**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C.20549**

 

**FORM 10-Q**

 

**ý****   QUARTERLY REPORT PURSUANT TO SECTION13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the Quarterly PeriodEnded   June 30, 2003**

 

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

 

**Commission File No. 0-31525**

 

**COMMUNITY VALLEY BANCORP**

(Exact name of registrant as specified in its charter)

 

| **California**                                                  |   | **68-0479553**           |
|-----------------------------------------------------------------|--------|--------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (IRS Employer ID Number) |
|                                                            |   |                     |
| **2041 Forest Avenue, Chico, California**                       |   | **95928**                |
| (Address of principal executive offices)                        |   | (Zip code)               |

 

**(530) 899-2344**

(Registrant’s telephone number,including area code)

 

**not applicable**

(Former name, former address and formerfiscal year, if changedsince last report.)

 

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past 90 days.

 

Yes  ý     No  o

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Exchange Act Rule 12-b-2)

 

Yes  o     No  ý

 

Indicate the number of sharesoutstanding of each of the issuer’s classes of common stock, as of the latestpracticable date:

 

No par value Common Stock –2,706,864 shares outstanding at July 31, 2003.

 

 

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PART 1-FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

 

COMMUNITY VALLEY BANCORP

CONSOLIDATED BALANCE SHEET (Unaudited)

 
| **(In thousands)**                                                                                                                                                          |   | **June 30,  2003** |    | **December 31,  2002** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|---------|------------------------|--------|
| ASSETS                                                                                                                                                                      |   |               |    |                   |   |
|                                                                                                                                                                        |   |               |    |                   |   |   |   |
| Cash and due from banks                                                                                                                                                     |   | $                  | 18,565  |                   | $      | 15,621 |   |
| Federal funds sold                                                                                                                                                          |   | 74,300             |    | 57,410                 |   |
| Interest-bearing deposits in banks                                                                                                                                          |   | 6,638              |    | 4,061                  |   |
| Investment securities (market value of  $2,461 at June 30, 2003 and $3,438 at December 31, 2002)                                                                            |   | 2,410              |    | 3,387                  |   |
| Loans held for sale                                                                                                                                                         |   | 4,611              |    | 7,912                  |   |
| Loans, less allowance for loan losses of  $3,277 at June 30, 2003 and $3,007 at December 31, 2002                                                                           |   | 241,716            |    | 229,699                |   |
| Bank premises and equipment, net                                                                                                                                            |   | 6,860              |    | 6,653                  |   |
| Accrued interest receivable and other  assets                                                                                                                               |   | 13,982             |    | 12,492                 |   |
|                                                                                                                                                                        |   | $                  | 369,082 |                   | $      | 337,235 |   |
|                                                                                                                                                                        |   |               |    |                   |   |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                                                                   |   |               |    |                   |   |
|                                                                                                                                                                        |   |               |    |                   |   |
| Deposits:                                                                                                                                                                   |   |               |    |                   |   |
| Non-interest bearing                                                                                                                                                        |   | $                  | 68,951  |                   | $      | 62,889 |   |
| Interest bearing                                                                                                                                                            |   | 260,062            |    | 235,092                |   |
| Total deposits                                                                                                                                                              |   | 329,013            |    | 297,981                |   |
|                                                                                                                                                                        |   |               |    |                   |   |
| Employee stock ownership plan note payable                                                                                                                                  |   | 742                |    | 732                    |   |
| Mandatorily redeemable cumulative trust  preferred securities of subsidiary grantor trust                                                                                   |   | 8,000              |    | 8,000                  |   |
|                                                                                                                                                                        |   |               |    |                   |   |
| Accrued  interest payable and other liabilities                                                                                                                             |   | 4,125              |    | 5,141                  |   |
|                                                                                                                                                                        |   |               |    |                   |   |
| Total liabilities                                                                                                                                                           |   | 341,880            |    | 311,854                |   |
|                                                                                                                                                                        |   |               |    |                   |   |
| Commitments and contingencies                                                                                                                                               |   |               |    |                   |   |
|                                                                                                                                                                        |   |               |    |                   |   |
| Shareholders’ equity:                                                                                                                                                  |   |               |    |                   |   |
| Common stock – no par value; 20,000,000  shares authorized; issued and outstanding – 2,692,278 shares at June 30, 2003  and 2,700,339 shares at December 31, 2002 |   | 6,935              |    | 6,660                  |   |
| Unearned ESOP shares (65,458 shares at June  30, 2003 and 65,437 shares at December 31, 2002, at cost)                                                                      |   | (906               | )       | (852                   | )      |
|                                                                                                                                                                        |   |               |    |                   |   |
| Retained earnings                                                                                                                                                           |   | 21,173             |    | 19,559                 |   |
|                                                                                                                                                                        |   |               |    |                   |   |
| Accumulated other comprehensive income  (Note 3)                                                                                                                            |   | 0                  |    | 14                     |   |
|                                                                                                                                                                        |   |               |    |                   |   |
| Total shareholders’ equity                                                                                                                                             |   | 27,202             |    | 25,381                 |   |
|                                                                                                                                                                        |   | $                  | 369,082 |                   | $      | 337,235 |   |

 

See Notes to UnauditedConsolidated Financial Statements

 

2

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COMMUNITY VALLEY BANCORP

CONSOLIDATED STATEMENT OF INCOME

(Unaudited)

 
|                                                             |   | **For the  periods ended June 30,** |       |
|------------------------------------------------------------------|--------|-------------------------------------|------------|
|                                                             |   | **Three  months**                   |       | **Six Months** |   |
| **(In  thousands, except per share data)**                       |   | **2003**                            |       | **2002** |   | **2003** |   | **2002** |   |
|                                                             |   |                                | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Interest income:                                                 |   |                                |       |   |   |   |   |   |   |
| Interest and fees on loans                                       |   | $                                   | 4,871      |   | $ | 4,170 |   | $ | 9,645 |   | $ | 8,394 |   |
| Interest on Federal funds sold                                   |   | 199                                 |       | 148 |   | 381 |   | 288 |   |
| Interest on deposits in banks                                    |   | 49                                  |       | 14 |   | 90 |   | 24 |   |
| Interest and dividends on investment  securities:                |   |                                |       |   |   |   |   |   |   |
| Taxable                                                          |   | 26                                  |       | 20 |   | 62 |   | 36 |   |
| Exempt from Federal income taxes                                 |   | 19                                  |       | 26 |   | 38 |   | 54 |   |
| Dividends                                                        |   |                                |       | 1 |   |   |   |   |   |
|                                                             |   |                                |       |   |   |   |   |   |   |
| Total interest income                                            |   | 5,164                               |       | 4,379 |   | 10,216 |   | 8,796 |   |
| Interest expense:                                                |   |                                |       |   |   |   |   |   |   |
| Interest on deposits                                             |   | 1,019                               |       | 1,157 |   | 2,032 |   | 2,487 |   |
| Interest on long-term debt                                       |   | 112                                 |       | 10 |   | 250 |   | 20 |   |
| Total interest expense                                           |   | 1,131                               |       | 1,167 |   | 2,282 |   | 2,507 |   |
|                                                             |   |                                |       |   |   |   |   |   |   |
| Net interest income                                              |   | 4,033                               |       | 3,212 |   | 7,934 |   | 6,289 |   |
|                                                             |   |                                |       |   |   |   |   |   |   |
| Provision for loan losses                                        |   | 120                                 |       | 150 |   | 270 |   | 253 |   |
| Net interest income after provision for  loan losses             |   | 3,913                               |       | 3,062 |   | 7,664 |   | 6,036 |   |
|                                                             |   |                                |       |   |   |   |   |   |   |
| Non-interest income                                              |   | 1,383                               |       | 1,256 |   | 2,566 |   | 3,315 |   |
|                                                             |   |                                |       |   |   |   |   |   |   |
| Non-interest expense:                                            |   |                                |       |   |   |   |   |   |   |
| Salaries and employee benefits                                   |   | 1,945                               |       | 1,362 |   | 3,886 |   | 2,823 |   |
| Occupancy                                                        |   | 204                                 |       | 169 |   | 376 |   | 306 |   |
| Furniture and equipment                                          |   | 233                                 |       | 238 |   | 473 |   | 411 |   |
| Other expense                                                    |   | 950                                 |       | 954 |   | 1,816 |   | 2,947 |   |
| Total non-interest expense                                       |   | 3,332                               |       | 2,723 |   | 6,551 |   | 6,487 |   |
|                                                             |   |                                |       |   |   |   |   |   |   |
| Income before income taxes                                       |   | 1,964                               |       | 1,634 |   | 3,679 |   | 2,864 |   |
|                                                             |   |                                |       |   |   |   |   |   |   |
| Income taxes                                                     |   | 848                                 |       | 662 |   | 1,526 |   | 639 |   |
|                                                             |   |                                |       |   |   |   |   |   |   |
| Net income                                                       |   | $                                   | 1,116      |   | $ | 972 |   | $ | 2,153 |   | $ | 2,225 |   |
|                                                             |   |                                |       |   |   |   |   |   |   |
| Basic earnings per share (Note 2)                                |   | $                                   | .42        |   | $ | .38 |   | $ | .81 |   | $ | .87 |   |
| Diluted earnings per share (Note 2)                              |   | $                                   | .40        |   | $ | .36 |   | $ | .78 |   | $ | .82 |   |
|                                                             |   |                                |       |   |   |   |   |   |   |
| Cash dividends per share of issued and  outstanding common stock |   | $                                   | .10        |   | $ | .075 |   | $ | .10 |   | $ | .075 |   |

 

See Notes toUnaudited Consolidated Financial Statements

 

