**SECURITIES AND EXCHANGE COMMISSION****WASHINGTON, D.C. 20549**

**FORM 10-Q**

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

**For the Quarterly Period Ended June 30, 2006**

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

**COMMUNITY VALLEY BANCORP******(Exact name of registrant as specified in its charter)
| California                                 | ** ** | **0-31525**              | ** ** | **68-0479553**           |
|--------------------------------------------|------------|--------------------------|------------|--------------------------|
| (State or other jurisdiction of            |       | (Commission File Number) |       | (IRS Employer ID Number) |
| incorporation or organization)             |       |                     |       |                     |
|                                       |       |                     |       |                     |
| **2041 Forest Avenue,  Chico, California** | ** ** | **95928**                |
| (Address of principal executive offices)   |       | (Zip code)               |

 

**(530) 899-2344**

(Registrant’s telephone number,

including area code)

**not applicable**

(Former name, former address and former fiscal year, if changed

since last report.)

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirements forthe past 90 days.

Yes  x  No  o

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Exchange Act Rule 12-b-2.
| Large accelerated filer |   | o |   | Accelerated filer |   | x |   | Non-accelerated filer |   | o |
|-------------------------|--------|---|--------|-------------------|--------|---|--------|-----------------------|--------|---|

 

Indicateby check mark whether the registrant is a shell company (as defined in ExchangeAct Rule 12b-2. Yes  o  No  x

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date:

No parvalue Common Stock — 7,450,863 shares outstanding at July 31, 2006.

 

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PART 1-FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

COMMUNITY VALLEY BANCORPCONDENSED CONSOLIDATED BALANCE SHEET(Unaudited)
| **(In thousands except per share data)**                                                                                                | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ASSETS                                                                                                                                                           |       |                    |       |                        |       |
|                                                                                                                                                             |       |                    |       |                        |       |
| Cash and due from banks                                                                                                                                          |       | $                       | 19,255     |                        | $          | 18,988 |   |
| Federal funds sold                                                                                                                                               |       | 18,895                  |       | 29,015                      |       |
| Total cash and cash  equivalents                                                                                                                                 |       | 38,150                  |       | 48,003                      |       |
|                                                                                                                                                             |       |                    |       |                        |       |
| Interest-bearing  deposits in banks                                                                                                                              |       | 3,961                   |       | 6,636                       |       |
| Investment securities  (fair value of $5,170 at June 30, 2006 and $6,640 at December 31, 2005)                                                                   |       | 5,232                   |       | 6,676                       |       |
| Loans held for  sale, at lower of cost or market                                                                                                                 |       | 2,142                   |       | 2,197                       |       |
| Loans, less allowance  for loan losses of $5,184 at June 30, 2006 and $4,716 at December 31, 2005                                                                |       | 437,450                 |       | 401,221                     |       |
|                                                                                                                                                             |       |                    |       |                        |       |
| Premises and equipment,  net                                                                                                                                     |       | 12,519                  |       | 11,221                      |       |
| Accrued interest  receivable and other assets                                                                                                                    |       | 19,200                  |       | 18,823                      |       |
|                                                                                                                                                             |       |                    |       |                        |       |
| Total assets                                                                                                                                                     |       | $                       | 518,654    |                        | $          | 494,777 |   |
|                                                                                                                                                             |       |                    |       |                        |       |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                                                                                       |       |                    |       |                        |       |
|                                                                                                                                                             |       |                    |       |                        |       |
| Deposits:                                                                                                                                                        |       |                    |       |                        |       |
| Non-interest  bearing                                                                                                                                            |       | $                       | 84,477     |                        | $          | 83,336 |   |
| Interest bearing                                                                                                                                                 |       | 371,175                 |       | 350,682                     |       |
| Total deposits                                                                                                                                                   |       | 455,652                 |       | 434,018                     |       |
|                                                                                                                                                             |       |                    |       |                        |       |
| Notes payable                                                                                                                                                    |       | 1,073                   |       | 1,782                       |       |
| Junior subordinated  debentures                                                                                                                                  |       | 8,248                   |       | 8,248                       |       |
| Accrued interest  payable and other liabilities                                                                                                                  |       | 8,828                   |       | 9,174                       |       |
|                                                                                                                                                             |       |                    |       |                        |       |
| Total  liabilities                                                                                                                                               |       | 473,801                 |       | 453,222                     |       |
|                                                                                                                                                             |       |                    |       |                        |       |
| Commitments and  contingencies                                                                                                                                   |       |                    |       |                        |       |
|                                                                                                                                                             |       |                    |       |                        |       |
| Shareholders’ equity:                                                                                                                                       |       |                    |       |                        |       |
| Common stock –  no par value; 20,000,000 shares authorized; outstanding – 7,450,013 shares at  June 30, 2006 and 7,408,047 shares at December 31, 2005 |       | 9,691                   |       | 9,051                       |       |
|                                                                                                                                                             |       |                    |       |                        |       |
| Unallocated ESOP  shares (169,421 shares at June 30, 2006 and 185,051 shares at December 31,  2005, at cost)                                                     |       | (1,434                  | )          | (1,391                      | )          |
|                                                                                                                                                             |       |                    |       |                        |       |
| Retained  earnings                                                                                                                                               |       | 36,636                  |       | 33,908                      |       |
|                                                                                                                                                             |       |                    |       |                        |       |
| Accumulated  other comprehensive loss, net of taxes                                                                                                              |       | (40                     | )          | (13                         | )          |
|                                                                                                                                                             |       |                    |       |                        |       |
| Total  shareholders’ equity                                                                                                                                 |       | 44,853                  |       | 41,555                      |       |
| Total liabilities and  shareholders’ equity                                                                                                                 |       | $                       | 518,654    |                        | $          | 494,777 |   |

 

See Notes toUnaudited Condensed Consolidated Financial Statements

2

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COMMUNITY VALLEYBANCORPCONDENSED CONSOLIDATED STATEMENT OF INCOME(Unaudited)
| ** **                                                         | ** ** | **For the periods ended June 30,** | ** ** |
|--------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                                         | ** ** | **Three months**                                       | ** ** | **Six Months** | ** ** |
| **(In thousands, except per share data)** | ** ** | **2006**                                                    | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Interest income:                                                   |       |                                                        |       |   |   |   |   |   |   |
| Interest and fees on loans                                         |       | $                                                           | 9,848      |   | $ | 7,291 |   | $ | 18,789 |   | $ | 13,979 |   |
| Interest on Federal funds sold                                     |       | 150                                                         |       | 233 |   | 355 |   | 465 |   |
| Interest on deposits in banks                                      |       | 51                                                          |       | 68 |   | 107 |   | 128 |   |
| Interest and dividends on investment securities:                   |       |                                                        |       |   |   |   |   |   |   |
| Taxable                                                            |       | 44                                                          |       | 47 |   | 94 |   | 94 |   |
|                                                               |       |                                                        |       |   |   |   |   |   |   |
| Exempt from Federal income taxes                                   |       | 16                                                          |       | 31 |   | 32 |   | 56 |   |
| Dividends                                                          |       | 8                                                           |       | 7 |   | 8 |   | 7 |   |
| Total interest income                                              |       | 10,117                                                      |       | 7,677 |   | 19,385 |   | 14,729 |   |
|                                                               |       |                                                        |       |   |   |   |   |   |   |
| Interest  expense:                                                 |       |                                                        |       |   |   |   |   |   |   |
| Interest on deposits                                               |       | 2,015                                                       |       | 1,012 |   | 3,554 |   | 2,017 |   |
| Interest on junior subordinated debentures                         |       | 182                                                         |       | 143 |   | 352 |   | 274 |   |
| Interest on note payable                                           |       | 19                                                          |       | 14 |   | 37 |   | 25 |   |
| Total interest expense                                             |       | 2,216                                                       |       | 1,169 |   | 3,943 |   | 2,316 |   |
|                                                               |       |                                                        |       |   |   |   |   |   |   |
| Net interest income before provision for loan losses               |       | 7,901                                                       |       | 6,508 |   | 15,442 |   | 12,413 |   |
|                                                               |       |                                                        |       |   |   |   |   |   |   |
| Provision for  loan losses                                         |       | 225                                                         |       | 225 |   | 450 |   | 450 |   |
| Net interest income after provision for loan losses                |       | 7,676                                                       |       | 6,283 |   | 14,992 |   | 11,963 |   |
|                                                               |       |                                                        |       |   |   |   |   |   |   |
| Non-interest  income                                               |       | 1,878                                                       |       | 1,629 |   | 3,361 |   | 3,265 |   |
|                                                               |       |                                                        |       |   |   |   |   |   |   |
| Non-interest  expenses:                                            |       |                                                        |       |   |   |   |   |   |   |
| Salaries and employee benefits                                     |       | 3,800                                                       |       | 2,788 |   | 7,488 |   | 5,824 |   |
| Occupancy                                                          |       | 322                                                         |       | 277 |   | 639 |   | 558 |   |
| Furniture and equipment                                            |       | 483                                                         |       | 439 |   | 939 |   | 830 |   |
| Other expense                                                      |       | 1,430                                                       |       | 1,430 |   | 2,729 |   | 2,594 |   |
| Total non-interest expense                                         |       | 6,035                                                       |       | 4,934 |   | 11,795 |   | 9,806 |   |
|                                                               |       |                                                        |       |   |   |   |   |   |   |
| Income before provision for income taxes                           |       | 3,519                                                       |       | 2,978 |   | 6,558 |   | 5,422 |   |
|                                                               |       |                                                        |       |   |   |   |   |   |   |
| Provision for  income taxes                                        |       | 1,409                                                       |       | 1,248 |   | 2,699 |   | 2,238 |   |
|                                                               |       |                                                        |       |   |   |   |   |   |   |
| Net income                                                         |       | $                                                           | 2,110      |   | $ | 1,730 |   | $ | 3,859 |   | $ | 3,184 |   |
|                                                               |       |                                                        |       |   |   |   |   |   |   |
| Basic earnings  per share                                          |       | $                                                           | .29        |   | $ | .24 |   | $ | .53 |   | $ | .45 |   |
| Diluted earnings  per share                                        |       | $                                                           | .28        |   | $ | .23 |   | $ | .50 |   | $ | .42 |   |
| Cash dividends per  share                                          |       | $                                                           | .06        |   | $ | .04 |   | $ | .11 |   | $ | .0775 |   |

 

