Table of Contents

** **

 

** **

**SECURITIESAND EXCHANGE COMMISSION****WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

| **x**                                                        | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**   |
|--------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------|
|                                                         |
| **For the Quarterly Period  Ended March 31, 2009** |
|                                                         |
| **o**                                                        | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

 

**COMMUNITY VALLEY BANCORP**(Exact name of registrant as specified in its charter)

 

| **California**                               | ** ** | **000-51678**            | ** ** | **68-0479553**           |
|----------------------------------------------|------------|--------------------------|------------|--------------------------|
| (State or other jurisdiction of              |       | (Commission File Number) |       | (IRS Employer ID Number) |
| incorporation or organization)               |       |                     |       |                     |
|                                         |       |                     |       |                     |
| **1360 E. Lassen Avenue, Chico, California** |       | **95973**                |
| (Address of principal executive offices)     |       | (Zip code)               |

 

**(530) 899-2344**

(Registrant’s telephone number, including area code)

 

 

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

 

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

 

Indicate by check mark whether the registrant hassubmitted electronically and posted on its corporate Web site, if any, everyInteractive Data File required to be submitted and posted pursuant to Rule 405of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (orfor such shorter period that the registrant was required to submit and postsuch files).    Yes x No o

 

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

 

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

 

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

 

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

 

No par value Common Stock — 6,699,603 shares outstanding at April 24, 2009.

 

 

 

Table of Contents

 

**Table of Contents**

 
| PART I  |   |                                                                                                                            |   | 3      |
|--------------|--------|---------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|         |   |                                                                                                                            |   |   |
|         |   | Item  1. Financial Statements (unaudited)                                                                                       |   | 3      |
|         |   |                                                                                                                            |   |   |
|         |   | Item 2. Management’s  Discussion and Analysis f Financial Condition and Results of Operations of  Community Valley Bancorp |   | 11     |
|         |   |                                                                                                                            |   |   |
|         |   | Item 3.  Quantitative and Qualitative Disclosures about Market Risk                                                             |   | 26     |
|         |   |                                                                                                                            |   |   |
|         |   | Item 4. Controls  and Procedures                                                                                                |   | 27     |
|         |   |                                                                                                                            |   |   |
| PART II |   |                                                                                                                            |   | 29     |
|         |   |                                                                                                                            |   |   |
|         |   | Item 1. Legal  Proceedings                                                                                                      |   | 29     |
|         |   |                                                                                                                            |   |   |
|         |   | Item  1A. Risk Factors                                                                                                          |   | 29     |
|         |   |                                                                                                                            |   |   |
|         |   | Item 2.  Changes in Securities and Use of Proceeds                                                                              |   | 29     |
|         |   |                                                                                                                            |   |   |
|         |   | Item 4. Submission of Matters to a Vote of Security  Holders                                                                    |   | 29     |
|         |   |                                                                                                                            |   |   |
|         |   | Item 5. Other  Information                                                                                                      |   | 29     |
|         |   |                                                                                                                            |   |   |
|         |   | Item  6. Exhibits                                                                                                               |   | 29     |
|         |   |                                                                                                                            |   |   |
|         |   | Signatures                                                                                                                      |   | 30     |
|         |   |                                                                                                                            |   |   |
|         |   | Ex. 31.1. Certification of CEO Pursuant to  Section 302 of the Sarbanes Oxley Act of 2002                                  |   |   |
|         |   |                                                                                                                            |   |   |
|         |   | Ex. 31.2 Certification of CFO Pursuant to  Section 302 of the Sarbanes Oxley Act of 2002                                   |   |   |
|         |   |                                                                                                                            |   |   |
|         |   | Ex. 32.1 Certification of CEO Pursuant to  Section 906 of the Sarbanes Oxley Act of 2002                                   |   |   |
|         |   |                                                                                                                            |   |   |
|         |   | Ex. 32.2 Certification of CFO Pursuant to  Section 906 of the Sarbanes Oxley Act of 2002                                   |   |   |

 

2

Table of Contents

 

**PART I - FINANCIAL INFORMATION**

**Item 1**

 

**COMMUNITY VALLEY BANCORP**

**CONDENSED CONSOLIDATED BALANCE SHEET (Unaudited)**

(dollars in thousands, except share data)

 
| ** **                                                                                                                                                                    | ** ** | **March 31, 2009** | ** ** | **December 31, 2008** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| ASSETS                                                                                                                                                                        | ** ** | ** **              | ** ** | ** **                 | ** ** |
| Cash and due from banks                                                                                                                                                       |       | $                       | 15,427     |                       | $          | 21,743 |   |
| Federal funds sold & other                                                                                                                                           |       | 57,170                  |       | 36,605                     |       |
| Total cash & cash equivalents                                                                                                                                        |       | 72,597                  |       | 58,348                     |       |
|                                                                                                                                                                          |       |                    |       |                       |       |
| Interest-bearing deposits in banks                                                                                                                                            |       | 1,883                   |       | 2,576                      |       |
| Investment securities (fair value of $6,850 at March 31, 2009, and  $7,100 at December 31, 2008)                                                                    |       | 6,835                   |       | 7,096                      |       |
| Loans held for sale at lower of cost or market                                                                                                                                |       | 2,418                   |       | 320                        |       |
| Loans, less allowance for loan losses of $8,697 at March 31,  2009 and $7,826 at December 31, 2008                                                                  |       | 473,655                 |       | 486,522                    |       |
| Premises and equipment, net                                                                                                                                                   |       | 6,618                   |       | 7,013                      |       |
| Other real estate                                                                                                                                                             |       | 9,620                   |       | 2,068                      |       |
| Bank owned life insurance                                                                                                                                                     |       | 11,310                  |       | 11,199                     |       |
| Accrued interest receivable and other assets                                                                                                                                  |       | 18,984                  |       | 20,102                     |       |
| Total assets                                                                                                                                                                  |       | $                       | 603,920    |                       | $          | 595,244 |   |
|                                                                                                                                                                          |       |                    |       |                       |       |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                                                                     |       |                    |       |                       |       |
|                                                                                                                                                                          |       |                    |       |                       |       |
| Deposits:                                                                                                                                                                     |       |                    |       |                       |       |
| Non-interest bearing                                                                                                                                                          |       | $                       | 73,243     |                       | $          | 82,159 |   |
| Interest bearing                                                                                                                                                              |       | 462,141                 |       | 444,326                    |       |
| Total deposits                                                                                                                                                                |       | 535,384                 |       | 526,485                    |       |
|                                                                                                                                                                          |       |                    |       |                       |       |
| ESOP and other notes payable                                                                                                                                                  |       | 5,232                   |       | 5,054                      |       |
| Junior subordinated debentures                                                                                                                                                |       | 8,248                   |       | 8,248                      |       |
| Accrued interest payable and other liabilities                                                                                                                                |       | 14,920                  |       | 15,318                     |       |
| Total liabilities                                                                                                                                                             |       | 563,784                 |       | 555,105                    |       |
|                                                                                                                                                                          |       |                    |       |                       |       |
| Commitments and contingencies (Note 5)                                                                                                                                        |       |                    |       |                       |       |
|                                                                                                                                                                          |       |                    |       |                       |       |
| Shareholders’ equity                                                                                                                                                     |       |                    |       |                       |       |
| Common stock - no par value; 20,000,000 shares authorized; issued and  outstanding - 6,699,603 shares at March 31, 2009, and 6,699,553 shares  at December 31, 2008 |       | 10,163                  |       | 10,147                     |       |
|                                                                                                                                                                          |       |                    |       |                       |       |
| Unallocated ESOP shares - 171,881 shares at March 31, 2009 and  124,207 shares at December 31, 2008 (at cost)                                                       |       | (1,635                  | )          | (1,438                     | )          |
| Retained Earnings                                                                                                                                                             |       | 31,516                  |       | 31,416                     |       |
| Accumulated other comprehensive income, net                                                                                                                                   |       | 92                      |       | 14                         |       |
|                                                                                                                                                                          |       |                    |       |                       |       |
| Total shareholders’ equity                                                                                                                                               |       | 40,136                  |       | 40,139                     |       |
| Total liabilities and shareholders’ equity                                                                                                                               |       | $                       | 603,920    |                       | $          | 595,244 |   |

 

See Notes to Unaudited Condensed Consolidated Financial Statements

 

3

----

Table ofContents

 

**COMMUNITY VALLEY BANCORP**

**CONDENSEDCONSOLIDATED STATEMENT OF INCOME (Unaudited)**

(dollars in thousands, except per share data)

 
| ** **                                           | ** ** | **For the three months  ended March 31,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------|------------|
|                                                 | ** ** | **2009**                                       | ** ** | **2008** | ** ** |
| Interest income:                                     |       |                                           |       |   |   |
| Interest and fees on loans                           |       | $                                              | 7,047      |   | $ | 8,945 |   |
| Interest on Federal funds sold                       |       | 28                                             |       | 314 |   |
| Interest on deposits in banks                        |       | 24                                             |       | 235 |   |
| Interest on investment securities:                   |       |                                           |       |   |   |
| Taxable                                              |       | 55                                             |       | 101 |   |
| Exempt from Federal income tax                       |       | 16                                             |       | 16 |   |
| Total interest income                                |       | 7,170                                          |       | 9,611 |   |
|                                                 |       |                                           |       |   |   |
| Interest expense:                                    |       |                                           |       |   |   |
| Interest expense on deposits                         |       | 1,870                                          |       | 2,784 |   |
| Interest expense on junior subordinated debentures   |       | 143                                            |       | 137 |   |
| Interest expense on notes payable                    |       | 78                                             |       | 19 |   |
| Total interest expense                               |       | 2,091                                          |       | 2,940 |   |
| Net interest income before provision for loan losses |       | 5,079                                          |       | 6,671 |   |
| Provision for loan losses                            |       | 3,100                                          |       | 225 |   |
| Net interest income after provision for loan losses  |       | 1,979                                          |       | 6,446 |   |
|                                                 |       |                                           |       |   |   |
| Non-interest income:                                 |       |                                           |       |   |   |
| Sale of merchant processing portfolio                |       | 2,640                                          |       | — |   |
| Loss on sale of investment security                  |       | (172                                           | )          | — |   |
| Other income                                         |       | 2,359                                          |       | 1,959 |   |
| Total non-interest income                            |       | 4,827                                          |       | 1,959 |   |
|                                                 |       |                                           |       |   |   |
| Non-interest expenses:                               |       |                                           |       |   |   |
| Salaries and employee benefits                       |       | 3,399                                          |       | 3,697 |   |
| Occupancy                                            |       | 705                                            |       | 675 |   |
| Furniture and equipment                              |       | 649                                            |       | 641 |   |
| Other expense                                        |       | 2,021                                          |       | 1,979 |   |
| Total non-interest expense                           |       | 6,774                                          |       | 6,992 |   |
|                                                 |       |                                           |       |   |   |
| Income before (benefit) provision for income taxes   |       | 32                                             |       | 1,413 |   |
|                                                 |       |                                           |       |   |   |
| (Benefit) provision for income taxes                 |       | (68                                            | )          | 589 |   |
|                                                 |       |                                           |       |   |   |
| Net income                                           |       | $                                              | 100        |   | $ | 824 |   |
|                                                 |       |                                           |       |   |   |
| Basic earnings per share                             |       | $                                              | 0.02       |   | $ | 0.11 |   |
| Diluted earnings per share                           |       | $                                              | 0.02       |   | $ | 0.11 |   |
|                                                 |       |                                           |       |   |   |
| Cash dividends per share                             |       | $                                              | —     |   | $ | 0.08 |   |

 

See Notesto Unaudited Condensed Consolidated Financial Statements

 

4

----

Table of Contents

 

