months Ended March 31, 2010 over 2009  (In thousands)** | ** ** | **Volume** | ** ** | **Rate (2)** | ** ** | **Net Change** | ** ** |
|-----------------------------------------------------------------------|------------|------------|------------|--------------|------------|----------------|------------|
| Increase  (decrease) due to change in:                                |       |       |       |         |       |           |       |
| Interest-earning  assets:                                             |       |       |       |         |       |           |       |
| Net  loans                                                            |       | $          | (906       | )            | $          | (660           | )          | $ | (1,566 | ) |
| Taxable  investment securities                                        |       | (25        | )          | —       |       | (25            | )          |
| Tax  exempt investment securities (1)                                 |       | 1          |       | (1           | )          | —         |       |
| Federal  funds sold                                                   |       | —     |       | (1           | )          | (1             | )          |
| Interest  bearing deposits in banks                                   |       | 3          |       | (15          | )          | (12            | )          |
| Total                                                                 |       | (927       | )          | (677         | )          | (1,604         | )          |
|                                                                  |       |       |       |         |       |           |       |
| Interest-bearing  liabilities:                                        |       |       |       |         |       |           |       |
| NOW  and MMDA deposits                                                |       | 1          |       | (83          | )          | (82            | )          |
| Savings  deposits                                                     |       | 18         |       | (151         | )          | (133           | )          |
| Time  deposits                                                        |       | (310       | )          | (427         | )          | (737           | )          |
| Other  borrowings                                                     |       | (67        | )          | 162          |       | 95             |       |
| Total                                                                 |       | (358       | )          | (499         | )          | (857           | )          |
| Interest  differential                                                |       | $          | (569       | )            | $          | (178           | )          | $ | (747 | ) |

 

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| (1)  Does not  include taxable-equivalent adjustments that primarily relate to income on  certain securities that is exempt from federal income taxes. |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                        |
| (2)  The  rate/volume variance has been included in the rate variance.                                                                                 |

 

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**Non-interest Income**

 

TableFour below provides a summary of the components of non-interest income for theperiods indicated:

 

**Table Four:  Components of Non-interest Income**

 
| ** **                             | ** ** | **Three months ended  March 31,** | ** ** | **Change** | ** ** |
|----------------------------------------|------------|----------------------------------------|------------|------------|------------|
| ** **                             | ** ** | **2010**                               | ** ** | **2009**   | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                             | ** ** | **(In thousands)**                     | ** ** |
| Sale  of merchant processing portfolio |       | $                                      | —     |       | $          | 2,640 |   | $ | (2,640 | ) | (100.00 | )% |
| Loss  on sale of investment security   |       | —                                 |       | (172       | )          | 172 |   | (100.00 | )% |
| Service  charges on deposit accounts   |       | 771                                    |       | 916        |       | (145 | ) | (15.83 | )% |
| Loan  servicing fees                   |       | 108                                    |       | 140        |       | (32 | ) | (22.86 | )% |
| Fees  - alternative investment sales   |       | 140                                    |       | 109        |       | 31 |   | 28.44 | % |
| Merchant  fee income                   |       | —                                 |       | 86         |       | (86 | ) | (100.00 | )% |
| Gain  on the sale of loans             |       | 146                                    |       | 503        |       | (357 | ) | (70.97 | )% |
| Other                                  |       | 743                                    |       | 605        |       | 138 |   | 22.81 | % |
| Total  non-interest income             |       | $                                      | 1,908      |       | $          | 4,827 |   | $ | (2,919 | ) | (358.41 | )% |

 

Theprimary reason for the decrease in non-interest income is from the one timegain on the sale of the merchant processing portfolio of $2,640,000 in March 2009. Non-interest income decreased $279,000 from March 31, 2009 excluding theone time gain on the sale of the merchant processing portfolio. The gain on thesale of loans into the secondary market decreased compared to the first quarterof 2009 as there were fewer loans originated to sell during this period by our governmentlending division. Service charges on deposit accounts also decreased asconsumers are managing their accounts more efficiently in order to avoidservice charges and fees.

 

**Non-interest Expense**

 

TableFive below provides a summary of the components of non-interest expense for theperiods indicated:

 

**Table Five:  Components of Non-interest Expense**

 
| ** **                                       | ** ** | **Three months ended  March 31,** | ** ** | **Change** | ** ** |
|--------------------------------------------------|------------|----------------------------------------|------------|------------|------------|
| ** **                                       | ** ** | **2010**                               | ** ** | **2009**   | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                       | ** ** | **(In thousands)**                     | ** ** |
| Salaries  and employee benefits                  |       | $                                      | 2,993      |       | $          | 3,399 |   | $ | (406 | ) | (11.94 | )% |
| Occupancy                                        |       | 697                                    |       | 705        |       | (8 | ) | (1.13 | )% |
| Furniture  and equipment                         |       | 486                                    |       | 649        |       | (163 | ) | (25.12 | )% |
| Loss  on disposal of Bank premises and equipment |       | 306                                    |       | —     |       | 306 |   | 0.00 | % |
| Professional  fees                               |       | 367                                    |       | 317        |       | 50 |   | 15.77 | % |
| Telephone  and postage                           |       | 173                                    |       | 177        |       | (4 | ) | (2.26 | )% |
| Stationery  and supply costs                     |       | 122                                    |       | 139        |       | (17 | ) | 12.23 | % |
| Director  fees and retirement                    |       | 81                                     |       | 82         |       | (1 | ) | (1.22 | )% |
| Advertising  and promotion                       |       | 264                                    |       | 334        |       | (70 | ) | (20.96 | )% |
| FDIC  assessments                                |       | 344                                    |       | 333        |       | 11 |   | 3.30 | % |
| Other  real estate expense                       |       | 1,390                                  |       | 61         |       | 1,329 |   | 2178.69 | % |
| Other                                            |       | 514                                    |       | 578        |       | (64 | ) | 11.07 | % |
| Total  non-interest expense                      |       | $                                      | 7,737      |       | $          | 6,774 |   | $ | 962 |   | 2139.26 | % |

 

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Theprimary reasons for the increase in non-interest expense is the increase inother real estate expenses due to write-downs of $969,000 and managementexpenses of $421,000, and loss on the disposal of Bank premises and equipmentwhich was due to the closing of the Churn Creek, Redding Office when it wasconsolidated with the Hilltop, Redding Office. This was partially mitigated by the reduction in salaries and employeebenefits largely due to lower full time equivalent employees, salary freezes,and reduced employee benefits.