See Notes to Unaudited Condensed ConsolidatedFinancial Statements

3

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COMMUNITY VALLEYBANCORPCONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY(Unaudited)(In thousands except number of shares)
| ** **                                                                 | ** ** | ** **            | ** ** | ** **      | ** ** | ** **   | ** ** | **Accumulated**   | ** ** | ** **             | ** ** | ** **        | ** ** |
|----------------------------------------------------------------------------|------------|-----------------------|------------|-----------------|------------|--------------|------------|-------------------|------------|------------------------|------------|-------------------|------------|
| ** **                                                                 | ** ** | ** **            | ** ** | **Unallocated** | ** ** | ** **   | ** ** | **Other**         | ** ** | ** **             | ** ** | ** **        | ** ** |
| ** **                                                                 | ** ** | **Common Stock** | ** ** | **ESOP**        | ** ** | **Retained** | ** ** | **Comprehensive** | ** ** | **Shareholders’** | ** ** | **Comprehensive** | ** ** |
| ** **                                                                 | ** ** | **Shares**            | ** ** | **Amount**      | ** ** | **Shares**   | ** ** | **Earnings**      | ** ** | **Income (loss)** | ** ** | **Equity**        | ** ** | **Income** | ** ** |
| ** **                                                                 | ** ** | ** **            | ** ** | ** **      | ** ** | ** **   | ** ** | ** **        | ** ** | ** **             | ** ** | ** **        | ** ** | ** ** | ** ** |
| Balance, January  1, 2005                                                  |       | 7,273,582             |       | $               | 7,862      |         | $          | (1,144)           |       | $                      | 27,802     |              | $          | 11 |   | $ | 34,531 |   |   |   |
|                                                                       |       |                  |       |            |       |         |       |              |       |                   |       |              |       |   |   |
| Comprehensive income                                                       |       |                  |       |            |       |         |       |              |       |                   |       |              |       |   |   |
| Net income                                                                 |       |                  |       |            |       |         |       | 7,198             |       |                   |       | 7,198             |       | $ | 7,198 |   |
| Other comprehensive loss, net of taxes                                     |       |                  |       |            |       |         |       |              |       |                   |       |              |       |   |   |
| Net change in unrealized loss on available-for-sale  investment securities |       |                  |       |            |       |         |       |              |       | (24                    | )          | (24               | )          | (24 | ) |
| Total comprehensive income                                                 |       |                  |       |            |       |         |       |              |       |                   |       |              |       | $ | 7,174 |   |
|                                                                       |       |                  |       |            |       |         |       |              |       |                   |       |              |       |   |   |
| Exercise of stock  options and related tax benefit                         |       | 134,465               |       | 1,039           |       |         |       |              |       |                   |       | 1,039             |       |   |   |
| Amortization of  stock compensation – ESOP shares                     |       |                  |       | 150             |       | 101          |       |              |       |                   |       | 251               |       |   |   |
| Shares acquired  or redeemed by ESOP                                       |       |                  |       |            |       | (348         | )          |              |       |                   |       | (348              | )          |   |   |
| Cash dividends-  $.16 per share                                            |       |                  |       |            |       |         |       | (1,092            | )          |                   |       | (1,092            | )          |   |   |
|                                                                       |       |                  |       |            |       |         |       |              |       |                   |       |              |       |   |   |
| Balance, December  31, 2005                                                |       | 7,408,047             |       | 9,051           |       | (1,391       | )          | 33,908            |       | (13                    | )          | 41,555            |       |   |   |
|                                                                       |       |                  |       |            |       |         |       |              |       |                   |       |              |       |   |   |
| Comprehensive  income                                                      |       |                  |       |            |       |         |       |              |       |                   |       |              |       |   |   |
| Net income                                                                 |       |                  |       |            |       |         |       | 3,859             |       |                   |       | 3,859             |       | $ | 3,859 |   |
| Other comprehensive loss, net of taxes:                                    |       |                  |       |            |       |         |       |              |       |                   |       |              |       |   |   |
| Net change in unrealized loss on available-for-sale  investment securities |       |                  |       |            |       |         |       |              |       | (27                    | )          | (27               | )          | (27 | ) |
|                                                                       |       |                  |       |            |       |         |       |              |       |                   |       |              |       |   |   |
| Total comprehensive income                                                 |       |                  |       |            |       |         |       |              |       |                   |       |              |       | $ | 3,832 |   |
| Exercise of stock  options and related tax benefit                         |       | 70,566                |       | 583             |       |         |       |              |       |                   |       | 583               |       |   |   |
| Retirement of  common stock                                                |       | (28,600               | )          | (168            | )          |         |       | (312              | )          |                   |       | (480              | )          |   |   |
| Shares acquired  or redeemed by ESOP                                       |       |                  |       |            |       | (151         | )          |              |       |                   |       | (151              | )          |   |   |
| Amortization of  stock compensation - ESOP shares                          |       |                  |       | 139             |       | 108          |       |              |       |                   |       | 247               |       |   |   |
| Stock-based  compensation expense – stock options                     |       |                  |       | 86              |       |         |       |              |       |                   |       | 86                |       |   |   |
| Cash dividends -  $0.11 per share                                          |       |                  |       |            |       |         |       | (819              | )          |                   |       | (819              | )          |   |   |
|                                                                       |       |                  |       |            |       |         |       |              |       |                   |       |              |       |   |   |
| Balance, June 30, 2006                                                     |       | 7,450,013             |       | $               | 9,691      |         | $          | (1,434            | )          | $                      | 36,636     |              | $          | (40 | ) | $ | 44,853 |   |   |   |

 

SeeNotes to Unaudited Condensed Consolidated Financial Statements

4

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COMMUNITY VALLEY BANCORPCONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS(Unaudited)(In thousands)
| ** **                                                                         | ** ** | **For the six months ended June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2006**                                                            | ** ** | **2005** | ** ** |
| Cash flows from  operating activities:                                             |       |                                                                |       |   |   |
| Net income                                                                         |       | $                                                                   | 3,859      |   | $ | 3,184 |   |
| Adjustments to reconcile net income to net cash provided  by operating activities: |       |                                                                |       |   |   |
| Provision for loan losses                                                          |       | 450                                                                 |       | 450 |   |
| Decrease in deferred loan origination costs, net                                   |       | (99                                                                 | )          | (66 | ) |
| Depreciation, amortization and accretion, net                                      |       | 801                                                                 |       | 736 |   |
| Gain on disposition of premises and equipment                                      |       |                                                                |       | (20 | ) |
| Net increase (decrease) in loans held for sale                                     |       | 55                                                                  |       | (1,955 | ) |
| Increase in cash surrender value of bank-owned life  insurance                     |       | (165                                                                | )          | (146 | ) |
| Non-cash compensation expense associated with the ESOP                             |       | 247                                                                 |       | 91 |   |
| Share based compensation expense associated with stock  options                    |       | 86                                                                  |       |   |   |
| Deferred tax benefit of stock based compensation                                   |       | (313                                                                | )          |   |   |
| Provision for deferred tax benefit                                                 |       | (7                                                                  | )          |   |   |
| Decrease (increase) in accrued interest receivable  and other assets               |       | 139                                                                 |       | (1,170 | ) |
| (Decrease) increase in accrued interest payable and other  liabilities             |       | (470                                                                | )          | 344 |   |
|                                                                               |       |                                                                |       |   |   |
| Net cash provided by operating activities                                          |       | 4,583                                                               |       | 1,447 |   |
|                                                                               |       |                                                                |       |   |   |
| Cash flows from  investing activities:                                             |       |                                                                |       |   |   |
|                                                                               |       |                                                                |       |   |   |
| Decrease in interest-bearing deposits in banks                                     |       | 2,675                                                               |       | 297 |   |
| Purchase of available-for-sale investment securities                               |       |                                                                |       | (999 | ) |
| Proceeds from called available-for-sale investment securities                      |       |                                                                |       | 1,000 |   |
| Proceeds from matured available-for-sale investment securities                     |       | 1,000                                                               |       |   |   |
| Proceeds from principal payments of  available-for-sale investment securities      |       | 12                                                                  |       |   |   |
| Proceeds from called held-to-maturity investment securities                        |       | 246                                                                 |       |   |   |
| Proceeds from matured held-to-maturity investment securities                       |       |                                                                |       | 100 |   |
| Proceeds from principal payments of held-to-maturity  investment securities        |       | 138                                                                 |       | 195 |   |
| Purchase of held-to-maturity investment securities                                 |       |                                                                |       | (995 | ) |
| Purchases of premises and equipment                                                |       | (2,096                                                              | )          | (2,638 | ) |
| Proceeds from sale of premises and equipment                                       |       |                                                                |       | 31 |   |
| Premiums paid for bank owned life insurance                                        |       |                                                                |       | (1,450 | ) |
| Net increase in loans                                                              |       | (36,606                                                             | )          | (46,505 | ) |
| Net cash used in investing activities                                              |       | (34,631                                                             | )          | (50,964 | ) |
|                                                                                    |            |                                                                     |            |  |  |  |  |

5

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| Cash flows from  financing activities:                                    |   |   |    |    |   |
|---------------------------------------------------------------------------|--------|--------|---------|---------|--------|
|                                                                      |   |   |    |    |   |
| Net (decrease) increase in demand, interest-bearing and  savings deposits |   | $      | (23,951 | )       | $      | 14,119 |   |
| Net increase in time deposits                                             |   | 45,585 |    | 1,570   |   |
| Proceeds from note payable                                                |   |   |    | 800     |   |
| Payment of note payable                                                   |   | (800   | )       |    |   |
| Repayments of ESOP note payable                                           |   | (60    | )       | (67     | )      |
| Proceeds from ESOP loan                                                   |   | 151    |    |    |   |
| Payment of cash dividends                                                 |   | (668   | )       | (547    | )      |
| ESOP shares redeemed                                                      |   | (151   | )       |    |   |
| Proceeds from exercise of stock options                                   |   | 257    |    | 324     |   |
| Deferred tax benefit of stock based compensation                          |   | 313    |    |    |   |
| Repurchase of common stock                                                |   | (480   | )       | (348    | )      |
|                                                                      |   |   |    |    |   |
| Net cash provided by financing activities                                 |   | 20,196 |    | 16,199  |   |
|                                                                      |   |   |    |    |   |
| (Decrease) increase in cash and cash equivalents                          |   | (9,853 | )       | (33,318 | )      |
|                                                                      |   |   |    |    |   |
| Cash and cash  equivalents at beginning of year                           |   | 48,003 |    | 68,218  |   |
|                                                                      |   |   |    |    |   |
| Cash and cash  equivalents at end of period                               |   | $      | 38,150  |    | $      | 34,900 |   |

 

See Notes to Unaudited Condensed ConsolidatedFinancial Statements

6

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Community Valley Bancorp

NOTES TO UNAUDITEDCONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OFPRESENTATION

The accompanyingunaudited condensed consolidated financial statements of Community ValleyBancorp and subsidiaries (the “Company”) have been prepared pursuant to therules and regulations of the Securities Exchange Commission (the “SEC”) and theinstructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly,certain information and footnote disclosures required by accounting principles generallyaccepted in the United States of America for annual financial statements arenot included herein. In the opinion of management, all adjustments (whichconsist solely of normal recurring adjustments) considered necessary for a fairpresentation of the results for the interim periods presented have beenincluded. These interim consolidated financial statements should be read inconjunction with the financial statements and related notes contained in theCompany’s 2005 Annual Report to Shareholders on Form 10-K.

The condensedconsolidated financial statements include the accounts of the Company and itswholly owned subsidiaries, Butte Community Bank (the “Bank”) and CVB InsuranceAgency, LLC. The name has subsequently been changed to Butte Community InsuranceAgency LLC.

All significantinter-company balances and transactions have been eliminated in consolidation.The Company has also established a wholly-owned unconsolidated subsidiary,Community Valley Bancorp Trust I (the “Trust”), a Delaware statutory businesstrust, formed for the sole purpose of issuing trust preferred securities. Theresults of operations for the three-month and six-month periods ended June 30,2006 may not necessarily be indicative of the operating results for the fullyear 2006.

Management hasdetermined 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.

The preparation ofconsolidated financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions.  These estimates and assumptions affect the reportedamounts of assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reportingperiod.  Actual results could differ from these estimates.

2. EARNINGS PERSHARE COMPUTATION

Basic earnings pershare are computed by dividing net income by the weighted average common sharesoutstanding for the period (7,279,749 and 7,264,629 shares for the three andsix month periods ended June 30, 2006 and 7,148,463 and 7,129,218 shares forthe three month and six month periods ended June 30, 2005). Diluted earningsper share reflect the potential dilution that could occur if outstanding stockoptions were exercised using the treasury stock method. Diluted earnings pershare is computed by dividing net income by the weighted average common sharesoutstanding for the period plus the dilutive effect of options (386,570 and384,249 shares for the three and six month periods ended June 30, 2006 and457,823 and 464,183 shares for the three and six month periods ended June 30,2005). During the periods covered the Company had no stock options that wereconsidered anti-dilutive.