**COMMUNITY VALLEY BANCORP**

**CONDENSED CONSOLIDATED STATEMENTOF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)**

 (In thousandsexcept number of shares)

 
| ** **                                                                  | ** ** | ** **            | ** ** | ** **      | ** ** | ** **           | ** ** | ** **                   | ** ** | **Accumulated  Other** | ** ** | ** **        | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------|------------|-----------------|------------|----------------------|------------|------------------------------|------------|------------------------|------------|-------------------|------------|------------|------------|
| ** **                                                                  | ** ** | ** **            | ** ** | ** **      | ** ** | ** **           | ** ** | ** **                   | ** ** | **Comprehensive**      | ** ** | **Total**         | ** ** | ** ** | ** ** |
| ** **                                                                  | ** ** | **Common Stock** | ** ** | **Unallocated** | ** ** | **Retained**         | ** ** | **Income, net of** | ** ** | **Shareholders’** | ** ** | **Comprehensive** | ** ** |
| ** **                                                                  | ** ** | **Shares**            | ** ** | **Amount**      | ** ** | **ESOP shares** | ** ** | **Earnings**                 | ** ** | **taxes**              | ** ** | **Equity**        | ** ** | **Income** | ** ** |
| Balance,  January 1, 2008                                              |       | 7,607,908             |       | $               | 10,910     |                 | $          | (1,407                       | )          | $                      | 41,454     |              | $          | 17         |       | $ | 50,974 |   |   |   |
|                                                                        |       |                  |       |            |       |                 |       |                         |       |                   |       |              |       |       |       |
| Comprehensive  income                                                       |       |                  |       |            |       |                 |       |                         |       |                   |       |              |       |       |       |
| Net income                                                                  |       |                  |       |            |       |                 |       | 2,739                        |       |                   |       | 2,739             |       | $          | 2,739      |   |
| Other comprehensive  income                                                 |       |                  |       |            |       |                 |       |                         |       |                   |       |              |       |       |       |
| Net change in  unrealized gains on available-for-sale investment securities |       |                  |       |            |       |                 |       |                         |       | (3                     | )          | (3                | )          | (3         | )          |
| Total  comprehensive income                                                 |       |                  |       |            |       |                 |       |                         |       |                   |       |              |       | $          | 2,736      |   |
|                                                                        |       |                  |       |            |       |                 |       |                         |       |                   |       |              |       |       |       |
| Exercise of stock  options and related tax benefit                          |       | 103,651               |       | 654             |       |                 |       |                         |       |                   |       | 654               |       |       |       |
| Amortization of  stock compensation- ESOP shares                            |       |                  |       | (8              | )          | 90                   |       |                         |       |                   |       | 82                |       |       |       |
| Shares acquired  by ESOP                                                    |       |                  |       |            |       | (121                 | )          |                         |       |                   |       | (121              | )          |       |       |
| Cash dividends-  $.16 per share                                             |       |                  |       |            |       |                 |       | (1,148                       | )          |                   |       | (1,148            | )          |       |       |
| Stock based  compensation expense                                           |       |                  |       | 80              |       |                 |       |                         |       |                   |       | 80                |       |       |       |
| Retirement of  common stock                                                 |       | (1,012,006            | )          | (1,489          | )          |                 |       | (11,629                      | )          |                   |       | (13,118           | )          |       |       |
|                                                                        |       |                  |       |            |       |                 |       |                         |       |                   |       |              |       |       |       |
| Balance,  December 31, 2008                                            |       | 6,699,553             |       | 10,147          |       | (1,438               | )          | 31,416                       |       | 14                     |       | 40,139            |       |       |       |
|                                                                        |       |                  |       |            |       |                 |       |                         |       |                   |       |              |       |       |       |
| Comprehensive  income                                                       |       |                  |       |            |       |                 |       |                         |       |                   |       |              |       |       |       |
| Net income                                                                  |       |                  |       |            |       |                 |       | 100                          |       |                   |       | 100               |       | $          | 100        |   |
| Other  comprehensive income                                                 |       |                  |       |            |       |                 |       |                         |       |                   |       |              |       |       |       |
| Net change in  unrealized gains on available-for-sale investment securities |       |                  |       |            |       |                 |       |                         |       | 78                     |       | 78                |       | 78         |       |
| Total  comprehensive income                                                 |       |                  |       |            |       |                 |       |                         |       |                   |       |              |       | $          | 178        |   |
|                                                                        |       |                  |       |            |       |                 |       |                         |       |                   |       |              |       |       |       |
| Exercise of stock  options and related tax benefit                          |       | 50                    |       | 1               |       |                 |       |                         |       |                   |       | 1                 |       |       |       |
| Amortization of  stock compensation-ESOP shares                             |       |                  |       | (1              | )          | 20                   |       |                         |       |                   |       | 19                |       |       |       |
| Shares acquired  by ESOP                                                    |       |                  |       |            |       | (217                 | )          |                         |       |                   |       | (217              | )          |       |       |
| Stock based  compensation expense                                           |       |                  |       | 16              |       |                 |       |                         |       |                   |       | 16                |       |       |       |
|                                                                        |       |                  |       |            |       |                 |       |                         |       |                   |       |              |       |       |       |
| Balance,  March 31, 2009                                               |       | 6,699,603             |       | $               | 10,163     |                 | $          | (1,635                       | )          | $                      | 31,516     |              | $          | 92         |       | $ | 40,136 |   |   |   |

 

SeeNotes to Unaudited Condensed Consolidated Financial Statements

 

5

----

Table of Contents

 

**COMMUNITY VALLEY BANCORP**

**CONDENSED CONSOLIDATED STATEMENTOF CASH FLOWS (Unaudited)**

(In thousands)

 
| ** **                                                                         | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                         | ** ** | **March 31,**     | ** ** |
| ** **                                                                         | ** ** | **2009**               | ** ** | **2008** | ** ** |
| Cash flows from operating activities:                                              |       |                   |       |   |   |
| Net income                                                                         |       | $                      | 100        |   | $ | 824 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities: |       |                   |       |   |   |
| Provision for loan losses                                                          |       | 3,100                  |       | 225 |   |
| Decrease in deferred loan origination fees                                         |       | (141                   | )          | (107 | ) |
| Depreciation and amortization, net                                                 |       | 490                    |       | 574 |   |
| Gain on disposition of Bank premises and equipment                                 |       | (14                    | )          | (4 | ) |
| Loss on write-down of other real estate                                            |       | 564                    |       | — |   |
| Net increase in loans held for sale                                                |       | (2,098                 | )          | (220 | ) |
| Increase in cash surrender value of bank-owned life insurance, net                 |       | (111                   | )          | (95 | ) |
| Excess tax benefit from exercise of stock options                                  |       | —                 |       | (145 | ) |
| Non-cash compensation expense associated with the ESOP                             |       | 19                     |       | 38 |   |
| Stock based compensation                                                           |       | 16                     |       | 21 |   |
| Loss recognized on investment security                                             |       | 172                    |       | — |   |
| Decrease (increase) in accrued interest receivable and other assets                |       | 1,066                  |       | (459 | ) |
| (Decrease) increase in accrued interest payable and other liabilities              |       | (345                   | )          | 5,651 |   |
| Provision for deferred income taxes                                                |       | —                 |       | (300 | ) |
| Net cash provided by operating activities                                          |       | 2,818                  |       | 6,003 |   |
|                                                                               |       |                   |       |   |   |
| Cash flows from investing activities:                                              |       |                   |       |   |   |
| Decrease (increase) in interest-bearing deposits in banks                          |       | 693                    |       | (1,386 | ) |
| Proceeds from matured or called available-for-sale investment  securities          |       | 2,000                  |       | 1,000 |   |
| Proceeds from principal payments on available-for-sale investment  securities      |       | 54                     |       | 75 |   |
| Proceeds from matured or called held-to-maturity investment  securities            |       | 88                     |       | 1,000 |   |
| Proceeds from principal payments of held-to-maturity investment  securities        |       | 76                     |       | 36 |   |
| Purchase of available-for-sale investment securities                               |       | (1,000                 | )          | (3,010 | ) |
| Purchase of held-to-maturity investment securities                                 |       | (996                   | )          | — |   |
| Purchases of premises and equipment                                                |       | (105                   | )          | (160 | ) |
| Proceeds from sale of premises and equipment                                       |       | 20                     |       | 9,700 |   |
| Proceeds from sale of other real estate                                            |       | 176                    |       | — |   |
| Net decrease (increase) in loans                                                   |       | 1,564                  |       | (11,844 | ) |
| Net cash provided by (used in) investing activities                                |       | 2,570                  |       | (4,589 | ) |
|                                                                               |       |                   |       |   |   |
| Cash flows from financing activities:                                              |       |                   |       |   |   |
| Net (decrease) increase in demand, interest-bearing and savings  deposits          |       | (4,908                 | )          | 2,812 |   |
| Net increase (decrease) in time deposits                                           |       | 13,807                 |       | (1,809 | ) |
| Repayment of ESOP note payable                                                     |       | (39                    | )          | (36 | ) |
| Proceeds from ESOP note payable                                                    |       | 217                    |       | — |   |
| Purchase of ESOP shares                                                            |       | (217                   | )          | — |   |
| Payment of cash dividends                                                          |       | —                 |       | (609 | ) |
| Tax benefit from the exercise of stock options                                     |       | —                 |       | 145 |   |
| Proceeds from exercise of stock options                                            |       | 1                      |       | 322 |   |
| Retirement of common stock                                                         |       | —                 |       | (119 | ) |
| Repayment of junior subordinated debentures                                        |       | —                 |       | (8,248 | ) |
| Net cash provided by (used in) financing activities                                |       | 8,861                  |       | (7,542 | ) |
|                                                                               |       |                   |       |   |   |
| Increase (decrease) in cash and cash equivalents                                   |       | 14,249                 |       | (6,128 | ) |
|                                                                               |       |                   |       |   |   |
| Cash and cash equivalents at beginning of year                                     |       | 58,348                 |       | 86,004 |   |
|                                                                               |       |                   |       |   |   |
| Cash and cash equivalents at end of period                                         |       | $                      | 72,597     |   | $ | 79,876 |   |

 

SeeNotes to Unaudited Condensed Consolidated Financial Statements

 

6

----

Table of Contents

 

Community Valley Bancorp

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

**1. BASIS OF PRESENTATION**

 

Theaccompanying unaudited condensed consolidated financial statements of CommunityValley Bancorp and subsidiaries (the “Company”) have been prepared pursuant tothe rules and regulations of the Securities and Exchange Commission (the “SEC”)and the instructions to Form 10-Q and Article 10 of Regulation S-X.Accordingly, certain information and footnote disclosures required byaccounting principles generally accepted in the United States of America (GAAP)for annual financial statements are not included herein, however the Companybelieves that the disclosures made are adequate to make the information notmisleading. In the opinion of management, all adjustments (which consist solelyof normal recurring adjustments) considered necessary for a fair presentationof the results for the interim periods presented have been included. Theseinterim consolidated financial statements should be read in conjunction withthe financial statements and related notes contained in the Company’s 2008Annual Report to Shareholders on Form 10-K.

 

Thecondensed consolidated financial statements include the accounts of the Companyand its wholly owned subsidiaries, Butte Community Bank (the “Bank”) and BCBInsurance Agency, LLC. All significant inter-company balances and transactionshave been eliminated in consolidation. The Company also has a wholly-ownedunconsolidated subsidiary, Community Valley Bancorp Trust II (the “Trust”), aDelaware statutory business trust, formed for the sole purpose of issuing trustpreferred securities. Community valley Bancorp Trust I, which was also formedfor the sole purpose of issuing trust preferred securities, was dissolved in January 2008in conjunction with the redemption of the Trust I securities.  The results of operations for the three-monthperiod ended March 31, 2009 may not necessarily be indicative of theoperating results for the full year 2009.

 

Managementhas determined that because all of the commercial banking products and servicesoffered by the Company are available in each branch of the bank, all branchesare located within the same economic environment and management does notallocate resources based on the performance of different lending or transactionactivities, it is appropriate to aggregate the Bank branches and report them asa single operating segment. No single customer accounts for more than 10% ofthe revenues of the Company or the Bank.