3

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COMMUNITY VALLEY BANCORP

CONSOLIDATED STATEMENT OFCHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

(In thousands except number ofshares)

 
|                                                             |       | **Common  Stock** |       | **Unearned  ESOP  Shares** |   | **Retained  Earnings** |   | **Accumulated  Other  Comprehensive  Income** |   | **Total  Shareholders’  Equity** |   | **Comprehensive  Income** |   |
|------------------------------------------------------------------|------------|-------------------|------------|----------------------------|--------|------------------------|--------|-----------------------------------------------|--------|---------------------------------------|--------|---------------------------|--------|
|                                                             |       |              |       |                       |   |                   |
|                                                             |       |              |       |                       |   |                   |
|                                                             | **Shares** |              | **Amount** |                       |   |                   |   |                                          |   |
|                                                             |       |              |       |                       |   |                   |   |                                          |   |                                  |   |                      |   |   |   |
| Balance, January 1, 2002                                         |       | 2,648,389         |       | $                          | 6,131  |                   | $      | (902                                          | )      | $                                     | 15,592 |                      |   |   | $ | 20,821 |   |   |   |
|                                                             |       |              |       |                       |   |                   |   |                                          |   |                                  |   |                      |   |   |   |
| Comprehensive income (Note 3):                              |       |              |       |                       |   |                   |   |                                          |   |                                  |   |                      |   |   |   |
| Net income                                                       |       |              |       |                       |   |                   |   | 4,849                                         |   |                                  |   | 4,849                     |   | $ | 4,849 |   |
| Other comprehensive gain except unrealized  gain                 |       |              |       |                       |   |                   |   |                                          |   | $                                     | 14     |                      | 14     |   | 14 |   |
| Total comprehensive income                                       |       |              |       |                       |   |                   |   |                                          |   |                                  |   |                      |   | $ | 4,863 |   |
|                                                             |       |              |       |                       |   |                   |   |                                          |   |                                  |   |                      |   |   |   |
| Exercise of stock options and related tax  benefit               |       | 36,962            |       | 426                        |   |                   |   |                                          |   |                                  |   | 426                       |   |   |   |
| Earned ESOP shares                                               |       |              |       | 108                        |   | 50                     |   |                                          |   |                                  |   | 158                       |   |   |   |
| Cash dividends- $.33 per share                                   |       |              |       |                       |   |                   |   | (882                                          | )      |                                  |   | (882                      | )      |   |   |
| Cash in lieu of fractional shares in  four-for-three stock split |       |              |       | (5                         | )      |                   |   |                                          |   |                                  |   | (5                        | )      |   |   |
|                                                             |       |              |       |                       |   |                   |   |                                          |   |                                  |   |                      |   |   |   |
| Balance, December 31, 2002                                       |       | 2,685,351         |       | 6,660                      |   | (852                   | )      | 19,559                                        |   | 14                                    |   | 25,381                    |   |   |   |
|                                                             |       |              |       |                       |   |                   |   |                                          |   |                                  |   |                      |   |   |   |
| Comprehensive income (Note 3):                                   |       |              |       |                       |   |                   |   |                                          |   |                                  |   |                      |   |   |   |
| Net income                                                       |       |              |       |                       |   |                   |   | 2,153                                         |   |                                  |   | 2,153                     |   | $ | 2,153 |   |
| Other comprehensive loss, net of tax:                            |       |              |       |                       |   |                   |   |                                          |   |                                  |   |                      |   |   |   |
| Unrealized loss on available-for-sale  investment securities     |       |              |       |                       |   |                   |   |                                          |   | (14                                   | )      |                      |   | (14 | ) |
|                                                             |       |              |       |                       |   |                   |   |                                          |   |                                  |   |                      |   |   |   |
| Total comprehensive income                                       |       |              |       |                       |   |                   |   |                                          |   |                                  |   |                      |   | $ | 2,139 |   |
|                                                             |       |              |       |                       |   |                   |   |                                          |   |                                  |   |                      |   |   |   |
| Exercise of stock options and related tax  benefit               |       | 14,988            |       | 216                        |   |                   |   |                                          |   |                                  |   | 216                       |   |   |   |
| Earned ESOP shares                                               |       |              |       | 59                         |   | 24                     |   |                                          |   |                                  |   | 83                        |   |   |   |
| Shares acquired by ESOP                                          |       |              |       |                       |   | (78                    | )      |                                          |   |                                  |   | (78                       | )      |   |   |
| Cash dividends declared                                          |       |              |       |                       |   |                   |   | (539                                          | )      |                                  |   | (539                      | )      |   |   |
|                                                             |       |              |       |                       |   |                   |   |                                          |   |                                  |   |                      |   |   |   |
| Balance, June 30, 2003                                           |       | 2,700,339         |       | $                          | 6,935  |                   | $      | (906                                          | )      | $                                     | 21,173 |                      | $      | 0 |   | $ | 27,202 |   |   |   |

 

See Notes to UnauditedConsolidated Financial Statements

 

4

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COMMUNITY VALLEY BANCORP

CONSOLIDATED STATEMENT OF CASHFLOWS(Unaudited)

 
| **(In thousands)**                                                                 |   |     |   |     |   |
|------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|
| **For the six months ended June 30,**                                              |   | **2003** |   | **2002** |   |
|                                                                               |   |     |   |     |   |
| Cash flows from operating activities:                                              |   |     |   |     |   |
| Net income                                                                         |   | $        | 2,153  |     | $      | 2,225 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |   |     |   |     |   |
| Provision for loan losses                                                          |   | 270      |   | 253      |   |
| Deferred loan origination costs, net                                               |   | (50      | )      | (62      | )      |
| Depreciation and amortization                                                      |   | 497      |   | 311      |   |
| Net decrease in loans held for sale                                                |   | 3,301    |   | 2,208    |   |
| (Increase) decrease in cash surrender value  of life insurance                     |   | (1,705   | )      | 102      |   |
| Compensation expense on cashless exchange  of stock options                        |   |     |   | 79       |   |
| Loss on sale of other real estate                                                  |   |     |   | 13       |   |
| Deferred Taxes                                                                     |   |     |   | 977      |   |
| Non-cash compensation expense associated  with the ESOP                            |   | 83       |   |     |   |
| Decrease (increase) in accrued interest  receivable and other assets               |   | 367      |   | (1,707   | )      |
| Decrease in accrued interest payable and  other liabilities                        |   | (1,017   | )      | (523     | )      |
| Gain on disposition of Bank premises and  equipment                                |   | (1       | )      | (160     | )      |
|                                                                               |   |     |   |     |   |
| Net cash provided by operating activities                                          |   | 3,898    |   | 3,716    |   |
|                                                                               |   |     |   |     |   |
| Cash flows from investing activities:                                              |   |     |   |     |   |
|                                                                               |   |     |   |     |   |
| Increase in interest-bearing deposits in  banks                                    |   | (2,577   | )      | (792     | )      |
| Proceeds from called held-to-maturity investment  securities                       |   | 2,200    |   | 250      |   |
| Purchase of held-to-maturity investment  securities                                |   | (1,311   | )      | (562     | )      |
| Purchases of bank premises and equipment                                           |   | (748     | )      | (1,184   | )      |
| Proceeds from sale of bank premises and  equipment                                 |   | 32       |   |     |   |
| Net increase in loans                                                              |   | (12,237  | )      | (16,039  | )      |
|                                                                               |   |     |   |     |   |
| Net cash (used in) provided by investing  activities                               |   | (14,641  | )      | (18,327  | )      |
|                                                                               |   |     |   |     |   |
| Cash flows from financing activities:                                              |   |     |   |     |   |
|                                                                               |   |     |   |     |   |
| Net increase in demand, interest-bearing  and savings deposits                     |   | $        | 27,720 |     | $      | 25,216 |   |
| Net (increase) decrease in time deposits                                           |   | 3,312    |   | (17,103  | )      |
| Proceeds from repayment of ESOP loan, net                                          |   | 10       |   | (59      | )      |
| Payment of cash dividends                                                          |   | (538     | )      | (398     | )      |
| Exercise of stock options                                                          |   | 151      |   | 86       |   |
| Purchase of unearned ESOP shares                                                   |   | (78      | )      |     |   |
|                                                                               |   |     |   |     |   |
| Net cash provided by financing activities                                          |   | 30,577   |   | 7,742    |   |
|                                                                               |   |     |   |     |   |
| Increase (decrease) in cash and cash  equivalents                                  |   | 19,834   |   | (6,869   | )      |
|                                                                               |   |     |   |     |   |
| Cash and cash equivalents at beginning of  year                                    |   | 73,031   |   | 49,672   |   |
|                                                                               |   |     |   |     |   |
| Cash and cash equivalents at end of period                                         |   | $        | 92,865 |     | $      | 42,803 |   |

 

See Notes to UnauditedConsolidated Financial Statements

 

5

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**Community Valley Bancorp and Subsidiaries**

 

NOTES TOUNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

1.   BASIS OF PRESENTATION

 

In May 2002,shareholders of Butte Community Bank (the “Bank”) approved a plan ofreorganization and merger whereby the Bank became a wholly owned subsidiary ofa newly formed bank holding company, Community Valley Bancorp.  Management expects that the holding companystructure will facilitate growth within the banking field and in areas relatedto banking, either by the creation of new subsidiaries or the acquisition ofexisting companies and banks.

 

Theaccompanying unaudited consolidated financial statements of Community ValleyBancorp and subsidiaries (the “Company”) have been prepared in accordance withaccounting principles generally accepted in the United States of America forinterim financial information and with the instructions to Form 10-Q and Article10 of Regulation S-X.  In the opinion ofmanagement, all adjustments (which consist solely of normal recurring accruals)considered necessary for a fair presentation of the results for the interimperiods presented have been included. These interim consolidated financial statements should be read inconjunction with the financial statements and related notes contained in theCompany’s 2002 Annual Report to Shareholders on Form 10-K.

 

In December2002, the Company issued to CVB Trust I subordinated deferrable interestdebentures due December 31, 2032. Simultaneously, CVB Trust I issued 8,000 floating rate capitalsecurities, with liquidation values of $1,000 per security, for gross proceedsof $8,000,000.  The subordinateddebentures represent the sole assets of CVB Trust I.  The subordinated debentures are redeemableby the Company, subject to the receipt by the Company of prior approval fromthe Federal Reserve Bank (FRB), if then required under applicable capitalguidelines or policies of the FRB.  TheCompany may redeem the subordinated debentures on any December 31st on or afterDecember 31, 2007.  The redemption priceshall be par plus accrued and unpaid interest, except in the case of redemptionunder a special event which is defined in the debenture.  The floating rate capital securities aresubject to mandatory redemption to the extent of any early redemption of thesubordinated debentures and upon maturity of the subordinated debentures onDecember 31, 2032.