3. COMPREHENSIVEINCOME

Comprehensiveincome is reported in addition to net income for all periods presented.Comprehensive income is made up of net income plus other comprehensive incomeor loss. The Company’s only source of comprehensive income or loss, iscomprised of 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.

7

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4. STOCK –BASEDCOMPENSATION

The Company issuesstock options under two stock-based compensation plans, the Community ValleyBancorp 1997 and 2000 Stock Option Plans. The plans require that the optionprice may not be less than the fair market value of the stock at the date theoption is granted, and that the stock must be paid in full at the time theoption is exercised. The options expire on a date determined by the Board ofDirectors, but not later than ten years from the date of grant. The vestingperiod is determined by the Board of Directors and is generally over fiveyears; however, nonstatutory options granted during 1997 vested immediately.Under the 1997 plan, 251,240 shares of common stock remain reserved forissuance to employees and directors, and the related options are exercisableuntil their expiration. However, no new options will be granted under theseplans. Under the Company’s 2000 stock option plan, 518,944 shares of commonstock remain reserved for issuance to employees and directors, of which 75,877shares are available for future grants.

On January 1,2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”)No. 123(R), “Share-Based Payment,” which addresses the accounting forstock-based payment transactions. SFAS No. 123(R) eliminates the abilityto account for stock-based compensation transactions using the intrinsic valuemethod under Accounting Principles Board Opinion (“APB”) No. 25, “Accountingfor Stock Issued to Employees,” and instead generally requires that suchtransactions be accounted for using a fair-value based method. The Company haselected the modified prospective transition method as permitted under SFASNo. 123(R), and accordingly prior periods have not been restated toreflect the impact of SFAS No. 123(R). The modified prospective transitionmethod requires that stock-based compensation expense be recorded for all newand unvested stock options that are ultimately expected to vest as therequisite service is rendered beginning on January 1, 2006. Stock-basedcompensation for awards granted prior to January 1, 2006 is based upon thegrant-date fair value of such compensation as determined under the pro formaprovisions of SFAS No. 123, “Accounting for Stock-Based Compensation.” TheCompany issues new shares of common stock upon the exercise of stock options.

The Company uses aBlack-Scholes option valuation model to determine the fair value of stock-basedcompensation under SFAS No. 123(R), consistent with that used for proforma disclosures under SFAS No. 123. The Black-Scholes model incorporatesvarious assumptions including the expected term of awards, volatility of stockprice, risk-free rates of return and dividend yield. The expected term of anaward is generally no less than the option vesting period and is based on theCompany’s historical experience. Expected volatility is based upon thehistorical volatility of the Company’s stock price. The risk-free interest rateis approximated using rates available on U.S. Treasury securities with aremaining term equal to the option’s expected life.

SFAS 123(R)requires the cash flows resulting from the tax benefits resulting from taxdeductions in excess of the compensation cost recognized for those options(excess tax benefits) to be classified as a cash flow from financing in thestatement of cash flows. These excess tax benefits were $313,000 for theCompany.

The Companyrecorded an incremental $43 thousand ($39 thousand after tax) of stock-basedcompensation expense during the three months ended June 30, 2006 and $86thousand ($79 thousand after tax) for the six month period ended June 30, 2006as a result of the adoption of SFAS No. 123(R). As a result, there was nota significant impact on the net income before or after the provision for incometaxes or on the basic or diluted earnings per share. SFAS No. 123(R),*  Share-BasedPayment* , requires the fair value method of accounting for stockoptions whereby compensation expense will be recognized based on the computedfair value of the options on the grant date for stock options granted on orafter the effective date of the standard, January 1, 2006. Certain pro formadisclosures of the expense recognition provisions of Statement No. 123 arerequired for periods prior to implementation of the standard for companies,such as Community Valley Bancorp, which used the intrinsic-value method foraccounting for stock options, and are as follows:
| ** **                                                                                                                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                               | ** ** | **June 30, 2005**      | ** ** | **June 30, 2005**    | ** ** |
| Net earnings as  reported                                                                                                                |       | $                                | 1,730      |                           | $          | 3,184 |   |
|                                                                                                                                     |       |                             |       |                           |       |
| Deduct: Total stock-based compensation expense  determined under the fair value based method for all awards, net of related  tax effects |       | $                                | (89        | )                              | $          | (177 | ) |
|                                                                                                                                     |       |                             |       |                           |       |
| Pro forma net  income                                                                                                                    |       | $                                | 1,641      |                           | $          | 3,007 |   |
|                                                                                                                                     |       |                             |       |                           |       |
| Basic earnings  per share - as reported                                                                                                  |       | $                                | 0.24       |                           | $          | 0.45 |   |
| Basic earnings  per share - pro forma                                                                                                    |       | $                                | 0.23       |                           | $          | 0.42 |   |
|                                                                                                                                     |       |                             |       |                           |       |
| Diluted earnings  per share - as reported                                                                                                |       | $                                | 0.23       |                           | $          | 0.42 |   |
| Diluted earnings per  share - pro forma                                                                                                  |       | $                                | 0.22       |                           | $          | 0.40 |   |

 

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The fair value ofthe options granted during the six month periodended June 30, 2006 and 2005 arenoted below and are based on the following assumptions:
|                                                                 | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                      | ** ** | **June 30, 2006**    | ** ** | **June 30, 2005** | ** ** |
|                                                            |       |                           |       |   |   |
| Expected  Volatility                                            |       | 32.35                          | %          | 29.27 | % |
| Risk-free  interest rate                                        |       | 4.50                           | %          | 4.00 | % |
| Expected Option  Life                                           |       | 7.5 years                      |       | 6.5 years |   |
| Weighted average fair  value of options granted during the year |       | $                              | 3.58       |   | $ | 6.91 |   |
|                                                                 |            |                                |            |  |  |  |  |

 

Stock optionactivity for the six month period ended June 30, 2006 and 2005 is summarized asfollows:
| **2006**                                       | ** ** | **Number of Stock  Options Outstanding** | ** ** | **Exercise Price Range** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Weighted Average  Contractual Life** | ** ** |
|------------------------------------------------|------------|---------------------------------------------------------|------------|------------------------------------|------------|------------------------------------------------|------------|--------------------------------------------------|------------|
|                                           |       |                                                    |       |                               |       |                                           |       |                                             |       |
| Outstanding at  January 1                      |       | 841,950                                                 |       | $2.30 to $14.75                    |       | $                                              | 5.74       |                                             |       |   |
| Exercised                                      |       | (70,566                                                 | )          | $2.23 to $13.25                    |       | $                                              | 3.64       |                                             |       |   |
| Granted                                        |       | 6,000                                                   |       | $15.40                             |       | $                                              | 15.40      |                                             |       |   |
| Cancelled or  expired                          |       | (7,200                                                  | )          | $7.13 to $14.75                    |       | $                                              | 11.36      |                                             |       |   |
|                                           |       |                                                    |       |                               |       |                                           |       |                                             |       |
| Outstanding at  June 30                        |       | 770,184                                                 |       | $2.30 to $15.40                    |       | $                                              | 5.84       |                                             | 5.28 years |   |
| Options vested  or expected to vest at June 30 |       | 755,418                                                 |       | $2.30 to $15.40                    |       | $                                              | 5.76       |                                             | 2.9 years  |   |
| Exercisable at June 30                         |       | 650,632                                                 |       | $2.30 to $15.40                    |       | $                                              | 4.79       |                                             | 5.0 years  |   |

 
| **2005**                  | ** ** | **Number of  Stock Options  Outstanding** | ** ** | **Exercise Price  Range** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|---------------------------|------------|-----------------------------------------------------|------------|--------------------------------|------------|----------------------------------------|------------|
|                      |       |                                                |       |                           |       |                                   |       |
| Outstanding at  January 1 |       | 966,028                                             |       | $1.02 to $13.88                |       | $                                      | 5.22       |   |
| Exercised                 |       | (82,518                                             | )          | $1.02 to $7.50                 |       | $                                      | 3.92       |   |
| Granted                   |       | 20,000                                              |       | $13.25 to $13.75               |       | $                                      | 14.05      |   |
| Cancelled or  expired     |       | (10,000                                             | )          | $13.75                         |       | $                                      | 13.75      |   |
|                      |       |                                                |       |                           |       |                                   |       |
| Outstanding at  June 30   |       | 893,510                                             |       | $2.30 to $13.75                |       | $                                      | 5.46       |   |
| Exercisable at June 30    |       | 780,846                                             |       | $2.30 to $13.75                |       | $                                      | 4.62       |   |

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The total fairvalue of the shares that vested during the quarter and six months ended June30, 2006 was $60,000 and $125,000.  Theaggregate intrinsic value is calculated as the difference between the exerciseprice of the underlying awards and the quoted price of the Company’s commonstock for options that were in-the-money at June 30, 2006. The intrinsic valueof options outstanding, options vested or expected to vest, and exercisablerelating to the above stock option plan was $8.56 million, $8.45 million and$7.9 million, respectively, as of June 30, 2006. During the six months endedJune 30, 2006 and 2005, the aggregate intrinsic value of options exercisedrelating to the above stock option plan was $942,000 and $865,000,respectively.

As required bySFAS 123 (R), management made an estimate of expected forfeitures and isrecognizing compensation costs only for those equity awards expected to vest.Management has estimated the forfeiture rate to be approximately 2% for theremaining non-vested options.

At June 30, 2006,the total compensation cost related to non-vested stock option awards grantedto employees under the Company’s stock option plans but not yet recognized was$398,000 million. Stock option compensation expense is recognized on astraight-line basis over the vesting period of the option. This cost isexpected to be recognized over a weighted average remaining period of 2.5 yearsand will be adjusted for subsequent changes in estimated forfeitures.

5. COMMITMENTS ANDCONTINGENCIES

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

In the normalcourse of business, there are various outstanding commitments to extend creditwhich are not reflected in the financial statements, including loan commitmentsof $201,855,000 and $200,693,000 and stand-by letters of credit of $2,684,000and $4,895,000 at June 30, 2006 and December 31, 2005, respectively.

Of the loancommitments outstanding at June 30, 2006, $127,627,000 are real estateconstruction loan commitments that are expected to fund within the next twelvemonths. The remaining commitments primarily relate to revolving lines of creditor other commercial loans, and many of these are expected to expire withoutbeing drawn upon. Therefore, the total commitments do not necessarily representfuture cash requirements. Each loan commitment and the amount and type ofcollateral obtained, if any, are evaluated on an individual basis. Collateralheld varies, but may include real property, bank deposits, debt or equitysecurities or business assets.

Stand-by lettersof credit are conditional commitments written to guarantee the performance of acustomer to a third party. These guarantees are primarily related to thepurchases of inventory by commercial customers and are typically short-term innature. Credit risk is similar to that involved in extending loan commitmentsto customers and accordingly, evaluation and collateral requirements similar tothose for loan commitments are used. The fair value of the liability related tothese stand-by letters of credit, which represents the fees received forissuing the guarantees, was not significant at June 30, 2006 and December 31,2005. The Company recognizes these fees as revenues over the term of thecommitment or when the commitment is used.