 

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

 

**2. EARNINGS PER SHARE COMPUTATION**

 

Basicearnings per share are computed by dividing net income by the weighted averagecommon shares outstanding for the period (6,557,505 shares for the three monthperiod ended March 31, 2009 and 7,522,758 shares for the three monthperiod ended March 31, 2008). Diluted earnings per share reflect thepotential dilution that could occur if outstanding stock options were exercisedusing the treasury stock method. Diluted earnings per share is computed bydividing net income by the weighted average common shares outstanding for theperiod plus the dilutive effect of options (zero shares for the three monthperiod ended March 31, 2009 and 144,104 shares for the three month periodended March 31, 2008).  As of March 31,2009, 325,381 outstanding options were “out of the money “compared to 121,804at March 31, 2008, that is the option price was higher than the marketprice so these shares were not used in the calculation of earnings per share asthey are considered antidilutive.

 

**3. COMPREHENSIVE INCOME**

 

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. Comprehensive income was$178,000 for the three month period ended March 31, 2009 compared to$863,000 for the same period in 2008.

 

**4. STOCK - BASED COMPENSATION**

 

The Company issues stock options under twostock-based compensation plans, the Community Valley Bancorp 1997 and 2000 StockOption Plans. The plans require that the option price may not be less than thefair market value of the stock at the date the option is granted, and that thestock must be paid in full at the time the option is exercised. The optionsexpire on a

 

7

----

Table of Contents

 

datedetermined by the Board of Directors, but not later than ten years from thedate of grant. The vesting period is determined by the Board of Directors andis generally over five years; however, nonstatutory options granted during 1997vested immediately. Under the 1997 plan, 8,254 shares of common stock remainreserved for issuance to employees, and the related options are exercisableuntil their expiration. However, no new options will be granted under thisplan. Under the Company’s 2000 stock option plan, 341,127 shares of commonstock remain reserved for issuance to employees and directors. There are 97,716additional shares available for future grants.

 

Stockoption activity for the interim 2009 period is summarized below:

 
| **2009**                                            | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|-----------------------------------------------------|------------|------------|------------|---------------------------------------|------------|------------------------------------------|------------|---------------------------------|------------|
| Outstanding at January 1                       |       | 350,231    |       | $                                     | 8.03       |                                     | 3.4  years |                            | $          | — |   |
| Exercised                                           |       | (50        | )          | $                                     | 4.71       |                                     |       |                            |       |   |
| Granted                                             |       | —     |       | $                                     | —     |                                     |       |                            |       |   |
| Cancelled/Expired                                   |       | (800       | )          | $                                     | 4.46       |                                     |       |                            |       |   |
| Outstanding at March 31                        |       | 349,381    |       | $                                     | 8.29       |                                     | 3.2  years |                            | $          | — |   |
| Options vested or expected to vest at March 31 |       | 342,393    |       | $                                     | 8.12       |                                     | 3.1  years |                            | $          | — |   |
| Exercisable at March 31                        |       | 325,381    |       | $                                     | 7.75       |                                     | 2.9  years |                            | $          | — |   |

 

**5. COMMITMENTS AND CONTINGENCIES**

 

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

 

Inthe normal course of business, there are various outstanding commitments to extendcredit which are not reflected in the financial statements, including loancommitments of $128,131,000 and $148,000,000 and stand-by letters of credit of$6,284,000 and $6,482,000 at March 31, 2009 and December 31, 2008,respectively.

 

Ofthe loan commitments outstanding at March 31, 2009, $38,882,000 are realestate construction loan commitments that are not expected to fund within the next twelve months due to thecurrent downturn in the real estate market. The remaining commitments primarilyrelate to revolving lines of credit or other commercial loans, and many ofthese are expected to expire without being drawn upon. Therefore, the totalcommitments do not necessarily represent future cash requirements. Each loancommitment and the amount and type of collateral obtained, if any, areevaluated on an individual basis. Collateral held varies, but may include realproperty, bank deposits, debt or equity securities or business assets.

 

Stand-byletters of credit are conditional commitments written to guarantee theperformance of a customer to a third party. These guarantees are primarilyrelated to the purchases of inventory by commercial customers and are typicallyshort-term in nature. Credit risk is similar to that involved in extending loancommitments to customers and accordingly, evaluation and collateralrequirements similar to those for loan commitments are used. The fair value ofthe liability related to these stand-by letters of credit, which represents thefees received for issuing the guarantees, was not significant at March 31,2009 and December 31, 2008. The Company recognizes these fees as revenuesover the term of the commitment or when the commitment is used.

 

## **6.  INCOME TAXES**

##  

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

 

The Companyaccounts for income taxes using the liability or balance sheet method. Under thismethod, deferred tax assets and liabilities are recognized for the taxconsequences of temporary differences between the reported amounts of assetsand liabilities and their tax bases. Deferred tax assets and liabilities areadjusted for the effects of changes in tax laws and rates on the date ofenactment. On the consolidated balance sheet, net deferred tax assets areincluded in accrued interest receivable and other assets.

 

8

----

Table ofContents

 

****7.  ESOP AND OTHER NOTES PAYABLE****

 

****Othernotes payable represents a $4 million note payable from a correspondent bank tothe holding company which was down-streamed to Butte Community Bank in the formof additional common stock issued to the holding company.  This note is for a two year period with amaturity date of June 30, 2010 and an interest rate equal to the threemonth LIBOR rate plus 3.25% adjusted quarterly. The rate, based on an independentindex, was adjusted to 5.75% on March 31, 2009.  The remaining $1,232,000 represents thebalance of the ESOP note payable due April 10, 2014 with an interest rateof 5.75% at March 31, 2009. The ESOP line of credit was increased by$338,000 in the third quarter 2008. This amount was fully funded during thefourth quarter 2008 and first quarter 2009 to purchase additional shares forthe ESOP.****

 

## **8. FAIR VALUE MEASUREMENTS**

##  

Ingeneral, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) inactive markets for identical assets or liabilities that the Company has theability to access. Fair values determined by Level 2 inputs utilize inputsother than quoted prices included in Level 1 that are observable for the assetor liability, either directly or indirectly. Level 2 inputs include quotedprices for similar assets and liabilities in active markets, and inputs otherthan quoted prices that are observable for the asset or liability, such asinterest rates and yield curves that are observable at commonly quotedintervals. Level 3 inputs are unobservable inputs for the asset or liability,and include situations where there is little, if any, market activity for theasset or liability. In certain cases, the inputs used to measure fair value mayfall into different levels of the fair value hierarchy. In such cases, thelevel in the fair value hierarchy within which the fair value measurement inits entirety falls has been determined based on the lowest level input that issignificant to the fair value measurement in its entirety. The Company’sassessment of the significance of a particular input to the fair valuemeasurement in its entirety requires judgment, and considers factors specificto the asset or liability.

 

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

 

Assets andliabilities measured at fair value on a recurring basis are summarized below:

 
| ** **                                               | ** ** | **Fair Value Measurements  at March 31, 2009, Using** | ** ** |
|----------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| **Description**                                          | ** ** | **Fair Value  31-Mar-09**                                                      | ** ** | **Quoted Prices in  Active Markets for  Identical Assets  (Level 1)** | ** ** | **Other  Observable  Inputs  (Level 2)** | ** ** | **Significant**

**Unobservable**

**Inputs**

**(Level 3)** | ** ** |
| Investment securities                                    |       | $                                                                                   | 5,540      |   | $ | 5,540 |   | $ | — |   | $ | — |   |
| Total assets measured at fair value on a recurring basis |       | $                                                                                   | 5,540      |   | $ | 5,540 |   | $ | — |   | $ | — |   |

 

The following methodswere used to estimate the fair value of each class of financial instrumentabove:

 

***Securities***- Fair values for investment securities are based onquoted market prices.

*** ***

Assets measured at fairvalue on a non recurring basis are summarized below:

 
| ** **                                                   | ** ** | **Fair Value Measurements  at March 31, 2009, Using** | ** ** |
|--------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| **Description**                                              | ** ** | **Fair Value  31-Mar-09**                                                      | ** ** | **Quoted Prices in  Active Markets for  Identical Assets  (Level 1)** | ** ** | **Other  Observable  Inputs  (Level 2)** | ** ** | **Significant**

**Unobservable**

**Inputs**

**(Level 3)** | ** ** |
| Impaired loans                                               |       | $                                                                                   | 17,483     |   | $ | — |   | $ | 17,483 |   | $ | — |   |
| Other real estate                                            |       | $                                                                                   | 9,620      |   | $ | — |   | $ | 9,620 |   | $ | — |   |
| Total assets measured at fair value on a non recurring basis |       | $                                                                                   | 27,103     |   | $ | — |   | $ | 27,103 |   | $ | — |   |

 

***Impaired Loans –***The fair value of impaired loans is based on the fairvalue of the collateral for all collateral dependent loans and for otherimpaired loans is estimated using a discounted cash flow model.

*** ***

***Other Real Estate***** –**The fair value of other real estate is based primarilyon the values obtained through property appraisals or similar information.

 

9

----

Table of Contents

 

**9.  NEW ACCOUNTING PRONOUNCEMENTS**

 

In April 2009, theFinancial Accounting Standards Board (FASB) issued the following three FASBStaff Positions (FSPs) intended to provide additional guidance and enhancedisclosures regarding fair value measurements and impairment of securities:

 

FSP FAS 157-4, *Determining Fair Value When the Volume and Level of Activity for theAsset or Liability Have Significantly Decreased and Identifying TransactionsThat Are Not Orderly*, provides additional guidance for estimatingfair value in accordance with SFAS No. 157 when the volume and level ofactivity for the asset or liability have decreased significantly.  FSP FAS157-4 also provides guidance on identifying circumstances that indicate atransaction is not orderly.  The provisions of FSP FAS 157-4 are effectivefor the Company’s interim period ending on June 30, 2009.  Managementis currently evaluating the effect that the provisions of FSP FAS 157-4 mayhave on the Company’s condensed consolidated financial statements

 

FSP FAS 107-1 and APB28-1, *Interim Disclosures about Fair Value of FinancialInstruments*,* *requiresdisclosures about fair value of financial instruments in interim reportingperiods of publicly traded companies that were previously only required to bedisclosed in annual financial statements.  The provisions of FSP FAS 107-1and APB 28-1 are effective for the Company’s interim period ending on June 30,2009.  As FSP FAS 107-1 and APB 28-1 amends only the disclosurerequirements about fair value of financial instruments in interim periods, theadoption of FSP FAS 107-1 and APB 28-1 is not expected to affect the Company’scondensed consolidated financial statements.

 

FSP FAS 115-2 and FAS124-2, *Recognition and Presentation ofOther-Than-Temporary Impairments*, amends currentother-than-temporary impairment guidance in GAAP for debt securities to makethe guidance more operational and to improve the presentation and disclosure ofother-than-temporary impairments on debt and equity securities in the financialstatements.  This FSP does not amend existing recognition and measurementguidance related to other-than-temporary impairments of equitysecurities.  The provisions of FSP FAS 115-2 and FAS 124-2 are effectivefor the Company’s interim period ending on June 30, 2009.  Managementis currently evaluating the effect that the provisions of FSP FAS 115-2 and FAS124-2 may have on the Company’s condensed consolidated financial statements.

 

10

----

Table ofContents

 

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

 

Thefollowing is Community Valley Bancorp’s (the “Company”) management’s discussionand analysis of the significant changes in balance sheet accounts between March 31,2009 and December 31, 2008 and income and expense accounts for the threemonth periods ended March 31, 2009 and 2008. The discussion is designed toprovide a better understanding of significant trends related to the Company’sfinancial condition, results of operations, liquidity, capital resources andinterest rate sensitivity.

 

Inaddition to the historical information contained herein, this report on Form 10-Qcontains certain forward-looking statements. The reader of this report shouldunderstand that all such forward-looking statements are subject to variousuncertainties and risks that could affect their outcome. The Company’s actualresults could differ materially from those suggested by such forward-lookingstatements. Factors that could cause or contribute to such differences include,but are not limited to, variances in the actual versus projected growth inassets, return on assets, loan losses, expenses, rates charged on loans andearned on securities investments, rates paid on deposits, competition effects,fee and other noninterest income earned, general economic conditions,nationally, regionally and in the operating market areas of the Company and itssubsidiaries, changes in the regulatory environment, changes in businessconditions and inflation, changes in securities markets, data processingproblems, a decline in real estate values in the Company’s market area, the effects of terrorism, including the events of September 11, 2001 andthereafter, and the conduct of the war on terrorism by the United States andits allies, as well as other factors. This entire report should be read puttingsuch forward-looking statements in context.

