Table ofContents

 

 

 

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

 

**FORM 10-Q**

 
| **x** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|-------|---------------------------------------------------------------------------------------------------------|

 

**For the Quarterly PeriodEnded June 30, 2009**

 
| **o** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|----------------------------------------------------------------------------------------------------------|

 

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

 
| **California**                                                                       | ** ** | **000-51678**            | ** ** | **68-0479553**           |
|--------------------------------------------------------------------------------------|------------|--------------------------|------------|--------------------------|
| (State or other jurisdiction of                                                      |       | (Commission File Number) |       | (IRS Employer ID Number) |
| incorporation or organization)                                                       |       |                     |       |                     |
|                                                                                 |       |                     |       |                     |
| **1360 E. Lassen Avenue, Chico, California**                                         | ** ** | **95973**                |
| (Address of principal executive offices)                                             |       | (Zip code)               |
|                                                                                 |       |                     |       |                     |
|                                                                                 |       | **(530) 899-2344**       |       |                     |
| (Registrant’s telephone number, including area code)                            |
|                                                                                 |       |                     |       |                     |
|                                                                                 |
| (Former name, former address and former fiscal year, if changed since  last report.) |

 

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

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files). Yes  o  No  o

 

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

 

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

 

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

 

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

 

No par value Common Stock — 6,699,603 shares outstanding at August 14, 2009.

 

 

** **

Table of Contents

 

**Table of Contents**

 
| PART I  |                                                                                                                            | 3      |
|--------------|---------------------------------------------------------------------------------------------------------------------------------|--------|
|         |                                                                                                                            |   |
|         | Item 1.  Financial Statements (unaudited)                                                                                       | 3      |
|         |                                                                                                                            |   |
|         | Item 2. Management’s Discussion and Analysis of Financial  Condition and Results of Operations of Community Valley Bancorp | 13     |
|         |                                                                                                                            |   |
|         | Item 3. Quantitative and Qualitative Disclosures about  Market Risk                                                             | 30     |
|         |                                                                                                                            |   |
|         | Item 4. Controls and Procedures                                                                                                 | 31     |
|         |                                                                                                                            |   |
| PART II |                                                                                                                            | 33     |
|         |                                                                                                                            |   |
|         | Item  1. Legal Proceedings                                                                                                      | 33     |
|         |                                                                                                                            |   |
|         | Item  1A. Risk Factors                                                                                                          | 33     |
|         |                                                                                                                            |   |
|         | Item 2. Changes in Securities and Use of Proceeds                                                                               | 33     |
|         |                                                                                                                            |   |
|         | Item 4. Submission of Matters to a Vote of Security  Holders.                                                                   | 33     |
|         |                                                                                                                            |   |
|         | Item  5. Other Information                                                                                                      | 33     |
|         |                                                                                                                            |   |
|         | Item 6.  Exhibits                                                                                                               | 34     |
|         |                                                                                                                            |   |
|         | Signatures                                                                                                                      | 35     |
|         |                                                                                                                            |   |
|         | Ex. 31.1. Certification of  CEO Pursuant to Section 302 of the Sarbanes Oxley Act of 2002                                  |   |
|         |                                                                                                                            |   |
|         | Ex. 31.2 Certification of  CFO Pursuant to Section 302 of the Sarbanes Oxley Act of 2002                                   |   |
|         |                                                                                                                            |   |
|         | Ex. 32.1 Certification of  CEO Pursuant to Section 906 of the Sarbanes Oxley Act of 2002                                   |   |
|         |                                                                                                                            |   |
|         | Ex. 32.2 Certification of  CFO Pursuant to Section 906 of the Sarbanes Oxley Act of 2002                                   |   |

 

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**PART I - FINANCIAL INFORMATION**

**Item 1**

 

**COMMUNITY VALLEY BANCORP**

**CONDENSED CONSOLIDATED BALANCE SHEET (Unaudited)**

(dollars in thousands, except share data)

 
| ** **                                                                                                                                                                    | ** ** | **June 30, 2009** | ** ** | **December 31, 2008** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| ASSETS                                                                                                                                                                        |       |                   |       |                       |       |
| Cash  and due from banks                                                                                                                                                      |       | $                      | 15,856     |                       | $          | 21,743 |   |
| Federal  funds sold & other                                                                                                                                          |       | 39,600                 |       | 36,605                     |       |
| Total  cash & cash equivalents                                                                                                                                       |       | 55,456                 |       | 58,348                     |       |
|                                                                                                                                                                          |       |                   |       |                       |       |
| Interest-bearing  deposits in banks                                                                                                                                           |       | 3,433                  |       | 2,576                      |       |
| Investment  securities (fair value of $5,711 at June 30, 2009, and $7,100 at  December 31, 2008)                                                                    |       | 5,695                  |       | 7,096                      |       |
| Loans  held for sale at lower of cost or market                                                                                                                               |       | 1,221                  |       | 320                        |       |
| Loans,  less allowance for loan losses of $9,218 at June 30, 2009 and $7,826 at  December 31, 2008                                                                  |       | 462,199                |       | 486,522                    |       |
| Premises  and equipment, net                                                                                                                                                  |       | 6,152                  |       | 7,013                      |       |
| Other  real estate                                                                                                                                                            |       | 12,578                 |       | 2,068                      |       |
| Bank  owned life insurance                                                                                                                                                    |       | 11,455                 |       | 11,199                     |       |
| Accrued  interest receivable and other assets                                                                                                                                 |       | 23,506                 |       | 20,102                     |       |
| Total  assets                                                                                                                                                                 |       | $                      | 581,695    |                       | $          | 595,244 |   |
|                                                                                                                                                                          |       |                   |       |                       |       |
| LIABILITIES  AND SHAREHOLDERS’ EQUITY                                                                                                                                    |       |                   |       |                       |       |
|                                                                                                                                                                          |       |                   |       |                       |       |
| Deposits:                                                                                                                                                                     |       |                   |       |                       |       |
| Non-interest  bearing                                                                                                                                                         |       | $                      | 72,214     |                       | $          | 82,159 |   |
| Interest  bearing                                                                                                                                                             |       | 442,331                |       | 444,326                    |       |
| Total  deposits                                                                                                                                                               |       | 514,545                |       | 526,485                    |       |
|                                                                                                                                                                          |       |                   |       |                       |       |
| ESOP  and other notes payable                                                                                                                                                 |       | 4,696                  |       | 5,054                      |       |
| Junior  subordinated debentures                                                                                                                                               |       | 8,248                  |       | 8,248                      |       |
| Accrued  interest payable and other liabilities                                                                                                                               |       | 16,555                 |       | 15,318                     |       |
| Total  liabilities                                                                                                                                                            |       | 544,044                |       | 555,105                    |       |
|                                                                                                                                                                          |       |                   |       |                       |       |
| Commitments  and contingencies (Note 5)                                                                                                                                       |       |                   |       |                       |       |
|                                                                                                                                                                          |       |                   |       |                       |       |
| Shareholders’  equity                                                                                                                                                    |       |                   |       |                       |       |
| Preferred  stock - no par value; 10,000,000 shares authorized; none outstanding                                                                                               |       |                   |       |                       |       |
| Common  stock - no par value; 20,000,000 shares authorized; issued and outstanding -  6,699,603 shares at June 30, 2009, and 6,699,553 shares at  December 31, 2008 |       | 10,173                 |       | 10,147                     |       |
|                                                                                                                                                                          |       |                   |       |                       |       |
| Unallocated  ESOP shares - 167,894 shares at June 30, 2009 and 124,207 shares at  December 31, 2008 (at cost)                                                       |       | (1,616                 | )          | (1,438                     | )          |
| Retained  Earnings                                                                                                                                                            |       | 29,016                 |       | 31,416                     |       |
| Accumulated  other comprehensive income, net                                                                                                                                  |       | 78                     |       | 14                         |       |
|                                                                                                                                                                          |       |                   |       |                       |       |
| Total  shareholders’ equity                                                                                                                                              |       | 37,651                 |       | 40,139                     |       |
| Total  liabilities and shareholders’ equity                                                                                                                              |       | $                      | 581,695    |                       | $          | 595,244 |   |