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6. NEW ACCOUNTINGPRONOUNCEMENTS

*Accountingfor Servicing of Financial Assets*

In March 2006, theFinancial Accounting Standards Board (FASB) issued Statement No. 156 (SFAS156),*Accounting for Servicing of FinancialAssets — An Amendment of FASB Statement No. 140.*  SFAS 156 requires that a servicing asset orliability be recognized each time a contract to service a financial asset isentered into, requires that all separately recognized servicing assets andservicing liabilities be initially measured at fair value, if practicable, andpermits the subsequent measurement of servicing assets and servicingliabilities based on the amortization method or the fair value measurementmethod. SFAS 156 also permits a one-time reclassification of available-for-salesecurities to trading securities provided that the available-for-salesecurities are identified in some manner as offsetting the entity’s exposure tochanges in the fair value of servicing assets or servicing liabilities that aservicer elects to are subsequently measured at fair value. SFAS 156 willbecome effective as of the beginning of the first fiscal year that begins afterSeptember 15, 2006. Earlier adoption is permitted at the beginning of an entity’sfiscal year provided the entity has not yet issued financial statements,including interim financial statements, for any period of that fiscal year.

The Company shouldapply the requirements for recognition and initial measurement of servicingassets and servicing liabilities prospectively to all transactions after theeffective date entered into on or after January 1, 2007  SFAS 156 permitsa one-time reclassification of available-for-sale securities to tradingsecurities provided that they are identified in some manner as offsetting theentity’s exposure to changes in fair value of servicing assets or servicingliabilities that a servicer elects to subsequently measure at fair value. Theprovisions of SFAS 156 are effective as of the beginning of the first fiscalyear that begins after September 15, 2006. Management has not completed itsevaluation of the impact that SFAS 156 will have but believes that the effecton the Company’s financial position and results of operations will not bematerial.

*Accountingfor Uncertainty in Income Taxes*

In July 2006, theFASB issued Financial Accounting Standards Interpretation No. 48 (FIN), *Accounting for Uncertainty in Income Taxes. *FIN 48 clarifies the accountingfor uncertainty in income taxes recognized in an enterprise’s financialstatements in accordance with FASB Statement No. 109, *Accountingfor Income Taxes,*Fin 48 prescribes a recognition threshold andmeasurement attributable for the financial statement recognition andmeasurement of a tax position taken or expected to be taken in a taxreturn.  FIN 48 also provides guidance onderecognition, classification, interest and penalties, accounting in interimperiods, disclosures and transitions. FIN 48 is effective for fiscal years beginning after December 15,2006.  Management has not completed itsevaluation of the impact that FIN 48 will have.

**Item2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS OF COMMUNITY VALLEY BANCORP**

The following isCommunity Valley Bancorp’s (the “Company”) management’s discussion and analysisof the significant changes in balance sheet accounts for June 30, 2006 andDecember 31, 2005 and income and expense accounts for the three and six monthperiods ended June 30, 2006 and 2005. The discussion is designed to provide abetter understanding of significant trends related to the Company’s financialcondition, results of operations, liquidity, capital resources and interestrate sensitivity.

In addition to thehistorical information contained herein, this report on Form 10-Q containscertain forward-looking statements. The reader of this report should understandthat all such forward-looking statements are subject to various uncertaintiesand risks that could affect their outcome. The Company’s actual results coulddiffer materially from

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those suggested by suchforward-looking statements. Factors that could cause or contribute to suchdifferences include, but are not limited to, variances in the actual versusprojected growth in assets, return on assets, loan losses, expenses, ratescharged on loans and earned on securities investments, rates paid on deposits,competition effects, fee and other noninterest income earned, general economicconditions, nationally, regionally and in the operating market areas of theCompany and its subsidiaries, changes in the regulatory environment, changes inbusiness conditions and inflation, changes in securities markets, dataprocessing problems, a decline in real estate values in the Company’s marketarea,  the effects of terrorism, including the events of September 11,2001 and thereafter, and the conduct of the war on terrorism by the UnitedStates and its allies, as well as other factors. This entire report should beread putting such forward-looking statements in context.

**GeneralDevelopment of Business**

Community ValleyBancorp (the “Company”) is a financial holding company (“FHC”) registered andauthorized to engage in the activities permitted under the Bank Holding CompanyAct of 1956, as amended. The Company was incorporated under the laws of theState of California in 2002 and elected to change to a FHC in 2004. As afinancial holding company, the Company is subject to the Federal HoldingCompany Act and to supervision by the board of Governors of the Federal ReserveSystem (“FRB”). Its principal office is located at 2041 Forest Avenue, Chico,California 95928 and its telephone number is (530) 899-2344.

The Company owns100% of the issued and outstanding common shares of Butte Community Bank. ButteCommunity Bank was incorporated and commenced business in Paradise andOroville, California in 1990. Butte Community Bank operates thirteen fullservice offices within its service areas of Butte, Sutter, Yuba, Tehama,Shasta, and Colusa Counties. The Bank also maintains Loan Production Offices inCitrus Heights and Gridley. 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.

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

On December 1,2004, the Company formed a wholly-owned subsidiary, CVB Insurance Agency LLCfor the purpose of providing insurance related services.  The name has subsequently been changed toButte Community Insurance Agency LLC.

**CriticalAccounting Policies**

*General*

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

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*Allowancefor Loan Losses (ALL)*

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

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

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

*LoanSales and Servicing*

The Companyoriginates government guaranteed loans and mortgage loans that may be sold inthe secondary market.  The amounts of gains recorded on sales of loans andthe initial recording of servicing assets and interest only (I/O) strips isbased on the estimated fair values of the respective components.  Inrecording the initial value of the servicing assets and the fair value of theI/O strips receivable, the Company uses estimates which are based on management’sexpectations of future prepayments and discount rates.  Servicing assetsare amortized over the estimated life of the related loan.  I/O strips arenot significant at June 30, 2006.  These prepayment and discount rateswere based on current market conditions and historical performance of thevarious pools of serviced loans.  If actual prepayments with respect tosold loans occur more quickly than projected the carrying value of theservicing assets may have to be adjusted through a charge to earnings.

*Stock-BasedCompensation*

On January 1,2006, the Company adopted Statement of Financial Accounting Standards No.123(R),*Share Based Payment*  (“SFAS 123(R)”) using the modifiedprospective transition method. Prior periods have not been restated to reflectthe impact of SFAS No. 123(R). Prior to adoption of this statement, the Companyaccounted for its share-based employee compensation plans under the recognitionand measurement provisions of APB Opinion No. 25, Accounting

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*forStock-Based Compensation* and no stock-based compensation expense was recorded*.* As a result of adopting this statement the Company will recognizestock-based compensation expense for all preexisting non-vested stock optionsand all new stock option grants that are expected to vest as the requisiteservice is rendered. See Note 4 to the Condensed Consolidated FinancialStatements for additional information related to implementation of SFAS 123(R).

*Revenuerecognition*

The Company’sprimary source of revenue is interest income, which is the difference betweenthe interest income it receives on interest-earning assets and the interestexpense it pays on interest-bearing liabilities, and (ii) fee income,which includes fees earned on deposit services, income from SBA lending,electronic-based cash management services, mortgage brokerage fee income andmerchant credit card processing services. Interest income is recorded on anaccrual basis. Note 1 to the Consolidated Financial Statements in the Company’s2005 Annual Report to Shareholders on Form 10-K offers an explanation of theprocess for determining when the accrual of interest income is discontinued onan impaired loan.

**Overview**

The Companyrecorded net income of $2,110,000 for the quarter ended June 30, 2006, whichwas a 22% increase from the $1,730,000 reported for the same period of 2005.Diluted earnings per share for the second quarter of 2006 were $0.28, comparedto the $0.23 recorded in the second quarter of 2005. The annualized return onaverage equity (ROAE) and annualized return on average assets (ROAA) for thesecond quarter of 2006 were 19.03% and 1.64%, respectively, as compared to18.65% and 1.49%, respectively, for the same period in 2005. The primary reasonfor the increase in net income was due to significant growth in average earningassets and the increase in the net interest margin, as a result of the positiveeffect of the rising interest rate environment. These increases were offset byhigher interest expense from growth in the levels of the average interestbearing deposit balances and increases in the rates paid, and increases innon-interest expenses, primarily in salaries and benefits.

Net income for thesix months ended June 30, 2006 was $3,859,000 which was a 21% increase from the$3,184,000 reported for the same period of 2005. Diluted earnings per share forthe six months ended June 30, 2006 were $0.50, compared to the $0.42 recordedfor the same period 2005. The annualized return on average equity (ROAE) andannualized return on average assets (ROAA) for the six months ended 2006 were17.85% and 1.53%, respectively, as compared to 17.27% and 1.39%, respectively,for the same period in 2005. The primary reasons for the increase in net incomefor the six month period is consistent with increases discussed above for thesecond quarter.

Total assets ofthe Company increased by $23,877,000 4.8% from $494,777,000 at December 31,2005 to $518,654,000 at June 30, 2006. Net loans increased to $439,531,000, up$36,113,000, 8.9% from the ending balances on December 31, 2005. Depositbalances at June 30, 2006 increased to $455,652,000 up $20,634,000, 5.0% fromDecember 31, 2005.

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

**Table One:  Components of Net Income**
| ** **                                                              | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                              | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| **(In thousands, except percentages)**                   | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net interest  income                                                    |       | $                                | 7,901      |                           | $          | 6,508 |   | $ | 15,442 |   | $ | 12,413 |   |
| Provision for  loan losses                                              |       | (225                             | )          | (225                           | )          | (450 | ) | (450 | ) |
| Non-interest  income                                                    |       | 1,878                            |       | 1,629                          |       | 3,361 |   | 3,265 |   |
| Non-interest  expenses                                                  |       | (6,035                           | )          | (4,934                         | )          | (11,795 | ) | (9,806 | ) |
| Provision for  income taxes                                             |       | (1,409                           | )          | (1,248                         | )          | (2,699 | ) | (2,238 | ) |
|                                                                    |       |                             |       |                           |       |   |   |   |   |
| Net income                                                              |       | $                                | 2,110      |                           | $          | 1,730 |   | $ | 3,859 |   | $ | 3,184 |   |
|                                                                    |       |                             |       |                           |       |   |   |   |   |
| Average total  assets (In millions)                                     |       | $                                | 516.0      |                           | $          | 466.0 |   | $ | 507.2 |   | $ | 457.9 |   |
| Net income (annualized)  as a percentage of average total assets (ROAA) |       | 1.64                             | %          | 1.49                           | %          | 1.53 | % | 1.40 | % |

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**Resultsof Operations**

**NetInterest Income and Net Interest Margin**

Net interestincome represents the excess of interest and fees earned on interest earningassets (loans, securities, federal funds sold and investments in time deposits)over the interest paid on deposits and borrowed funds.  Net interestmargin is net interest income expressed as a percentage of average earningassets.

The Company’s netinterest margin was 6.79% for the three months ended June 30, 2006 and 6.76%for the six month period ending June 30, 2005 compared to 6.18% and 6.06% forthe same periods in the prior year.  Netinterest income increased $1,393,000 (21.4%) for the second quarter of 2006compared to the same period in 2005.  Net interest income increased$3,029,000 (24.4%) for the six months ended June 30, 2006 over the same periodin 2005.  The primary reason for thisincrease was the growth in average loans of $69,875,000 and $47,385,000 for thesecond quarter and first six months of 2006 over the same periods in 2005 andincreases in loan fees attributable to the growth in loans.

The averagebalances of interest bearing liabilities of $379,950,000 were $52,362,000 (16%)higher in the second quarter of 2006 versus the same quarter in 2005.  Asinterest bearing balances increased, rates paid on these liabilities increasedby 91 basis points on a quarter over quarter basis.  As a result, interestexpense was $1,047,000 (89.6%) higher in the second quarter versus the sameperiod in 2005.  The average balances ofinterest bearing liabilities were $36,858,000 (11.3%) higher in the six-monthperiod ended June 30, 2006 versus the same period in 2005.  Rates paid on interest bearing liabilitiesincreased 75 basis points compared to the six month period ended June 30, 2005.