 

Holders of thesecurities are entitled to cumulative cash distributions on the liquidationamount of $1,000 per security.  Interestrates on the capital securities and debentures are computed on a 360-daybasis.  The stated interest rate is thethree-month London Interbank Offered Rate (LIBOR) plus 3.3%, with a maximumrate of 12.5% annually, adjustable quarterly.

 

Theconsolidated financial statements include the accounts of the Company and itswholly owned bank subsidiary, Butte Community Bank, and CVB Trust I. Allsignificant inter-company balances and transactions have been eliminated inconsolidation.  The results ofoperations for the three and six month periods ended June 30, 2003 may notnecessarily be indicative of the operating results for the full year 2003.

 

2.  EARNINGS PER SHARE COMPUTATION

 

Basic earningsper share are computed by dividing net income by the weighted average commonshares outstanding for the period (2,628,336 and 2,626,803 shares for the threeand six month periods ended June 30, 2003 and 2,588,869 and 2,584,083 sharesfor the three and six month periods ended June 30, 2002).  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 by dividing net income by theweighted average common shares outstanding for the period plus the dilutiveeffect of options (146,415 and 139,796 shares for the three and six monthperiods ended June 30, 2003 and 139,957 and 135,688 shares for the three andsix

 

6

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month periods ended June 30,2002).  Earnings per share areretroactively adjusted for stock splits and dividends for all periodspresented.

 

3. COMPREHENSIVE INCOME

 

Comprehensive income isreported in addition to net income for all periods presented.  Comprehensive income is made up of netincome plus other comprehensive income or loss.  Other comprehensive income or loss, net of taxes, is comprised ofchanges in unrealized gains or losses, net of taxes, on available-for-salesecurities, adjusted for the effect of realized gains or losses onavailable-for-sale securities, net of taxes.

 

4.  STOCK –BASED COMPENSATION

 

The Companyissues stock options under three stock-based compensation plans, the CommunityValley Bancorp 1991, 1997 and 2000 Stock Option Plans.  The Company accounts for these plans underthe recognition and measurement principles of APB Opinion No. 25, *Accountingfor Stock Issued to Employees*, and related Interpretations.  No stock-based compensation cost isreflected in net income, as all options granted under these plans had anexercise price equal to the market value of the underlying common stock on thedate of grant.  In accordance with FinancialAccounting Standards Board (“FASB”) No. 148, *Accountingfor Stock-Based Compensation – Transition and Disclosure, an Amendment of FASBNo. 12,* the following table illustrates the effect on net income andearnings per share if the Company had applied the fair value recognitionprovisions of FASB Statement No. 123, *Accounting for Stock-Based Compensation*,to stock-based employee compensation.

 

Pro formaadjustments to the Company’s consolidated net earnings and earnings per shareare disclosed during the periods in which the options become vested.

 
|                                                                                                                                           |   | **Three  Months Ended** |      |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|-----------|
|                                                                                                                                           |   | **June 30, 2003**       |      | **June 30, 2002** |   |
|                                                                                                                                           |   |                    |      |   |   |
| Net earnings as reported                                                                                                                       |   | $                       | 1,116,709 |   | $ | 972,415 |   |
|                                                                                                                                           |   |                    |      |   |   |   |   |
| Deduct:   Total stock-based compensation expense determined under the fair value  based method for all awards, net of related tax effects |   | (64,512                 | )         | (68,467 | ) |
|                                                                                                                                           |   |                    |      |   |   |
| Pro forma net income                                                                                                                           |   | $                       | 1,052,197 |   | $ | 903,948 |   |
|                                                                                                                                           |   |                    |      |   |   |
| Basic earnings per share - as reported                                                                                                         |   | $                       | 0.42      |   | $ | 0.38 |   |
|                                                                                                                                           |   |                    |      |   |   |
| Basic earnings per share - pro forma                                                                                                           |   | $                       | 0.40      |   | $ | 0.35 |   |
|                                                                                                                                           |   |                    |      |   |   |
| Diluted earnings per share - as reported                                                                                                       |   | $                       | 0.40      |   | $ | 0.36 |   |
|                                                                                                                                           |   |                    |      |   |   |
| Diluted earnings per share - pro forma                                                                                                         |   | $                       | 0.38      |   | $ | 0.34 |   |

 

7

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|                                                                                                                                           |   | **Six Months  Ended** |      |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------|-----------|
|                                                                                                                                           |   | **June 30, 2003**     |      | **June 30, 2002** |   |
|                                                                                                                                           |   |                  |      |   |   |
| Net earnings as reported                                                                                                                       |   | $                     | 2,153,484 |   | $ | 2,225,549 |   |
|                                                                                                                                           |   |                  |      |   |   |   |   |
| Deduct:   Total stock-based compensation expense determined under the fair value  based method for all awards, net of related tax effects |   | (129,024              | )         | (136,934 | ) |
|                                                                                                                                           |   |                  |      |   |   |
| Pro forma net income                                                                                                                           |   | $                     | 2,024,461 |   | $ | 2,088,615 |   |
|                                                                                                                                           |   |                  |      |   |   |
| Basic earnings per share - as reported                                                                                                         |   | $                     | 0.82      |   | $ | 0.86 |   |
|                                                                                                                                           |   |                  |      |   |   |
| Basic earnings per share - pro forma                                                                                                           |   | $                     | 0.77      |   | $ | 0.81 |   |
|                                                                                                                                           |   |                  |      |   |   |
| Diluted earnings per share - as reported                                                                                                       |   | $                     | 0.78      |   | $ | 0.82 |   |
|                                                                                                                                           |   |                  |      |   |   |
| Diluted earnings per share - pro forma                                                                                                         |   | $                     | 0.74      |   | $ | 0.78 |   |

 

5.  ACCOUNTING PRONOUNCEMENTS

 

In December2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 148,Accounting for Stock-Based Compensation—Transition and Disclosure—an amendmentof FASB Statement No. 123.  ThisStatement amends SFAS No. 123, Accounting for Stock-Based Compensation, toprovide alternative methods of transition for a voluntary change to the fairvalue based method of accounting for stock-based employee compensation.  In addition, this statement amends thedisclosure requirements of SFAS No. 123 to require prominent disclosuresin both annual and interim financial statements about the method of accountingfor stock-based employee compensation and the effect of the method used onreported results.  The transition guidanceand annual disclosure provisions of SFAS No. 148 are effective for fiscalyears ending after December 15, 2002. The interim disclosure provisions are effective for financial reportingcontaining financial statements for interim periods beginning afterDecember 15, 2002.  Because theCompany accounts for the compensation cost associated with its stock optionplan under the intrinsic value method, the alternative methods of transitionwill not apply to the Company.  Inmanagement’s opinion, the adoption of this Statement did not have a materialimpact on the Company’s consolidated financial position or results ofoperations.

 

On April 30,2003, the Financial Accounting Standards Board issued Statement No. 149,“Amendment of Statement 133 on Derivative Instruments and HedgingActivities.”  This Statement amends andclarifies the accounting for derivative instruments by providing guidancerelated to circumstances under which a contract with a net investment meets thecharacteristics of a derivative as discussed in Statement 133.  The Statement also clarifies when aderivative contains a financing component.  The Statement is intended to result in more consistent reporting for derivativecontracts and must be applied prospectively for contracts entered into ormodified after June 30, 2003, except for hedging relationships designated afterJune 30, 2003.   In management’sopinion, adoption of this Statement is not expected to have a material effecton the Company’s consolidated financial position or results of operations.

 

8

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In May 2003,the FASB issued SFAS No. 150, *Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity*.  This Statement establishes standards for howan issuer classifies and measures certain financial instruments withcharacteristics of both liabilities and equity.  It requires that an issuer classify a financial instrument thatis within its scope as a liability (or an asset in some circumstances).  Some of the provisions of this Statement areconsistent with the current definition of liabilities in FASB ConceptsStatement No. 6, *Elements of Financial Statements.*  The remaining provisions of this Statement incorporate the FASB’sintention to revise the definition to encompass certain obligations that areporting entity can or must settle by issuing its own equity shares, dependingon the nature of the relationship established between the holder and theissuer. This Statement concludes the first phase of the FASB’s redeliberationsof the Exposure Draft, *Accounting for Financial Instruments withCharacteristics of Liabilities, Equity, or Both.*  This Statement is effective for financialinstruments entered into or modified after May 31, 2003, and otherwise is effectiveat the beginning of the first interim period beginning after June 15, 2003,except for mandatorily redeemable financial instruments of nonpublicentities.  In management’s opinion,adoption of this statement did not have a material effect on the Company’sconsolidated financial position or results of operations.

 

9

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

 

The followingis Community Valley Bancorp’s (the “Company”) management’s discussion andanalysis of the significant changes in balance sheet accounts for June 30, 2003and December 31, 2002 and income and expense accounts for the three and sixmonth periods ended June 30, 2003 and 2002. 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.

 

In addition tothe historical information contained herein, this report on Form 10-Q containscertain forward-looking statements.  Thereader of this report should understand that all such forward-lookingstatements are subject to various uncertainties and risks that could affecttheir outcome.   The Company’s actualresults could differ materially from those suggested by such forward-lookingstatements.  Factors that could cause orcontribute to such differences include, but are not limited to, variances inthe actual versus projected growth in assets, return on assets, loan losses,expenses, rates charged on loans and earned on securities investments, ratespaid on deposits, competition effects, fee and other noninterest income earned,general economic conditions, nationally, regionally and in the operating marketareas of the Company and its subsidiaries, changes in the regulatoryenvironment, changes in business conditions and inflation, changes insecurities markets, data processing problems, a decline in real estatevalues in the Company’s market area,  the effects of terrorism, including theevents of September 11, 2001 and thereafter, and the conduct of the war onterrorism by the United States and its allies, as well as other factors. This entire report should beread putting such forward-looking statements in context.

 

**GeneralDevelopment of Business**

 

The Company isa bank holding company registered under the Bank Holding Company Act of 1956,as amended. The Company was incorporated under the laws of the State ofCalifornia in 2002.  As a bank holdingcompany, the Company is authorized to engage in the activities permitted underthe Bank Holding Company Act of 1956, as amended, and regulations thereunder.** **Its principal office is locatedat 2041 Forest Avenue, Chico, California 95928 and its telephone number is(530) 899-2344.