 

See Notes to Unaudited Condensed Consolidated Financial Statements

 

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**COMMUNITY VALLEY BANCORP**

**CONDENSED CONSOLIDATED STATEMENT OF INCOME (Unaudited)**

(dollars in thousands, except per share data)

 
| ** **                                                 | ** ** | **For the periods ended June 30,** | ** ** |
|------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                 | ** ** | **Three Months**                        | ** ** | **Six Months** | ** ** |
| ** **                                                 | ** ** | **2009**                                | ** ** | **2008** | ** ** | **2009** | ** ** | **2008** | ** ** |
| Interest income:                                           |       |                                    |       |   |   |   |   |   |   |
| Interest  and fees on loans                                |       | $                                       | 7,363      |   | $ | 8,956 |   | $ | 14,410 |   | $ | 17,901 |   |
| Interest  on Federal funds sold                            |       | 23                                      |       | 138 |   | 51 |   | 452 |   |
| Interest  on deposits in banks                             |       | 19                                      |       | 71 |   | 43 |   | 306 |   |
| Interest  on investment securities:                        |       |                                    |       |   |   |   |   |   |   |
| Taxable                                                    |       | 64                                      |       | 117 |   | 119 |   | 218 |   |
| Exempt  from Federal income tax                            |       | 16                                      |       | 16 |   | 32 |   | 32 |   |
| Total  interest income                                     |       | 7,485                                   |       | 9,298 |   | 14,655 |   | 18,909 |   |
|                                                       |       |                                    |       |   |   |   |   |   |   |
| Interest  expense:                                         |       |                                    |       |   |   |   |   |   |   |
| Interest  expense on deposits                              |       | 1,653                                   |       | 2,424 |   | 3,523 |   | 5,208 |   |
| Interest  expense on junior subordinated debentures        |       | 143                                     |       | 143 |   | 286 |   | 280 |   |
| Interest  expense on notes payable                         |       | 81                                      |       | 15 |   | 159 |   | 34 |   |
| Total  interest expense                                    |       | 1,877                                   |       | 2,582 |   | 3,968 |   | 5,522 |   |
| Net  interest income before provision for loan losses      |       | 5,608                                   |       | 6,716 |   | 10,687 |   | 13,387 |   |
| Provision  for loan losses                                 |       | 4,000                                   |       | 450 |   | 7,100 |   | 675 |   |
| Net  interest income after provision for loan losses       |       | 1,608                                   |       | 6,266 |   | 3,587 |   | 12,712 |   |
|                                                       |       |                                    |       |   |   |   |   |   |   |
| Non-interest  income:                                      |       |                                    |       |   |   |   |   |   |   |
| Sale  of merchant processing portfolio                     |       | —                                  |       | — |   | 2,640 |   | — |   |
| Loss  on sale of investment security                       |       | —                                  |       | — |   | (172 | ) | — |   |
| Other  income                                              |       | 2,670                                   |       | 2,210 |   | 5,029 |   | 4,170 |   |
| Total  non-interest income                                 |       | 2,670                                   |       | 2,210 |   | 7,497 |   | 4,170 |   |
|                                                       |       |                                    |       |   |   |   |   |   |   |
| Non-interest  expenses:                                    |       |                                    |       |   |   |   |   |   |   |
| Salaries  and employee benefits                            |       | 3,165                                   |       | 3,654 |   | 6,564 |   | 7,351 |   |
| Occupancy                                                  |       | 681                                     |       | 714 |   | 1,386 |   | 1,389 |   |
| Furniture  and equipment                                   |       | 639                                     |       | 651 |   | 1,288 |   | 1,292 |   |
| Other  real estate                                         |       | 733                                     |       | 3 |   | 1,357 |   | 8 |   |
| FDIC  assessments                                          |       | 955                                     |       | 79 |   | 1,048 |   | 156 |   |
| Other  expense                                             |       | 1,885                                   |       | 1,621 |   | 3,189 |   | 3,518 |   |
| Total  non-interest expense                                |       | 8,058                                   |       | 6,722 |   | 14,832 |   | 13,714 |   |
|                                                       |       |                                    |       |   |   |   |   |   |   |
| (Loss)  income before (benefit) provision for income taxes |       | (3,780                                  | )          | 1,754 |   | (3,748 | ) | 3,168 |   |
|                                                       |       |                                    |       |   |   |   |   |   |   |
| (Benefit)  provision for income taxes                      |       | (1,280                                  | )          | 711 |   | (1,348 | ) | 1,300 |   |
|                                                       |       |                                    |       |   |   |   |   |   |   |
| Net  (loss) income                                         |       | $                                       | (2,500     | ) | $ | 1,043 |   | $ | (2,400 | ) | $ | 1,868 |   |
|                                                       |       |                                    |       |   |   |   |   |   |   |
| Basic  (loss) earnings per share                           |       | $                                       | (0.38      | ) | $ | 0.15 |   | $ | (0.37 | ) | $ | 0.26 |   |
| Diluted  (loss) earnings per share                         |       | $                                       | (0.38      | ) | $ | 0.15 |   | $ | (0.37 | ) | $ | 0.25 |   |
|                                                       |       |                                    |       |   |   |   |   |   |   |
| Cash  dividends per share                                  |       | $                                       | —     |   | $ | 0.04 |   | $ | — |   | $ | 0.12 |   |

 

SeeNotes to Unaudited Condensed Consolidated Financial Statements

 

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**COMMUNITY VALLEY BANCORP**

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

 (In thousandsexcept number of shares)