Table Two,Analysis of Net Interest Margin, sets forth the average daily balances for themajor 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.

Table Three,Analysis of Volume and Rate changes on Net Interest Income, analyzes thechanges in net interest income for the three and six month periods ended June30, 2006 compared to June 30, 2005 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.

For example, TableTwo shows that interest income from loans for the three months ended June 30,2006 increased by $2,557,000 from $7,291,000 at June 30, 2005 to$9,848,000.  The average balance of loansincreased from $373,520,000 to $443,395,000 and the interest rate earned increasedfrom 7.83% to 8.91%.  Table Three showsthe $2,557,000 increase in interest income from loans was actually the resultof a $1,364,000 increase in interest income from the larger balance of loansand $1,193,000 from the increase in interest rates in the second quarter of2006 compared to the same period in 2005.

A shift in therelative size of the major balance sheet categories has an impact on netinterest 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 rates paid on loans.  However, changing the asset mix in this waycomes at the price of additional risks that must 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.

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**TableTwo:  Analysis of Net Interest Margin**

 
| ** **                                            | ** ** | **Three Months Ended June 30,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                            | ** ** | **2006**                        | ** ** | **2005** | ** ** |
| **(In thousands, except percentages)** | ** ** | **Avg Balance**            | ** ** | **Interest** | ** ** | **Yield  (4)** | ** ** | **Avg  Balance** | ** ** | **Interest** | ** ** | **Yield (4)** | ** ** |
| Earning assets:                                       |       |                            |       |   |   |   |   |   |   |   |   |   |   |
|  Loans (1)                                       |       | $                               | 443,395    |   | $ | 9,848 |   | 8.91 | % | $ | 373,520 |   | $ | 7,291 |   | 7.83 | % |
|  Taxable investment securities                   |       | 4,715                           |       | 52 |   | 4.42 | % | 5,779 |   | 54 |   | 3.75 | % |
|  Tax exempt investment securities (2)            |       | 1,378                           |       | 16 |   | 4.71 | % | 2,430 |   | 31 |   | 5.12 | % |
|  Federal funds sold                              |       | 12,835                          |       | 150 |   | 4.70 | % | 32,112 |   | 233 |   | 2.91 | % |
|  Interest bearing deposits in banks              |       | 4,554                           |       | 51 |   | 4.46 | % | 8,701 |   | 68 |   | 3.13 | % |
| Total earning  assets                                 |       | 466,877                         |       | $ | 10,117 |   | 8.69 | % | 422,542 |   | $ | 7,677 |   | 7.29 | % |
|                                                  |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Cash and due  from banks                              |       | 17,141                          |       |   |   |   |   | 24,688 |   |   |   |   |   |
| Other assets                                          |       | 32,225                          |       |   |   |   |   | 18,770 |   |   |   |   |   |
|                                                  |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Average total  assets                                 |       | $                               | 516,243    |   |   |   |   |   | $ | 466,001 |   |   |   |   |   |
|                                                  |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |
|  NOW & MMDA                                  |       | $                               | 174,242    |   | 437 |   | 1.01 | % | $ | 181,326 |   | $ | 266 |   | 0.59 | % |
|  Savings                                         |       | 35,511                          |       | 44 |   | 0.50 | % | 36,611 |   | 44 |   | 0.48 | % |
|  Time deposits                                   |       | 160,915                         |       | 1,534 |   | 3.82 | % | 100,359 |   | 702 |   | 2.81 | % |
|  Other borrowings                                |       | 9,282                           |       | 201 |   | 8.69 | % | 9,292 |   | 157 |   | 6.78 | % |
| Total interest  bearing liabilities                   |       | 379,950                         |       | 2,216 |   | 2.34 | % | 327,588 |   | 1,169 |   | 1.43 | % |
|                                                  |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                       |       | 82,659                          |       |   |   |   |   | 92,691 |   |   |   |   |   |
| Other  liabilities                                    |       | 9,167                           |       |   |   |   |   | 8,474 |   |   |   |   |   |
| Total  liabilities                                    |       | 471,776                         |       |   |   |   |   | 428,753 |   |   |   |   |   |
| Shareholders’  equity                            |       | 44,467                          |       |   |   |   |   | 37,248 |   |   |   |   |   |
| Average  liabilities & equity                     |       | $                               | 516,243    |   |   |   |   |   | $ | 466,001 |   |   |   |   |   |
|  Net interest income & margin (3)            |       |                            |       | $ | 7,901 |   | 6.79 | % |   |   | $ | 6,508 |   | 6.18 | % |

 

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(1)             Loaninterest includes loan fees of $628,000 and $610,000 during the three monthsended June 30, 2006 and June 30, 2005, respectively.

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

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

(4)             Averageyield is calculated based on actual days in quarter (91 for June 30, 2006 and91 for June 30, 2005) and annualized to actual days in year (365 for 2006 and2005).

16

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| ** **                                            | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                            | ** ** | **2006**                      | ** ** | **2005** | ** ** |
| **(In thousands, except percentages)** | ** ** | **Avg Balance**          | ** ** | **Interest** | ** ** | **Yield (4)** | ** ** | **Avg  Balance** | ** ** | **Interest** | ** ** | **Yield (4)** | ** ** |
| Earning assets:                                       |       |                          |       |   |   |   |   |   |   |   |   |   |   |
|  Loans (1)                                       |       | $                             | 434,418    |   | $ | 18,789 |   | 8.72 | % | $ | 360,762 |   | $ | 13,979 |   | 7.81 | % |
|  Taxable  investment securities                  |       | 4,987                         |       | 102 |   | 4.12 | % | 5,913 |   | 101 |   | 3.44 | % |
|  Tax exempt  investment securities (2)           |       | 1,379                         |       | 32 |   | 4.71 | % | 2,236 |   | 56 |   | 5.05 | % |
|  Federal funds  sold                             |       | 15,808                        |       | 355 |   | 4.53 | % | 35,091 |   | 465 |   | 2.67 | % |
|  Interest  bearing deposits in banks             |       | 5,298                         |       | 107 |   | 4.06 | % | 8,741 |   | 128 |   | 2.95 | % |
| Total earning assets                                  |       | 461,890                       |       | $ | 19,385 |   | 8.46 | % | 412,743 |   | $ | 14,729 |   | 7.20 | % |
|                                                  |       |                          |       |   |   |   |   |   |   |   |   |   |   |
| Cash and due from banks                               |       | 16,639                        |       |   |   |   |   | 18,720 |   |   |   |   |   |
| Other assets                                          |       | 28,695                        |       |   |   |   |   | 26,424 |   |   |   |   |   |
|                                                  |       |                          |       |   |   |   |   |   |   |   |   |   |   |
| Average total assets                                  |       | $                             | 507,224    |   |   |   |   |   | $ | 457,887 |   |   |   |   |   |
|                                                  |       |                          |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                         |       |                          |       |   |   |   |   |   |   |   |   |   |   |
|  NOW &  MMDA                                 |       | $                             | 182,925    |   | $ | 862 |   | 0.95 | % | $ | 181,114 |   | $ | 536 |   | 0.60 | % |
|  Savings                                         |       | 32,367                        |       | 88 |   | 0.55 | % | 35,620 |   | 86 |   | 0.49 | % |
|  Time deposits                                   |       | 139,532                       |       | 2,604 |   | 3.76 | % | 101,304 |   | 1,395 |   | 2.78 | % |
|  Other  borrowings                               |       | 9,247                         |       | 389 |   | 8.48 | % | 9,175 |   | 299 |   | 6.57 | % |
| Total interest bearing liabilities                    |       | 364,071                       |       | $ | 3,943 |   | 2.18 | % | 327,213 |   | $ | 2,316 |   | 1.43 | % |
|                                                  |       |                          |       |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                       |       | 88,448                        |       |   |   |   |   | 87,178 |   |   |   |   |   |
| Other liabilities                                     |       | 11,118                        |       |   |   |   |   | 7,125 |   |   |   |   |   |
| Total liabilities                                     |       | 463,637                       |       |   |   |   |   | 421,516 |   |   |   |   |   |
| Shareholders’ equity                             |       | 43,587                        |       |   |   |   |   | 36,371 |   |   |   |   |   |
| Average liabilities & equity                      |       | $                             | 507,224    |   |   |   |   |   | $ | 457,887 |   |   |   |   |   |
|  Net interest income & margin (3)            |       |                          |       | $ | 15,442 |   | 6.76 | % |   |   | $ | 12,413 |   | 6.06 | % |

 

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(1)             Loaninterest includes loan fees of $1,245,000 and $1,226,000 during the six monthsended June 30, 2006 and June 30, 2005, respectively.

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

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

(4)             Averageyield is calculated based on actual days in quarter (181 for June 30, 2006 andJune 30, 2005) and annualized to actual days in year (365 for 2006 and 2005).

Table Three setsforth a summary of the changes in interest income and interest expense fromchanges in average asset and liability balances (volume) and changes in averageinterest rates.  On a quarter over quarter basis for the period endingJune 30, 2006 net interest income has increased $1,392,000 over the same timeperiod in 2005.  Interest income from earning assets has increased by$2,441,000. Changes in the volume of earning assets, primarily loans, have resultedin an increase in interest income of $1,169,000 while interest income fromchanges in rates has increased by $1,272,000.  Interest expense frominterest bearing liabilities has increased by $1,049,000.  Changes in the volume of interest bearingliabilities, primarily the increase in balances of time deposits, has resultedin a net increase of interest expense of $413,000.  Increases in average rates paid, primarilytime deposits and interest bearing checking accounts have resulted in aninterest expense increase of $636,000.

17

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On a year-to-datebasis through June 30, 2006, net interest income has increased $3,030,000 overthe total at June 30, 2005.  Interestincome from earning assets has increased by $4,656,000.  Changes in the volume of earning assets,primarily loans, have resulted in an increase in interest income of $2,511,000while interest income from changes in rates has increased by $2,145,000.   Interest expense for the six month periodending June 30, 2006 was $1,627,000 more than the total at June 30, 2005.  Changes in the volume of interest bearingliabilities, primarily the increase in balances of time deposits, have resultedin a net increase of interest expense of $525,000.  Increases in average rates paid, primarily ontime deposits and interest bearing checking accounts have resulted in aninterest expense increase of $1,102,000.

**TableThree:  Analysis of Volume and Rate Changes on Net Interest Income andExpenses**

 
| **(In thousands) Three Months Ended June 30,  2006 over 2005  Increase (decrease) due to change in:** | ** ** | **Volume** | ** ** | **Rate (3)** | ** ** | **Net**    | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|------------|------------|-------------------|------------|------------|------------|
| **Interest-earning assets:**                                                                          | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** |
| Net loans (1)                                                                                         |       | $          | 1,364      |              | $          | 1,193      |       | $ | 2,557 |   |
| Taxable investment securities                                                                         |       | (10        | )          | 8                 |       | (2         | )          |
| Tax exempt investment securities (2)                                                                  |       | (14        | )          | (1                | )          | (15        | ))         |
| Federal funds sold                                                                                    |       | (140       | )          | 57                |       | (83        | )          |
| Interest bearing deposits in banks                                                                    |       | (32        | )          | 15                |       | (17        | )          |
| Total                                                                                                 |       | 1,168      |       | 1,272             |       | 2,440      |       |
|                                                                                                  |       |       |       |              |       |       |       |
| Interest-bearing liabilities:                                                                         |       |       |       |              |       |       |       |
| NOW and MMDA deposits                                                                                 |       | (10        | )          | 181               |       | 171        |       |
| Savings deposits                                                                                      |       | (1         | )          | 1                 |       | 0          |       |
| Time deposits                                                                                         |       | 424        |       | 408               |       | 832        |       |
| Other borrowings                                                                                      |       | 0          |       | 44                |       | 44         |       |
| Total                                                                                                 |       | 413        |       | 634               |       | 1,047      |       |
| Interest differential                                                                                 |       | $          | 756        |              | $          | 638        |       | $ | 1,393 |   |

 

----

(1)             Theaverage balance of non-accruing loans is not significant as a percentage oftotal loans and, as such, has been included in net loans.