 

The Companyowns 100% of the issued and outstanding common shares of Butte Community Bankand CVB Trust I.  Butte Community Bankwas incorporated and commenced business in Paradise and Oroville, California in1990.  Butte Community Bank operatesseven full service offices within its primary service areas of Butte and SutterCounties.  The Bank also maintains aLoan Production Office in Roseville. Butte Community Bank’s primary business isserving the commercial banking needs of small to mid-sized businesses andconsumers within those counties.  ButteCommunity Bank accepts checking and savings deposits, offers money marketdeposit accounts and certificates of deposit, makes secured and unsecuredcommercial, secured real estate, and other installment and term loans andoffers other customary banking services.

 

**Overview**

 

The Companyrecorded net income of $1,116,000 for the quarter ended June 30, 2003, whichwas a 15% increase from the $972,000 reported for the same period of 2002.  Diluted earnings per share for the secondquarter of 2003 were $0.40, compared to the $0.36 recorded in the secondquarter of 2002.  The annualized returnon average equity (ROAE) and the return on average assets (ROA) for the secondquarter of 2003 were 16.62% and 1.25%, respectively, as compared to 17.19% and1.41%, respectively, for the same period in 2002.

 

10

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Net income for the six monthsended June 30, 2003 was $2,153,000 (down 3.2%) compared to the $2,225,000recorded in the first six months of 2002. The primary reason for the decline innet income is the net increase in tax expense of $887,000.  The Company realized a net credit of $23,000for the first quarter of 2002 due to the tax-free proceeds from key maninsurance policies the Bank received in March of 2002 as a result of the deathof the Company’s Chief Operating Officer.

 

Total assets of the Companyincreased by $31,874,000 or (9.4%) from December 31, 2002 to $369,082,000 atJune 30, 2003.  Net loans totaled$241,716,000, up $12,017,000 (5.2%) from the ending balances on December 31,2002.  Deposit balances at June 30, 2003totaled $329,013,000, up $31,032,000 (10.4%) from December 31, 2002.

 

Table Onebelow provides a summary of the components of net income for the periodsindicated:

 

**Table One: Components of Net Income**

 
|                                                             |   | **Three  months ended  June 30,** |   | **Six months  ended  June 30,** |   |
|------------------------------------------------------------------|--------|-----------------------------------|--------|---------------------------------|--------|
| **(In thousands, except percentages)**                           |   | **2003**                          |   | **2002**                        |   | **2003** |   | **2002** |   |
|                                                             |   |                              |   |                            |   |   |   |   |   |
| Net interest income                                              |   | $                                 | 4,033  |                            | $      | 3,212 |   | $ | 7,934 |   | $ | 6,289 |   |
| Provision for loan losses                                        |   | (120                              | )      | (150                            | )      | (270 | ) | (253 | ) |
| Non-interest income                                              |   | 1,383                             |   | 1,295                           |   | 2,566 |   | 3,315 |   |
| Non-interest expense                                             |   | (3,332                            | )      | (2,723                          | )      | (6,551 | ) | (6,487 | ) |
| (Provision for) benefit from income taxes                        |   | (848                              | )      | (662                            | )      | (1,526 | ) | (639 | ) |
|                                                             |   |                              |   |                            |   |   |   |   |   |
| Net income                                                       |   | $                                 | 1,116  |                            | $      | 972 |   | $ | 2,153 |   | $ | 2,225 |   |
|                                                             |   |                              |   |                            |   |   |   |   |   |
| Average total assets (In millions)                               |   | $                                 | 360.9  |                            | $      | 275.6 |   | $ | 346.3 |   | $ | 271.4 |   |
| Net income (annualized) as a percentage of  average total assets |   | 1.25                              | %      | 1.41                            | %      | 1.24 | % | 1.64 | % |

 

**Results of Operations**

 

**NetInterest Income and Net Interest Margin**

 

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

 

The Company’snet interest margin was 5.01% for the three months ended June 30, 2003 and 5.08%for the six months ended June 30, 2003. Net interest income increased $820,000 (25.6%) for the second quarter of2003 compared to the same period in 2002. Net interest income increased $1,645,000 (26.2%) for the six monthsended June 30, 2003 over the same period in 2002.   The primary reason for this increase was the loan growth and theresulting interest income and fees associated with that growth together withthe decrease in the interest rates paid on deposits.

 

11

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Interestexpense was $36,000 (3.1%) lower in the second quarter of 2003 versus the prioryear period. The average balances of interest bearing liabilities were$59,466,000 (20.6%) higher in the second quarter of 2003 versus the same quarterin 2002. Even though the interest bearing balances increased, rates paid onthese liabilities decreased 57 basis points on a quarter over quarterbasis.     Interest expense was $225,000(9.6%) lower in the six month period ended June 30, 2003 versus the prior yearperiod.  The average balances ofinterest bearing liabilities were $54,433,000 (26.8%) higher in the six-monthperiod ended June 30, 2003 versus the same period in 2002.  Rates paid on interest bearing liabilitiesdecreased 70 basis points on a year over year basis.  The reason for this decrease was the ability of management tochange the mix of the deposits away from higher interest rate certificates ofdeposit to lower rate demand deposits and to lower the average cost ofcertificates of deposit as higher cost deposits were re-priced in a lower rateenvironment.

 

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

 

**Table Two: Analysis of Net Interest Margin on Earning Assets (Unaudited)**

 
| **Three Months Ended June 30,**                 |   | **2003**         |    | **2002**     |   |
|-------------------------------------------------|--------|------------------|---------|--------------|--------|
| **(In thousands, except percentages)**          |   | **Avg  Balance** |    | **Interest** |   | **Avg  Yield (4)** |   | **Avg  Balance** |   | **Interest** |   | **Avg  Yield (4)** |   |
| **Assets:**                                     |   |             |    |         |   |   |   |   |   |   |   |   |   |
| Earning assets                                  |   |             |    |         |   |   |   |   |   |   |   |   |   |
| Loans (1)                                       |   | $                | 246,939 |         | $      | 4,871 |   | 7.91 | % | $ | 207,092 |   | $ | 4,170 |   | 8.08 | % |
| Taxable investment securities                   |   | 1,812            |    | 26           |   | 5.76 | % | 1,232 |   | 20 |   | 6.51 | % |
| Tax-exempt investment securities (2)            |   | 975              |    | 19           |   | 7.82 | % | 2,083 |   | 27 |   | 5.20 | % |
| Federal funds sold                              |   | 67,480           |    | 199          |   | 1.18 | % | 34,760 |   | 148 |   | 1.71 | % |
| Investments in time deposits                    |   | 5,884            |    | 49           |   | 3.34 | % | 948 |   | 14 |   | 5.93 | % |
| Total earning assets                            |   | 323,090          |    | 5,164        |   | 6.41 | % | 246,115 |   | 4,379 |   | 7.14 | % |
| Cash & due from banks                       |   | 14,681           |    |         |   |   |   | 12,807 |   |   |   |   |   |
| Other assets                                    |   | 23,112           |    |         |   |   |   | 16,729 |   |   |   |   |   |
|                                            |   | $                | 360,884 |         |   |   |   |   | $ | 275,651 |   |   |   |   |   |
|                                            |   |             |    |         |   |   |   |   |   |   |   |   |   |
| **Liabilities & Shareholders’ Equity** |   |             |    |         |   |   |   |   |   |   |   |   |   |
| Interest bearing liabilities:                   |   |             |    |         |   |   |   |   |   |   |   |   |   |
| NOW & MMDA                                  |   | $                | 145,708 |         | 370    |   | 1.03 | % | $ | 95,691 |   | 296 |   | 1.24 | % |
| Savings                                         |   | 21,678           |    | 26           |   | .49 | % | 19,533 |   | 50 |   | 1.03 | % |
| Time deposits                                   |   | 87,836           |    | 623          |   | 2.88 | % | 88,485 |   | 811 |   | 3.68 | % |
| Other borrowings                                |   | 8,756            |    | 112          |   | 5.19 | % | 803 |   | 10 |   | 4.99 | % |
| Total interest bearing liabilities              |   | 263,978          |    | 1,131        |   | 1.72 | % | 204,512 |   | 1,167 |   | 2.29 | % |
| Demand deposits                                 |   | 61,715           |    |         |   |   |   | 44,232 |   |   |   |   |   |
| Other liabilities                               |   | 8,265            |    |         |   |   |   | 4,228 |   |   |   |   |   |
| Total liabilities                               |   | 333,958          |    |         |   |   |   | 252,972 |   |   |   |   |   |
| Shareholders’ equity                       |   | 26,926           |    |         |   |   |   | 22,679 |   |   |   |   |   |
|                                            |   | $                | 360,884 |         |   |   |   |   | $ | 275,651 |   |   |   |   |   |
| Net interest income & margin (3)            |   |             |    | $            | 4,033  |   | 5.01 | % |   |   | $ | 3,212 |   | 5.23 | % |

 

----

(1)   Loaninterest includes loan fees of $437,000 and $527,000 during the three monthsended June 30, 2003 and June 30, 2002, respectively.

(2)   Doesnot include taxable-equivalent adjustments that primarily relate to income oncertain securities that are exempt from federal income taxes.

 

12

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

(4)   Averageyield is calculated based on actual days in quarter (91 for June 30, 2003 andJune 30, 2002) and annualized to actual days in year (365 for 2003 and 2002).