 

**Provision for Loan Losses**

 

TheCompany provided $5,289,000 for loan losses in the first quarter of 2010compared to $3,100,000 in the first quarter of 2009.  Net loan charge-offsfor the first quarter of 2010 and 2009 were $3,285,000 and $2,281,000, respectively.Management assesses its loan quality on a monthly basis to maintain an adequateallowance for loan losses.  The Company’s loan portfolio composition,non-performing assets and allowance for loan losses are further discussed underthe Balance Sheet Analysis section below.

 

**Income Taxes**

 

Thebenefit for income taxes for the first quarter of 2010 was $2,307,000 ascompared to the tax benefit for income taxes of $68,000 for the same period in2009.  The effective benefit rate forstate and federal income taxes was 34% for the three months ended March 31,2010 compared to an effective tax rate of 216.7% for the same period in2009.  The difference in the effectivetax rate compared to the statutory tax rate (approximately 42.05%) is primarilythe result of the Company’s investment in municipal securities andCompany-owned life insurance policies whose income is exempt from Federaltaxes. In addition, the Company receives special tax benefits from the State ofCalifornia Franchise Tax Board for operating and providing loans in designated ‘EnterpriseZones’.

 

For the three years ended December 31, 2009, 2008and 2007, the Company is in a cumulative pretax loss position. For purposes ofestablishing a deferred tax valuation allowance, this cumulative pretax lossposition is considered significant, objective evidence that the Company may notbe able to realize the Company’s deferred tax assets in the future. Thecumulative pretax loss position was caused primarily by the significant amountof loan loss provision and other real estate expense taken in 2009. As a resultof these losses and the losses in the current quarter, a valuation allowancewas recorded at March 31, 2010 and December 31, 2009. Due to continueddeteriorating market conditions, the Company has determined that there is notsufficient additional positive evidence to support the realization of its net deferredtax assets. However, a current tax receivable that can be realized from thecarryback of the 2010 projected net operating loss. Net operating losscarrybacks for the year ending December 31, 2010 are limited to the $4.1million in taxes paid for the 2008 tax year.

 

The amount ofdeferred tax assets considered realizable is subject to adjustment in futureperiods. Management will need to continue to monitor all available evidencerelated to the Company’s ability to utilize its net deferred tax assets. TheCompany’s income tax expense in future periods will be increased or reduced tothe extent of offsetting increases or decreases to the Company’s net deferredtax asset valuation allowance.

 

**Balance Sheet Analysis**

 

TheCompany’s total assets were $522,188,000 at March 31, 2010, down$16,274,000 (3.02%) from $538,462,000 at December 31, 2009.  On ayear over year basis, the average balance of total assets for the three monthsended March 31, 2010 was $520,590,000, which represents a decrease of$73,669,000 (12.39%) from $594,259,000 during the three months ended March 31,2009.

 

**Loans**

 

TheCompany concentrates its lending activities in the following areas: 1)commercial; 2) real estate mortgage; 3) residential real estate and real estateconstruction (both commercial and residential); 4) agriculture; and 5) consumerloans.  Commercial and residential real estate loans are generally securedby improved property, with original maturities of 3-10 years.

 

Loanbalances have declined in the current quarter mainly in agriculture loans asthese loans tend to be seasonal with higher volumes during the fourth quarter.Reductions in real estate construction loans have been the result ofrepayments, foreclosures and reclassification to other real estate (ORE).  Decreases in loan balances from December 31,2009 consist of agriculture loans of $4,807,000 or 12.5%, real estateconstruction loans of $1,950,000 or 8.5%, and consumer loans of $336,000 or..5%. The reduction of real estate construction loans is consistent with theplan to reduce our dependency on real estate related lending and furtherdiversify the loan portfolio to mitigate risk. Table Six below summarizes thecomposition of the loan portfolio as of March 31, 2010 and December 31,2009.

 

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**Table Six: Loan Portfolio Composition**

** **
| **(In thousands)**         | ** ** | **March 31, 2010** | ** ** | **% of Total Loans** | ** ** | **December 31, 2009** | ** ** | **% of Total Loans** | ** ** |
|----------------------------|------------|-------------------------|------------|----------------------|------------|----------------------------|------------|----------------------|------------|
| Commercial                 |       | $                       | 80,493     |                 | 18.88      | %                          | $          | 80,758               |       | 18.64 | % |
| Real  estate:              |       |                    |       |                 |       |                       |       |                 |       |
| Mortgage                   |       | 229,099                 |       | 53.75                | %          | 228,678                    |       | 52.79                | %          |
| Construction               |       | 21,040                  |       | 4.94                 | %          | 22,990                     |       | 5.31                 | %          |
| Agriculture                |       | 33,637                  |       | 7.89                 | %          | 38,444                     |       | 8.87                 | %          |
| Consumer                   |       | 61,988                  |       | 14.54                | %          | 62,324                     |       | 14.39                | %          |
| Total  loans               |       | 426,258                 |       |                 |       | 433,194                    |       |                 |       |
| Allowance  for loan losses |       | (14,979                 | )          |                 |       | (12,975                    | )          |                 |       |
| Deferred  loan fees, net   |       | (148                    | )          |                 |       | (183                       | )          |                 |       |
| Total  net loans           |       | $                       | 411,131    |                 |       |                       | $          | 420,036              |       |   |   |

 

Themajority of the Company’s loans are direct loans made to individuals and localbusinesses.  The Company relies substantially on local promotionalactivity and personal contacts by bank officers, directors and employees tocompete with other financial institutions.  The Company makes loans toborrowers whose applications include a sound purpose and a viable primaryrepayment source, generally supported by a secondary source of repayment.

 

Commercialloans consist of credit lines for operating needs, loans for equipmentpurchases, working capital, and various other business loan products. Consumer loans include a range of traditional consumer loan products such aspersonal lines of credit and loans to finance purchases of autos, boats, recreationalvehicles, mobile homes and various other consumer items.