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

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

 
| **(In thousands) Six Months Ended June 30, 2006  over 2005  Increase (decrease) due to change in:** | ** ** | **Volume** | ** ** | **Rate (3)** | ** ** | **Net**    | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------|------------|-------------------|------------|------------|------------|
| **Interest-earning assets:**                                                                        | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** |
| Net loans (1)                                                                                       |       | $          | 2,854      |              | $          | 1,956      |       | $ | 4,810 |   |
| Taxable  investment securities                                                                      |       | (16        | )          | 17                |       | 1          |       |
| Tax exempt  investment securities (2)                                                               |       | (13        | )          | (3                | )          | (24        | )          |
| Federal funds  sold                                                                                 |       | (140       | )          | 146               |       | (110       | )          |
| Interest bearing  deposits in banks                                                                 |       | (32        | )          | 29                |       | (21        | )          |
| Total                                                                                               |       | 2,511      |       | 2,145             |       | 4,656      |       |
|                                                                                                |       |       |       |              |       |       |       |
| Interest-bearing liabilities:                                                                       |       |       |       |              |       |       |       |
| NOW and MMDA  deposits                                                                              |       | 5          |       | 321               |       | 326        |       |
| Savings deposits                                                                                    |       | (8         | )          | 10                |       | 2          |       |
| Time deposits                                                                                       |       | 526        |       | 683               |       | 1,209      |       |
| Other borrowings                                                                                    |       | 2          |       | 88                |       | 90         |       |
| Total                                                                                               |       | 525        |       | 1,102             |       | 1,627      |       |
| Interest  differential                                                                              |       | $          | 1,986      |              | $          | 1,043      |       | $ | 3,029 |   |

 

18

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**Non-interest Income**

Table Four belowprovides a summary of the components of non-interest income for the periodsindicated (dollars in thousands):

**Table Four:  Components ofNon-interest Income**

Three Months Ended June 30, 
|                                      | ** ** | **2006** | ** ** | **% of Avg. Assets** | ** ** | **2005** | ** ** | **% of Avg. Assets** | ** ** |
|--------------------------------------|------------|----------|------------|-------------------------------------|------------|----------|------------|-------------------------------------|------------|
|                                 |       |     |       |                                |       |     |       |                                |       |
| Service charges  on deposit accounts |       | 679      |       | 0.53                                |       | 604      |       | 0.52                                |       |
| Loan servicing  fees                 |       | 107      |       | 0.08                                |       | 104      |       | 0.09                                |       |
| Fees -  alternative investment sales |       | 86       |       | 0.07                                |       | 176      |       | 0.15                                |       |
| Merchant fee  income                 |       | 99       |       | 0.08                                |       | 108      |       | 0.09                                |       |
| Gain on the sale  of loans           |       | 576      |       | 0.45                                |       | 341      |       | 0.29                                |       |
| Other                                |       | 331      |       | 0.25                                |       | 296      |       | 0.25                                |       |
| Total  non-interest income           |       | 1,878    |       | 1.46                                |       | 1,629    |       | 1.39                                |       |

 

Six Months Ended June 30,
|                                      | ** ** | **2006** | ** ** | **% of Avg. Assets** | ** ** | **2005** | ** ** | **% of Avg. Assets** | ** ** |
|--------------------------------------|------------|----------|------------|-------------------------------------|------------|----------|------------|-------------------------------------|------------|
|                                 |       |     |       |                                |       |     |       |                                |       |
| Service charges  on deposit accounts |       | 1,257    |       | 0.50                                |       | 1,143    |       | 0.50                                |       |
| Loan servicing  fees                 |       | 211      |       | 0.08                                |       | 200      |       | 0.09                                |       |
| Fees -  alternative investment sales |       | 155      |       | 0.06                                |       | 335      |       | 0.15                                |       |
| Merchant fee  income                 |       | 187      |       | 0.07                                |       | 186      |       | 0.08                                |       |
| Gain on the sale  of loans           |       | 932      |       | 0.37                                |       | 814      |       | 0.36                                |       |
| Other                                |       | 619      |       | 0.24                                |       | 587      |       | 0.26                                |       |
| Total  non-interest income           |       | 3,361    |       | 1.32                                |       | 3,265    |       | 1.44                                |       |

 

Non-interestincome increased by $249,000 (15.3%) to $1,878,000 for the three months endedJune 30, 2006 as compared to $1,629,000 for the three months ended June 30,2005.  Increases in non-interest income were realized in fees from servicecharges (up 12.4%), loan servicing fees (up 2.9%), gains on the sale of loans(up 68.9%) and other income (up 11.8%). Decreases were in fees from alternative investment sales (down 104.7%)and merchant fee income (down 9.1%) for the three months ended June 30, 2006 ascompared to June 30, 2005.  The increase in service charge income was theresult of additional deposit accounts opened during the second quarterthroughout our system of branches.  Loan servicing fees increased as thevolume of loans sold in the secondary market for which the Company retainsservicing rights increased slightly. Gains on sales of loans into thesecondary market increased compared to the prior year as the loans sold by ourGovernment and Mortgage Lending Divisions were of greater total value.  The Alternative Investment Department, whichsells third-party mutual funds and annuities, experienced a decrease in feesdue to a decline in sales during the second quarter.  Merchant fee incomewas down due to a lower volume of credit card sales.

Non-interestincome increased by $96,000 (2.9%) to $3,361,000 for the six months ended June30, 2006 as compared to $3,265,000 for the six months ended June 30,2005.  Increases in non-interest income were realized in fees from servicecharges (up 10%), loan servicing fees (up 5.5%), merchant fee income (up .5%),gains on the sale of loans (up 14.5%) and other income (up 4.8%).    There was a decrease in fees fromalternative investment sales (down 116.1%), The increase in service charge incomewas the result of additional deposit accounts opened during the first half ofthe year throughout our system of branches.  Loan servicing fees increasedas the volume of loans sold in the secondary market for which the Companyretains servicing rights increased slightly.  Gains on sales of loans intothe secondary market increased during the first half of 2006 as compared to thesame period in 2005 as the loans sold by our Government and Mortgage LendingDivisions were of greater total value generating more income.  Alternative investment fee income was lessthan the same time period in 2005 due to fewer sales of mutual funds andannuities.

19

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**Non-interestExpense**

Non-interestexpense increased $1,101,000 (22.3%) from $4,934,000 in the second quarter of2005 to $6,035,000 in the second quarter of 2006.  Salary and employeebenefits increased $1,012,000 (36.3%) resulting from normal cost of livingraises, commissions paid to Butte Community Bank’s Real Estate Loan agents andstaffing additions made during the year as the Company continues to grow. On a quarter over quarter basis, full time equivalent employees increased by 7to 246 (2.9%).  Benefit costs and employer taxes increased commensuratewith the salaries.  On a quarter over quarter basis, occupancy expenseswere higher by $45,000 (16.2%).  This increase in costs is associated withbuilding leases, utilities, janitorial services and property taxes. Furniture and equipment expense was $483,000 in the second quarter of 2006compared to $439,000 in the same period of 2005, representing a 10% increase. This increase relates to the depreciation recorded on the purchase of newtechnology software and hardware. Other expenses in the second quarter of 2006were consistent with the second quarter of 2005.

Non-interestexpense increased $1,989,000 (20.3%) from $9,806,000 in the first six months of2005 to $11,795,000 in the first six months of 2006.  Salaries and benefits increased by $1,664,000(28.6%) due to cost of living raises added benefit costs and employer taxesassociated with the staffing additions made during the year as the Companycontinues to grow.  On a year over yearbasis, full time equivalent employees increased by 20 to 246.  Occupancy expense was up $81,000 (14.5%) fromthe first six months of 2005 to the first six months of 2006 due to increasesin utilities, landscape maintenance, janitorial services and property taxes.Furniture and equipment expense was up $109,000 (13.1%) from the first sixmonths of 2005 to the first six months of 2006 due to increases in depreciationfrom purchases of equipment and associated maintenance contracts.  Other expenses increased by $135,000(5.2%).  This increase was attributableto higher telephone, postage and insurance costs as well as increasedadvertising and promotion costs.

**Provisionfor Loan Losses**

The Companyprovided $225,000 for loan losses for the second quarter of 2006 and2005.  Net loan charge-offs for the second quarter of 2006 were $9,000.Net charge-offs for the period ended June 30, 2005 were $5,000.  For the first six months of 2006, the Companymade provisions for loan losses of $450,000 which was the same amount as theprovision for the first six months of 2005. Net loan charge-offs for the six months ended June 30, 2006 were $9,000as compared to $6,000 for the six months ended June 30, 2005.   Management assesses its loan quality on amonthly basis to maintain an adequate allowance for loan losses.  TheCompany’s loan portfolio composition, non-performing assets and allowance forloan losses are further discussed under the Balance Sheet Analysis sectionbelow.

**Provisionfor Income Taxes**

The effective taxrate for the second quarter and first six months of 2006 remained fairlyconsistent at 40.0% and 41.2%, versus 41.9% and 41.3% for the same periods in 2005.

**BalanceSheet Analysis**

The Company’stotal assets were $518,654,000 at June 30, 2006 up $23,877,000 (4.8%) from$494,777,000 at December 31, 2005.  On a year over year basis, the averagebalance of total assets for the six months ended June 30, 2006 was$507,224,000, which represents an increase of $49,337,000 (10.8%) over the$457,887,000 during the six-month period ended June 30, 2005.

**Loans**

The Companyconcentrates its lending activities in the following principal 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.  At June 30,2006, these principal areas accounted for approximately 15%, 43%, 26%, 7% and9%, respectively, of the Company’s loan portfolio.  The mix at December31, 2005 was 15%, 43%, 27%, 6% and 9%.  Continuing strong economicactivity in the Company’s market area, new borrowers developed through theCompany’s marketing efforts and credit lines expanded to existing borrowers,offset by normal loan pay-downs and payoffs, resulted in net increases in loanbalances from December 31, 2005 for commercial loans of $4,249,000 or (6.9%),commercial and 

20

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residential mortgage realestate loans of $16,107,000 or (9.3%) real estate construction loans of$6,157,000 or (5.5%), consumer loans of $5,650,000 or (15.5%), and agriculturalloans of $4,734,000 or (19.1%).  Table Five below summarizes thecomposition of the loan portfolio as of June 30, 2006 and December 31, 2005.

**TableFive: Loan Portfolio Composition**
|                           | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------|------------|-------------------|------------|-----------------------|------------|
| **(In thousands)**   | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| Commercial                |       | 65,411            |       | 61,162                |       |
| Real estate:              |       |              |       |                  |       |
| Mortgage                  |       | 189,257           |       | 173,449               |       |
| Construction              |       | 117,287           |       | 111,130               |       |
|                      |       |              |       |                  |       |
| Agriculture               |       | 29,537            |       | 24,803                |       |
| Consumer                  |       | 42,151            |       | 36,501                |       |
| Total loans               |       | 443,643           |       | 407,045               |       |
| Allowance for loan losses |       | (5,184            | )          | (4,716                | )          |
| Deferred loan fees, net   |       | (1,009            | )          | (1,108                | )          |
| Total net loans           |       | 437,450           |       | 401,221               |       |

 

The majority ofthe 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.