 
| ** **                                                                  | ** ** | ** **        | ** ** | ** **      | ** ** | ** **       | ** ** | ** **          | ** ** | **Accumulated  Other** | ** ** | ** **        | ** ** | ** **         | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------|------------|-----------------|------------|------------------|------------|---------------------|------------|------------------------|------------|-------------------|------------|--------------------|------------|
| ** **                                                                  | ** ** | ** **        | ** ** | ** **      | ** ** | ** **       | ** ** | ** **          | ** ** | **Comprehensive**      | ** ** | **Total**         | ** ** | ** **         | ** ** |
| ** **                                                                  | ** ** | **Common  Stock** | ** ** | **Unallocated** | ** ** | **Retained**     | ** ** | **Income,  net of** | ** ** | **Shareholders’** | ** ** | **Comprehensive** | ** ** |
| ** **                                                                  | ** ** | **Shares**        | ** ** | **Amount**      | ** ** | **ESOP  shares** | ** ** | **Earnings**        | ** ** | **taxes**              | ** ** | **Equity**        | ** ** | **Income  (Loss)** | ** ** |
| Balance,  January 1, 2008                                              |       | 7,607,908         |       | $               | 10,910     |             | $          | (1,407              | )          | $                      | 41,454     |              | $          | 17                 |       | $ | 50,974 |   |   |   |
|                                                                        |       |              |       |            |       |             |       |                |       |                   |       |              |       |               |       |
| Comprehensive  income                                                       |       |              |       |            |       |             |       |                |       |                   |       |              |       |               |       |
| Net  income                                                                 |       |              |       |            |       |             |       | 2,739               |       |                   |       | 2,739             |       | $                  | 2,739      |   |
| Other  comprehensive income                                                 |       |              |       |            |       |             |       |                |       |                   |       |              |       |               |       |
| Net  change in unrealized gains on available-for-sale investment securities |       |              |       |            |       |             |       |                |       | (3                     | )          | (3                | )          | (3                 | )          |
| Total  comprehensive income                                                 |       |              |       |            |       |             |       |                |       |                   |       |              |       | $                  | 2,736      |   |
|                                                                        |       |              |       |            |       |             |       |                |       |                   |       |              |       |               |       |
| Exercise  of stock options and related tax benefit                          |       | 103,651           |       | 654             |       |             |       |                |       |                   |       | 654               |       |               |       |
| Amortization  of stock compensation-ESOP shares                             |       |              |       | (8              | )          | 90               |       |                |       |                   |       | 82                |       |               |       |
| Shares  acquired by ESOP                                                    |       |              |       |            |       | (121             | )          |                |       |                   |       | (121              | )          |               |       |
| Cash  dividends- $.16 per share                                             |       |              |       |            |       |             |       | (1,148              | )          |                   |       | (1,148            | )          |               |       |
| Stock  based compensation expense                                           |       |              |       | 80              |       |             |       |                |       |                   |       | 80                |       |               |       |
| Retirement  of common stock                                                 |       | (1,012,006        | )          | (1,489          | )          |             |       | (11,629             | )          |                   |       | (13,118           | )          |               |       |
|                                                                        |       |              |       |            |       |             |       |                |       |                   |       |              |       |               |       |
| Balance,  December 31, 2008                                            |       | 6,699,553         |       | 10,147          |       | (1,438           | )          | 31,416              |       | 14                     |       | 40,139            |       |               |       |
|                                                                        |       |              |       |            |       |             |       |                |       |                   |       |              |       |               |       |
| Comprehensive  (loss) income                                                |       |              |       |            |       |             |       |                |       |                   |       |              |       |               |       |
| Net  loss                                                                   |       |              |       |            |       |             |       | (2,400              | )          |                   |       | (2,400            | )          | $                  | (2,400     | ) |
| Other  comprehensive income                                                 |       |              |       |            |       |             |       |                |       |                   |       |              |       |               |       |
| Net  change in unrealized gains on available-for-sale investment securities |       |              |       |            |       |             |       |                |       | 64                     |       | 64                |       | 64                 |       |
| Total  comprehensive loss                                                   |       |              |       |            |       |             |       |                |       |                   |       |              |       | $                  | (2,336     | ) |
|                                                                        |       |              |       |            |       |             |       |                |       |                   |       |              |       |               |       |
| Exercise  of stock options and related tax benefit                          |       | 50                |       | 1               |       |             |       |                |       |                   |       | 1                 |       |               |       |
| Amortization  of stock compensation-ESOP shares                             |       |              |       | (6              | )          | 39               |       |                |       |                   |       | 33                |       |               |       |
| Shares  acquired by ESOP                                                    |       |              |       |            |       | (217             | )          |                |       |                   |       | (217              | )          |               |       |
| Stock  based compensation expense                                           |       |              |       | 31              |       |             |       |                |       |                   |       | 31                |       |               |       |
|                                                                        |       |              |       |            |       |             |       |                |       |                   |       |              |       |               |       |
| Balance,  June 30, 2009                                                |       | 6,699,603         |       | $               | 10,173     |             | $          | (1,616              | )          | $                      | 29,016     |              | $          | 78                 |       | $ | 37,651 |   |   |   |

 

SeeNotes to Unaudited Condensed Consolidated Financial Statements

 

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**COMMUNITY VALLEY BANCORP**

**CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS(Unaudited)**

(In thousands)

 
| ** **                                                                         | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                         | ** ** | **June 30,**    | ** ** |
| ** **                                                                         | ** ** | **2009**             | ** ** | **2008** | ** ** |
| Cash  flows from operating activities:                                             |       |                 |       |   |   |
| Net  (loss) income                                                                 |       | $                    | (2,400     | ) | $ | 1,868 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                 |       |   |   |
| Provision  for loan losses                                                         |       | 7,100                |       | 675 |   |
| Decrease  in deferred loan origination fees                                        |       | (255                 | )          | (138 | ) |
| Depreciation  and amortization, net                                                |       | 994                  |       | 1,099 |   |
| Gain  on disposition of Bank premises and equipment                                |       | (14                  | )          | (4 | ) |
| Loss  on write-down of other real estate                                           |       | 1,798                |       | — |   |
| Net  increase in loans held for sale                                               |       | (901                 | )          | (566 | ) |
| Increase  in cash surrender value of bank-owned life insurance, net                |       | (217                 | )          | (205 | ) |
| Excess  tax benefit from exercise of stock options                                 |       | —               |       | (162 | ) |
| Non-cash  compensation expense associated with the ESOP                            |       | 33                   |       | 81 |   |
| Stock  based compensation                                                          |       | 31                   |       | 43 |   |
| Loss  recognized on investment security                                            |       | 172                  |       | — |   |
| (Increase)  decrease in accrued interest receivable and other assets               |       | (2,454               | )          | 593 |   |
| Increase  in accrued interest payable and other liabilities                        |       | 1,322                |       | 4,305 |   |
| Provision  for deferred income taxes                                               |       | (992                 | )          | (252 | ) |
| Net  cash provided by operating activities                                         |       | 4,217                |       | 7,337 |   |
|                                                                               |       |                 |       |   |   |
| Cash  flows from investing activities:                                             |       |                 |       |   |   |
| Increase  in interest-bearing deposits in banks                                    |       | (857                 | )          | (594 | ) |
| Proceeds  from matured or called available-for-sale investment securities          |       | 3,000                |       | 1,000 |   |
| Proceeds  from principal payments on available-for-sale investment securities      |       | 154                  |       | 107 |   |
| Proceeds  from matured or called held-to-maturity investment securities            |       | 88                   |       | 1,000 |   |
| Proceeds  from principal payments of held-to-maturity investment securities        |       | 92                   |       | 170 |   |
| Purchase  of available-for-sale investment securities                              |       | (1,000               | )          | (3,010 | ) |
| Purchase  of held-to-maturity investment securities                                |       | (996                 | )          | (1,750 | ) |
| Purchases  of premises and equipment                                               |       | (142                 | )          | (506 | ) |
| Proceeds  from sale of premises and equipment                                      |       | 20                   |       | 9,700 |   |
| Proceeds  from sale of other real estate                                           |       | 1,265                |       | — |   |
| Premiums  paid for life insurance policies                                         |       | (39                  | )          | — |   |
| Net  decrease (increase) in loans                                                  |       | 3,820                |       | (49,616 | ) |
| Net  cash provided by (used in) investing activities                               |       | 5,405                |       | (43,499 | ) |
|                                                                               |       |                 |       |   |   |
| Cash  flows from financing activities:                                             |       |                 |       |   |   |
| Net  (decrease) increase in demand, interest-bearing and savings deposits          |       | (7,191               | )          | 6,079 |   |
| Net  decrease in time deposits                                                     |       | (4,749               | )          | (9,878 | ) |
| (Repayment)  proceeds from note payable                                            |       | (500                 | )          | 4,000 |   |
| Repayment  of ESOP note payable                                                    |       | (75                  | )          | (76 | ) |
| Proceeds  from ESOP note payable                                                   |       | 217                  |       | — |   |
| Purchase  of ESOP shares                                                           |       | (217                 | )          | — |   |
| Payment  of cash dividends                                                         |       | —               |       | (1,223 | ) |
| Tax  benefit from the exercise of stock options                                    |       | —               |       | 162 |   |
| Proceeds  from exercise of stock options                                           |       | 1                    |       | 402 |   |
| Retirement  of common stock                                                        |       | —               |       | (13,118 | ) |
| Repayment  of junior subordinated debentures                                       |       | —               |       | (8,248 | ) |
| Net  cash used in financing activities                                             |       | (12,514              | )          | (21,900 | ) |
|                                                                               |       |                 |       |   |   |
| Decrease  in cash and cash equivalents                                             |       | (2,892               | )          | (58,062 | ) |
|                                                                               |       |                 |       |   |   |
| Cash  and cash equivalents at beginning of year                                    |       | 58,348               |       | 86,004 |   |
|                                                                               |       |                 |       |   |   |
| Cash  and cash equivalents at end of period                                        |       | $                    | 55,456     |   | $ | 27,942 |   |