 

**General Development of Business**

 

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

 

TheCompany owns 100% of the issued and outstanding common shares of ButteCommunity Bank (the “Bank”). The Bank was incorporated and commenced businessin Paradise and Oroville, California in 1990. The Bank operates fifteen fullservice offices within its service areas of Butte, Sutter, Yuba, Tehama,Shasta, and Colusa Counties. The Bank also maintains a Loan Production Officein Citrus Heights. In March 2009, the Gridley LPO was consolidated withthe full service Yuba City Office. Butte Community Bank’s primary business isserving the commercial banking needs of small to mid-sized businesses andconsumers within those counties. Butte Community Bank accepts checking andsavings deposits, offers money market deposit accounts and certificates ofdeposit, makes secured and unsecured commercial, secured real estate, and otherinstallment and term loans and offers other customary banking services.

 

OnDecember 1, 2004, the Company formed a wholly-owned subsidiary, CVBInsurance Agency LLC for the purpose of providing insurance relatedservices.  The name was subsequentlychanged to Butte Community Insurance Agency LLC in April 2006.

 

OnJuly 10, 2007 the Company formed a wholly-owned unconsolidated subsidiary,Community Valley Bancorp Trust II (the “Trust”), a Delaware statutory businesstrust, for the purpose of issuing trust preferred securities.  Community Valley Bancorp Trust I wasdissolved in January 2008 when the Trust I securities were redeemed.

 

**Critical Accounting Policies**

 

*General*

 

TheCompany’s significant accounting principles are described in Note 1 of theconsolidated financial statements in the Company’s 2008 Annual Report toShareholders on Form 10-K and are essential to understanding Management’sDiscussion and Analysis of Results of Operations and Financial Condition.Community Valley Bancorp’s annual consolidated financial statements areprepared in accordance with accounting principles generally accepted in theUnited States of America (GAAP). The financial information contained within ourstatements is, to a significant extent, financial information that is based onmeasures of the financial effects of transactions and events that have alreadyoccurred. Some of the Company’s accounting principles require significantjudgment to estimate values of assets or liabilities. In addition, certainaccounting principles require significant judgment in applying the complexaccounting principles to transactions to determine the most appropriatetreatment. The following is a summary of the more judgmental and complexaccounting estimates and principles.

 

11

----

Table ofContents

 

*Allowance for Loan Losses (ALL)*

 

Theallowance for loan losses is management’s best estimate of the probable lossesthat may be sustained in our loan portfolio. The allowance is based on twobasic principles of accounting:  (1) SFAS No. 5 which requiresthat losses be accrued when they are probable of occurring and estimable and (2) SFASNo. 114, as amended by SFAS No. 118, which requires that losses beaccrued on impaired loans based on the differences between the value ofcollateral, present value of future cash flows or values that are observable inthe secondary market and the loan balance.

 

TheCompany performs periodic and systematic detailed evaluations of its lendingportfolio to identify and estimate the inherent risks and assess the overallcollectibility. These evaluations include general conditions such as theportfolio composition, size and maturities of various segmented portions of theportfolio such as secured, unsecured, construction, and Small BusinessAdministration (“SBA”).

 

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

 

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

 

*Loan Sales and Servicing*

 

TheCompany originates government guaranteed loans and mortgage loans that may besold in the secondary market.  The amount of gains recorded on sales ofloans and the initial recording of servicing assets and interest only (I/O)strips is based on the estimated fair values of the respectivecomponents.  In recording the initial value of the servicing assets and thefair value of the I/O strips receivable, the Company uses estimates which arebased on management’s expectations of future prepayments and discountrates.  Servicing assets are amortized over the estimated life of therelated loan.  I/O strips are not significant at March 31,2009.  These prepayment and discount rates were based on current marketconditions and historical performance of the various pools of servicedloans.  If actual prepayments with respect to sold loans occur morequickly than projected, the carrying value of the servicing assets may have tobe adjusted through a charge to earnings.

 

*Stock-BasedCompensation*

 

Compensation costis recognized for all share-based payments over the requisite service periodsof the awards based on the grant-date fair value of the options determinedusing the Black-Scholes-Merton based option valuation model.  Critical assumptions that are assessed incomputing the fair value of share-based payments include stock price volatility,expected dividend rates, the risk free interest rate and the expected lives ofsuch options. Compensation cost recorded is net of estimated forfeituresexpected to occur prior to vesting. See Note 4 to the Unaudited CondensedConsolidated Financial Statements for additional information related tostock-based compensation.

 

*Impairment of Investment Securities*

 

Investment securities are evaluated forother-than-temporary impairment on at least a quarterly basis and morefrequently when economic or market conditions warrant such an evaluation todetermine whether a decline in their value below amortized cost is other thantemporary. Management utilizes criteria such as the magnitude and duration ofthe decline, the financial condition of the issuer, rating agency changesrelated to the issuer’s securities and the intent and ability of the Bank to

 

12

----

Table of Contents

 

retainits investment in the issues for a period of time sufficient to allow for ananticipated recovery in fair value, in addition to the reasons underlying the decline,to determine whether the loss in value is other than temporary. The term “otherthan temporary” is not intended to indicate that the decline is permanent, butindicates that the prospects for a near-term recovery of value is notnecessarily favorable, or that there is a lack of evidence to support arealizable value equal to or greater than the carrying value of the investment.Once a decline in value is determined to be other than temporary, the value ofthe security is reduced and a corresponding charge to earnings is recognized.

 

*Revenue recognition*

 

TheCompany’s primary source of revenue is net interest income, which is thedifference between the interest income it receives on interest-earning assetsand the interest expense it pays on interest-bearing liabilities, and (ii) feeincome, which includes fees earned on deposit services, income from sales andservicing of SBA loans, electronic-based cash management services, and mortgagebrokerage fee income.  Interest income isrecorded on an accrual basis. Note 1 to the Consolidated Financial Statementsin the Company’s 2008 Annual Report to Shareholders on Form 10-K offers anexplanation of the process for determining when the accrual of interest incomeis discontinued on an impaired loan.

 

*Income Taxes*

 

The Company accounts forincome taxes under the asset and liability method. Under the asset andliability method, deferred tax assets and liabilities are recognized for thefuture tax consequences attributable to differences between the financial statementcarrying amounts of existing assets and liabilities and their respective taxbases. Deferred tax assets and liabilities are measured using currently enactedtax rates applied to such taxable income in the years in which those temporarydifferences are expected to be recovered or settled. The effect on deferred taxassets and liabilities of a change in tax rates is recognized in income in theperiod that includes the enactment date. If future income should provenon-existent or less than the amount of deferred tax assets within the taxyears to which they may be applied, the asset may not be realized and our netincome will be reduced.

 

The Company accounts foruncertainty in income taxes under Financial Accounting Standards Board (“FASB”)Interpretation No. 48, *Accounting forUncertainty in Income Taxes* (“FIN 48”).  Under the provisions of FIN 48, only taxpositions that met the more likely than not recognition threshold that the taxposition would be sustained in a tax examination were recognized or continue tobe recognized.

 

When tax returnsare filed, it is highly certain that some positions taken would be sustainedupon examination by the taxing authorities, while others are subject touncertainty about the merits of the position taken or the amount of theposition that would be ultimately sustained.  The benefit of a tax position isrecognized in the financial statements in the period during which, based on allavailable evidence, management believes it is more likely than not that theposition will be sustained upon examination, including the resolution ofappeals or litigation processes, if any.  Tax positions taken are notoffset or aggregated with other positions.  Tax positions that meet themore-likely-than-not recognition threshold are measured as the largest amountof tax benefit that is more than 50 percent likely of being realized uponsettlement with the applicable taxing authority.  The portion of thebenefits associated with tax positions taken that exceeds the amount measuredas described above is reflected as a liability for unrecognized tax benefits inthe accompanying balance sheet along with any associated interest and penaltiesthat would be payable to the taxing authorities upon examination. Interest expense and penalties associated with unrecognized tax benefits areclassified as income tax expense in the consolidated statement of income.

 

*FairValue*

 

Effective January 1,2008, the Company adopted SFAS No. 157, *FairValue Measurements,*which among other things, requires enhanced disclosuresabout financial instruments carried at fair value. SFAS No. 157establishes a hierarchical disclosure framework associated with the level ofobservable pricing scenarios utilized in measuring financial instruments atfair value. The degree of judgment utilized in measuring the fair value offinancial instruments generally correlates to the level of the observablepricing scenario. Financial instruments with readily available active quotedprices or for which fair value can be measured from actively quoted pricesgenerally will have a higher degree of observable pricing and a lesser degreeof judgment utilized in measuring fair value. Conversely, financial instrumentsrarely traded or not quoted will generally have little or no observable pricingand a higher degree of judgment utilized in measuring fair value. Observablepricing scenarios are impacted by a number of factors, including the type offinancial instrument, whether the financial instrument is new to the market andnot yet established and the characteristics specific to the transaction.

 

13

----

Table ofContents

 

**Overview**

 

The Company recorded net income of $100,000 for the quarter ended March 31,2009, which was an 87.9% decrease from the $824,000 reported for the sameperiod of 2008. Diluted earnings per share for the first quarter of 2009 were$0.02, compared to the $0.11 recorded in the first quarter of 2008. The annualizedreturn on average equity (ROAE) and annualized return on average assets (ROAA)for the first quarter of 2009 were 1.00% and .07%, respectively, as compared to6.80% and .58%, respectively, for the same period in 2008. The primary reasonsfor the decline in earnings for the first quarter ended March 31, 2009,are the increase in the level of the provision for loan losses, a decline innet interest income which was partially offset by the net gain on the sale ofthe merchant processing portfolio and decreases in the level of income taxes.

 

Weexperienced a compression of the net interest margin of 138 basis points asyields on earning assets decreased 210 basis points while rates paid oninterest bearing liabilities decreased 92 basis points. The compression is adirect result of the Federal Open market Committee of the Federal ReserveSystem (“FOMC”) reducing the Federal funds rate to a range of 0% - .25% in December 2008.Additionally, for the first quarter ended March 31, 2009 we increased theprovision for loan losses to $3,100,000 compared to $225,000 for the firstquarter of 2008. This was partially mitigated by the sale of the merchantprocessing portfolio for $2.6 million in March 2009 and other non-interestincome.

 

Totalassets of the Company increased by $8,676,000 or 1.5% from $595,244,000 at December 31,2008 to $603,920,000 at March 31, 2009. Cash and cash equivalentsincreased to $72,597,000, up $14,249,000 or 24.4%.  Net loans decreased to $473,655,000, down$12,867,000 or 2.64% from December 31, 2008. Deposit balances at March 31,2009 increased to $535,384,000, up $8,899,000 or 1.7% from December 31,2008. Premises and equipment decreased to $6,618,000, down $395,000 or 5.6%. Shareholder’sequity decreased to $40,136,000, down $3,000.