Commercial loansconsist of credit lines for operating needs, loans for equipment purchases,working capital, and various other business loan products.  Consumer loansinclude a range of traditional consumer loan products such as personal lines ofcredit and loans to finance purchases of autos, boats, recreational vehicles,mobile homes and various other consumer items.

Real estateconstruction loans are generally composed of commitments to customers withinthe Company’s service area for construction of both commercial properties andcustom and semi-custom single-family residences.  Other real estate loansconsist primarily of loans secured by first trust deeds on commercial andresidential properties typically with maturities from 3 to 10 years andoriginal loan to value ratios generally from 65% to 80%.  Agricultureloans consist primarily of crop loans to farmers of peaches, prunes, walnuts,and almonds.  In general, except in the case of loans with SBA or FMHAguarantees, the Company does not make long-term mortgage loans; however, ButteCommunity Bank has a residential lending division to assist customers insecuring most forms of longer term single-family mortgage financing.

**RiskElements**

The Companyassesses and manages credit risk on an ongoing basis through a total creditculture that emphasizes excellent credit quality, extensive internal monitoringand established formal lending policies.  Additionally, the Companycontracts with an outside loan review consultant to periodically review theexisting loan portfolio.  Management believes its ability to identify andassess risk and return characteristics of the Company’s loan portfolio iscritical for profitability and growth.  Management strives to continue itsemphasis on credit quality in the loan approval process, active credit administrationand regular monitoring.  With this in mind, management has designed andimplemented a comprehensive loan review and grading system that functions tocontinually assess the credit risk inherent in the loan portfolio.

Ultimately,underlying trends in economic and business cycles may 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.

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Special emphasisis placed within the communities in which the Company has offices (Chico,Paradise, Magalia, Oroville, Yuba City, Red Bluff, Marysville, Colusa, Corningand Redding).  The Company also maintains loan production offices in thecities of Citrus Heights and Gridley.  Single-family residentialconstruction is the primary lending product from the Citrus Heights locationserving the greater Sacramento area.  The primary focus of the loan productionoffice in Gridley is commercial and agricultural loans.

The Company hassignificant extensions of credit and commitments to extend credit that aresecured 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.

In extendingcredit and commitments to borrowers, the Company generally requires collateraland/or guarantees as security.  The repayment of such loans is expected tocome from cash flow or from proceeds from the sale of selected assets of theborrowers.  The Company’s requirement for collateral and/or guarantees isdetermined on a case-by-case basis in connection with management’s evaluationof the creditworthiness of the borrower.  Collateral held varies but mayinclude accounts receivable, inventory, property, plant and equipment,income-producing properties, residences and other real property.  TheCompany secures its collateral by perfecting its security interest in businessassets, obtaining deeds of trust, or outright possession among other means.

In management’sjudgment, a concentration exists in real estate loans, which representedapproximately 69.2% of the Company’s loan portfolio at June 30, 2006, which isslightly less, on a percentage basis, than the 69.9% concentration level atDecember 31, 2005.  Management believes the concentration to have no morethan the normal risk of collectability; however, a substantial decline in theeconomy in general, or a decline in real estate values in the Company’s primarymarket areas in particular, could have an adverse impact on the collectabilityof these loans and require an increase in the provision for loan losses whichcould adversely affect the Company’s future prospects, results of operations,profitability and stock price.  Management believes that its lendingpolicies and underwriting standards will tend to minimize losses in an economicdownturn; however, there is no assurance that losses will not occur under suchcircumstances.  The Company’s 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 their fieldof expertise, (3) basing real estate loan approvals not only on market demandfor the project, but also on the borrowers’ capacity to support the projectfinancially in the event it does not perform to expectations (whether sale orincome performance), and (4) maintaining conforming and prudent loan to valueand loan to cost ratios based on independent outside appraisals and ongoinginspection and analysis by the Company’s lending officers.

**Nonaccrual,Past Due and Restructured Loans**

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

Table Six belowsets forth nonaccrual loans as of June 30, 2006 and December 31, 2005. There were no loans past due 90 days or more and still accruing interest atJune 30, 2006 or December 31, 2005.

**TableSix:  Non-Performing Loans**
| ** **                  | ** ** | **June** | ** ** | **December 31,** | ** ** |
|-----------------------------|------------|----------|------------|-----------------------|------------|
| **(In thousands)**     | ** ** | **2006** | ** ** | **2005**              | ** ** |
| Nonaccrual:                 |       |     |       |                  |       |
| Commercial                  |       | 35       |       |                  |       |
| Real estate                 |       | 1,502    |       |                  |       |
| Consumer and  other         |       | 0        |       | 9                     |       |
| Total  non-performing loans |       | 1,537    |       | 9                     |       |

 

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At June 30, 2006, therewere two non-performing loans which were considered to be impaired.  Oneis a real estate secured government guaranteed loan for $1,502,000 of which theunguaranteed portion representing the Company’s potential loss exposure is$300,000.  The property is in foreclosure and management does not foreseea loss from this loan.  The other loan is an unsecured commercial businessloan in the amount of $35,000.  TheCompany does not foresee taking a loss on this loan.  There was nospecific valuation allowance on these impaired loans. There were no loanconcentrations in excess of 10% of total loans not otherwise disclosed as acategory of loans as of June 30, 2006 or December 31, 2005.  Management isnot aware of any potential problem loans, which were accruing and current atJune 30, 2006, where serious doubt exists as to the ability of the borrower tocomply with the present repayment terms.

 

**Allowancefor Loan Losses Activity**

We employ asystematic methodology for determining the allowance for loan losses thatincludes a monthly review process and monthly adjustment of theallowance.  Our process includes a periodic review of individual loansthat have been specifically identified as problem loans or have characteristicswhich could lead to impairment, as well as detailed reviews of other loans(either individually or in pools).  While this methodology utilizes historicaland other objective information, the establishment of the allowance for loanlosses and the classification of loans are, to some extent, based on management’sjudgment and experience.

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

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

Our methodologyis, and has been, consistently followed.  However, as we add new products,increase in complexity, and expand our geographic coverage, we expect toenhance our methodology to keep pace with the size and complexity of the loanportfolio.  On an ongoing basis we engage outside firms to independentlyassess our methodology, and to perform independent credit reviews of our loanportfolio.  The FDIC and the California Department of FinancialInstitutions review the allowance for loan losses as an integral part of theexamination processes.  Management believes that our current methodologyis appropriate given our size and level of complexity.  Further,management believes that the allowance for loan losses is adequate as of June 30,2006 to cover known and inherent risks in the loan portfolio.  However,fluctuations in credit quality, or changes in economic conditions or otherfactors could cause management to increase or decrease the allowance for loanlosses as necessary.

The Board ofDirectors of the Bank reviews the adequacy of the allowance for loan losses atleast quarterly to include consideration of the relative risks in the portfolioand current economic conditions.  The allowance is adjusted based on thatreview if, in the judgment of the loan committee and management, changes arewarranted.  The allowance for loan losses totaled $5,184,000 or 1.17% oftotal loans at June 30, 2006 and $4,717,000 or 1.16% at December 31,2005.  Net charge-offs for the quarter and six month period ended June 30,2006 were $9,000.

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

23

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**TableSeven: Allowance for Loan Losses**
| ** **                                                                | ** ** | **Three Months  Ended  June 30,** | ** ** | **Six Months  Ended  June 30,** | ** ** |
|---------------------------------------------------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|
| **(In thousands, except for percentages)**            | ** ** | **2006**                                    | ** ** | **2005**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                                      |       |                                        |       |                                      |       |   |   |   |   |
| Average loans  outstanding                                                |       | $                                           | 443,395    |                                      | $          | 373,520 |   | $ | 434,418 |   | $ | 360,762 |   |
|                                                                      |       |                                        |       |                                      |       |   |   |   |   |
| Allowance for  possible loan losses at beginning of period                |       | $                                           | 4,961      |                                      | $          | 4,224 |   | $ | 4,716 |   | $ | 4,000 |   |
|                                                                      |       |                                        |       |                                      |       |   |   |   |   |
| Loans charged  off:                                                       |       |                                        |       |                                      |       |   |   |   |   |
| Commercial                                                                |       |                                        |       |                                      |       |   |   |   |   |
| Real estate                                                               |       |                                        |       |                                      |       |   |   |   |   |
| Consumer                                                                  |       | (9                                          | )          | (5                                        | )          | (9 | ) | (6 | ) |
| Total                                                                     |       | (9                                          | )          | (5                                        | )          | (9 | ) | (6 | ) |
| Recoveries of  loans previously                                           |       |                                        |       |                                      |       |   |   |   |   |
| charged off:                                                              |       |                                        |       |                                      |       |   |   |   |   |
| Commercial                                                                |       |                                        |       |                                      |       |   |   |   |   |
| Real estate                                                               |       |                                        |       |                                      |       |   |   |   |   |
| Consumer                                                                  |       |                                        |       |                                      |       | 1 |   |   |   |
| Total                                                                     |       |                                        |       |                                      |       |   |   |   |   |
| Net loan  recoveries/charge-offs                                          |       | (9                                          | )          | (5                                        | )          | (8 | ) | (6 | ) |
|                                                                      |       |                                        |       |                                      |       |   |   |   |   |
| Additions to  allowance charged to operating expenses                     |       | 225                                         |       | 225                                       |       | 450 |   | 450 |   |
|  Allowance for unfunded commitments                                  |       | 7                                           |       |                                      |       | 26 |   |   |   |
|  Allowance for loan losses at end of period                          |       | $                                           | 5,184      |                                      | $          | 4,444 |   | $ | 5,184 |   | $ | 4,444 |   |
| Ratio of net  charge-offs to average loans outstanding                    |       | .00                                         | %          | .00                                       | %          | .00 | % | .00 | % |
| Provision for  possible loan losses to averageloans outstanding           |       | .06                                         | %          | .06                                       | %          | .12 | % | .12 | % |
| Allowance for loan  losses to loans net of deferred fees at end of period |       | 1.17                                        | %          | 1.15                                      | %          | 1.17 | % | 1.15 | % |

 

It is the policyof management to maintain the allowance for loan losses at a level adequate forknown and inherent risks in the portfolio.  Based on information currentlyavailable to analyze inherent credit risk, including economic factors, overallcredit quality, historical delinquencies and a history of actual charge-offs,management believes that the provision for loan losses and the allowance areadequate.  The Company generally makes monthly allocations to theallowance for loan losses.  The budgeted allocation is based on estimatesof loss risk and loan growth.  Adjustments may be made based ondifferences from estimated loan growth, the types of loans constituting thisgrowth, changes in risk ratings within the portfolio, and general economicconditions.  However, no prediction of the ultimate level of loans chargedoff in future years can be made with any certainty.

**OtherReal Estate**

At June 30, 2006and December 31, 2005, the Company did not have any other real estate (“ORE”)properties.

**Deposits**

At June 30, 2006,total deposits were $455,652,000 representing an increase of $21,634,000 (5.0%)over the December 31, 2005 balance of $434,018,000.  This increase isconcentrated mainly in certificates of deposit which have increased $46 millionor 38% since December 31, 2005.  Brokered certificates of depositrepresent $16 million of this increase with the remaining $30 million acquiredthrough the branch network.  In order tokeep up with the rapid growth in loans during the first half of 2006, rates oncertificates of deposit were raised to encourage depositors to move theirmaturing funds from other institutions to the Bank.  Non-interest bearingdemand deposits have increased by $825,000 while interest bearing demanddeposits have decreased by $24.6 million in the first six months of 2006.

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**CapitalResources**

The current andprojected capital position of the Company and the impact of capital plans andlong-term strategies are reviewed regularly by management. The Company’scapital position represents the level of capital available to support continuedoperations and expansion.