 

SeeNotes to Unaudited Condensed Consolidated Financial Statements

 

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Community Valley Bancorp

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

**1. BASIS OF PRESENTATION**

 

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

 

Thecondensed consolidated financial statements include the accounts of the Companyand its wholly owned subsidiaries, Butte Community Bank (the “Bank”) and BCBInsurance Agency, LLC. All significant inter-company balances and transactionshave been eliminated in consolidation. The Company also has a wholly-ownedunconsolidated subsidiary, Community Valley Bancorp Trust II (the “Trust”), aDelaware statutory business trust, formed for the sole purpose of issuing trustpreferred securities. The results of operations for the three-month and sixmonth periods ended June 30, 2009 may not necessarily be indicative of theoperating results for the full year 2009.

 

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

 

TheCompany evaluated subsequent events for potential recognition and/or disclosurethrough August 14, 2009, the date the condensed consolidated financialstatements were issued.

 

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

 

**2. EARNINGS PER SHARE COMPUTATION**

 

Basicearnings per share are computed by dividing net income by the weighted averagecommon shares outstanding for the period (6,527,737 and 6,542,539 shares forthe three and six month periods ended June 30, 2009 and 7,028,451 and 7,223,965shares for the three and six month periods ended June 30, 2008). Dilutedearnings per share reflect the potential dilution that could occur ifoutstanding stock options were exercised using the treasury stock method.Diluted earnings per share is computed by dividing net income by the weightedaverage common shares outstanding for the period plus the dilutive effect ofoptions (zero shares for the three and six month periods ended June 30, 2009and 93,979 and 109,191 shares for the three and six month periods ended June30, 2008).  As of June 30, 2009, 314,186outstanding options were “out of the money “compared to 153,330 at June 30,2008, that is the option price was higher than the market price so these shareswere not used in the calculation of earnings per share as they are consideredantidilutive.  In addition, dilutedearnings per share are not presented when a loss occurs because the conversionof potential common stock is anti-dilutive.

 

**3. COMPREHENSIVE (LOSS) INCOME**

 

Comprehensive(loss) income is reported in addition to net (loss) income for all periodspresented. Comprehensive (loss) income is made up of net income plus othercomprehensive income or loss. The Company’s only source of comprehensive incomeor loss, is changes in unrealized gains or losses, net of taxes, onavailable-for-sale securities, adjusted for the effect of realized gains orlosses on available-for-sale securities, net of taxes. Comprehensive (loss)income was $(2,514,000) and $(2,336,000) for the three and six month periodsended June 30, 2009 compared to $983,000 and $1,846,000 for the same period in2008, respectively.

 

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**4. STOCK - BASED COMPENSATION**

 

TheCompany issues stock options under two stock-based compensation plans, theCommunity Valley Bancorp 1997 and 2000 Stock Option Plans. The plans requirethat the option price may not be less than the fair market value of the stockat the date the option is granted, and that the stock must be paid in full atthe time the option is exercised. The options expire on a date determined bythe Board of Directors, but not later than ten years from the date of grant.The vesting period is determined by the Board of Directors and is generallyover five years; however, nonstatutory options granted during 1997 vestedimmediately. Under the 1997 plan, 4,738 shares of common stock remain reservedfor issuance to employees, and the related options are exercisable until theirexpiration. However, no new options will be granted under this plan. Under theCompany’s 2000 stock option plan, 332,048 shares of common stock remainreserved for issuance to employees and directors. There are 106,795 additional sharesavailable for future grants.

 

Stockoption activity for the interim 2009 period is summarized below:

 
| **2009**                                       | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|------------------------------------------------|------------|------------|------------|---------------------------------------|------------|------------------------------------------|------------|---------------------------------|------------|
| Outstanding  at January 1                      |       | 350,231    |       | $                                     | 8.30       |                                     | 3.4 years  |                            | $          | 0 |   |
| Exercised                                      |       | (50        | )          | $                                     | 4.71       |                                     |       |                            |       |   |
| Cancelled/Expired                              |       | (13,395    | )          | $                                     | 6.26       |                                     |       |                            |       |   |
| Outstanding  at June 30                        |       | 336,786    |       | $                                     | 8.25       |                                     | 2.9 years  |                            | $          | 0 |   |
| Options  vested or expected to vest at June 30 |       | 330,050    |       | $                                     | 8.09       |                                     | 2.8 years  |                            | $          | 0 |   |
| Exercisable  at June 30                        |       | 314,186    |       | $                                     | 7.72       |                                     | 2.7 years  |                            | $          | 0 |   |

 

**5. COMMITMENTS AND CONTINGENCIES**

 

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

 

Inthe normal course of business, there are various outstanding commitments toextend credit which are not reflected in the financial statements, includingloan commitments of $115,623,000 and $148,000,000 and stand-by letters ofcredit of $5,319,000 and $6,482,000 at June 30, 2009 and December 31,2008, respectively.

 

Ofthe loan commitments outstanding at June 30, 2009, $31,128,000 are real estateconstruction loan commitments  that are notexpected to fund within the next twelve months due to the current downturn inthe real estate market. The remaining commitments primarily relate to revolvinglines of credit or other commercial loans, and many of these are expected toexpire without being drawn upon. Therefore, the total commitments do notnecessarily represent future cash requirements. Each loan commitment and the amountand type of collateral obtained, if any, are evaluated on an individual basis.Collateral held varies, but may include real property, bank deposits, debt orequity securities or business assets.

 

Stand-byletters of credit are conditional commitments written to guarantee theperformance of a customer to a third party. These guarantees are primarilyrelated to the purchases of inventory by commercial customers and are typicallyshort-term in nature. Credit risk is similar to that involved in extending loancommitments to customers and accordingly, evaluation and collateralrequirements similar to those for loan commitments are used. The fair value ofthe liability related to these stand-by letters of credit, which represents thefees received for issuing the guarantees, was not significant at June 30, 2009and December 31, 2008. The Company recognizes these fees as revenues over theterm of the commitment or when the commitment is used.

 

**6.  INCOME TAXES**

 

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

 

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The Companyaccounts for income taxes using the liability or balance sheet method. Underthis method, deferred tax assets and liabilities are recognized for the taxconsequences of temporary differences between the reported amounts of assetsand liabilities and their tax bases. Deferred tax assets and liabilities areadjusted for the effects of changes in tax laws and rates on the date ofenactment. On the consolidated balance sheet, net deferred tax assets areincluded in accrued interest receivable and other assets. Management hasreviewed the deferred tax assets recorded at June 30, 2009 and has determinedthat a valuation allowance was not needed.