 

TableOne below provides a summary of the components of net income for the periodsindicated:

 

**Table One:  Components of Net Income**

 
| ** **                                                      | ** ** | **Three months ended  March 31,** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------------|------------|
| **(In thousands, except percentages)**                          | ** ** | **2009**                               | ** ** | **2008** | ** ** |
|                                                            |       |                                   |       |   |   |
| Net interest income                                             |       | $                                      | 5,079      |   | $ | 6,671 |   |
| Provision for loan losses                                       |       | (3,100                                 | )          | (225 | ) |
| Non-interest income                                             |       | 4,827                                  |       | 1,959 |   |
| Non-interest expense                                            |       | (6,774                                 | )          | (6,992 | ) |
| Benefit (provision) for income taxes                            |       | 68                                     |       | (589 | ) |
|                                                            |       |                                   |       |   |   |
| Net income                                                      |       | $                                      | 100        |   | $ | 824 |   |
|                                                            |       |                                   |       |   |   |
| Average total assets (In millions)                              |       | $                                      | 594.3      |   | $ | 574.3 |   |
| Net income (annualized) as a percentage of average total assets |       | 0.07                                   | %          | 0.58 | % |

 

14

Table of Contents

 

**Results of Operations**

 

**Net Interest Income and Net Interest Margin**

 

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

 

The Company’s net interest margin was 3.79% for thethree month period ended March 31, 2009 which was down 138 basis pointsfrom 5.17% for the three month period ended March 31, 2008.  Net interest income decreased $1,592,000(23.87%) for the first quarter of 2009 compared to the same period in2008.  The primary reason for this decrease was the compression of the netinterest margin as a result of 225 basis point decreases by the Federal ReserveBoard since March 2008 (ending with the current federal funds rate at arange of 0% - .25%) and because the repricing of our interest bearingliabilities tends to lag behind our interest bearing assets.

 

TableTwo, Analysis of Net Interest Margin, sets forth the average daily balances forthe major asset and liability categories, the related income or expense whereapplicable, and the resultant yield or cost attributable to the average earningassets and interest-bearing liabilities. Changes in the average balances and the rates received or paid depend onmarket opportunities, how well the Company has managed interest rate risks,product pricing policy, product mix, and external trends and developments.

 

TableThree, Analysis of Volume and Rate changes on Net Interest Income, analyzes thechanges in net interest income for the three month period ended March 31,2009 compared to March 31, 2008 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 these periodsfor each major category of assets or liabilities is due to changes in thebalances (volume) or to changes in rates.

 

Forexample, Table Two shows that interest income from loans for the three monthsended March 31, 2009 decreased by $1,898,000 from $8,945,000 at March 31,2008 to $7,047,000.  The average balanceof loans increased from $449,986,000 to $490,644,000 and the interest rateearned decreased from 8.00% to 5.84%. Table Three shows the $1,898,000 decrease in interest income from loanswas actually the result of an $800,000 increase in interest income from thehigher balance of loans and a $2,698,000 decrease from the decrease in yieldsearned in the first quarter of 2009 compared to the same period in 2008.

 

Ashift in the relative size of the major balance sheet categories has an impacton net interest income and net interest margin. For example, to the extent that funds received from maturing or soldsecurities can be repositioned into loans instead of re-invested in securities,earnings increase because of the higher yields received on loans.  However, changing the asset mix in this 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.

 

15

----

Table ofContents

 

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

 
| **Three months ended March 31,**            | ** ** | **2009**        | ** ** | **2008**     | ** ** |
|--------------------------------------------------|------------|-----------------|------------|--------------|------------|
| **(In thousands, except percentages)**           | ** ** | **Avg Balance** | ** ** | **Interest** | ** ** | **Avg Yield (4)** | ** ** | **Avg Balance** | ** ** | **Interest** | ** ** | **Avg Yield (4)** | ** ** |
| Assets                                           |       |            |       |         |       |   |   |   |   |   |   |   |   |
| Earning assets:                                  |       |            |       |         |       |   |   |   |   |   |   |   |   |
| Loans (1)                                        |       | $               | 490,644    |         | $          | 7,047 |   | 5.84 | % | $ | 449,986 |   | $ | 8,945 |   | 8.00 | % |
| Taxable investment securities                    |       | 5,529           |       | 55           |       | 4.05 | % | 5,312 |   | 101 |   | 7.66 | % |
| Tax-exempt investment securities (2)             |       | 1,370           |       | 16           |       | 4.75 | % | 1,383 |   | 16 |   | 4.70 | % |
| Federal funds sold & other              |       | 45,566          |       | 28           |       | 0.25 | % | 43,011 |   | 314 |   | 2.93 | % |
| Interest bearing deposits in banks               |       | 2,389           |       | 24           |       | 4.09 | % | 19,393 |   | 235 |   | 4.87 | % |
| Total earning assets                             |       | 545,498         |       | 7,170        |       | 5.35 | % | 519,085 |   | 9,611 |   | 7.45 | % |
| Cash & due from banks                   |       | 16,541          |       |         |       |   |   | 16,641 |   |   |   |   |   |
| Other assets                                     |       | 32,220          |       |         |       |   |   | 38,572 |   |   |   |   |   |
| Average total assets                             |       | $               | 594,259    |         |       |   |   |   | $ | 574,298 |   |   |   |   |   |
|                                             |       |            |       |         |       |   |   |   |   |   |   |   |   |
| Liabilities & Shareholders’ Equity |       |            |       |         |       |   |   |   |   |   |   |   |   |
| Interest bearing liabilities:                    |       |            |       |         |       |   |   |   |   |   |   |   |   |
| NOW & MMDA                              |       | $               | 152,259    |         | $          | 205 |   | 0.55 | % | $ | 150,340 |   | $ | 334 |   | 0.89 | % |
| Savings                                          |       | 108,167         |       | 296          |       | 1.11 | % | 114,788 |   | 603 |   | 2.11 | % |
| Time deposits                                    |       | 196,006         |       | 1,369        |       | 2.84 | % | 158,178 |   | 1,847 |   | 4.70 | % |
| Other borrowings                                 |       | 13,367          |       | 221          |       | 6.72 | % | 9,866 |   | 156 |   | 6.38 | % |
| Total interest bearing liabilities               |       | 469,799         |       | 2,091        |       | 1.81 | % | 433,172 |   | 2,940 |   | 2.73 | % |
| Demand deposits                                  |       | 73,518          |       |         |       |   |   | 75,608 |   |   |   |   |   |
| Other liabilities                                |       | 10,405          |       |         |       |   |   | 12,515 |   |   |   |   |   |
| Total liabilities                                |       | 553,722         |       |         |       |   |   | 521,295 |   |   |   |   |   |
| Shareholders’ equity                        |       | 40,537          |       |         |       |   |   | 53,003 |   |   |   |   |   |
| Average liabilities and equity                   |       | $               | 594,259    |         |       |   |   |   | $ | 574,298 |   |   |   |   |   |
|                                             |       |            |       |         |       |   |   |   |   |   |   |   |   |
| Net interest income & margin (3)        |       |            |       | $            | 5,079      |   | 3.79 | % |   |   | $ | 6,671 |   | 5.17 | % |

 

----

| (1)    |   | Loan  interest includes loan fees of $272,000 and $470,000 during the three months  ended March 31, 2009 and March 31, 2008, respectively.                                              |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                              |
| (2)    |   | Does  not include taxable-equivalent adjustments that primarily relate to income on  certain securities that is exempt from federal income taxes.                                                 |
|   |   |                                                                                                                                                                                              |
| (3)    |   | Net  interest margin is computed by dividing net interest income by total average  earning assets.                                                                                                |
|   |   |                                                                                                                                                                                              |
| (4)    |   | Average  yield is calculated based on actual days in quarter (90 for March 31,  2009 and 91 for March 31, 2008) and annualized to actual days in year  (365 for 2009 and 366 for 2008). |

 

16

----

Table ofContents

 

TableThree sets forth a summary of the changes in interest income and interestexpense from changes in average asset and liability balances (volume) andchanges in average interest rates.  On a quarter over quarter basis forthe period ending March 31, 2009, net interest income has decreased$1,592,000 from the same time period in 2008.  Interest income fromearning assets has decreased by $2,441,000. Changes in the volume of earningassets, primarily loans, have resulted in an increase in interest income of$618,000 while interest income from changes in rates has decreased by$3,059,000.  Interest expense for the first quarter of 2009 was $849,000less than the same period in 2008. Changes in the volume of interest bearing liabilities, primarily thechange in mix with an increase in balances of NOW, MMDA, time deposits, andother borrowings and a decrease in savings deposits, has resulted in a netincrease of interest expense of $462,000. Decreases in average rates paid, on all deposit products have resultedin an interest expense decrease of $1,311,000.

 

Theaverage balances of interest bearing liabilities of $469,799,000 were$36,627,000 (8.5%) higher in the first quarter of 2009 versus the same quarterin 2008.  As interest bearing liability balances increased, rates paid onthese liabilities decreased by 92 basis points on a quarter over quarterbasis.  As a result of both the decrease in interest rates and the volumeand mix of interest bearing liabilities, interest expense was $849,000 (28.9%)lower in the first quarter versus the same period in 2008.

 

As a result of the above, the Company’s net interestmargin declined 138 basis points to 3.79% for the three months ended March 31,2009 from 5.17% for the same period in the prior year.

 

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

** **
| **Three Months Ended March 31, 2009 over 2008** | ** ** | ** ** | ** ** | ** **   | ** ** | ** **     | ** ** |
|------------------------------------------------------|------------|------------|------------|--------------|------------|----------------|------------|
| **(In thousands)**                                   | ** ** | **Volume** | ** ** | **Rate (3)** | ** ** | **Net Change** | ** ** |
| Increase (decrease) due to change in:                |       |       |       |         |       |           |       |
| Interest-earning assets:                             |       |       |       |         |       |           |       |
| Net loans (1)                                        |       | $          | 800        |         | $          | (2,698         | )          | $ | (1,898 | ) |
| Taxable investment securities                        |       | 4          |       | (50          | )          | (46            | )          |
| Tax exempt investment securities (2)                 |       | —     |       | —       |       | —         |       |
| Federal funds sold                                   |       | 18         |       | (304         | )          | (286           | )          |
| Interest bearing deposits in banks                   |       | (204       | )          | (7           | )          | (211           | )          |
| Total                                                |       | 618        |       | (3,059       | )          | (2,441         | )          |
|                                                 |       |       |       |         |       |           |       |
| Interest-bearing liabilities:                        |       |       |       |         |       |           |       |
| NOW and MMDA deposits                                |       | 4          |       | (133         | )          | (129           | )          |
| Savings deposits                                     |       | (34        | )          | (273         | )          | (307           | )          |
| Time deposits                                        |       | 437        |       | (915         | )          | (478           | )          |
| Other borrowings                                     |       | 55         |       | 10           |       | 65             |       |
| Total                                                |       | 462        |       | (1,311       | )          | (849           | )          |
| Interest differential                                |       | $          | 156        |         | $          | (1,748         | )          | $ | (1,592 | ) |

 

----

| (1)    |   | The  average balance of non-accruing loans is not significant as a percentage of  total loans and, as such, has been included in net loans.       |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                              |
| (2)    |   | Does  not include taxable-equivalent adjustments that primarily relate to income on  certain securities that is exempt from federal income taxes. |
|   |   |                                                                                                                                              |
| (3)    |   | The  rate/volume variance has been included in the rate variance.                                                                                 |

 

17

----

Table ofContents

 

**Non-interest Income**

 

TableFour below provides a summary of the components of non-interest income for theperiods indicated (dollars in thousands):

 

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

** **
| **Three months ended March 31,** | ** ** | **2009** | ** ** | **% of Avg.  Assets** | ** ** | **2008** | ** ** | **% of Avg.  Assets** | ** ** |
|---------------------------------------|------------|----------|------------|-----------------------|------------|----------|------------|-----------------------|------------|
| Sale of merchant processing portfolio |       | $        | 2,640      |                  | 1.81       | %        | $          | —                |       | 0.00 | % |
| Loss on sale of investment security   |       | (172     | )          | (0.12                 | )%         | —   |       | 0.00                  | %          |
| Service charges on deposit accounts   |       | 916      |       | 0.63                  | %          | 856      |       | 0.60                  | %          |
| Loan servicing fees                   |       | 140      |       | 0.10                  | %          | 111      |       | 0.08                  | %          |
| Fees - alternative investment sales   |       | 109      |       | 0.07                  | %          | 145      |       | 0.10                  | %          |
| Merchant fee income                   |       | 86       |       | 0.06                  | %          | 101      |       | 0.07                  | %          |
| Gain on the sale of loans             |       | 503      |       | 0.34                  | %          | 228      |       | 0.16                  | %          |
| Other                                 |       | 605      |       | 0.41                  | %          | 518      |       | 0.36                  | %          |
| Total non-interest income             |       | $        | 4,827      |                  | 3.30       | %        | $          | 1,959                 |       | 1.37 | % |

 

Non-interestincome increased by $2,868,000 (146.4%) to $4,827,000 for the three monthsended March 31, 2009 as compared to $1,959,000 for the three months ended March 31,2008.  Increases in non-interest income were realized primarily from thegain on the sale of the merchant portfolio of $2,640,000 in addition to feesfrom service charges (up 7.0%), loan servicing fees (up 26.1%), gains on thesale of loans (up 120.6%), and other income (up 16.8%). Decreases were realizedin fees from alternative investment sales (down 24.8%), merchant fee income(down 14.6%) and a loss of $172,000 when the Company sold a trust preferredsecurity it held for investment.