 

Realestate construction loans are generally comprised of commitments to customerswithin the Company’s service area for construction of both commercialproperties and custom and semi-custom single-family residences.  Otherreal estate loans consist primarily of loans secured by first trust deeds oncommercial and residential properties typically with maturities from 3 to 10years and original loan to value ratios generally from 65% to 90%. Agriculture loans consist primarily of crop loans to farmers of peaches,prunes, walnuts, and almonds.  In general, except in the case of loanswith SBA or FMHA guarantees, the Company does not make long-term mortgageloans; however, Butte Community Bank has a residential lending division toassist customers in securing most forms of longer term single-family mortgagefinancing.

 

InMay 2010, agriculture loans and commercial real estate loans withprincipal balances totaling $22,210,000 were pledged as collateral to theFederal Reserve Bank of San Francisco (FRB). The amount of loans pledged doesnot represent the amount of outstanding borrowings at the FRB. The Bank pledgesloans as collateral for the Bank’s borrowings in accordance with the Bank’sagreement with the FRB.

 

**Risk Elements**

 

TheCompany assesses and manages credit risk on an ongoing basis through a creditculture that emphasizes excellent credit quality, extensive internal monitoringand established formal lending policies.  Additionally, the Companycontracts with an outside loan review consultant to semiannually review theexisting loan portfolio.  Management believes its ability to identify andassess risk and return characteristics of the Company’s loan portfolio iscritical.  Management strives to continue its emphasis on credit qualityin the loan approval process, active credit administration and regularmonitoring.  With this in mind, management has designed and implemented acomprehensive loan review and grading system that functions to continuallyassess the credit risk inherent in the loan portfolio.

 

Ultimately,underlying trends in economic and business cycles influence creditquality.  The Company’s business is concentrated in the Butte, Sutter andShasta County areas. The economy of these three counties is diversified withprofessional services, manufacturing, agriculture and real estate investmentand construction.  The real estateelement has been impacted by the continuing economic downturn with constructionactivity slowing dramatically beginning in the later part of 2008. Othersectors of the local economy are reasonably stable with agriculture beingaffected the least.

 

Specialemphasis on community development and lending is placed within the communitiesin which the Company has offices (Chico, Paradise, Magalia, Oroville, YubaCity, Red Bluff, Marysville, Colusa, Corning, Redding and Anderson).

 

TheCompany has significant extensions of credit and commitments to extend creditthat are secured by real estate.  The ultimate repayment of these loans isgenerally dependent on personal or business cash flows or the sale orrefinancing of the real estate.  The Company monitors the effects ofcurrent and expected market conditions and other factors on the collectabilityof real estate loans.  The more significant factors management considersinvolve the following:  lease, absorption and sale rates; real estatevalues and rates of return; operating expenses; inflation; and sufficiency ofcollateral independent of the real estate including, in limited instances,personal guarantees.  The mostsignificant condition management is dealing with concerning real estate loansis the declining values assigned to properties as new appraisals are completed.

 

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Inextending credit and commitments to borrowers, the Company generally requirescollateral and/or guarantees as security.  The repayment of such loans isexpected to come from cash flow or from proceeds from the sale of selectedassets of the borrowers.  The Company’s requirement for collateral and/orguarantees is determined on a case-by-case basis in connection with management’sevaluation of the creditworthiness of the borrower.  Collateral heldvaries but may include accounts receivable, inventory, property, plant andequipment, income-producing properties, residences and other realproperty.  The Company secures its collateral by perfecting its securityinterest in business assets, obtaining deeds of trust, or outright possessionamong other means.

 

Inmanagement’s judgment, a concentration exists in loans secured by real estate,which represented approximately 58.8% of the Company’s loan portfolio at March 31,2010, which has increased slightly from the 58.1% concentration level at December 31,2009.  Management believes the concentration has more than the normal riskof collectability due to the substantial decline in the economy in general andthe continuing decline in real estate values in the Company’s primary marketareas. As the Company has been impacted by the slowdown in the economy, we haveincreased the provision for loan losses which has adversely affected theCompany’s future prospects, results of operations, profitability and stockprice.  Management believes that its lending policies and underwritingstandards follow strict regulatory guidelines; however, there is no assurancethat losses will not continue to occur under the current economiccircumstances.  The Company’s loan policies and underwriting standardsinclude, but are not limited to, the following: (1) maintaining a thoroughunderstanding of the Company’s service area and originating a significantmajority of its loans within that area, (2) maintaining a thoroughunderstanding of borrowers’ knowledge, capacity, and market position in theirfield of expertise, (3) basing real estate loan approvals not only onmarket demand for the project, but also on the borrowers’ capacity to supportthe project financially in the event it does not perform to expectations(whether sale or income performance), and (4) maintaining conforming andprudent loan to value and loan to cost ratios based on independent outsideappraisals and ongoing inspection and analysis by the Company’s lendingofficers.  Although the lending officersfollowed these strict conservative underwriting standards at loan origination,the downturn in the current economy, with the rising unemployment rate and thedecline in real estate values, has had an impact on the ability of some of ourborrowers to service their debt.   TheCompany does not participate in any sub-prime lending activities nor is itexposed to sub-prime lending in its investment portfolio.

 

**Impaired,Nonaccrual, Past Due and Restructured Loans and Leases and Other NonperformingAssets**

 

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

 

TableSeven below sets forth nonaccrual loans as of March 31, 2010 and December 31,2009.   There were no loans past due90 days or more and still accruing interest at March 31, 2010 or December 31,2009.

 

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**TableSeven: ****Impaired, Nonaccrual, Past Due and Restructured Loans and Leases andOther Nonperforming Assets:**

** **

**Non-performingAssets**

(in thousands)

 
| ** **                   | ** ** | **March 31, 2010** | ** ** | **December 31, 2009** | ** ** |
|------------------------------|------------|-------------------------|------------|----------------------------|------------|
| **Nonaccrual Loans:**        |       |                    |       |                       |       |
| Commercial                   |       | $                       | 11,893     |                       | $          | 2,218 |   |
| Real  estate                 |       | 44,035                  |       | 48,778                     |       |
| Consumer  and other          |       | 1,529                   |       | 79                         |       |
| **SUBTOTAL**                 |       | 57,457                  |       | 51,075                     |       |
|                         |       |                    |       |                       |       |
| Other  Real Estate (ORE)     |       | 10,021                  |       | 13,493                     |       |
| Total  non-performing Assets |       | $                       | 67,478     |                       | $          | 64,568 |   |
| Restructured  Loans (1)      |       | $                       | 27,831     |                       | $          | 22,593 |   |

 

----

(1) $22,055 and$15,870 of the restructured loans are on nonaccrual and are included in thenonaccrual loans above at March 31, 2010 and December 31, 2009,respectively.