 

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

 

****Other notes payableinclude a note payable from a correspondent bank to the holding company in anoriginal amount of $4.0 million which was down-streamed to Butte Community Bankin the form of additional common stock issued to the holding company.  This note has a current principal balance of$3.5 million, is for a two year period with a maturity date of June 30, 2010and an interest rate equal to the three month LIBOR rate plus 8.125% adjustedquarterly. The rate was adjusted to 8.72% on June 30, 2009.  The remaining $1,195,974 represents thebalance of the ESOP note payable due April 10, 2014 with a variable interestrate based on an independent index.  AtJune 30, 2009 the interest rate was 5.75%. The ESOP line of credit was fullyfunded during the first quarter 2009 to purchase additional shares for theESOP.****

 

**8.  FAIR VALUE MEASUREMENTS**

 

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

 
| ** **                                                  | ** ** | **June 30, 2009**    | ** ** | **December 31, 2008** | ** ** |
|-------------------------------------------------------------|------------|----------------------|------------|-----------------------|------------|
| ** **                                                  | ** ** | **Carrying  Amount** | ** ** | **Fair Value**        | ** ** | **Carrying  Amount** | ** ** | **Fair Value** | ** ** |
|                                                        |       |                 |       |                  |       |   |   |   |   |
| Financial  assets:                                          |       |                 |       |                  |       |   |   |   |   |
| Cash  and due from banks                                    |       | $                    | 15,856     |                  | $          | 15,856 |   | $ | 21,743 |   | $ | 21,743 |   |
| Federal  Funds sold and other                               |       | 39,600               |       | 39,600                |       | 36,605 |   | 36,605 |   |
| Interest-bearing  deposits in banks                         |       | 3,433                |       | 3,435                 |       | 2,576 |   | 2,595 |   |
| Loans  held for sale                                        |       | 1,221                |       | 1,221                 |       | 320 |   | 320 |   |
| Investment  securities                                      |       | 5,695                |       | 5,711                 |       | 7,096 |   | 7,100 |   |
| Loans                                                       |       | 462,199              |       | 467,256               |       | 486,522 |   | 487,578 |   |
| Other  investments                                          |       | 1,055                |       | 1,055                 |       | 1,096 |   | 1,096 |   |
| Accrued  interest receivable                                |       | 3,838                |       | 3,838                 |       | 3,838 |   | 3,838 |   |
| Cash  surrender value of Bank owned life insurance policies |       | 11,455               |       | 11,455                |       | 11,199 |   | 11,199 |   |
| Loan  servicing assets                                      |       | 2,911                |       | 2,911                 |       | 2,004 |   | 2,004 |   |
|                                                        |       |                 |       |                  |       |   |   |   |   |
| Financial  liabilities:                                     |       |                 |       |                  |       |   |   |   |   |
| Deposits                                                    |       | $                    | 514,545    |                  | $          | 515,188 |   | $ | 526,485 |   | $ | 527,720 |   |
| Notes  payable                                              |       | 4,696                |       | 4,696                 |       | 5,054 |   | 5,054 |   |
| Junior  subordinated debentures                             |       | 8,248                |       | 9,806                 |       | 8,248 |   | 9,205 |   |
| Accrued  interest payable                                   |       | 651                  |       | 651                   |       | 6,450 |   | 645 |   |

 

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

 

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

 

The followingmethods and assumptions were used by the Company to estimate the fair value ofits financial instruments at June 30, 2009 and December 31, 2008:

 

Cash and cash equivalents: Cash and cash equivalents include cashand due from banks Federal funds sold and certain short-term interest-bearingdeposits in banks and the carrying amount is estimated to be fair value.

 

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

 

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

 

Loans: Fair values of loans held for sale areestimated using quoted market prices for similar loans or the amount that purchasershave committed to purchase the loans. For variable-rate loans that repricefrequently with no significant change in credit risk, fair values are based oncarrying values.  The fair values forother loans are estimated using discounted cash flow analyses, using interestrates offered at each reporting date for loans with similar terms to borrowersof comparable creditworthiness adjusted for the allowance for loan losses. Thecarrying amount of accrued interest receivable approximates its fair value.

 

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

 

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

 

Loan servicingassets: The fairvalue of servicing assets is estimated using projected cash flows, adjusted forthe effects of anticipated prepayments, using a market discount rate.

 

Deposits: The fair values for demand depositsare, by definition, equal to the amount payable on demand at each reportingdate represented by their carrying amount. Fair values for fixed-ratecertificates of deposit are estimated using a discounted cash flow analysisusing interest rates offered at each reporting date by the Bank forcertificates with similar remaining maturities. The carrying amount of accruedinterest payable approximates its fair value.

 

Notes payable: The ESOP note payable reprice is basedupon an independent index. The carrying amount of the notes payableapproximates its fair value. The other note payable reprice is based upon anindependent index plus a stated rate.

 

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

 

Commitments toextend credit and standby letters of credit: Commitments to extend credit are primarily forvariable rate loans and standby letters of credit. For these commitments, thereis no difference between the committed amounts and their fair values. The fairvalue of the commitments at each reporting date was not significant and notincluded in the accompanying table.

 

The followingtables present information about the Company’s assets and liabilities measuredat fair value on a recurring and non recurring basis as of June 30, 2009.

 

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Assets measured atfair value on a recurring basis are summarized below:

 
| ** **             | ** ** | **Fair  Value Measurements**      | ** ** |
|------------------------|------------|-----------------------------------|------------|
| ** **             | ** ** | **at  June 30, 2009, Using** | ** ** |
| ** **             | ** ** | ** **                        | ** ** | **Quoted  Prices in** | ** ** | **Other** | ** ** | **Significant** | ** ** |
| ** **             | ** ** | ** **                        | ** ** | **Active  Markets for** | ** ** | **Observable** | ** ** | **Unobservable** | ** ** |
| ** **             | ** ** | **Fair  Value**                   | ** ** | **Identical  Assets** | ** ** | **Inputs** | ** ** | **Inputs** | ** ** |
| **Description**        | ** ** | **30-Jun-09**                     | ** ** | **(Level  1)** | ** ** | **(Level  2)** | ** ** | **(Level  3)** | ** ** |
| Investment  securities |       | $                                 | 4,416      |   | $ | — |   | $ | 4,416 |   | $ | — |   |
|                        |            |                                   |            |  |  |  |  |  |  |  |  |  |  |

 

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

 

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

*** ***

Assets measured atfair value on a non recurring basis are summarized below:

 
| ** **                                                    | ** ** | **Fair  Value Measurements**      | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                    | ** ** | **at  June 30, 2009, Using** | ** ** |
| ** **                                                    | ** ** | ** **                        | ** ** | **Quoted  Prices in** | ** ** | **Other** | ** ** | **Significant** | ** ** |
| ** **                                                    | ** ** | ** **                        | ** ** | **Active  Markets for** | ** ** | **Observable** | ** ** | **Unobservable** | ** ** |
| ** **                                                    | ** ** | **Fair  Value**                   | ** ** | **Identical  Assets** | ** ** | **Inputs** | ** ** | **Inputs** | ** ** |
| **Description**                                               | ** ** | **30-Jun-09**                     | ** ** | **(Level  1)** | ** ** | **(Level  2)** | ** ** | **(Level  3)** | ** ** |
| Impaired  loans                                               |       | $                                 | 14,455     |   | $ | — |   | $ | 14,455 |   | $ | — |   |
| Other  real estate                                            |       | 12,578                            |       | — |   | 12,578 |   | — |   |
| Total  assets measured at fair value on a non recurring basis |       | $                                 | 27,033     |   | $ | — |   | $ | 27,033 |   | $ | — |   |