 

 
| **Six Months Ended June 30,**                   |   | **2003**         |    | **2002**     |   |
|-------------------------------------------------|--------|------------------|---------|--------------|--------|
| **(In thousands, except percentages)**          |   | **Avg  Balance** |    | **Interest** |   | **Avg  Yield (4)** |   | **Avg  Balance** |   | **Interest** |   | **Avg  Yield (4)** |   |
| **Assets:**                                     |   |             |    |         |   |   |   |   |   |   |   |   |   |
| Earning assets                                  |   |             |    |         |   |   |   |   |   |   |   |   |   |
| Loans (1)                                       |   | $                | 243,065 |         | $      | 9,645 |   | 8.00 | % | $ | 205,283 |   | $ | 8,328 |   | 8.18 | % |
| Taxable investment securities                   |   | 2,041            |    | 61           |   | 6.03 | % | 1,137 |   | 34 |   | 6.03 | % |
| Tax-exempt investment securities (2)            |   | 1,027            |    | 38           |   | 7.46 | % | 2,085 |   | 52 |   | 5.03 | % |
| Federal funds sold                              |   | 63,689           |    | 381          |   | 1.21 | % | 33,704 |   | 288 |   | 1.72 | % |
| Investments in time deposits                    |   | 5,284            |    | 90           |   | 3.43 | % | 795 |   | 24 |   | 6.09 | % |
| Total earning assets                            |   | 315,106          |    | 10,215       |   | 6.54 | % | 243,004 |   | 8,726 |   | 7.24 | % |
| Cash & due from banks                       |   | 14,297           |    |         |   |   |   | 12,368 |   |   |   |   |   |
| Other assets                                    |   | 22,169           |    |         |   |   |   | 15,918 |   |   |   |   |   |
|                                            |   | $                | 351,572 |         |   |   |   |   | $ | 271,290 |   |   |   |   |   |
|                                            |   |             |    |         |   |   |   |   |   |   |   |   |   |
| **Liabilities & Shareholders’ Equity** |   |             |    |         |   |   |   |   |   |   |   |   |   |
| Interest bearing liabilities:                   |   |             |    |         |   |   |   |   |   |   |   |   |   |
| NOW & MMDA                                  |   | $                | 141,325 |         | 728    |   | 1.04 | % | $ | 90,237 |   | 551 |   | 1.23 | % |
| Savings                                         |   | 21,108           |    | 63           |   | .60 | % | 18,448 |   | 90 |   | .98 | % |
| Time deposits                                   |   | 86,177           |    | 1,242        |   | 2.91 | % | 93,462 |   | 1,846 |   | 3.98 | % |
| Other borrowings                                |   | 8,745            |    | 250          |   | 5.76 | % | 775 |   | 20 |   | 5.20 | % |
| Total interest bearing liabilities              |   | 257,355          |    | 2,283        |   | 1.79 | % | 202,922 |   | 2,507 |   | 2.49 | % |
| Demand deposits                                 |   | 62,163           |    |         |   |   |   | 43,011 |   |   |   |   |   |
| Other liabilities                               |   | 5,561            |    |         |   |   |   | 3,271 |   |   |   |   |   |
| Total liabilities                               |   | 325,079          |    |         |   |   |   | 249,204 |   |   |   |   |   |
| Shareholders’ equity                       |   | 26,493           |    |         |   |   |   | 22,086 |   |   |   |   |   |
|                                            |   | $                | 351,572 |         |   |   |   |   | $ | 271,290 |   |   |   |   |   |
| Net interest income & margin (3)            |   |             |    | $            | 7,932  |   | 5.08 | % |   |   | $ | 6,912 |   | 5.16 | % |

 

----

(1)          Loaninterest includes loan fees of $917,000 and $878,000 during the six monthsended June 30, 2003 and June 30, 2002, respectively.

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

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

(4)          Averageyield is calculated based on actual days in period (181 for June 30, 2003 andJune 30, 2002) and annualized to actual days in year (365 for 2003 and 2002).

 

13

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Table Three sets forth asummary of the changes in interest income and interest expense from changes inaverage asset and liability balances (volume) and changes in average interestrates.  On a quarter over quarter basisfor the period ending June 30, 2003 net interest income has increased $821,000over the same time period in 2002. Interest income from earning assets has increased by $785,000. Changesin the volume of earning assets, primarily loans, have resulted in an increasein interest income of $1,009,000 while interest income from changes in rateshas decreased by $224,000.  Interestexpense for the second quarter of 2003 was $36,000 less than the same timeperiod in 2002.  Changes in the volumeof interest bearing liabilities, primarily the increase in balances of demanddeposits, as well as the addition of interest expense related to the trustpreferred securities, have resulted in a net increase of interest expense of$253,000.  Decreases in average ratespaid, primarily on certificates of deposit and demand deposits have resulted inan interest expense reduction of $289,000.  On a year-to-date basis through June 30, 2003, net interest income hasincreased $1,713,000 over the same time period in 2002.  Interest income from earning assets hasincreased by $1,489,000.  Changes in thevolume of earning assets, primarily loans, have resulted in an increase ininterest income of $1,926,000 while interest income from changes in rates hasdecreased by $437,000.  Interest expensefor the six month period was $224,000 less than the same time period in 2002.  Changes in the volume of interest bearingliabilities, primarily the increase in balances of demand deposits, as well asthe addition of interest expense related to the trust preferred securities,have resulted in a net increase of interest expense of $387,000.  Decreases in average rates paid, primarilyon certificates of deposit and demand deposits have resulted in an interestexpense reduction of $611,000.

 

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

 
| **(In thousands) Three Months Ended June 30, 2003 over  2002** |   |       |   |         |   |           |   |
|----------------------------------------------------------------|--------|------------|--------|--------------|--------|----------------|--------|
| **Increase (decrease) due to change in:**                      |   | **Volume** |   | **Rate (3)** |   | **Net Change** |   |
| Interest-earning assets:                                       |   |       |   |         |   |           |   |
| Net loans (1)                                                  |   | $          | 802    |         | $      | (101           | )      | $ | 701 |   |
| Taxable investment securities                                  |   | 9          |   | (3           | )      | 6              |   |
| Tax exempt investment securities (2)                           |   | (14        | )      | 6            |   | (8             | )      |
| Federal funds sold                                             |   | 139        |   | (88          | )      | 51             |   |
| Investment in time deposits                                    |   | 73         |   | (38          | )      | 35             |   |
| Total                                                          |   | 1,009      |   | (224         | )      | 785            |   |
|                                                           |   |       |   |         |   |           |   |
| Interest-bearing liabilities:                                  |   |       |   |         |   |           |   |
| Demand deposits                                                |   | 155        |   | (81          | )      | 74             |   |
| Savings deposits                                               |   | 5          |   | (29          | )      | (24            | )      |
| Time deposits                                                  |   | (6         | )      | (182         | )      | (188           | )      |
| Other borrowings                                               |   | 99         |   | 3            |   | 102            |   |
| Total                                                          |   | 253        |   | (289         | )      | (36            | )      |
| Interest differential                                          |   | $          | 756    |         | $      | 65             |   | $ | 821 |   |

 

----

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

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

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

 

14

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| **(In thousands) Six Months Ended June 30, 2003 over  2002** |   |       |   |         |   |           |   |
|--------------------------------------------------------------|--------|------------|--------|--------------|--------|----------------|--------|
| **Increase (decrease) due to change in:**                    |   | **Volume** |   | **Rate (3)** |   | **Net Change** |   |
| Interest-earning assets:                                     |   |       |   |         |   |           |   |
| Net loans (1)                                                |   | $          | 1,533  |         | $      | (216           | )      | $ | 1,317 |   |
| Taxable investment securities                                |   | 27         |   | 0            |   | 27             |   |
| Tax exempt investment securities (2)                         |   | (26        | )      | 12           |   | (14            | )      |
| Federal funds sold                                           |   | 256        |   | (163         | )      | 93             |   |
| Investment in time deposits                                  |   | 136        |   | (70          | )      | 66             |   |
| Total                                                        |   | 1,926      |   | (437         | )      | 1,489          |   |
|                                                         |   |       |   |         |   |           |   |
| Interest-bearing liabilities:                                |   |       |   |         |   |           |   |
| Demand deposits                                              |   | 312        |   | (135         | )      | 177            |   |
| Savings deposits                                             |   | 13         |   | (40          | )      | (27            | )      |
| Time deposits                                                |   | (144       | )      | (460         | )      | (604           | )      |
| Other borrowings                                             |   | 206        |   | 24           |   | 230            |   |
| Total                                                        |   | 387        |   | (611         | )      | (224           | )      |
| Interest differential                                        |   | $          | 1,539  |         | $      | 174            |   | $ | 1,713 |   |

 

----

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

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

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

 

15

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**Non-interestIncome**

 

Table Fourbelow provides a summary of the components of noninterest income for theperiods indicated (dollars in thousands) (percent of assets annualized):

 

**TableFour:  Components of Noninterest Income(Unaudited)**

 
| **Three Months Ended June 30,**     |   | **2003** |   | **% of Avg.  Assets** |   | **2002** |   | **% of Avg.  Assets** |   |
|-------------------------------------|--------|----------|--------|-----------------------|--------|----------|--------|-----------------------|--------|
|                                |   |     |   |                  |   |     |   |                  |   |
| Service charges on deposit accounts |   | $        | 264    |                  | .28    |     | $      | 250                   |   | .27 |   |
| Loan servicing fees                 |   | 374      |   | .40                   |   | 145      |   | .20                   |   |
| Fees - alternative investment sales |   | 61       |   | .08                   |   | 76       |   | .12                   |   |
| Merchant fee income                 |   | 45       |   | .04                   |   | 72       |   | .12                   |   |
| Gain on the sale of loans           |   | 472      |   | .52                   |   | 217      |   | .32                   |   |
| Other                               |   | 167      |   | .20                   |   | 535      |   | .80                   |   |
|                                |   |     |   |                  |   |     |   |                  |   |
| Total non-interest income           |   | $        | 1,383  |                  | 1.52   |     | $      | 1,295                 |   | 1.83 |   |

 
| **Six Months Ended June 30,**       |   | **2003** |   | **% of Avg.  Assets** |   | **2002** |   | **% of Avg.  Assets** |   |
|-------------------------------------|--------|----------|--------|-----------------------|--------|----------|--------|-----------------------|--------|
|                                |   |     |   |                  |   |     |   |                  |   |
| Service charges on deposit accounts |   | $        | 522    |                  | .30    |     | $      | 494                   |   | .36 |   |
| Loan servicing fees                 |   | 713      |   | .41                   |   | 266      |   | .20                   |   |
| Fees - alternative investment sales |   | 81       |   | .05                   |   | 85       |   | .06                   |   |
| Merchant fee income                 |   | 151      |   | .09                   |   | 134      |   | .10                   |   |
| Gain on the sale of loans           |   | 766      |   | .44                   |   | 442      |   | .33                   |   |
| Other                               |   | 333      |   | .19                   |   | 1,894    |   | 1.40                  |   |
|                                |   |     |   |                  |   |     |   |                  |   |
| Total non-interest income           |   | $        | 2,566  |                  | 1.48   |     | $      | 3,315                 |   | 2.45 |   |

 

16

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## **Non-interest income was up $88,000(6.8%) to $1,383,000 for the three months ended June 30, 2003 as compared to$1,295,000 for the three months ended June 30, 2002.    Increases in non-interest income were realized in fees fromservice charges (up 5.6%), loan servicing fees (up 158%), and gain on sale ofloans (up 118%).  The increase inservice charge income was the result of additional deposit accounts openedduring the second quarter.  The loanservicing income and the gain recognized on the sale of loans increased as aresult of more loans being sold on the secondary market through FNMA (FannieMae) as many customers of the Company took advantage of low levels in mortgagefinancing rates.  Servicing feeincreases were also realized in SBA (Small Business Administration) and FHMA(Farmers Home Administration) through their USDA (United States Department ofAgriculture) Business and Industry program. The Company retains the servicing of loans sold through these programs,which generates fee income.**

 

For the sixmonths ended June 30, 2003, non-interest income was down $749,000 (29%) to$2,566,000 as compared to the $3,315,000 total for the six months ended June30, 2002.   The major reason for thedecrease in non-interest income for this period can be attributed to thetax-free net proceeds from key man insurance policies the Bank received inMarch 2002 as a result of the death of the Company’s Chief Operating Officer.  All of the other components of thenon-interest income showed gains with the exception of fees from alternativeinvestment sales which was down 5%. Increases were realized in service charges on deposit accounts (up5.7%), loan servicing fees (up 168%), merchant fee income (up 12.7%), and gainon sale of loans (up 73%).