 

Non-performing loans (definedas non-accrual loans and loans 90 days or more past due and still accruinginterest) totaled $57,457,000 at March 31, 2010, an increase of $6,382,000from $51,075,000 at December 31, 2009 primarily as a result of increasingproblem loans in the Company’s real estate/development portfolio and commercialloan portfolios.  Specific reserves onthe non-performing loans of $3,205,000 have been recorded at March 31,2010 compared to $4,045,000 at December 31, 2009.  Nonperforming loans as a percentage of totalloans were 13.95% at March 31, 2010 compared to 12.16% at December 31,2009.

 

Non-performing assets,(non-performing loans and ORE) totaled $67,478,000 at March 31, 2010, anincrease of $2,910,000 from $64,568,000 at December 31, 2009.  Non-performing assets as a percentage oftotal assets were 12.9% at March 31, 2010 compared to 12.0% at December 31,2009.

 

Total non-performingassets consist of 103 loans for a total of $57,457,000 classified as impairedand on non-accrual and thirty-nine properties for a total of $10,021,000classified as other real estate (ORE) at March 31, 2010 compared to totalnon-performing assets of $13,493,000 at December 31, 2009.  Other than the loans included asnon-performing assets at March 31, 2010, the Company has not identifiedany potential problem loans that would result in any loan being included as anon-performing asset at the current date.

 

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Set forth below is atable of our significant non-performing assets:

 

Significant Non-Performing Loans:

(in thousands)

 
| ** **       | ** ** | ** **     | ** ** | **Loan  Balance** | ** ** | **Apprasial** | ** ** | **Nonaccrual** | ** ** | **Appraised** | ** ** | **Specific  Reserve** | ** ** | ** **     | ** ** | ** **    | ** ** |
|------------------|------------|----------------|------------|-------------------|------------|---------------|------------|----------------|------------|---------------|------------|-----------------------|------------|----------------|------------|---------------|------------|
| **Loan**         | ** ** | **Type**       | ** ** | **12/31/2009**    | ** ** | **3/31/2010** | ** ** | **Date**       | ** ** | **Date**      | ** ** | **Value**             | ** ** | **12/31/2009** | ** ** | **3/31/2010** | ** ** | **Chargeoffs** | ** ** | **Current  Collateral** | ** ** |
| 1                |       | Commerical  RE |       | $                 | 4,326      |          | $          | 4,326          |       | Apr-10        |       | Jan-09                |       | $              | 3,900      |          | $          | 43 |   | $ | — |   | $ | 153 |   | 28 Cottages |   |
| 2                |       | Development    |       | 3,839             |       | 3,782         |       | Aug-09         |       | Dec-09        |       | 2,592                 |       | 1,400          |       | 1,400         |       | — |   | 21 finished  lots & 29 paper lots |   |
| 3                |       | Development    |       | 1,977             |       | 1,953         |       | Jan-10         |       | Dec-09        |       | 2,070                 |       | —         |       | —        |       | 513 |   | 14.88 acres of land |   |
| 4 & 5   |       | Development    |       | 6,601             |       | 6,249         |       | Apr-10         |       | Jun-09        |       | 7,614                 |       | —         |       | —        |       | 1,234 |   | 148 finished lots, a  24.95 acre parcel and a 5 acre parcel |   |
| 6                |       | Development    |       | 2,239             |       | 2,239         |       | Nov-09         |       | Dec-09        |       | 2,592                 |       | —         |       | —        |       | — |   | Golf course |   |
| 7 & 8   |       | Commerical  RE |       | 1,902             |       | 1,878         |       | Apr-10         |       | Dec-09        |       | 5,900                 |       | —         |       | 73            |       | — |   | Hotel/inn |   |
| 9                |       | Development    |       | 1,614             |       | 1,592         |       | Jan-10         |       | Dec-09        |       | 1,700                 |       | —         |       | —        |       | 347 |   | 4290 sq.ft home on 20  acres |   |
| 10               |       | Development    |       | 2,471             |       | 1,955         |       | Oct-09         |       | Dec-09        |       | 2,605                 |       | —         |       | —        |       | 1,415 |   | 250 acres of land |   |
| 11               |       | Commerical  RE |       | 1,598             |       | 1,590         |       | Mar-10         |       | Dec-09        |       | 2,980                 |       | —         |       | —        |       | — |   | 67,600 sq.ft. industrial  office/warehouse building |   |
| 12 & 13 |       | Development    |       | 2,250             |       | 2,104         |       | Dec-09         |       | Dec-09        |       | 4,550                 |       | 151            |       | —        |       | 1,514 |   | 31 finished  lots & 2 completed homes |   |
| 14               |       | Development    |       | 2,451             |       | 2,418         |       | Sep-09         |       | Dec-09        |       | 1,915                 |       | 637            |       | 957           |       | — |   | 12 lot subdivision |   |
|             |       |           |       | $                 | 31,268     |          | $          | 30,086         |       |          |       |                  |       |           |       | $             | 2,231      |   | $ | 2,430 |   | $ | 5,176 |   |   |   |
|                  |            |                |            |                   |            |               |            |                |            |               |            |                       |            |                |            |               |            |  |  |  |  |  |  |  |  |  |  |

 

Loan1 is a government guaranteed loan under the United States Department ofAgriculture (USDA) Business and Industry program with an 80% guarantee andmaximum exposure to the Company of $743,000. In October of 2008, the Bank received notice that our borrower hadfiled bankruptcy under Chapter 11.  Itwas at this time that the Bank stopped receiving payments. The Company isprevented from pursuing any additional legal action due to the pendingbankruptcy.

 

The remainder of thenon-performing loans consists primarily of eleven impaired single family homeloans that total $4,224,000,  forty-oneimpaired lot loans that total $13,245,000, eleven commercial real estate loansthat total $6,523,000, ten commercial/industrial loans that total $1,823,000,one agricultural line of credit that totals $28,000, twelve single family homeloans secured with 2nd deeds of trust for $1,320,000, and threeconsumer loans that total $208,000. These loans are to borrowers who arelocated throughout Northern California from the Sacramento area to Redding.  After appropriate write downs, the currentappraised values provide the Company with adequate margins in most cases;however, the Bank has allocated a specific reserve that totals an additional $775,000on these loans.