 

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

*** ***

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

 

**9.  NEW ACCOUNTING PRONOUNCEMENTS**

 

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

 

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

 

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

 

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

 

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OnMay 28, 2009, the FASB issued Statement of Financial Accounting Standards(“SFAS”) No. 165, “Subsequent Events” (“SFAS 165”).  Under SFAS165, companies are required to evaluate events and transactions that occurafter the balance sheet date but before the date the financial statements areissued, or available to be issued in the case of non-publicentities.  SFAS 165 requires entities to recognize in the financialstatements the effect of all events or transactions that provide additionalevidence of conditions that existed at the balance sheet date, including theestimates inherent in the financial preparation process.  Entitiesshall not recognize the impact of events or transactions that provide evidenceabout conditions that did not exist at the balance sheet date but arose afterthat date.  SFAS 165 also requires entities to disclose the datethrough which subsequent events have been evaluated.  SFAS 165 waseffective for interim and annual reporting periods ending after June 15,2009.  The Company adopted the provisions of SFAS 165 for the quarterended June 30, 2009, as required, and adoption did not have a materialimpact on the Company’s financial statements taken as a whole.

 

OnJune 29, 2009, the FASB issued SFAS No. 168, “The FASB AccountingStandards Codification and the Hierarchy of Generally Accepted AccountingPrinciples — a replacement of FASB Statement No. 162” (“SFAS 168”).  SFAS168 establishes the FASB Accounting Standards CodificationTM as the source ofauthoritative accounting principles recognized by the FASB to be applied bynongovernmental entities in the preparation of financial statements inconformity with US GAAP.  SFAS 168 will be effective for financialstatements issued for interim and annual periods ending after September 15,2009, for most entities.  On the effective date, all non-SECaccounting and reporting standards will be superseded.  The Companywill adopt SFAS 168 for the quarterly period ended September 30, 2009, asrequired, and adoption is not expected to have a material impact on the Company’sfinancial statements taken as a whole.

 

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

 

Thefollowing is Community Valley Bancorp’s (the “Company”) management’s discussionand analysis of the significant changes in balance sheet accounts between June 30,2009 and December 31, 2008 and income and expense accounts for the threeand six month periods ended June 30, 2009 and 2008. The discussion isdesigned to provide a better understanding of significant trends related to theCompany’s financial condition, results of operations, liquidity, capitalresources and interest rate sensitivity.

 

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

 

**General Development of Business**

 

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

 

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

 

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

 

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

 

**Critical Accounting Policies**

 

*General*

 

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

 

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*Allowance for Loan Losses (ALL)*

 

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

 

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

 

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

 

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

 

*Loan Sales and Servicing*

 

TheCompany originates government guaranteed loans and mortgage loans that may besold in the secondary market.  The amount of gains recorded on sales ofloans and the initial recording of servicing assets and interest only (I/O)strips is based on the estimated fair values of the respectivecomponents.  In recording the initial value of the servicing assets andthe fair value of the I/O strips receivable, the Company uses estimates whichare based on management’s expectations of future prepayments and discountrates.  Servicing assets are amortized over the estimated life of therelated loan.  I/O strips are not significant at June 30, 2009. These prepayment and discount rates were based on current market conditions andhistorical performance of the various pools of serviced loans.  If actualprepayments with respect to sold loans occur more quickly than projected, thecarrying value of the servicing assets may have to be adjusted through a chargeto earnings.

 

*Stock-BasedCompensation*

 

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

 

*Impairment of Investment Securities*

 

Investmentsecurities are evaluated for other-than-temporary impairment on at least aquarterly basis and more frequently when economic or market conditions warrantsuch an evaluation to determine whether a decline in their value belowamortized cost is other than temporary. Management utilizes criteria such asthe magnitude and duration of the decline, the financial condition of theissuer, rating agency changes related to the issuer’s securities and the intentand ability of the Bank to retain its investment in 

 

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theissues for a period of time sufficient to allow for an anticipated recovery infair value, in addition to the reasons underlying the decline, to determinewhether the loss in value is other than temporary. The term “other thantemporary” is not intended to indicate that the decline is permanent, butindicates that the prospects for a near-term recovery of value is notnecessarily favorable, or that there is a lack of evidence to support arealizable value equal to or greater than the carrying value of the investment.Once a decline invalue is determined to be other-than-temporary and management has the abilityand intent to hold the security to a forecasted recovery of cost, only theportion of the impairment loss representing credit exposure would be recognizedas a charge to earnings, with the balance recognized as a charge to othercomprehensive income.  If management, intends to sell the security or itis more likely than not that it will be required to sell the security beforerecovering its forecasted cost, the entire impairment loss would be recognizedas a charge to earnings.

 

*Revenue recognition*

 

TheCompany’s primary source of revenue is net interest income, which is the differencebetween the interest income it receives on interest-earning assets and theinterest expense it pays on interest-bearing liabilities, and fee income, whichincludes fees earned on deposit services, income from sales and servicing ofSBA loans, electronic-based cash management services, and mortgage brokeragefee income.  Interest income is recordedon an accrual basis. Note 1 to the Consolidated Financial Statements in theCompany’s 2008 Annual Report to Shareholders on Form 10-K offers anexplanation of the process for determining when the accrual of interest incomeis discontinued on an impaired loan.

 

*Income Taxes*

 

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

 

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

 

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

 

*FairValue*

 

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

 

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**Overview**

 

The Company recorded a net loss of $2,500,000 for the quarter ended June 30,2009, which was a 339.7% decrease from the net income of $1,043,000 reportedfor the same period of 2008. Diluted earnings per share for the second quarterof 2009 were ($0.38), compared to the $0.15 recorded in the second quarter of2008. The annualized return on average equity (ROAE) and annualized return onaverage assets (ROAA) for the second quarter of 2009 were (24.76)% and (1.68)%,respectively, as compared to 9.42% and .74%, respectively, for the same periodin 2008. The primary reasons for the loss for the second quarter ended June 30,2009 are the increase in the level of the provision for loan losses, increasein the FDIC assessment, increase in other real estate expenses, and a declinein net interest income.  This was partially mitigated by increasesin other non-interest income and the recognition of an income tax benefit inthe current year.

 

Weexperienced a compression of the net interest margin of 105 basis points asyields on earning assets decreased 165 basis points while rates paid oninterest bearing liabilities decreased 80 basis points. The compression is adirect result of the Federal Open market Committee of the Federal ReserveSystem (“FOMC”) reducing the Federal Funds rate to a range of 0% - .25% in December 2008.Additionally, for the second quarter ended June 30, 2009 we increased theprovision for loan losses to $4,000,000 compared to $450,000 for the secondquarter of 2008. Other factors are the increase in FDIC assessment, to includea special assessment of approximately $268,000, to $955,000 from $79,000 andother real estate expense to $733,000 from $3,000 for the second quarter ended June 30,2009 compared to 2008, respectively. This was partially mitigated by increases in other noninterest income, government loan and mortgage loan servicing fees and gains onsales of loans totaling $590,000, and the recognition of an income tax benefit.