 

Theincrease in service charge income was the result of additional deposit accountsopened during the first quarter throughout our system of branches.  Loan servicing fees increased as the volumeof loans sold in the secondary market for which the Company retains servicingrights increased due to refinancing activity. The gain on the sale of loansinto the secondary market increased compared to the first quarter of 2008 asthe loans sold by our government Lending Division increased. Increases in the “Other”category were a result of commissions earned on the sales of insurance policiesand fees paid for payroll processing through our Business Services Division.The Alternative Investment Department, which sells third-party mutual funds andannuities, experienced a decrease in fees of $36,000 due to fewer sales ofinvestments during the first quarter as the uncertainty in the equities marketcontinued. Merchant fee income was lower in the first quarter due to a decreasein the volume of credit card sales.

 

**Non-interest Expense**

 

Non-interestexpense decreased $218,000 (3.1%) from $6,992,000 in the first quarter of 2008to $6,774,000 in the first quarter of 2009.  Salary and employee benefitsdecreased by $298,000 (8.1%), largely due to lower FTE (full time equivalent)employees from reductions in staffing in the first quarter 2009. On a quarterover quarter basis, occupancy expenses were higher by $30,000 (4.4%) which isrelated to the rents now being paid on seven buildings the Company sold in thefirst quarter of 2008 and is now leasing back. This expense is partially offset by the reduction of the depreciation onthose seven buildings.  Furniture and equipment expense was $649,000 inthe first quarter of 2009 compared to $641,000 in the same period of 2008,representing a 1.2% increase. This increase relates to maintenancecontracts and software licensing fees. Other expenses increased $42,000 (2.1%)from $1,979,000 to $2,021,000 in the first quarter of 2009 versus the firstquarter of 2008.  This increase wasattributed to higher telephone, postage and FDIC Assessment insurance accrualdue to the increase in the base assessment rate and the additional fees for theTransaction Account Guarantee Program.

 

**Provision for Loan Losses**

 

TheCompany provided $3,100,000 for loan losses in the first quarter of 2009. Inthe first quarter of 2008 the Company provided $225,000 for loan losses. Net loan charge-offs for the first quarter of 2009 and 2008 were $2,281,000 and$12,000, respectively.  Managementassesses its loan quality on a monthly basis to maintain an adequate allowancefor loan losses.  The Company’s loan portfolio composition, non-performingassets and allowance for loan losses are further discussed under the BalanceSheet Analysis section below.

 

18

----

Table ofContents

 

**Provision for Income Taxes**

 

Thebenefit for income taxes for the three months ended March 31, 2009 was$68,000 as compared to a provision for income taxes of $589,000 for the sameperiod in 2008.  The effective benefitrate for state and federal income taxes was 216.7% for the three months ended March 31,2009 compared to an effective tax rate of 41.7% for the same period in 2008.  The difference in the effective tax ratecompared to the statutory tax rate (approximately 42.05%) is primarily theresult of the Company’s investment in municipal securities and Company-ownedlife insurance policies whose income is exempt from Federal taxes. In addition,the Company receives special tax benefits from the State of CaliforniaFranchise Tax Board for operating and providing loans in designated ‘EnterpriseZones’.

 

**Balance Sheet Analysis**

 

TheCompany’s total assets were $603,920,000 at March 31, 2009, up $8,676,000(1.5%) from $595,244,000 at December 31, 2008.  On a year over yearbasis, the average balance of total assets for the three months ended March 31,2009 was $594,259,000, which represents an increase of $19,961,000 (3.5%) overthe $574,298,000 during the three month period ended March 31, 2008.

 

**Loans**

 

TheCompany concentrates its lending activities in the following principal areas:1) commercial; 2) real estate mortgage; 3) residential real estate and realestate construction (both commercial and residential); 4) agriculture; and 5)consumer loans.  Commercial and residential real estate loans aregenerally secured by improved property, with original maturities of 3-10years.  At March 31, 2009, these principal areas accounted for approximately17%, 53%, 11%, 6% and 13%, respectively, of the Company’s loan portfolio. The mix at December 31, 2008 was 17%, 51%, 13%, 6% and 13%.

 

Loanbalances have declined in the current quarter mainly in the real estateconstruction category as requests for these types of loans are no longer beingreceived as they were before the economic downturn. Further reductions havealso been the result of foreclosures and reclassification to other real estate(ORE). Decreases in loan balances from December 31, 2008 consist ofcommercial loans of $2,707,000 or (3.2%), real estate construction of$9,247,000 or (14.2%), agricultural loans of $822,000 or (2.9%), and consumerloans of $1,512,000 or (2.3%). These changes to the mix and reduction of thereal estate construction loans are consistent with the plan to reduce ourdependency on real estate related lending and further diversify the loanportfolio to mitigate risk. Table Five below summarizes the composition of theloan portfolio as of March 31, 2009 and December 31, 2008.

 

**Table Five: Loan Portfolio Composition**

** **
| **(In thousands)**        | ** ** | **March 31, 2009** | ** ** | **December 31, 2008** | ** ** |
|---------------------------|------------|-------------------------|------------|----------------------------|------------|
| Commercial                |       | $                       | 81,079     |                       | $          | 83,786 |   |
| Real estate:              |       |                    |       |                       |       |
| Mortgage                  |       | 254,169                 |       | 252,018                    |       |
| Construction              |       | 55,757                  |       | 65,004                     |       |
| Agriculture               |       | 27,806                  |       | 28,628                     |       |
| Consumer                  |       | 63,878                  |       | 65,390                     |       |
| Total loans               |       | 482,689                 |       | 494,826                    |       |
| Allowance for loan losses |       | (8,697                  | )          | (7,826                     | )          |
| Deferred loan fees, net   |       | (337                    | )          | (478                       | )          |
| Total net loans           |       | $                       | 473,655    |                       | $          | 486,522 |   |

 

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

 

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

 

Realestate construction loans are generally composed of commitments to customerswithin the Company’s service area for construction of both commercialproperties and custom and semi-custom single-family residences.  Otherreal estate loans consist primarily of loans secured by first trust deeds oncommercial and residential properties typically with maturities from 3 

 

19

----

Table ofContents

 

to10 years and original loan to value ratios generally from 65% to 80%. Agriculture loans consist primarily of crop loans to farmers of peaches,prunes, walnuts, and almonds.  In general, except in the case of loanswith SBA or FMHA guarantees, the Company does not make long-term mortgageloans; however, Butte Community Bank has a residential lending division toassist customers in securing most forms of longer term single-family mortgagefinancing.

 

**Risk Elements**

 

TheCompany assesses and manages credit risk on an ongoing basis through a creditculture that emphasizes excellent credit quality, extensive internal monitoringand established formal lending policies.  Additionally, the Companycontracts with an outside loan review consultant to periodically review the existingloan portfolio.  Management believes its ability to identify and assessrisk and return characteristics of the Company’s loan portfolio is critical forprofitability and growth.  Management strives to continue its emphasis oncredit quality in the loan approval process, active credit administration andregular 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.

 

Specialemphasis is placed within the communities in which the Company has offices(Chico, Paradise, Magalia, Oroville, Yuba City, Red Bluff, Marysville, Colusa,Corning, Redding and Anderson).  The Company also maintains a loanproduction office in Citrus Heights (the Gridley LPO was consolidated with theYuba City full service office in March 2009).  Single-familyresidential construction is the primary lending product from the Citrus Heightslocation serving the greater Sacramento area.  The primary focus of theloan production office that was located in Gridley and moved to Yuba City in March 2009is commercial and agricultural loans.

 

TheCompany has significant extensions of credit and commitments to extend creditthat are secured by real estate.  The ultimate repayment of these loans isgenerally dependent on personal or business cash flows or the sale orrefinancing of the real estate.  The Company monitors the effects of currentand expected market conditions and other factors on the collectability of realestate loans.  The more significant factors management considers involvethe following:  lease, absorption and sale rates; real estate values andrates of return; operating expenses; inflation; and sufficiency of collateralindependent of the real estate including, in limited instances, personalguarantees.

 

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

 

Inmanagement’s judgment, a concentration exists in real estate loans, whichrepresented approximately 64.2% of the Company’s loan portfolio at March 31,2009, which has remained constant with the 64.1% concentration level at December 31,2008.  Management believes the concentration may have more than the normalrisk of collectability due to the substantial decline in the economy in generaland the continuing decline in real estate values in the Company’s primarymarket areas. As the Company is not immune to the slowdown in the economy, wehave increased the provision for loan losses and may have to further increasethe provision which could adversely affect the Company’s future prospects,results of operations, profitability and stock price.  Management believesthat its lending policies and underwriting standards follow strict regulatoryguidelines; however, there is no assurance that losses will not continue tooccur under such circumstances.  The Company’s loan policies andunderwriting standards include, but are not limited to, the following: (1) maintaininga thorough understanding of the Company’s service area and originating asignificant majority of its loans within that area, (2) maintaining athorough understanding of borrowers’ knowledge, capacity, and market positionin their field of expertise, (3) basing real estate loan approvals notonly on market demand for the project, but also on the borrowers’ capacity tosupport the project financially in the event it does not perform toexpectations (whether sale or income performance), and (4) maintainingconforming and prudent loan to value and loan to cost ratios based onindependent outside appraisals and ongoing inspection and analysis by theCompany’s lending officers.  The Companydoes not participate in any sub-prime lending activities nor is it exposed tosub-prime lending in its investment portfolio.

 

20

----

Table ofContents

 

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

 

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

 

TableSix below sets forth nonaccrual loans as of March 31, 2009 and December 31,2008. There were no loans past due 90 days or more and still accruing interestat March 31, 2009 or December 31, 2008.

 

**TableSix: ****Impaired, Nonaccrual, Past Due and Restructured Loans and Leased andOther Nonperforming Assets:**

** **
| **(In thousands)**         | ** ** | **March 31, 2009** | ** ** | **December 31, 2008** | ** ** |
|----------------------------|------------|-------------------------|------------|----------------------------|------------|
| Nonaccrual:                |       |                    |       |                       |       |
| Commercial                 |       | $                       | 1,979      |                       | $          | 395 |   |
| Real estate                |       | 15,435                  |       | 14,490                     |       |
| Consumer and other         |       | 69                      |       | —                     |       |
| Total non-performing loans |       | $                       | 17,483     |                       | $          | 14,885 |   |

 

Non-performing loans(defined as non-accrual loans and loans 90 days or more past due and stillaccruing interest) totaled $17,483,000 at March 31, 2009, an increase of$2,598,000 from $14,885,000 at December 31, 2008 primarily as a result ofincreasing problem loans mainly in the Company’s real estate/developmentportfolio.  Specific reserves on thenon-performing loans of $1,207,000 have been recorded at March 31,2009.  Nonperforming loans as apercentage of total loans were 3.6% at March 31, 2009 compared to 3.1% at December 31,2008.

 

Nonperforming assets,(nonperforming loans and ORE) totaled $27,103,000 at March 31, 2009, anincrease of $10,150,000 from $16,953,000 at December 31, 2008.  Nonperforming assets as a percentage of totalassets were 4.5% at March 31, 2009 compared to 2.9% at December 31,2008.