 

Other Real Estate

 

The largest of our ORE atMarch 31, 2010 is a commercial real estate property for the constructionof 50,396 sq. feet of industrial condos in Shingle Springs, California carriedat $2,608,000.  The property wastransferred to ORE on December 24, 2009. To identify the Company’spotential loss exposure and properly value the collateral support provided bythe property, an updated appraisal was received on December 1, 2009 andshowed a value of $3,005,000.  TheCompany charged off an additional $96,000 to ORE expense on March 30,2010.  The property is currently inescrow for $2,775,000 and is scheduled to close in June 2009.

 

Another significant OREat March 31, 2010 is a 7.5 acre development property along the SacramentoRiver located in Anderson, California carried at $1,071,000. The original planswere to develop a fishing lodge and restaurant. The collateral for the loan consists of 7.5 acres plus six 20 acreparcels located in Red Bluff, California. This loan was transferred to ORE in October 2009.Due to the continued decline in real estate market, the Company ordered anupdated appraisal to understand the potential loss exposure and properly valuethe collateral.  In February 2010, anew appraisal valued the property at $1,190,000 and the Company charged-off anadditional $165,900 against ORE expense.

 

The remainder of otherreal estate includes twenty-three SFR lots that have a current value of$3,170,000, eleven single family homes at a combined balance of $2,580,000, andthree commercial real estate properties that total $592,000.  These amounts included in ORE are supportedby current appraisals received by the Company, all within the past 12 months.When loans are placed into ORE, the Company determines the fair market valueless the estimated selling costs.  Theshortfalls are charged to the allowance for loan losses at the time oftransfer.  Properties placed in ORE arereviewed continuously and the 

 

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Company will reappraisethe property if it is deemed necessary. At a minimum, properties are appraised at least annually.  If values have dropped, the Company willestablish a valuation allowance for the ORE through a separate provision forlosses on ORE. Over $5,600,000 in sales of ORE is scheduled to close in thenext 60 days.

 

**RestructuredLoans**

(in thousands)

 
| ** **                                         | ** ** | **March 31, 2010** | ** ** | **December 31, 2009** | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| ** **                                         | ** ** | **Accrual**             | ** ** | **Non  Accrual**           | ** ** | **Unfunded** | ** ** | **Accrual** | ** ** | **Non  Accrual** | ** ** | **Unfunded** | ** ** |
| Agricultural                                       |       | $                       | —     |                       | $          | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Commercial  and Industrial                         |       | —                  |       | —                     |       | — |   | — |   | — |   | — |   |
| **Real Estate**                                    |       |                    |       |                       |       |   |   |   |   |   |   |   |   |
| Secured  by Commercial/Professional Office         |       | —                  |       | 4,651                      |       | — |   | — |   | 4,386 |   | — |   |
| Properties  Including Construction and Development |       | 5,776                   |       | 15,916                     |       | 424 |   | 6,723 |   | 10,147 |   | 424 |   |
| Secured  by Residential Properties                 |       | —                  |       | 1,033                      |       | — |   | — |   | 835 |   | — |   |
| Secured  by Farmland                               |       | —                  |       | —                     |       | — |   | — |   | — |   | — |   |
| Consumer  Loans                                    |       | —                  |       | 455                        |       | — |   | — |   | 502 |   | — |   |
|                                               |       |                    |       |                       |       |   |   |   |   |   |   |   |   |
| Total  Restructured Loans                          |       | $                       | 5,776      |                       | $          | 22,055 |   | $ | 424 |   | $ | 6,723 |   | $ | 15,870 |   | $ | 424 |   |
|                                               |       |                    |       |                       |       |   |   |   |   |   |   |   |   |
| Restructured  loans as % of total gross loans      |       | 6.53                    | %          |                       |       |   |   | 5.20 | % |   |   |   |   |

 

Restructured loans totaled $27,831,000 at March 31,2010, an increase of $5,238,000 from the total at December 31, 2009. Aloan may be restructured when the Bank determines that a borrower’s financialcondition has deteriorated, but still has the ability to repay the loan. A loanis considered to be a troubled debt restructure when the original terms havebeen modified in favor of the borrower such that either principal or interesthas been forgiven, contractual payments are deferred, or the interest rate isreduced. If the restructured terms are reasonable based on the current marketand the borrower has made their payments as contractually required for sixmonths, the loan is reviewed and interest may again be accrued. No additionalfunds were lent to the borrowers of the restructured loans.

 

**Allowance for Loan Losses Activity**

 

Weemploy a systematic methodology for determining the allowance for loan lossesthat includes a monthly review process and monthly adjustment of the allowance. Our process includes a monthly 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’sensitivity to external factors including commodity prices as well as acts ofnature (freezes, earthquakes, fires, etc.) that occur in a particular period.

 

Qualitativefactors include the impact of the general economic environment in our marketsand, in particular, the state of the agriculture industry and other keyindustries in the Northern Sacramento Valley.  The way a particular loanmight be structured, the extent and nature of waivers of existing loanpolicies, loan concentrations, trends in delinquencies and charge-offs, and therate 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 DFI review the allowance for loanlosses as an integral part of the examination process.  Managementbelieves that our current methodology is appropriate given our size and levelof complexity.  Further, management believes that the allowance for loanlosses is adequate as of March 31, 2010 to cover known and inherent risksin the loan portfolio.  However, fluctuations in credit quality, orchanges in economic conditions or other factors could cause management toincrease or decrease the allowance for loan losses as necessary.

 

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TheBoard of Directors of the Bank reviews the adequacy of the allowance for loanlosses at least quarterly to include consideration of the relative risks in theportfolio and current economic conditions.  The allowance is adjustedbased on that review if, in the judgment of the Board of Directors andmanagement, changes are warranted.  The allowance for loan losses totaled$14,979,000 or 3.51% of total loans at March 31, 2010 and $8,697,000 or1.80% at December 31, 2009.  Net charge-offs for the quarter ended March 31,2010 were $3,285,000. The Company has a separate reserve for unfunded loancommitments of $261,000 as of March 31, 2010 and $244,000 as of December 31,2009 that is included in other liabilities on the balance sheet.

 

TableEight below summarizes, for the periods indicated, the activity in theallowance for loan losses.