 

The net loss for the sixmonths ended June 30, 2009 was $2,400,000 which was a decrease of 228.5%from the net income of $1,868,000 reported for the same period of 2008. Dilutedearnings per share for the six months ended June 30, 2009 were ($0.37),compared to the $0.25 recorded for the same period in 2008. The annualizedreturn on average equity (ROAE) and the annualized return on average assets(ROAA) for the six months ended June 30, 2009 were  (11.94)% and (0.81)%, respectively, ascompared to 7.71% and 0.66%, respectively, for the same period in 2008. Theprimary reasons for the decrease in net income for the six month period isgenerally consistent with the discussion above for the second quarter as thenet interest margin decreased 121 basis points from June 30, 2008,provision for loan losses increased by $6,425,000 to $7,100,000 from $675,000for the same period in 2008, FDIC assessment increased $892,000 to $1,048,000from $156,000, and other real estate expenses increased by $1,349,000 to$1,357,000 from $8,000 for the six month period ended June 30, 2008.

 

Totalassets of the Company decreased by $13,549,000 or 2.3% from $595,244,000 at December 31,2008 to $581,695,000 at June 30, 2009. Cash and cash equivalents decreasedto $55,456,000, down $2,892,000 or 5.0%. Net loans decreased to $462,199,000, down $24,323,000 or 5.0% from December 31,2008. Deposit balances at June 30, 2009 decreased to $514,545,000, down$11,940,000 or 2.3% from December 31, 2008.   Premises and equipment decreased to $6,152,000,down $861,000 or 12.3%.   Shareholder’sequity decreased to $37,651,000, down $2,488,000.

 

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

 

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

 
| ** **                                                              | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **(In thousands, except percentages)**                                  | ** ** | **2009**                              | ** ** | **2008**                            | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                    |       |                                  |       |                                |       |   |   |   |   |
| Net  interest income                                                    |       | $                                     | 5,608      |                                | $          | 6,716 |   | $ | 10,687 |   | $ | 13,387 |   |
| Provision  for loan losses                                              |       | (4,000                                | )          | (450                                | )          | (7,100 | ) | (675 | ) |
| Non-interest  income                                                    |       | 2,670                                 |       | 2,210                               |       | 7,497 |   | 4,170 |   |
| Non-interest  expense                                                   |       | (8,058                                | )          | (6,722                              | )          | (14,832 | ) | (13,714 | ) |
| Benefit  (provision) for income taxes                                   |       | 1,280                                 |       | (711                                | )          | 1,348 |   | (1,300 | ) |
|                                                                    |       |                                  |       |                                |       |   |   |   |   |
| Net  (loss) income                                                      |       | $                                     | (2,500     | )                                   | $          | 1,043 |   | $ | (2,400 | ) | $ | 1,868 |   |
|                                                                    |       |                                  |       |                                |       |   |   |   |   |
| Average  total assets (in millions)                                     |       | $                                     | 597.2      |                                | $          | 565.4 |   | $ | 595.7 |   | $ | 569.8 |   |
| Net  (loss) income (annualized) as a percentage of average total assets |       | (1.68                                 | )%         | 0.74                                | %          | (0.81 | )% | 0.66 | % |

 

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** **

**Results of Operations**

 

**Net Interest Income and Net Interest Margin**

 

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

 

The Company’s net interest margin was 4.17% for thethree month period ended June 30, 2009 and 3.98% for the six month periodending June 30, 2009 compared to 5.22% and 5.19% for the same periods inthe prior year which were down 105 basis points and 121 basis points,respectively.  Net interest incomedecreased $1,108,000 (16.49%) for the second quarter of 2009 compared to thesame period in 2008.  Net interest income decreased $2,700,000 (20.16%)for the six months ended June 30, 2009 over the same period in 2008.  The primary reason for this decrease was thecompression of the net interest margin as a result of 200 basis point decreasesby the Federal Reserve Board since June 2008 (ending with the currentfederal funds rate at a range of 0% - .25%) and because the pricing of ourinterest bearing liabilities are at a point where they cannot decrease muchfurther.

 

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

 

TableThree, Analysis of Volume and Rate changes on Net Interest Income, analyzes thechanges in net interest income for the three and six month periods ended June 30,2009 compared to June 30, 2008 that are reported in Table Two.  The analysis shows the impact of volume andrate changes on the major categories of assets and liabilities between theseperiods.  The table explains what portionof the difference or variance in interest income or expense between theseperiods for each major category of assets or liabilities is due to changes inthe balances (volume) or to changes in rates.

 

Forexample, Table Two shows that interest income from loans for the three monthsended June 30, 2009 decreased by $1,593,000 from $8,956,000 at June 30,2008 to $7,363,000.  The average balanceof loans increased from $477,500,000 to $480,272,000 and the interest rateearned decreased from 7.54% to 6.15%. Table Three shows the $1,593,000 decrease in interest income from loans wasactually the result of a $52,000 increase in interest income from the higherbalance of loans and a $1,645,000 decrease from the decrease in yields earnedin the second quarter of 2009 compared to the same period in 2008.

 

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

 

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

 
| **Three Months Ended June 30,**              | ** ** | **2009**             | ** ** | **2008**     | ** ** |
|---------------------------------------------------|------------|----------------------|------------|--------------|------------|
| **(In thousands, except percentages)**            | ** ** | **Avg Balance** | ** ** | **Interest** | ** ** | **Avg Yield (4)** | ** ** | **Avg Balance** | ** ** | **Interest** | ** ** | **Avg Yield (4)** | ** ** |
| Assets:                                           |       |                 |       |         |       |   |   |   |   |   |   |   |   |
| Earning  assets                                   |       |                 |       |         |       |   |   |   |   |   |   |   |   |
| Loans  (1)                                        |       | $                    | 480,272    |         | $          | 7,363 |   | 6.15 | % | $ | 477,500 |   | $ | 8,956 |   | 7.54 | % |
| Taxable  investment securities                    |       | 5,306                |       | 64           |       | 4.84 | % | 7,494 |   | 117 |   | 6.30 | % |
| Tax-exempt  investment securities (2)        |       | 1,397                |       | 16           |       | 4.59 | % | 1,412 |   | 16 |   | 4.66 | % |
| Federal  funds sold                               |       | 50,069               |       | 23           |       | 0.18 | % | 26,027 |   | 138 |   | 2.13 | % |
| Interest  bearing deposits in banks               |       | 2,349                |       | 19           |       | 3.24 | % | 5,515 |   | 71 |   | 5.18 | % |
| Total  earning assets                             |       | 539,393              |       | 7,485        |       | 5.57 | % | 517,948 |   | 9,298 |   | 7.22 | % |
| Cash &  due from banks                   |       | 14,071               |       |         |       |   |   | 18,367 |   |   |   |   |   |
| Other  assets                                     |       | 43,693               |       |         |       |   |   | 29,087 |   |   |   |   |   |
| Average  total assets                             |       | $                    | 597,157    |         |       |   |   |   | $ | 565,402 |   |   |   |   |   |
|                                              |       |                 |       |         |       |   |   |   |   |   |   |   |   |
| Liabilities &  Shareholders’ Equity |       |                 |       |         |       |   |   |   |   |   |   |   |   |
| Interest  bearing liabilities:                    |       |                 |       |         |       |   |   |   |   |   |   |   |   |
| NOW &  MMDA                              |       | $                    | 151,949    |         | $          | 169 |   | 0.45 | % | $ | 151,726 |   | $ | 289 |   | 0.77 | % |
| Savings                                           |       | 107,874              |       | 239          |       | 0.89 | % | 118,338 |   | 522 |   | 1.77 | % |
| Time  deposits                                    |       | 195,283              |       | 1,245        |       | 2.56 | % | 152,529 |   | 1,613 |   | 4.25 | % |
| Other  borrowings                                 |       | 13,380               |       | 224          |       | 6.71 | % | 9,328 |   | 158 |   | 6.80 | % |
| Total  interest bearing liabilities               |       | 468,486              |       | 1,877        |       | 1.61 | % | 431,921 |   | 2,582 |   | 2.40 | % |
| Demand  deposits                                  |       | 74,011               |       |         |       |   |   | 73,683 |   |   |   |   |   |
| Other  liabilities                                |       | 14,157               |       |         |       |   |   | 15,334 |   |   |   |   |   |
| Total  liabilities                                |       | 556,654              |       |         |       |   |   | 520,938 |   |   |   |   |   |
| Shareholders’  equity                        |       | 40,503               |       |         |       |   |   | 44,464 |   |   |   |   |   |
| Average  liabilities and equity                   |       | $                    | 597,157    |         |       |   |   |   | $ | 565,402 |   |   |   |   |   |
|                                              |       |                 |       |         |       |   |   |   |   |   |   |   |   |
| Net  interest income & margin (3)        |       |                 |       | $            | 5,608      |   | 4.17 | % |   |   | $ | 6,716 |   | 5.22 | % |