 

Total non-performingassets consist of forty-three loans for a total of $17,483,000 classified asimpaired and on non-accrual and twenty-six properties for a total of $9,620,000classified as other real estate (ORE). Other than the loans included as non-performing assets at March 31,2009, the Company has not identified any potential problem loans that wouldresult in any loan being included as a non-performing assets at the currentdate.

 

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

 

A development loan forthe construction of an eight unit condominium project in the Yuba City area for$1,145,000 was included in our classified loans and risk rated Substandard at March 31,2009 based on the lack of cash flow and weakening real estate market.  Construction of the project is complete andas of March 31, 2008 five units had been leased. In June of 2008, theCompany received an updated appraisal on the units and found the estimated fairmarket value of the collateral to be below the carrying amount of the loanbalance.  The Company met with theborrower and requested additional collateral which the borrower was unable toprovide.  All payments were paid asagreed until October 2008.  In November of2008, the borrower notified the Company that they would no longer be able tomake the payments.  The loan was placedon non-accrual on December 30, 2008. Due to the continued decline in the real estate market, the Companyordered another appraisal to understand the potential loss exposure andproperly value the collateral.  A newappraisal was received in December 2008 with an appraised value for the 8units of $1,050,000.  On March 18,2009 a charge-off of $500,000 against the allowance for loan losses was recorded.  Even though the Company has a pending lawsuitagainst the borrower, the Company did establish an additional specific reserveof $181,000.

 

A single familyresidential loan for the construction of a home located at Shaver Lake, CA. for$1,260,000 was included in our classified loans and risk rated Substandard at March 31,2009 based on the borrower’s lack of cash flow and the weakening real estatemarket. Construction of the home is complete and the borrower continues to tryand market the home. In February 2009, the borrower notified the Bank thathe could no longer make payments.  Toidentify the Company’s potential loss exposure and properly value thecollateral support provided by the property, a new appraisal was ordered andreceived in March 2009.  This newappraisal reflected the downturn in real estate values and demonstrated thecontinuing decline in the value of the underlying project.  The new appraisal valued the house at$1,475,000 and put the loan to value (LTV) at 85%.  The Company had no additional write-downs asof March 31, 2009.

 

21

----

Table ofContents

 

Another significantnon-performing loan is a commercial real estate loan for the refinance oftwenty-eight cottages located in Fortuna, California for $4,478,000.  This loan was included in our classifiedloans and risk rated substandard at March 31, 2009 due to lack of paymentand pending bankruptcy of the borrower. This loan is a government guaranteed loan under the USDA program with an80% guarantee and maximum exposure to the Company of $896,000.  In October of 2008, the Bank receivednotice that our borrower had filed Bankruptcy under Chapter 11.  It was at this time that the Bank stoppedreceiving payments. On the advice of our attorney, the Company placed the loanon non-accrual on January 7, 2009. To identify the Company’s potential loss exposure and properly value thecollateral support provided by the property, a new appraisal was ordered in January 2009and received on March 9, 2009.  Thenew appraisal put the value at $4,129,000 and reflects the downturn in realestate values as it was significantly lower than the original appraisal.  The Company is prevented from pursuing anyadditional legal action due to the pending Bankruptcy. The Company hasallocated a specific reserve of $96,000 for this loan at March 31, 2009.

 

The last significantnon-performing loan is for the construction of a 227 unit mini-storage locatedin Orland, California for $1,272,000. The Company has a 1st deed of trust of $954,000 and a 2nd deed of trustof $318,000.  These loans were includedin our classified loans and risk rated substandard at March 31, 2009.These loans have a government guarantee under the USDA program with an 80%guarantee and a maximum exposure to the Company of $254,000. In January 2009the borrower informed the Company that he was having cash flow problems.  The Company met with the borrower and wasnotified that he would not be making any more payments.  The loans were placed on non-accrual on January 29,2009 and foreclosure was started. To identify the Company’s potential lossexposure and properly value the collateral support provided by the property, anew appraisal was ordered in January 2009 and received on April 6,2009.  The new appraisal came in at$1,190,000 and reflects the downturn in real estate values as it wassignificantly lower than the original appraisal.  Additional funds of $40,000 will be specificallyreserved for in April 2009.

 

The remainder of thenon-performing loans consists primarily of twelve impaired single family homesthat total $3,885,000 of which three homes are currently under construction,sixteen impaired lot loans that total $3,412,000, three commercial real estateloans that total $1,255,000, four commercial/industrial loans that total$708,000 and three single family homes secured with 2nd deeds of trustfor $69,000. These loans are located throughout Northern California from the Sacramentoarea to Redding and the current appraised values provide the Company with anadequate margin and no specific reserves were allocated to these loans.

 

Other Real Estate

 

The largest of our ORE atMarch 31, 2009 consists of two development loan properties to the sameborrower for a total of $3,032,000.  Theproperties were transferred to ORE on March 16, 2009. The project consistsof 46 finished lots and 61 paper lots. To identify the Company’s potential loss exposure and properly value thecollateral support provided by the property, a new appraisal was received on October 8,2008.  The appraisal demonstrated thecontinuing decline in the value of the underlying project.  The Company charged off an additional $56,000against the allowance for loan losses at the date of transfer.  The October appraised value for the 61paper lots was $945,000 compared to the ORE balance of $752,000 resulting inloan to value (LTV) of 81%.  As thisprovides the Company with an adequate margin, no additional funds were chargedto the ALLL at this time.

 

Another developmentproperty with a fair value of $1,643,000 at March 31, 2009 is included inour ORE assets.  This loan represents a37% participation interest in a loan from another bank. The project consists of46 lots of an original 49 lot subdivision located in Nevada County,California.  The borrower made thedecision to “Deed in Lieu” the property back to the participating bank due toslow sales and the continued weak real estate market.  To identify the Company’s potential lossexposure and properly value the collateral support provided by the property, anew appraisal was ordered and received in December 2008.  This new appraisal reflects the downturn inreal estate values and demonstrated the continuing decline in the value of theunderlying project.  The new appraisalfor the entire project supported a value of $4,400,000 of which our 37%interest represents approximately $1,628,000 resulting in a LTV ofapproximately 100%.  The Company recordeda Deed in Lieu of Foreclosure in February, 2009.  After the Deed in Lieu was completed, theCompany charged-off an additional $167,000 against the allowance for loanlosses upon transferring the property to ORE.

 

The remainder of thenon-performing assets includes twelve SFR lots that currently total $2,170,000and are in ORE.  There are eight singlefamily homes that are included in ORE with a combined balance of$1,936,000.  The amounts placed in OREare supported by current appraisals received by the Company all within the past12 months. In addition, there are three commercial real estate loans that areincluded in ORE at March 31, 2009 with a combined balance of $1,062,000and supported by current appraisals. When loans are placed into ORE, the Company determines the fair marketvalue less the estimated selling costs. The shortfalls are charged to the allowance for loan losses at the timeof transfer.  Properties placed in OREare reviewed continuously and the Company will reappraise the property if it isdeemed necessary.  At a minimum,properties are appraised at least annually. If values have dropped, the Company will establish a valuation allowancefor the ORE through a separate provision for losses on ORE.

 

22

----

Table ofContents

 

Restructured Loans

 

Restructured loans were$20,799,000 at March 31, 2009, an increase of $9,392,000 at December 31,2008. Restructured loans consist of nine land/development loans for a total of$16,611,000.  Three of theseland/development loans are considered impaired in the amount of $1,328,000 andare included as part of the non-performing loans. Three other restructured loansare construction loans for the construction of individual homes and total$2,710,000.  One loan is for theconstruction of a spec home in the amount of $173,000 and is consideredimpaired and included as part of the non-performing loans.  One loan is a single family residence for$247,000.  There is one commercial loanfor $522,000.  The last two loans arecommercial real estate loans totaling $536,000. Both of these loans represent the unguaranteed portion of the USDA loansand have guarantees under this program. Except for the loans mentioned above, the remaining restructured loansare performing as agreed and were all current at March 31, 2009.  No additional funds were lent to theborrowers of the restructured loans.

 

**Allowance for Loan Losses Activity**

 

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

 

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

 

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

 

Ourmethodology is, and has been, consistently followed.  However, as we addnew products, increase in complexity, and expand our geographic coverage, weexpect to enhance our methodology to keep pace with the size and complexity ofthe loan portfolio.  On an ongoing basis we engage outside firms toindependently assess our methodology, and to perform independent credit reviewsof our loan portfolio.  The FDIC and the California Department ofFinancial Institutions review the allowance for loan losses as an integral partof the examination processes.  Management believes that our currentmethodology is appropriate given our size and level of complexity. Further, management believes that the allowance for loan losses is adequate asof March 31, 2009 to cover known and inherent risks in the loanportfolio.  However, fluctuations in credit quality, or changes ineconomic conditions or other factors could cause management to increase ordecrease the allowance for loan losses as necessary.

 

TheBoard of Directors of the Bank reviews the adequacy of the allowance for loanlosses at least quarterly to include consideration of the relative risks in theportfolio and current economic conditions.  The allowance is adjustedbased on that review if, in the judgment of the loan committee and management,changes are warranted.  The allowance for loan losses totaled $8,697,000or 1.80% of total loans at March 31, 2009 and $7,826,000 or 1.58% at December 31,2008.  Net charge-offs for the quarter ended March 31, 2009 were$2,281,000. The Company has a separate reserve for unfunded loan commitments of$241,000 as of March 31, 2009 and $293,000 as of December 31, 2008.

 

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

 

23

----

Table ofContents

 

**Table Seven: Allowance for Loan Losses**

** **
| ** **                                                                | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------------------|------------|
| **(In thousands, except for percentages)**                                | ** ** | **2009**                               | ** ** | **2008** | ** ** |
| Average loans outstanding                                                 |       | $                                      | 490,644    |   | $ | 449,986 |   |
|                                                                      |       |                                   |       |   |   |
| Allowance for possible loan losses at beginning of period                 |       | $                                      | 7,826      |   | $ | 6,092 |   |
|                                                                      |       |                                   |       |   |   |
| Loans charged off:                                                        |       |                                   |       |   |   |
| Commercial                                                                |       | (50                                    | )          | (7 | ) |
| Real estate                                                               |       | (2,228                                 | )          | — |   |
| Consumer                                                                  |       | (4                                     | )          | (5 | ) |
| Total                                                                     |       | (2,282                                 | )          | (12 | ) |
| Recoveries of loans previously charged off:                               |       |                                   |       |   |   |
| Commercial                                                                |       | —                                 |       | — |   |
| Real estate                                                               |       | —                                 |       | — |   |
| Consumer                                                                  |       | 1                                      |       | — |   |
| Total                                                                     |       | 1                                      |       | — |   |
| Net loan charge offs                                                      |       | (2,281                                 | )          | (12 | ) |
|                                                                      |       |                                   |       |   |   |
| Additions to allowance charged to operating expenses                      |       | 3,100                                  |       | 225 |   |
|                                                                      |       |                                   |       |   |   |
| Gross allowance for loan losses at end of period                          |       | $                                      | 8,645      |   | $ | 6,305 |   |
|                                                                      |       |                                   |       |   |   |
| Allowance for unfunded commitments                                        |       | 52                                     |       | (280 | ) |
|                                                                      |       |                                   |       |   |   |
| Net allowance for loan losses at end of period                            |       | 8,697                                  |       | 6,025 |   |
|                                                                      |       |                                   |       |   |   |
| Ratio of net charge-offs to average loans outstanding                     |       | 0.46                                   | %          | 0.00 | % |
| Provision for possible loan losses to average loans outstanding           |       | 0.63                                   | %          | 0.05 | % |
| Allowance for loan losses to loans net of deferred fees at end of  period |       | 1.80                                   | %          | 1.32 | % |

 

Itis the policy of management to maintain the allowance for loan losses at alevel adequate for known and inherent risks in the portfolio.  Based oninformation currently available to analyze inherent credit risk, includingeconomic factors, overall credit quality, historical delinquencies and ahistory of actual charge-offs, management believes that the provision for loanlosses and the allowance are adequate.  The Company generally makesmonthly allocations to the allowance for loan losses.  The budgetedallocation is based on estimates of loss risk and loan growth. Adjustments may be made based on differences from estimated loan growth, thetypes of loans constituting this growth, changes in risk ratings within theportfolio, and general economic conditions.  However, no prediction of theultimate level of loans charged off in future periods can be made with any certainty.