 

**Table Eight: Allowance for Loan Losses**

 
| ** **                                                                | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------------------|------------|
| **(In  thousands, except for percentages)**                               | ** ** | **2010**                               | ** ** | **2009** | ** ** |
|                                                                      |       |                                   |       |   |   |
| Average  loans outstanding                                                |       | $                                      | 427,526    |   | $ | 490,644 |   |
|                                                                      |       |                                   |       |   |   |
| Allowance  for possible loan losses at beginning of period                |       | $                                      | 12,975     |   | $ | 7,826 |   |
|                                                                      |       |                                   |       |   |   |
| Loans  charged off:                                                       |       |                                   |       |   |   |
| Commercial                                                                |       | (223                                   | )          | (50 | ) |
| Real  estate                                                              |       | (2,846                                 | )          | (2,228 | ) |
| Consumer                                                                  |       | (461                                   | )          | (4 | ) |
| Total                                                                     |       | (3,530                                 | )          | (2,282 | ) |
| Recoveries  of loans previously charged off:                              |       |                                   |       |   |   |
| Commercial                                                                |       | 12                                     |       | — |   |
| Real  estate                                                              |       | 206                                    |       | — |   |
| Consumer                                                                  |       | 27                                     |       | 1 |   |
| Total                                                                     |       | 245                                    |       | 1 |   |
| Net  loan charge offs                                                     |       | (3,285                                 | )          | (2,281 | ) |
|                                                                      |       |                                   |       |   |   |
| Additions  to allowance charged to operating expenses                     |       | 5,289                                  |       | 3,152 |   |
|                                                                      |       |                                   |       |   |   |
| Allowance  for loan losses at end of period                               |       | $                                      | 14,979     |   | $ | 8,697 |   |
|                                                                      |       |                                   |       |   |   |
| Ratio  of net charge-offs to average loans outstanding                    |       | 0.83                                   | %          | 0.46 | % |
| Provision  for possible loan losses to average loans outstanding          |       | 1.24                                   | %          | 0.63 | % |
| Allowance  for loan losses to loans net of deferred fees at end of period |       | 3.51                                   | %          | 1.80 | % |

 

Itis the policy of management to maintain the allowance for loan losses at alevel adequate for known and inherent risks in the portfolio.  Based oninformation currently available to analyze inherent credit risk, includingeconomic factors, overall credit quality, historical delinquencies and a historyof actual charge-offs, management believes that the provision for loan lossesand the allowance are adequate.  The Company generally makes monthlyallocations to the allowance for loan losses.  The budgeted allocation isbased on estimates of loss risk and loan growth.  Adjustments may be madebased on differences from estimated loan growth, the types of loansconstituting this growth, changes in risk ratings within the portfolio,recognition of loan impairment and general economic conditions.  However,no prediction of the ultimate level of loans charged off in future periods canbe made with any certainty.

 

**Deposits**

 

AtMarch 31, 2010, total deposits were $486,213,000 representing a decreaseof $11,950,000 (2.4%) over the December 31, 2009 balance of $498,163,000. Wehave experienced a decrease in the level of our non-interest bearing demanddeposits in the first three months of 2010, down $10,532,000. Interest bearingchecking and money market accounts increased $2,435,000 to $155,926,000 andsavings accounts increased $7,705,000 to $116,986,000 during the first quarter.Certificate of deposit balances decreased by $11,558,000 to $146,493,000 at March 13,2010. Brokered deposits totaled $3,862,000 and $17,633,000 at March 31,2010 and December 31, 2009, respectively.

 

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TheEmergency Economic Stabilization Act of 2008 included a provision for an increase inthe amount of deposits insured by the FDIC to $250,000. In addition, the Bankis participating in the FDIC Transaction Account Guarantee Program. Under thatprogram, through December 31, 2010, all noninterest-bearing transactionaccounts and qualifying NOW accounts are fully guaranteed by the FDIC for theentire amount in the account. Coverage under the Transaction Account GuaranteeProgram is in addition to and separate from the coverage available under theFDIC’s general deposit insurance rules. Participating institutions arecurrently assessed a 10 basis point surcharge on the additional insureddeposits.

 

**Capital Resources**

 

TheCompany and the Bank are subject to certain regulatory capital requirementsadministered by the Board of Governors of the Federal Reserve System and theFDIC. Failure to meet these minimum capital requirements can initiate certainmandatory, and possibly additional discretionary, actions by regulators that,if undertaken, could have a direct material effect on the Company’sconsolidated financial statements. Under capital adequacy guidelines, theCompany and the Bank must meet specific capital guidelines that involvequantitative measures of their assets, liabilities and certain off-balancesheet items as calculated under regulatory accounting practices.  These quantitative measures are establishedby regulation and require that minimum amounts and ratios of total and Tier 1capital to risk-weighted assets and of Tier 1 capital to average assets bemaintained.  Capital amounts andclassifications are also subject to qualitative judgments by the regulatorsabout components,risk weightings and other factors. Accordingly, the regulators have requiredthe Bank to increase its Tier 1 to average assets capital ratio to equal orexceed 10% and its risk based capital ratio to 13% under the ConsentOrder.   The Company and the Bank areconsidered to be significantly undercapitalized at March 31, 2010 underthese regulatory guidelines.

 

The Bank is also subjectto additional capital guidelines under the regulatory framework for promptcorrective action.  To be categorized as adequatelycapitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-basedand Tier 1 leverage ratios as set forth in the table below.  At March 31, 2010, theBank is considered significantly undercapitalized under the prompt correctivecapital regulations and will be required to file a capital restoration plan andis automatically subject to among other things, restrictions on dividends,restrictions on access to the Federal Reserve’s discount window, restrictionson asset growth, and being prohibited from opening new branches, or engaging innew lines of business without the approval of the FDIC.

 

In an effort tostrengthen the Company’s operations and capital position and enable it tobetter withstand these continued adverse market conditions, the CapitalAugmentation Committee has been working diligently to raise additional capitaland identify additional capital sources and alternatives inclusive of astrategic combination.

 

AtMarch 31, 2010, shareholders’ equity was $11,434,000 representing adecrease of $4,518,000 over the December 31, 2009 balance of $15,952,000.

 

TableNine below lists the Company’s and the Bank’s capital ratios at March 31,2010 and December 31, 2009, as well as the minimum ratios required underregulatory definitions of capital adequacy and requirements for the Bankincluded in the Consent Order.