The Board ofDirectors of the Company authorized the payment of a quarterly cash dividendstotaling $0.16 per share for 2005 and $0.11 per share for the first twoquarters of 2006.  The payment of dividends in the future is subject tothe discretion of the Board of Directors of the Company and will depend onearnings, the financial condition of the Company and other relevant factors.

The Company andits subsidiary Bank are subject to certain regulations issued by the Board ofGovernors of the Federal Reserve System and the FDIC which require maintenanceof certain levels of capital.  At June 30, 2006, shareholders’ equity was$44,853,000, representing an increase of $3,298,000 (7.9%) from $41,555,000 atDecember 31, 2005.  The increase is primarily the result of the exerciseof stock options and net income from the period offset by the stock basedcompensation expense recorded and cash dividends discussed above.  TheBank’s ratio of total risk-based capital to risk adjusted assets was 10.9% atJune 30, 2006 compared to 11.3% at December 31, 2005.  Tier 1 risk-basedcapital to risk-adjusted assets was 9.7% at June 30, 2006 and 10.1% at December31, 2005.

Table Eight belowlists the Company’s and the Bank’s capital ratios at June 30, 2006 and December31, 2005, as well as the minimum ratios required under regulatory definitionsof capital adequacy.

**TableEight: Capital Ratios**
| **Capital to Risk-Adjusted Assets** | ** ** | **At June 30, 2006** | ** ** | **At December 31, 2005** | ** ** | **Minimum** | ** ** |
|----------------------------------------------------|------------|-------------------------------------|------------|-----------------------------------------|------------|-------------|------------|
| ** **                                         | ** ** | ** **                          | ** ** | ** **                              | ** ** | ** **  | ** ** |
| **Company**                                        | ** ** | ** **                          | ** ** | ** **                              | ** ** | ** **  | ** ** |
| Leverage ratio                                     |       | 10.4                                | %          | 9.8                                     | %          | 4.0         | %          |
|                                               |       |                                |       |                                    |       |        |       |
| Tier 1 Risk-Based  Capital                         |       | 10.9                                | %          | 11.4                                    | %          | 4.0         | %          |
|                                               |       |                                |       |                                    |       |        |       |
| Total Risk-Based  Capital                          |       | 12.1                                | %          | 12.5                                    | %          | 8.0         | %          |
|                                               |       |                                |       |                                    |       |        |       |
| **Bank**                                           | ** ** | ** **                          | ** ** | ** **                              | ** ** | ** **  | ** ** |
|                                               |       |                                |       |                                    |       |        |       |
| Leverage ratio                                     |       | 9.3                                 | %          | 8.8                                     | %          | 4.0         | %          |
|                                               |       |                                |       |                                    |       |        |       |
| Tier 1 Risk-Based  Capital                         |       | 9.7                                 | %          | 10.1                                    | %          | 4.0         | %          |
|                                               |       |                                |       |                                    |       |        |       |
| Total Risk-Based Capital                           |       | 10.9                                | %          | 11.3                                    | %          | 8.0         | %          |

 

25

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Capital ratios arereviewed on a regular basis to ensure that capital exceeds the prescribedregulatory minimums and is adequate to meet future needs.  All ratios arein excess of the regulatory definition of “Minimum” at June 30, 2006 andDecember 31, 2005.  The Bank was considered “well-capitalized” byregulatory standards, at June 30, 2006 and December 31, 2005.

**Item3.  Quantitative and Qualitative Disclosures about Market Risk**

**MarketRisk Management**

*Overview*. Market risk is the risk of loss from adverse changes in market prices andrates.  The Company’s market risk arises primarily from interest rate riskinherent in its loan, investment and deposit portfolios.  The goal for managingthe assets 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.

The Board ofDirectors has overall responsibility for the interest rate risk managementpolicies.  The Bank has an Asset and Liability Management Committee (ALCO)that establishes and monitors guidelines to control the sensitivity of earningsto changes in interest rates.

*Asset/LiabilityManagement*.  Activities involved in asset/liabilitymanagement include, but are not limited to, lending, accepting and placingdeposits, investing in securities, using trust preferred securities andborrowings.  Interest rate risk is the primary market risk associated withasset/liability management.  Sensitivity of earnings to interest ratechanges arises when yields on assets change in a different time period or in adifferent amount from that of interest costs on liabilities.  To mitigateinterest rate risk, the structure of the balance sheet is managed with the goalthat movements of interest rates on assets and liabilities are correlated andcontributes to earnings even in periods of volatile interest rates.  Theasset/liability management policy sets limits on the acceptable amount ofvariance in net interest margin and market value of equity under changinginterest environments.  The Company uses simulation models to forecastearnings, net interest margin and market value of equity.

Simulation ofearnings 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 liability (i.e.deposits/borrowings) positions as the beginning base.  The forecastbalance sheet is processed against seven interest rate scenarios.  Thesescenarios include a 100, 200 and 300 basis point rising rate forecast, a flatrate forecast and a 100, 200 and 300 basis point falling rate forecast whichtake place within a one year time frame.  The net interest income ismeasured during the year assuming a gradual change in rates over the twelve-monthhorizon.  The Company’s net interest income, as forecast below, wasmodeled utilizing a forecast balance sheet projected from balances as of thedate indicated.

Table Nine belowsummarizes the effect on net interest income (NII) of a ±200 basis point changein interest rates as measured against a constant rate (no change)scenario.  The results shown in Table nine for the two periods, fallwithin the parameters of the Bank’s policy for interest rate risk.

26

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**TableNine:  Interest Rate Risk Simulation of Net Interest as of June 30, 2006and December 31, 2005**
|                                         | ** ** | **$ Change in NII from Current** | ** ** | **$ Change in NII from Current** | ** ** |
|-----------------------------------------|------------|-----------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                              | ** ** | **12 Month Horizon**                            | ** ** | **12 Month Horizon**                            | ** ** |
| **(In thousands)**                 | ** ** | **June 30, 2006**                               | ** ** | **December 31, 2005**                           | ** ** |
| Variation from a constant rate scenario |       |                                                      |       |                                                      |       |
| +200bp                                  |       | 3,353                                                     |       | 1,732                                                     |       |
| - 200bp                                 |       | (4,199                                                    | )          | (2,380                                                    | )          |

 

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

**Inflation**

The impact of inflationon a financial institution differs significantly from that exerted onmanufacturing, or other commercial concerns, primarily because its assets andliabilities are largely monetary.  In general, inflation primarily affectsthe Company and it subsidiaries through its effect on market rates of interest,which affects the Company’s ability to attract loan customers.  Inflationaffects the growth of total assets by increasing the level of loan demand, andpotentially adversely affects capital adequacy because loan growth ininflationary periods can increase at rates higher than the rate capital growsthrough retention of earnings, which may be generated in the future.  Inaddition to its effects on interest rates, inflation increases overall operatingexpenses.  Inflation has not had a material effect upon the results ofoperations of the Company and its subsidiaries during the periods ended June30, 2006, and 2005.

**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.  Federal funds lines, short-terminvestments and securities, and loan repayments contribute to liquidity, alongwith deposit increases, while loan funding and deposit withdrawals decreaseliquidity.  The Company assesses the likelihood of projected fundingrequirements by reviewing historical funding patterns, current and forecastedeconomic conditions and individual client funding needs.  Commitments tofund loans and stand-by letters of credit at June 30, 2006 and December 31,2005 were approximately $204,539,000 and $205,588,000, respectively.  Suchloans relate primarily to revolving lines of credit and other commercial loans,and to real estate construction loans.

The Company’ssources of liquidity consist of cash and due from correspondent banks,overnight funds sold to correspondent banks, unpledged marketable investmentsand loans held for sale.  On June 30, 2006, consolidated liquid assetstotaled $42.2 million or 8.1% of total assets compared to $52.2 million or10.5% of total assets on December 31, 2005.  In addition to liquid assets,the Company maintains short-term lines of credit in the amount of $15,000,000with correspondent banks.  There were no borrowings outstanding underthese arrangements at June 30, 2006.

The Bank also hasinformal agreements with various other banks to sell participations in loans,if necessary.  The Company serves primarily a business and professionalcustomer base and, as such, its deposit base is susceptible to economicfluctuations.  Accordingly, management strives to maintain a balancedposition of liquid assets to volatile and cyclical deposits.

Liquidity is alsoaffected by portfolio maturities and the effect of interest rate fluctuationson the marketability of both assets and liabilities.  The Company can sellany of its unpledged securities held in the available-for-sale category to meetliquidity needs.

27

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**Off-BalanceSheet Items**

The Company hascertain ongoing commitments under operating leases.  These commitments donot significantly impact operating results. As of June 30, 2006 and December31, 2005, commitments to extend credit and letters of credit were the onlyfinancial instruments with off-balance sheet risk.  The Company has notentered into any contracts for financial derivative instruments such asfutures, swaps, options or similar instruments.  Loan commitments andstand-by letters of credit were $204,539,000 and $205,588,000 at June 30, 2006and December 31, 2005, respectively.  As a percentage of net loans, theseoff-balance sheet items represent 46.5% and 51.2%, respectively.

**OtherMatters**

** Item 4.  Controls and Procedures**

(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)) wascarried 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 endedJune 30, 2006. 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’s management(including the Chief Executive Officer and Chief Financial Officer) to allowtimely decisions regarding required disclosure, and (ii) recorded, processed,summarized and reported within the time periods specified in the Commission’srules 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 Rules13a-15(f) and 15d-15(f)), that occurred during the Company’s fiscal quarterended June 30, 2006, was carried out under the supervision and with theparticipation of the Company’s Chief Executive Officer, Chief Financial Officerand other members of the Company’s senior management. The Company’s ChiefExecutive Officer and Chief Financial Officer concluded that no changeidentified in connection with such evaluation has materially affected, or isreasonably likely to materially affect, the Company’s internal control overfinancial reporting.

**Item5.  Subsequent Events**

On July 31, 2006 theCompany moved its full service branch office in Redding to 2951 Churn CreekRoad.  This location is a larger sitewith better visibility and a drive-up window capability.

28

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**PARTII – OTHER INFORMATION**

Item 1. Legal Proceedings.

None.

Item 1A. RiskFactors

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

Item 2. Changes in Securities and Use of Proceeds.

None.

Item 3. Defaults Upon Senior Securities.

None.

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

The Annual Shareholder meeting of theRegistrant was held on May 25, 2006.

6,087,389 shares or 82% of the outstandingvoting stock was available for quorum.

Proposal #1  6,086,609 shares or 82% voted for the election of thirteen directorsnamed in the proxy statement for terms expiring on the date of the annualmeeting in 2007.

Proposal #2  4,512,595 shares or 57% voted for the By Law Amendment to increase thesize of the range of directors from 7 to 13 to 8 to 15.

Item 5.  Other Information.

None

Item 6.  Exhibits

(a)  Exhibits

29

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| 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. |

 

30

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**SIGNATURES**

Pursuant to therequirements of the Securities and Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.
|                 | COMMUNITY VALLEY BANCORP |
|-----------------|--------------------------|
|            |                     |   |
| August 11, 2006 |                     |   | *By: /s/ Keith C. Robbins* | * * |
|            |                     |   |
|            |                     | Keith C. Robbins |
|            |                     |   |
|            |                     | President, Chief Executive Officer |
|            |                     |   |
| August 11, 2006 |                     |   | *By: /s/ John F. Coger* | * * |
|            |                     |   |
|            |                     | John F. Coger |
|            |                     |   |
|            |                     | Executive Vice President, CFO, COO |
|                 |                          |  |  |  |  |  |

 

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