 

**Non-interest Expense**

 

Non-interest expense increased $608,000 (22.3%) to $3,331,000 in thesecond quarter of 2003 versus $2,723,000 in the second quarter of 2002.  On a quarter over quarter basis, full time equivalentemployees increased by 16.  Salary andemployee benefits increased $583,000 (42.8%) resulting from normal cost ofliving raises, commissions paid to Butte Community Bank’s Real Estate Loanagents and staffing additions made during the year as the Company continues togrow and implement the new technology acquired during the year.  Benefit costs and employer taxes increasedcommensurate with the salaries.    On aquarter over quarter basis, occupancy expenses were higher by $35,000(20.7%).  This increase in costs isassociated with the opening of the North Paradise office and the move of theMagalia office into the Holiday Quality Foods market, and is related tobuilding depreciation, utilities, janitorial services and property taxes.   Fixed asset expense was $233,000 in thesecond quarter of 2003 compared to $238,000 in the same period of 2002,representing a 2.1% decrease.   Otherexpenses decreased $4,000 (.4%) in the second quarter of 2003 versus the secondquarter of 2002.

 

Non-interest expense for the six month period ended June 30, 2003 was$6,551,000 versus $6,487,000 for the same period in 2002.  Salaries and benefits increased by$1,063,000 (37.7%) due to cost of living raises added benefit costs andemployer taxes associated with the staffing additions made during the year asthe Company continues to grow and implement the new technology acquired duringthe year.  On a year over year basis,full time equivalent employees increased by 31.   Premises expense was up $70,000 (22.9%) from the first sixmonths of 2002 to the first six months of 2003.  Fixed asset expense was up 62,000 (15.1%).  A portion of this increase relates totechnology upgrades made to our core banking system such as the digital imageprocessing system introduced in the first quarter of this year.  As with the quarter-to-quarter comparison,much of the increase in premise expense is related to the opening of the newNorth Paradise office and the move of the Magalia office to the Holiday QualityFoods market.  Other expenses decreasedby $1,131,000 (38.4%).   As discussed inthe non-interest income section, most of this decrease was attributable to theaccelerated accrual of salary continuation plan benefits, in March 2002,associated with the death of the Company’s Chief Operating Officer that will besubsequently paid to his beneficiary.

 

## **Provision for Loan Losses**

 

The Companyprovided $120,000 for loan and lease losses for the second quarter of 2003 ascompared to $150,000 for the second quarter of 2002.  Net loan recoveries for the three months ended June 30, 2003 were$3,000 as compared to $1,000 in charge-offs for the three months ended June 30,2002.   For the first six months of2003, the Company made provisions for loan losses of $270,000.   This compares to the provision for loanlosses of $253,000 for the first six months of 2002.

 

17

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**Provision for Income Taxes**

 

The effectivetax rate for the second quarter and first six months of 2003 was 43.2% and41.4%, versus 40.5% and 22.3%, for the same period in 2002.  The lower effective tax rate for the firstsix months of 2002 was attributable to the tax-free net proceeds from key maninsurance policies received as the result of the death of one of the Company’sexecutives.

 

**Balance Sheet Analysis**

 

The Company’stotal assets were $369,082,000 at June 30, 2003 as compared to $337,235,000 atDecember 31, 2002, representing an increase of 9.4%.  The average balance of total assets for the six months ended June30, 2003 was $351,572,000, which represents an increase of $80,137,000 (29.5%)over the $271,435,000 during the six-month period ended June 30, 2002.

## ** **

## **Loans**

 

The Companyconcentrates its lending activities in the following principal areas: 1)commercial; 2) real estate; 3) residential real estate and real estateconstruction (both commercial and residential); 4) agriculture; and 5) consumerloans.  Commercial and residential realestate loans are generally secured by improved property, with originalmaturities of 3-10 years.  At June 30,2003, these principal areas accounted for approximately 22%, 29%, 31%, 10% and8%, respectively, of the Company’s loan portfolio.    The mix at December 31, 2002 was 21%, 35%, 28%, 8% and 8%.  These changes are consistent with theCompany’s history of increased real estate construction activity during thesummer months.  Continuing strongeconomic activity in the Company’s market area, new borrowers developed throughthe Company’s marketing efforts and credit extensions expanded to existing borrowers,offset by normal loan pay-downs and payoffs, resulted in net increases in loanbalances for commercial loans ($4,815,000 or 9.9%), real estate construction($11,944,000 or 18.5%) agricultural loans ($4,996,000 or 26.4%),and consumer($723,000 or 3.7%) and a decrease in residential real estate ($10,243,000 or14.2%).  Table Five below summarizes thecomposition of the loan portfolio as of June 30, 2003 and December 31, 2002.

 

**Table Five: Loan Portfolio Composition(Unaudited)**

 
| **(In thousands)**        |   | **June 30,  2003** |    | **December  31,  2002** |   |
|---------------------------|--------|--------------------|---------|-------------------------|--------|
| Commercial                |   | $                  | 53,476  |                    | $      | 48,661 |   |
| Real estate:              |   |               |    |                    |   |
| Mortgage                  |   | 71,814             |    | 82,057                  |   |
| Construction              |   | 76,509             |    | 64,565                  |   |
|                      |   |               |    |                    |   |
| Agriculture               |   | 23,931             |    | 18,935                  |   |
| Consumer                  |   | 20,048             |    | 19,325                  |   |
| Total loans               |   | 245,778            |    | 233,543                 |   |
| Allowance for loan losses |   | (3,277             | )       | (3,007                  | )      |
| Deferred loan fees, net   |   | (786               | )       | (837                    | )      |
| Total net loans           |   | $                  | 241,715 |                    | $      | 229,699 |   |

 

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

 

18

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Commercial loans consist of credit lines for operating needs, loans forequipment purchases, working capital, and various other business loan products.  Consumer loans include a range oftraditional consumer loan products such as personal lines of credit and loansto finance purchases of autos, boats, recreational vehicles, mobile homes andvarious other consumer items. 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.  Other real estate loans consist primarily ofloans secured by first trust deeds on commercial and residential propertiestypically with maturities from 3 to 10 years and original loan to value ratiosgenerally from 65% to 80%.  Agricultureloans consist primarily of crop loans to farmers of peaches, prunes, walnuts,and almonds.  In general, except in thecase of loans with SBA or FMHA guarantees, the Company does not make long-termmortgage loans; however, Butte Community Bank has a residential lendingdivision to assist customers in securing most forms of longer termsingle-family mortgage financing.

## ** **

## **Risk Elements**

 

The Company assesses and manages credit risk on an ongoing basisthrough a total credit culture that emphasizes excellent credit quality,extensive internal monitoring and established formal lending policies.  Additionally, the Company contracts with anoutside loan review consultant to periodically review the existing loanportfolio.  Management believes itsability to identify and assess risk and return characteristics of the Company’sloan portfolio is critical for profitability and growth.  Management strives to continue its emphasison credit quality in the loan approval process, active credit administrationand regular monitoring.  With this inmind, management has designed and implemented a comprehensive loan review andgrading system that functions to continually assess the credit risk inherent inthe loan portfolio.

 

Ultimately, underlying trends in economic and business cycles mayinfluence credit quality.  The Company’sbusiness is concentrated in the Butte and Sutter County Area. The economy ofthese two counties is diversified with professional services, manufacturing,agriculture and real estate investment and construction.

 

Special emphasis is placed within the communities in which the Companyhas offices (Chico, Paradise, Magalia, Oroville and Yuba City).  The Company also maintains loan productionoffices in the cities of Roseville and Redding.  Single-family residential construction is the primary lendingproduct from the Roseville location serving the greater Sacramento area.  The primary focus of the loan productionoffice in Redding is commercial loans with an emphasis on SBA and othergovernment loan programs.

 

The Company has significant extensions of credit and commitments toextend credit that are secured by real estate. The ultimate repayment of these loans is generally dependent on personalor business cash flows or the sale or refinancing of the real estate.  The Company monitors the effects of currentand expected market conditions and other factors on the collectability of realestate loans.  The more significantfactors management considers involve the following:  lease, absorption and sale rates; real estate values and rates ofreturn; operating expenses; inflation; and sufficiency of collateral independentof the real estate including, in limited instances, personal guarantees.

 

In extending credit and commitments to borrowers, the Company generallyrequires collateral and/or guarantees as security.  The repayment of such loans is expected to come from cash flow orfrom proceeds from the sale of selected assets of the borrowers.  The Company’s requirement for collateraland/or guarantees is determined on a case-by-case basis in connection withmanagement’s evaluation of the creditworthiness of the borrower.  Collateral held varies but may includeaccounts receivable, inventory, property, plant and equipment, income-producingproperties, residences and other real property.  The Company secures its collateral by perfecting its securityinterest in business assets, obtaining deeds of trust, or outright possessionamong other means.