 

**TableNine: Capital Ratios**

 
| **Capital to Risk-Adjusted Assets** | ** ** | **At March 31, 2010** | ** ** | **At December 31,  2009** | ** ** | **Minimum Regulatory  Requirement** | ** ** | **Required  Under the  Consent Order** | ** ** |
|----------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                         |       |                                 |       |                                |       |                                     |       |                                             |       |
| Company                                            |       |                                 |       |                                |       |                                     |       |                                             |       |
| Leverage  ratio                                    |       | 2.0                                  | %          | 3.0                                 | %          | 4.0                                      | %          |                                             |       |
|                                               |       |                                 |       |                                |       |                                     |       |                                             |       |
| Tier  1 Risk-Based Capital                         |       | 2.2                                  | %          | 3.5                                 | %          | 4.0                                      | %          |                                             |       |
|                                               |       |                                 |       |                                |       |                                     |       |                                             |       |
| Total  Risk-Based Capital                          |       | 5.4                                  | %          | 6.2                                 | %          | 8.0                                      | %          |                                             |       |
| ** **                                         |       |                                 |       |                                |       |                                     |       |                                             |       |
| Bank                                               |       |                                 |       |                                |       |                                     |       |                                             |       |
| Leverage  ratio                                    |       | 3.5                                  | %          | 4.0                                 | %          | 4.0                                      | %          | 10.0                                             | %          |
|                                               |       |                                 |       |                                |       |                                     |       |                                             |       |
| Tier  1 Risk-Based Capital                         |       | 4.0                                  | %          | 4.7                                 | %          | 4.0                                      | %          | —                                           |       |
|                                               |       |                                 |       |                                |       |                                     |       |                                             |       |
| Total  Risk-Based Capital                          |       | 5.2                                  | %          | 5.9                                 | %          | 8.0                                      | %          | 13.0                                             | %          |

 

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Management is currentlyadjusting its capital plan in order to conform to these requirements throughrestructuring of the balance sheet and the addition of new capital in the formof common stock.  In addition, anamendment to the Company bylaws to allow issuance of preferred stock wasapproved by the shareholders at the annual meeting that was held June 4,2009. The Company is considering various transactions that might enhance its capitalposition.

 

**Item 3.  Quantitative and Qualitative Disclosures aboutMarket Risk**

 

**Market Risk Management**

 

*Overview*.  Market risk is therisk of loss from adverse changes in market prices and rates.  The Company’smarket risk arises primarily from interest rate risk inherent in its loan,investment, deposit and borrowing portfolios.  The goal for managing theassets and liabilities of the Company is to maximize shareholder value andearnings while maintaining a high quality balance sheet without exposing theCompany to undue interest rate risk.

 

TheBoard of Directors has overall responsibility for the interest rate riskmanagement policies.  The Bank has an Asset and Liability ManagementCommittee (ALCO) that establishes and monitors guidelines to control thesensitivity of earnings to changes in interest rates.

 

*Asset/Liability Management*.  Activities involvedin asset/liability management include, but are not limited to, lending,accepting and placing deposits, investing in securities, issuing trust preferredsecurities and borrowings.  Interest rate risk is the primary market riskassociated with asset/liability management.  Sensitivity of earnings tointerest rate changes arises when yields on assets change in a different timeperiod or in a different amount from that of interest costs onliabilities.  To mitigate interest rate risk, the structure of the balancesheet is managed with the goal that movements of interest rates on assets andliabilities are correlated and contributes to earnings even in periods ofvolatile interest rates.  The asset/liability management policy setslimits on the acceptable amount of variance in net interest margin and marketvalue of equity under changing interest environments.  The Company usessimulation models to forecast earnings, net interest margin and market value ofequity.

 

Simulationof earnings is the primary tool used to measure the sensitivity of earnings tointerest rate changes.  Using computer-modeling techniques, the Company isable to estimate the potential impact of changing interest rates onearnings.  A balance sheet forecast is prepared monthly using inputs ofactual loans, securities and interest bearing liabilities (i.e.deposits/borrowings) positions as the beginning base.  The forecast balancesheet is processed against eight interest rate scenarios.  These scenariosinclude a 100, 200, 300 and 400 basis point rising rate forecast, a flat rateforecast and a 100, 200 and 300 basis point falling rate forecast which takeplace within a one year time frame.

 

Thenet interest income is measured during the year assuming a gradual change inrates over the twelve-month horizon.  The Company’s net interest income,as forecast below, was modeled utilizing a forecast balance sheet projectedfrom balances as of the date indicated.

 

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

 

**TableTen:  Interest Rate Risk Simulation of Net Interest as of March 31,2010 and December 31, 2009**

** **
| **(In  thousands)**                      | ** ** | **$ Change in NII  from Current  12 Month Horizon  March 31, 2010** | ** ** | **$ Change in NII  from Current  12 Month Horizon  December 31, 2009** | ** ** |
|------------------------------------------|------------|-------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| Variation  from a constant rate scenario |       |                                                                          |       |                                                                             |       |
| +200bp                                   |       | $                                                                             | 852        |                                                                             | $          | 965 |   |
| -  200bp                                 |       | $                                                                             | (357       | )                                                                                | $          | (36 | ) |

 

Assumptionsare inherently uncertain, and, consequently, the model cannot precisely measurenet interest income or precisely predict the impact of changes in interestrates on net interest income. Actual results will differ from simulated resultsdue to timing, magnitude and frequency of interest rate changes, as well aschanges in market conditions and management strategies which might moderate thenegative consequences of interest rate deviations. In the model above, thesimulation shows that the Company is asset sensitive over the one-year horizonas increasing rates have a greater positive impact on net interest income thandeclining rates.

 

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**Inflation**

 

Theimpact of inflation on a financial institution differs significantly from thatexerted on manufacturing, or other commercial concerns, primarily because itsassets and liabilities are largely monetary.  In general, 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 growth of total assets by increasing thelevel of loan demand, and potentially adversely affects capital adequacybecause loan growth in inflationary periods can increase at rates higher thanthe rate capital grows through retention of earnings, which may be generated inthe future.  In addition to its effects on interest rates, inflationincreases overall operating expenses.