 

**Deposits**

 

AtMarch 31, 2009, total deposits were $535,384,000 representing an increaseof $8,899,000 (1.7%) over the December 31, 2008 balance of$526,485,000.  We have experienced a decrease in the level of ournon-interest bearing demand deposits in the first three months of 2009 (down$8.9 million).  We have seen an increasein the interest bearing checking, money market, and savings accounts (up $3million), and an increase in certificates of deposit (up $14.8 million).Brokered deposits totaled $39.2 million of which $25.7 million is from existingBank customers who elected to participate in the Certificate of Deposit AccountRegistry Service (CDARS) reciprocal deposits program.

 

TheEmergency Economic Stabilization Act of 2008 included a provision for an increase inthe amount of deposits insured by the FDIC to $250,000. In addition, the Bankis participating in the FDIC Transaction Account Guarantee Program. Under thatprogram, through December 31, 2009, all noninterest-bearing transactionaccounts are fully guaranteed by the FDIC for the entire amount in the account.Coverage under the Transaction Account Guarantee Program is in addition to andseparate from the coverage available under the FDIC’s general deposit insurancerules. Participating institutions will be assessed a 10 basis point surchargeon the additional insured deposits.

 

24

----

Table ofContents

 

**Capital Resources**

 

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

 

AtMarch 31, 2009 shareholders’ equity was $40,136,000 representing adecrease of $3,000 over the December 31, 2008 balance of $40,139,000.

 

On June 30, 2008 theCompany borrowed $4 million from one of its correspondent banks which wasdown-streamed to Butte Community Bank in the form of additional common stockissued to the holding company.  This note is for a two year period with amaturity date of June 30, 2010 and an interest rate equal to the threemonth LIBOR rate plus 3.25% adjusted quarterly, or 5.75% at March 31,2009.

 

TheBoard of Directors of the Company authorized the payment of quarterly cashdividends of $0.08, $0.04 and $0.04 per share for the first, second, and thirdquarters, respectively, in 2008 and chose to suspend paying dividends in thefourth quarter of 2008 and the first quarter of 2009. The payment of dividendsin the future is subject to the discretion of the Board of Directors of theCompany and will depend on earnings, the financial condition of the Company andother 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.  The Bank’s ratio of total risk-basedcapital to risk adjusted assets was 10.5% at March 31, 2009 and 10.4% at December 31,2008.  Tier 1 risk-based capital to risk-adjusted assets was 9.2% at March 31,2009 and 9.1% at December 31, 2008.

 

TableEight below lists the Company’s and the Bank’s capital ratios at March 31,2009 and December 31, 2008, as well as the minimum ratios required underregulatory definitions of capital adequacy.

 

**TableEight: Capital Ratios**

** **
| **Capital to Risk-Adjusted Assets** | ** ** | **At March 31, 2009** | ** ** | **At December 31,  2008** | ** ** | **Minimum Regulatory  Requirement** | ** ** |
|-------------------------------------|------------|----------------------------|------------|--------------------------------|------------|-------------------------------------|------------|
|                                |       |                       |       |                           |       |                                |       |
| Company                             |       |                       |       |                           |       |                                |       |
| Leverage ratio                      |       | 8.1                        | %          | 8.1                            | %          | 4.0                                 | %          |
|                                |       |                       |       |                           |       |                                |       |
| Tier 1 Risk-Based Capital           |       | 9.0                        | %          | 8.8                            | %          | 4.0                                 | %          |
|                                |       |                       |       |                           |       |                                |       |
| Total Risk-Based Capital            |       | 10.2                       | %          | 10.0                           | %          | 8.0                                 | %          |
|                                |       |                       |       |                           |       |                                |       |
| Bank                                |       |                       |       |                           |       |                                |       |
| Leverage ratio                      |       | 8.3                        | %          | 8.2                            | %          | 4.0                                 | %          |
|                                |       |                       |       |                           |       |                                |       |
| Tier 1 Risk-Based Capital           |       | 9.2                        | %          | 9.1                            | %          | 4.0                                 | %          |
|                                |       |                       |       |                           |       |                                |       |
| Total Risk-Based Capital            |       | 10.5                       | %          | 10.4                           | %          | 8.0                                 | %          |

 

Capitalratios are reviewed on a regular basis to ensure that capital exceeds theprescribed regulatory minimums and is adequate to meet future needs.  Allratios are in excess of the regulatory definition of “Minimum” at March 31,2009 and December 31, 2008.  The Bank was considered “well-capitalized”by regulatory standards, at March 31, 2009 and December 31, 2008.

 

The Company and the Bankmeet all of their capital requirements and the Bank is considered wellcapitalized. The Company’s capital position and other liquidity sources providedeposit customers with an important level of safety and confidence in theCompany that is essential in these uncertain economic times.

 

As a result of a recentregulatory examination, the Bank must obtain the prior written consent of itsprimary regulators before paying dividends and has agreed to increase itsLeverage Ratio to 10.0% by October 31, 2009.  In addition, the Bank is to maintain othercapital ratios above well capitalized thresholds. Management is currentlyadjusting its capital plan in order to conform to this requirement throughrestructuring of the balance sheet and or the addition of new capital in theform of common or preferred stock. An amendment to the Company bylaws to allowissuance of preferred stock is currently before the shareholders for vote andwill be decided at the annual meeting to be held June 4, 2009.

 

25

----

Table ofContents

 

**Item 3.  Quantitative andQualitative Disclosures about Market Risk**

 

**Market Risk Management**

 

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

 

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

 

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

 

Simulationof earnings is the primary tool used to measure the sensitivity of earnings tointerest rate changes.  Using computer-modeling techniques, the Company isable to estimate the potential impact of changing interest rates onearnings.  A balance sheet forecast is prepared monthly using inputs ofactual loans, securities and interest bearing 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 is measured during theyear assuming a gradual change in rates over the twelve-month horizon. The Company’s net interest income, as forecast below, was modeled utilizing aforecast balance sheet projected from balances as of the date indicated.

 

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

 

**TableNine:  Interest Rate Risk Simulation of Net Interest as of March 31,2009 and December 31, 2008**

** **
| **(In thousands)**                 | ** ** | **$ Change in NII  from Current  12 Month Horizon  March 31, 2009** | ** ** | **$ Change in NII  from Current  12 Month Horizon  December 31, 2008** | ** ** |
|-----------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------|------------|
| Variation from a constant rate scenario |       |                                                                                                        |       |                                                                                                      |       |
| +200bp                                  |       | $                                                                                                           | 3,408      |                                                                                                      | $          | 3,522 |   |
| - 200bp                                 |       | $                                                                                                           | 356        |                                                                                                      | $          | 328 |   |

 

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

 

26

----

Table ofContents

 

**Inflation**

 

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

 

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

 

**Liquidity**

 

Liquiditymanagement refers to the Company’s ability to provide funds on an ongoing basisto meet fluctuations in deposit levels as well as the credit needs andrequirements of its clients.  Both assets and liabilities contribute tothe Company’s liquidity position.  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.

 

TheCompany’s sources of liquidity consist of cash and due from correspondentbanks, overnight funds sold to correspondent banks, unpledged marketableinvestments and loans held for sale.  On March 31, 2009, consolidatedliquid assets totaled $72.6 million or 12% of total assets compared to $58.3million or 9.8% of total assets on December 31, 2008.  In addition toliquid assets, the Company maintains short-term lines of credit in the amountof $15,000,000 with correspondent banks.  There were no borrowingsoutstanding under these arrangements at March 31, 2009.

 

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

 

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

 

**Off-Balance Sheet Items**

 

TheCompany has certain ongoing commitments under operating leases.  Thesecommitments do not significantly impact operating results. As of March 31,2009 and December 31, 2008, commitments to extend credit and letters ofcredit were the only financial instruments with off-balance sheet risk. The Company has not entered into any contracts for financial derivativeinstruments such as futures, swaps, options or similar instruments. Commitmentsto fund loans and stand-by letters of credit at March 31, 2009 and December 31,2008 were approximately $134,415,000 and $154,482,000 respectively.  Suchloans relate primarily to revolving lines of credit and other commercial loans,and to real estate construction loans. As a percentage of net loans, these off-balance sheet items represent28.3% and 31.7%, respectively. Of the loan commitments outstanding at March 31,2009, $38,882,000 are real estate construction loan commitments that are notexpected to fund within the next twelve months due to the current downturn inthe real estate market. The remaining commitments primarily relate to revolvinglines of credit or other commercial loans, and many of these are expected toexpire without being drawn upon. Therefore, the total commitments do notnecessarily represent future cash requirements.

 

**Other Matters**

 

**Item 4.  Controls andProcedures**

 

(a) DisclosureControls and Procedures: An evaluation of the Company’s disclosure controls andprocedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e))was carried out under the supervision and with the participation of the Company’sChief Executive Officer, Chief Financial Officer and other members of theCompany’s senior management as of the end of the Company’s fiscal quarter endedMarch 31, 2009. The Company’s Chief Executive Officer and Chief Financial 

 

27

----

Table ofContents

 

Officerconcluded that the Company’s disclosure controls and procedures as currently ineffect are effective in ensuring that the information required to be disclosedby the Company in the reports it files or submits under the Exchange Act is (i) accumulatedand communicated to the Company’s management (including the Chief ExecutiveOfficer and Chief Financial Officer) to allow timely decisions regardingrequired disclosure, and (ii) recorded, processed, summarized and reportedwithin the time periods specified in the Commission’s rules and forms.

 

(b) InternalControl Over Financial Reporting: An evaluation of any changes in the Company’sinternal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and15d-15(f)), that occurred during the Company’s fiscal quarter ended March 31,2009, was carried out under the supervision and with the participation of theCompany’s Chief Executive Officer, Chief Financial Officer and other members ofthe Company’s senior management. The Company’s Chief Executive Officer andChief Financial Officer concluded that no change identified in connection withsuch evaluation has materially affected, or is reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

 

**Item 5.  Subsequent Events**

 

None.

 

28

----

Table ofContents

 

**PART II— OTHER INFORMATION**

 

Item 1.  Legal Proceedings.

 

None.

 

Item 1A.  Risk Factors

 

Inaddition to the other information set forth in this report, you shouldcarefully consider the factors discussed in Part I, “Item 1A. Risk Factors”in our Annual Report on Form 10-K for the year ended December 31,2008, which could materially affect our business, financial condition or futureresults. The risks described in our Annual Report on Form 10-K are not theonly risks facing our Company. Additional risks and uncertainties not currentlyknown to us or that we currently deem to be immaterial also may materiallyadversely affect our business, financial condition and/or operating results.

 

Item 2.  Changes in Securities and Use ofProceeds.

 

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

 

Duringthe three months ended March 31, 2009, no shares of common stock wererepurchased under the share repurchase program. There is approximately$5,671,796 remaining that may yet be purchased under the plan.

 

Item 3.  Defaults Upon Senior Securities.

 

None.

 

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

 

None.

 

Item 5.  Other Information.

 

None.

 

Item 6.  Exhibits

 

(a)  Exhibits

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

 

29

----

Table ofContents

 

**SIGNATURES**

 

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

 

|         |     | COMMUNITY VALLEY BANCORP |
|--------------|----------|--------------------------|
|         |     |                     |   |   |
| May 15, 2009 | * * | * *                 | *By:* | */s/ Keith C. Robbins* |
|         |     |                     |   |   |
|         |     |                     |   | Keith C. Robbins |
|         |     |                     |   |   |
|         |     |                     | President, Chief Executive  Officer |
|         |     |                     |   |   |
| May 15, 2009 | * * | * *                 | *By:* | */s/ John F. Coger* |
|         |     |                     |   |   |
|         |     |                     |   | John F. Coger |
|         |     |                     |   |   |
|         |     |                     | Executive Vice President,  CFO, COO |

 

30

----