## ** **

## **In management’s judgment, aconcentration exists in real estate loans, which represented approximately 60%of the Company’s loan portfolio at June 30, 2003, which reflects an improvementfrom the 62.8% concentration level at December 31, 2002.  Management believes the concentration tohave no more than the normal risk of collectability; however, a substantialdecline in the economy in general, or a decline in real estate**

 

19

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## **values in the Company’s primary market areas in particular,could have an adverse impact on the collectability of these loans and requirean increase in the provision for loan losses which could adversely affect theCompany’s future prospects, results of operations, profitability and stockprice.  Management believes that itslending policies and underwriting standards will tend to minimize losses in aneconomic downturn; however, there is no assurance that losses will not occurunder such circumstances.  The Company’sloan policies and underwriting standards include, but are not limited to, thefollowing: (1) maintaining a thorough understanding of the Company’s servicearea and originating a significant majority of its loans within that area, (2)maintaining a thorough understanding of borrowers’ knowledge, capacity, andmarket position in their field of expertise, (3) basing real estate loanapprovals not only on market demand for the project, but also on the borrowers’capacity to support 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.**

## ** **

## **Nonaccrual, Past Due andRestructured Loans**

 

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.  Loans are charged off when, in the opinionof management, collection appears unlikely.

 

Table Six below sets forthnonaccrual loans as of June 30, 2003 and December 31, 2002.  There were no loans past due 90 days or moreand still accruing interest at June 30, 2003 or December 31, 2002.

 

 

**TableSix:  Non-Performing Loans (Unaudited)**

 
| **(In thousands)**         |   | **June 30,  2003** |   | **December  31,  2002** |   |
|----------------------------|--------|--------------------|--------|-------------------------|--------|
| Nonaccrual:                |   |               |   |                    |   |
| Commercial                 |   | 67                 |   | 134                     |   |
| Real estate                |   | 460                |   | 460                     |   |
| Consumer and other         |   | 75                 |   | —                  |   |
| Total non-performing loans |   | $                  | 835    |                    | $      | 594 |   |
|                            |        |                    |        |                         |        |  |  |

 

At June 30,2003, non-performing loans and leases were .34% of total loans and leases.  The recorded investments in loans that wereconsidered to be impaired totaled six loans with balances of $835,000 at June30, 2003 and two loans with balances of $594,000 at December 31, 2002.  One of the seven impaired loans shown forJune 30, 2003 had a U.S. Government guarantee for 90% of the loan balance whichwas $440,000.  On July 11, 2003 theentire balance of this loan was paid in full. The remaining six loans have a very low potential for loss.  There were no loan concentrations in excessof 10% of total loans not otherwise disclosed as a category of loans as of June30, 2003 or December 31, 2002. Management is not aware of any potential problem loans, which wereaccruing and current at June 30, 2003, where serious doubt exists as to theability of the borrower to comply with the present repayment terms.

 

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## **Allowance for Loan LossesActivity**

 

The provisionfor loan losses is based upon management’s evaluation of the adequacy of theexisting allowance for loans outstanding. This allowance is increased byprovisions charged to expense and recoveries and is reduced by loancharge-offs. Management determines an appropriate provision based upon theinteraction of three primary factors: (1) loan portfolio growth, (2) acomprehensive grading and review formula for total loans outstanding, and (3)estimated inherent credit risk in the portfolio.

 

Managementestablishes general reserve factors for loans based upon an assessment of acredit risk by loan type and loan grade. These reserve factors, which are basedon historical loss information, may be adjusted for significant commercial andreal estate loans that are individually evaluated by management for specificrisk of loss.  In addition, reservefactors ranging from 0.25% to 2.50% are assigned to currently performing loansthat are not otherwise graded as Special Mention, Substandard or Doubtful.  These factors are assigned based onmanagement’s assessment of the following for each identified loan type: (1)inherent credit risk, (2) historical losses and, (3) where the Company has notexperienced losses, historical losses experienced by peer banks.    Finally, a residual component ismaintained to cover uncertainties that could affect management’s estimate ofprobable losses.  This residual componentof the allowance reflects a margin of imprecision inherent in the underlyingassumptions used to estimate losses in specifically graded loans and expectedlosses in the performing portfolio.

 

The LoanCommittee of the Bank reviews the adequacy of the allowance for loan losses atleast quarterly to include consideration of the relative risks in the portfolioand current economic conditions.  Theallowance is adjusted based on that review if, in the judgment of the loancommittee and management, changes are warranted.  The allowance for loan losses totaled $3,277,000 or 1.34% of totalloans at June 30, 2003 and $3,007,000 or 1.29% at December 31, 2002.  Net charge-offs to average loans for thesecond quarter and year to date through June 30, 2003 are zero.

 

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

 

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**Table Seven: Allowance for Loan Losses(Unaudited)**

 
|                                                                            |   | **Three Months  Ended  June 30,** |    | **Six Months  Ended  June 30,** |   |
|---------------------------------------------------------------------------------|--------|-----------------------------------|---------|---------------------------------|--------|
| **(In thousands, except for percentages)**                                      |   | **2003**                          |    | **2002**                        |   | **2003** |   | **2002** |   |
|                                                                            |   |                              |    |                            |   |   |   |   |   |
| Average loans outstanding                                                       |   | $                                 | 239,661 |                            | $      | 215,108 |   | $ | 236,876 |   | $ | 210,515 |   |
|                                                                            |   |                              |    |                            |   |   |   |   |   |
| Allowance for possible loan losses at beginning of period                       |   | $                                 | 3,154   |                            | $      | 2,496 |   | $ | 3,007 |   | $ | 2,397 |   |
|                                                                            |   |                              |    |                            |   |   |   |   |   |
| Loans charged off:                                                              |   |                              |    |                            |   |   |   |   |   |
| Commercial                                                                      |   | —                            |    |                            |   |   |   |   |   |
| Real estate                                                                     |   | —                            |    | —                          |   |   |   | (4 | ) |
| Consumer                                                                        |   | (1                                | )       | —                          |   | (4 | ) |   |   |
| Total                                                                           |   | (1                                | )       |                            |   | (4 | ) | (4 | ) |
| Recoveries of loans previously charged off:                                     |   |                              |    |                            |   |   |   |   |   |
| Commercial                                                                      |   | —                            |    | 1                               |   |   |   | 1 |   |
| Real estate                                                                     |   | —                            |    | —                          |   |   |   |   |   |
| Consumer                                                                        |   | 4                                 |    |                            |   | 4 |   |   |   |
| Total                                                                           |   | 4                                 |    | 1                               |   | 4 |   | 1 |   |
| Net loan charge offs                                                            |   | 3                                 |    | 1                               |   | — |   | (3 | ) |
|                                                                            |   |                              |    |                            |   |   |   |   |   |
| Additions to allowance charged to operating expenses                            |   | 120                               |    | 150                             |   | 270 |   | 253 |   |
| Allowance for loan losses at end of period                                      |   | $                                 | 3,277   |                            | $      | 2,647 |   | 3,277 |   | 2,647 |   |
| Ratio of net charge-offs to average loans outstanding                           |   | .00                               | %       | .00                             | %      | .00 | % | .00 | % |
| Provision for possible loan losses to average loans outstanding                 |   | .05                               | %       | .07                             | %      | .11 | % | .12 | % |
| Allowance for loan  losses to  loans net of deferred fees at end of period |   | 1.34                              | %       | 1.20                            | %      | 1.34 | % | 1.20 | % |

 

It is the policy of management to maintain the allowance for loanlosses at a level adequate for known and inherent risks in the portfolio.  Based on information currently available toanalyze inherent credit risk, including economic factors, overall credit quality,historical delinquencies and a history of actual charge-offs, managementbelieves that the provision for loan losses and the allowance are prudent andadequate.  The Company generally makesmonthly allocations to the allowance for loan losses.  The budgeted allocation is based on estimates of loss risk andloan growth.  Adjustments may be madebased on differences from estimated loan growth, the types of loansconstituting this growth, changes in risk ratings within the portfolio, andgeneral economic conditions.  However,no prediction of the ultimate level of loans charged off in future years can bemade with any certainty.

 

**Other Real Estate**

 

At June 30,2003 and December 31, 2002, the Company did not have any other real estate(“ORE”) properties.

 

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## **Deposits**

 

At June 30,2003, total deposits were $329,013,000 representing an increase of $31,032,000(10.4%) over the December 31, 2002 balance of $297,981,000.

## ** **

## **Capital Resources**

 

The currentand projected capital position of the Company and the impact of capital plansand long-term strategies are reviewed regularly by management. The Company’scapital position represents the level of capital available to support continuedoperations and expansion.

 

The Board ofDirectors of the Company authorized the payment of a cash dividend of $.075 pershare on January 28, 2002, April 25, 2002, and July 26, 2002, $.08 per share onOctober 25, 2002, $.10 per share on January 23, 2003, and $.10 per share onApril 24, 2003.  The payment ofdividends in the future is subject to the discretion of the Board of Directorsof the Company and will depend on earnings, the financial condition of theCompany and other relevant factors.  Theper share amounts have been retroactively restated for the Company’s 4 for 3stock split approved by the Board of Directors on August 20, 2002.

 

The Companyand its subsidiary Bank are subject to certain regulations issued by the Boardof Governors of the Federal Reserve System and the FDIC which requiremaintenance of certain levels of capital. At June 30, 2003, shareholders’ equity was $27,202,000, representing anincrease of $1,821,000 (7.2%) from $25,381,000 at December 31, 2002.  The Bank’s ratio of total risk-based capitalto risk adjusted assets was 12.6% at June 30, 2003 compared to 10.9% atDecember 31, 2002.  Tier 1 risk-basedcapital to risk-adjusted assets was 11.4% at June 30, 2003 and 9.7% at December31, 2002.

 

Table Eightbelow lists the Company and the Bank capital ratios at June 30, 2003 andDecember 31, 2002, as well as the minimum ratios required under regulatorydefinitions of capital adequacy. 