 

In an inflationaryenvironment, people tend to reduce overall spending and begin tosave more. But as individuals andbusinesses curtail expenditures in an effort to trim costs; thiscauses the gross domestic product (GDP) to decline.Unemployment rates rise becausecompanies lay off workers to cut costs.  It is these combined factors thatcause the economy to fall into a recession.  The current economic slow down is evidencedby continued negative growth in GDP for the first quarter.

 

**Liquidity**

 

Liquiditymanagement refers to the Company’s ability to provide funds on an ongoing basisto meet fluctuations in deposit levels as well as the credit needs andrequirements of its clients.  Both assets and liabilities contribute tothe Company’s liquidity position.  The line of credit with the Federal ReserveBank, short-term investments and securities, and loan repayments contribute toliquidity, along with deposit increases, while loan funding and depositwithdrawals decrease liquidity.  The Company assesses the likelihood ofprojected funding requirements by reviewing historical funding patterns,current and forecasted economic conditions and individual client funding needs.

 

TheCompany’s sources of liquidity consist of cash and due from correspondentbanks, overnight funds sold to correspondent banks, unpledged marketableinvestments and loans held for sale.  On March 31, 2010, consolidatedliquid assets totaled $59,112,000 or 11.3% of total assets compared to$58,654,000 or 10.9% of total assets on December 31, 2009.  Inaddition to liquid assets, the Bank has a line of credit with the DiscountWindow at the Federal Reserve Bank of San Francisco, on which the currentborrowing capacity is $9,665,000.

 

TheBank also has informal agreements with various other banks to sellparticipations in loans, if necessary.  The Company serves primarily abusiness and professional customer base and, as such, its deposit base issusceptible to economic fluctuations.  Accordingly, management strives tomaintain a balanced position of liquid assets to volatile and cyclicaldeposits.

 

Liquidityis also affected by portfolio maturities and the effect of interest ratefluctuations on the marketability of both assets and liabilities.  TheCompany can sell any of its unpledged securities held in the available-for-salecategory to meet liquidity needs.

 

**Off-Balance Sheet Items**

 

TheCompany has certain ongoing commitments under operating leases.  Thesecommitments do not significantly impact operating results. As of March 31,2010 and December 31, 2009, commitments to extend credit and letters ofcredit were the only financial instruments with off-balance sheet risk. The Company has not entered into any contracts for financial derivativeinstruments such as futures, swaps, options or similar instruments.   Commitments to fund loans and stand-byletters of credit at March 31, 2010 and December 31, 2009 wereapproximately $99,706,000 and $115,277,000, respectively.  Such loansrelate primarily to revolving lines of credit and other commercial loans, andto real estate construction loans.  As apercentage of net loans, these off-balance sheet items represent 24.1% and27.4%, respectively. Of the loan commitments outstanding at March 31,2010, $16,727,000 are real estate construction loan commitments  that are not expected to fund within the nexttwelve months due to the current downturn in the real estate market. Theremaining commitments primarily relate to revolving lines of credit or othercommercial loans, and many of these are expected to expire without being drawnupon. Therefore, the total commitments do not necessarily represent future cashrequirements.

 

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**Other Matters**

 

**Item 4.  Controls andProcedures**

 

(a) DisclosureControls and Procedures: An evaluation of the Company’s disclosure controls andprocedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e))was carried out under the supervision and with the participation of the Company’sChief Executive Officer, Chief Financial Officer and other members of theCompany’s senior management as of the end of the Company’s fiscal quarter endedMarch 31, 2010. The Company’s Chief Executive Officer and Chief FinancialOfficer concluded that the Company’s disclosure controls and procedures ascurrently in effect are effective in ensuring that the information required tobe disclosed by the Company in the reports it files or submits under theExchange Act is (i) accumulated and communicated to the Company’smanagement (including the Chief Executive Officer and Chief Financial Officer)to allow timely decisions regarding required disclosure, and (ii) recorded,processed, summarized and reported within the time periods specified in theCommission’s rules and forms.

 

(b) InternalControl Over Financial Reporting: An evaluation of any changes in the Company’sinternal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and15d-15(f)), that occurred during the Company’s fiscal quarter ended March 31,2010, was carried out under the supervision and with the participation of theCompany’s Chief Executive Officer, Chief Financial Officer and other members ofthe Company’s senior management. The Company’s Chief Executive Officer andChief Financial Officer concluded that no change identified in connection withsuch evaluation has materially affected, or is reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

 

**Item 5.  Not Applicable**

 

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**PART II— OTHER INFORMATION**

 

Item 1.  Legal Proceedings.

 

None.

 

Item 1A. Risk Factors

 

Inaddition to the other information set forth in this report, you shouldcarefully consider the factors discussed in Part I, “Item 1A. Risk Factors”in our Annual Report on Form 10-K for the year ended December 31,2009, which could materially affect our business, financial condition or futureresults. The risks described in our Annual Report on Form 10-K are not theonly risks facing our Company. Additional risks and uncertainties not currentlyknown to us or that we currently deem to be immaterial also may materiallyadversely affect our business, financial condition and/or operating results.

 

Item 2.  Changes in Securities and Use ofProceeds.

 

TheBoard of Directors approved a plan at their March 2007 meeting torepurchase up to $6,000,000 of the outstanding common stock of theCompany.  The plan states that stockrepurchases may be made from time to time on the open market or throughprivately negotiated transactions.   Thetiming of purchases and the exact number of shares to be purchased depends onmarket conditions.  The share repurchaseplan does not include specific price targets or timetables and may be suspendedat any time.

 

Duringthe nine months ended March 31, 2010, no shares of common stock wererepurchased under the share repurchase program. There is approximately $5,671,796remaining that may yet be purchased under the plan.

 

Item3.  Defaults Upon Senior Securities.

 

None.

 

Item 4.  (Removed and Reserved)

 

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. |

 

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**SIGNATURES**

 

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

 

 
|               | COMMUNITY  VALLEY BANCORP |
|--------------------|---------------------------|
|               |                      |
| May 17,  2010 |                      | *By:* | */s/  John F. Coger* |
|               |                      |   |   |
|               |                      |   | John F. Coger |
|               |                      |   |   |
|               |                      |   | President, Chief Executive Officer |
|               |                      |   |   |
| May 17,  2010 |                      | *By:* | */s/  Barbara A. Crouse* |
|               |                      |   |   |
|               |                      |   | Barbara A. Crouse |
|               |                      |   |   |
|               |                      |   | Senior Vice President, CFO |

 

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