 

**TableEight:  Capital Ratios (Unaudited)**

 
| **Capital to Risk-Adjusted Assets** |   | **At June 30, 2003** |   | **At December 31,  2002** |   | **Minimum  Regulatory Requirement** |   |
|-------------------------------------|--------|----------------------|--------|---------------------------|--------|-------------------------------------|--------|
| **Company**                         |   |                 |   |                      |   |                                |   |
|                                |   |                 |   |                      |   |                                |   |
| Leverage ratio                      |   | 10.1                 | %      | 10.4                      | %      | 4.0                                 | %      |
|                                |   |                 |   |                      |   |                                |   |
| Tier 1 Risk-Based Capital           |   | 12.6                 | %      | 12.8                      | %      | 4.0                                 | %      |
|                                |   |                 |   |                      |   |                                |   |
| Total Risk-Based Capital            |   | 13.8                 | %      | 14.0                      | %      | 8.0                                 | %      |
|                                |   |                 |   |                      |   |                                |   |
| **Bank**                            |   |                 |   |                      |   |                                |   |
|                                |   |                 |   |                      |   |                                |   |
| Leverage ratio                      |   | 9.22                 | %      | 7.9                       | %      | 4.0                                 | %      |
|                                |   |                 |   |                      |   |                                |   |
| Tier 1 Risk-Based Capital           |   | 11.4                 | %      | 9.7                       | %      | 4.0                                 | %      |
|                                |   |                 |   |                      |   |                                |   |
| Total Risk-Based Capital            |   | 12.6                 | %      | 10.9                      | %      | 8.0                                 | %      |

 

Capital ratiosare reviewed on a regular basis to ensure that capital exceeds the prescribedregulatory minimums and is adequate to meet future needs.  All ratios are in excess of the regulatorydefinition of “Minimum” at June 30, 2003 and December 31, 2002.  The Bank was considered “well-capitalized”by regulatory standards, at June 30, 2003 and December 31, 2002.

 

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

 

**Market Risk Management**

 

*Overview*.  Market risk is the risk of loss from adversechanges in market prices and rates.  TheCompany’s market risk arises primarily from interest rate risk inherent in itsloan, investment and deposit portfolios. The goal for managing the assets and liabilities of the Company is tomaximize shareholder value and earnings while maintaining a high qualitybalance sheet without exposing the Company to undue interest rate risk.

 

The Board of Directors has overall responsibility for the interest raterisk management policies.  The Bank hasan Asset and Liability Management Committee (ALCO) that establishes andmonitors guidelines to control the sensitivity of earnings to changes ininterest rates.

 

*Asset/LiabilityManagement*. Activities involved in asset/liability management include, but are notlimited to, lending, accepting and placing deposits, investing in securities,using trust preferred securities and borrowings.  Interest rate risk is the primary market risk associated withasset/liability management.  Sensitivityof earnings 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 raterisk, the structure of the balance sheet is managed with the goal thatmovements of interest rates on assets and liabilities are correlated andcontributes to earnings even in periods of volatile 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 uses simulation models to forecast earnings, netinterest margin and market value of equity.

 

Simulation of earnings is the primary tool used to measure thesensitivity of earnings to interest rate changes.  Using computer-modeling techniques, the Company is able toestimate the potential impact of changing interest rates on earnings.  A balance sheet forecast is prepared monthlyusing inputs of actual loans, securities and interest bearing liability (i.e.deposits/borrowings) positions as the beginning base.  The forecast balance sheet is processed against seven interestrate scenarios.  These scenarios includea 100, 200 and 300 basis point rising rate forecast, a flat rate forecast and a100, 200 and 300 basis point falling rate forecast which take place within aone year time frame.  The net interestincome is measured during the year assuming a gradual change in rates over thetwelve-month horizon.  The Company’s netinterest income, as forecast below, was modeled utilizing a forecast balancesheet projected from balances as of the date indicated.

 

Table Nine below summarizes the effect on net interest income (NII) ofa ±200 basis point change in interest rates as measured against a constant rate(no change) scenario.  The results shownin Table nine for the two periods, fall within the parameters of the Bank’spolicy for interest rate risk.

 

**Table Nine:  Interest Rate Risk Simulation of NetInterest as of June 30, 2003 and December 31, 2002 (Unaudited)**

 
| **(In thousands)**                      |   | **$ Change  in NII  from Current  12 Month Horizon  June 30, 2003** |   | **$ Change  in NII  from Current  12 Month Horizon  December 31, 2002** |   |
|-----------------------------------------|--------|---------------------------------------------------------------------|--------|-------------------------------------------------------------------------|--------|
| Variation from a constant rate scenario |   |                                                                |   |                                                                    |   |
| +200bp                                  |   | $                                                                   | 379    |                                                                    | $      | 111 |   |
| - 200bp                                 |   | $                                                                   | (1,752 | )                                                                       | $      | (1,262 | ) |

## ** **

## **The simulations of earnings do not incorporate anymanagement actions which might moderate the negative consequences of interestrate deviations.  Therefore, they do notreflect likely actual results, but serve as estimates of interest raterisk.  In this simulation, the exposureto net interest income has increased due to a larger volume of assets maturingthan liabilities and re-pricing at lower rates.**

 

24

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## **Inflation**

 

The impact of inflation on afinancial institution differs significantly from that exerted on manufacturing,or other commercial concerns, primarily because its assets and liabilities arelargely 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 growthof total assets by increasing the level of loan demand, and potentiallyadversely affects capital adequacy because loan growth in inflationary periodscan increase at rates higher than the rate that capital grows through retentionof earnings, which may be generated in the future.  In addition to its effects on interest rates, inflation increasesoverall operating expenses.  Inflationhas not had a material effect upon the results of operations of the Company andits subsidiaries during the periods ended June 30, 2003, and 2002.

 

**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.  Bothassets and liabilities contribute to the Company’s liquidity position.  Federal funds lines, short-term investmentsand securities, and loan repayments contribute to liquidity, along with depositincreases, while loan funding and deposit withdrawals decrease liquidity.  The Company assesses the likelihood ofprojected funding requirements by reviewing historical funding patterns,current and forecasted economic conditions and individual client funding needs.  Commitments to fund loans at June 30, 2003 andDecember 31, 2002 were approximately $111,762,000 and $105,835,000,respectively.  Such loans relateprimarily to revolving lines of credit and other commercial loans, and to realestate construction loans.

 

The Company’s sources of liquidity consist of cash and due fromcorrespondent banks, overnight funds sold to correspondent banks, unpledgedmarketable investments and loans held for sale.  On June 30, 2003, consolidated liquid assets totaled $106 millionor 28.7% of total assets compared to $81.4 million or 24.1% of total assets onDecember 31, 2002.  In addition toliquid assets, the Company maintains short-term lines of credit in the amountof $6,000,000 with correspondent banks. There were no borrowings outstanding under these arrangements at June30, 2003.    The Bank also has informalagreements with various other banks to sell participations in loans, ifnecessary.  The Company serves primarilya business and professional customer base and, as such, its deposit base issusceptible to economic fluctuations. Accordingly, management strives to maintain a balanced position ofliquid assets to volatile and cyclical deposits.

 

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

 

## **Off-Balance Sheet Items**

 

The Companyhas certain ongoing commitments under operating leases.  These commitments do not significantlyimpact operating results. As of June 30, 2003 and December 31, 2002,commitments to extend credit and letters of credit were the only financialinstruments with off-balance sheet risk. The Company has not entered into any contracts for financial derivativeinstruments such as futures, swaps, options or similar instruments.  Loan commitments and letters of credit were$111,762,000 and $105,835,000 at June 30, 2003 and December 31, 2002,respectively.  As a percentage of netloans, these off-balance sheet items represent 45.3% and 46.1%, respectively.

 

**Other Matters**

 

Effects of Terrorism The terrorist actions on September 11, 2001 andthereafter have had significant adverse effects upon the United Stateseconomy.  Whether the terrorist activitiesin the future and the actions of the United States and its allies in combatingterrorism on a worldwide basis will adversely impact the Company and the extentof such impact is uncertain.  However,such events have had and may continue to have an adverse effect

 

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on theeconomy in the Company’s market areas. Such continued economic deterioration could adversely affect theCompany’s future results of operations by, among other matters, reducing thedemand for loans and other products and services offered by the Company,increasing nonperforming loans and the amounts reserved for loan losses, andcausing a decline in the Company’s stock price.

 

**Item4. Controls and Procedures**

 

The Company’sChief Executive Officer and Chief Financial Officer, based on their evaluationwithin 90 days prior to the date of this report of the Company’sdisclosure controls and procedures (as defined in Exchange ActRule 13a—14(c)), have concluded that the Company’s disclosure controls andprocedures are adequate and effective for purposes of Rule 13a—14(c) intimely alerting them to material information relating to the Company requiredto be included in the Company’s filings with the SEC under the SecuritiesExchange Act of 1934. There were no significant changes in the Company’sinternal controls or in other factors that could significantly affect internalcontrols subsequent to the date of their evaluation.

 

**PART II – OTHER INFORMATION**

 

Item 1.  Legal Proceedings.

 

None.

 

Item 2.  Changes in Securities and Use of Proceeds.

 

None.

 

Item 3.  Defaults Upon Senior Securities.

 

None.

 

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

 

None.

 

Item 5.  Other Information.

 

None

 

Item 6.  Exhibits

 

(a)  Exhibits

 

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

 

(b)  Reports on Form 8-K

 

On March 21, 2003, the Company filed a Report on form 8-K announcing aten cent per share cash dividend for shareholders of record on April 2, 2003,payable April 24, 2003.

 

On June 24, 2003, the Company filed a Report on form 8-k announcing aten cent per share Stock Dividend for shareholders of record on July 1, 2003,payable July 25, 2003.

 

On July 10, 2003, the Company filed a Report on form 8-k announcing theapproval by the Board of Directors of the Company of a stock repurchase plan.

 

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**SIGNATURES**

 

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

 

 
|            | COMMUNITY VALLEY BANCORP           |
|-----------------|------------------------------------|
|            |                               |
| August 11, 2003 |                               | By: */s/ Keith C. Robbins* |   |
|            |                               |
|            | Keith C. Robbins                   |
|            |                               |
|            | President, Chief Executive Officer |
|            |                               |
|            |                               |
| August 11, 2003 |                               | By: */s/ John F. Coger* |   |
|            |                               |
|            | John F. Coger                      |
|            |                               |
|            | Executive Vice President, CFO      |

 

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