 

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(1) Loan interestincludes loan fees of $347,000 and $440,000 during the quarters ended June 30,2009 and June 30, 2008, respectively.

 

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

 

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

 

(4)  Average yieldis calculated based on actual days in quarter (91 for June 30, 2009 and June 30,2008) and annualized to actual days in year (365 for 2009 and 366 for 2008).

 

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| **Six months ended June 30,**                | ** ** | **2009**             | ** ** | **2008**     | ** ** |
|---------------------------------------------------|------------|----------------------|------------|--------------|------------|
| **(In thousands, except percentages)**            | ** ** | **Avg Balance** | ** ** | **Interest** | ** ** | **Avg Yield (4)** | ** ** | **Avg Balance** | ** ** | **Interest** | ** ** | **Avg Yield (4)** | ** ** |
| Assets                                            |       |                 |       |         |       |   |   |   |   |   |   |   |   |
| Earning  assets:                                  |       |                 |       |         |       |   |   |   |   |   |   |   |   |
| Loans  (1)                                        |       | $                    | 484,880    |         | $          | 14,410 |   | 5.99 | % | $ | 463,743 |   | $ | 17,901 |   | 7.76 | % |
| Taxable  investment securities                    |       | 5,417                |       | 119          |       | 4.43 | % | 6,884 |   | 218 |   | 6.38 | % |
| Tax-exempt  investment securities (2)        |       | 1,383                |       | 32           |       | 4.67 | % | 1,397 |   | 32 |   | 4.66 | % |
| Federal  funds sold & other              |       | 47,830               |       | 51           |       | 0.22 | % | 34,519 |   | 452 |   | 2.63 | % |
| Interest  bearing deposits in banks               |       | 2,369                |       | 43           |       | 3.66 | % | 12,454 |   | 306 |   | 4.94 | % |
| Total  earning assets                             |       | 541,879              |       | 14,655       |       | 5.45 | % | 518,997 |   | 18,909 |   | 7.33 | % |
| Cash &  due from banks                   |       | 15,294               |       |         |       |   |   | 16,311 |   |   |   |   |   |
| Other  assets                                     |       | 38,545               |       |         |       |   |   | 34,508 |   |   |   |   |   |
| Average  total assets                             |       | $                    | 595,718    |         |       |   |   |   | $ | 569,816 |   |   |   |   |   |
|                                              |       |                 |       |         |       |   |   |   |   |   |   |   |   |
| Liabilities &  Shareholders’ Equity |       |                 |       |         |       |   |   |   |   |   |   |   |   |
| Interest  bearing liabilities:                    |       |                 |       |         |       |   |   |   |   |   |   |   |   |
| NOW &  MMDA                              |       | $                    | 152,007    |         | $          | 374 |   | 0.50 | % | $ | 150,861 |   | $ | 624 |   | 0.83 | % |
| Savings                                           |       | 108,019              |       | 535          |       | 1.00 | % | 116,563 |   | 1,125 |   | 1.94 | % |
| Time  deposits                                    |       | 195,642              |       | 2,614        |       | 2.69 | % | 155,354 |   | 3,459 |   | 4.48 | % |
| Other  borrowings                                 |       | 13,373               |       | 445          |       | 6.71 | % | 9,597 |   | 314 |   | 6.58 | % |
| Total  interest bearing liabilities               |       | 469,041              |       | 3,968        |       | 1.71 | % | 432,375 |   | 5,522 |   | 2.57 | % |
| Demand  deposits                                  |       | 73,867               |       |         |       |   |   | 74,818 |   |   |   |   |   |
| Other  liabilities                                |       | 12,291               |       |         |       |   |   | 13,909 |   |   |   |   |   |
| Total  liabilities                                |       | 555,199              |       |         |       |   |   | 521,102 |   |   |   |   |   |
| Shareholders’  equity                        |       | 40,519               |       |         |       |   |   | 48,714 |   |   |   |   |   |
| Average  liabilities and equity                   |       | $                    | 595,718    |         |       |   |   |   | $ | 569,816 |   |   |   |   |   |
|                                              |       |                 |       |         |       |   |   |   |   |   |   |   |   |
| Net  interest income & margin (3)        |       |                 |       | $            | 10,687     |   | 3.98 | % |   |   | $ | 13,387 |   | 5.19 | % |

 

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(1)  Loan interestincludes loan fees of $618,000 and $968,000 during the six months ended June 30,2009 and June 30, 2008, respectively.

 

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

 

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

 

(4)  Average yieldis calculated based on actual days in period (181 for June 30, 2009 and182 for June 30, 2008) and annualized to actual days in year (365 for 2009and 366 for 2008).

 

TableThree sets forth a summary of the changes in interest income and interestexpense from changes in average asset and liability balances (volume) andchanges in average interest rates.  On a quarter over quarter basis forthe period ending June 30, 2009, net interest income has decreased$1,108,000 from the same time period in 2008.  Interest income fromearning assets has decreased by $1,813,000. Changes in the volume of earningassets, primarily loans, have resulted in an increase in interest income of$105,000 while interest income from changes in rates has decreased by$1,918,000.  Interest expense for the second quarter of 2009 was $705,000less than the same period in 2008. Changes in the volume of interest bearing liabilities, primarily thechange in mix with an increase in balances of NOW, MMDA, time deposits, andother borrowings and a decrease in savings deposits, has resulted in a netincrease of interest expense of $476,000. Decreases in average rates paid, on all deposit products have resultedin an interest expense decrease of $1,181,000.

 

Ona year-to-date basis through June 30, 2009, net interest income has decreased$2,700,000 from the total at June 30, 2008.  Interest income fromearning assets has decreased by $4,254,000. Changes in the volume of earningassets, primarily loans, have resulted in an increase in interest income of$694,000 while interest income from changes in rates has decreased by$4,948,000.  Interest expense for the six month period ending June 30,2009 was $1,554,000 less than the same period in 2008.  Changes in the volume of interest bearingliabilities, primarily the change in mix with an increase in balances of NOW,MMDA, time deposits and other borrowings and a decrease in savings deposits,has resulted in a net increase of interest expense of $941,000.  Decreases in average rates paid on alldeposit products except other borrowings have resulted in an interest expensedecrease of $2,495,000.

 

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Theaverage balances of interest bearing liabilities of $468,486,000 were$36,565,000 (8.5%) higher in the second quarter of 2009 versus the same quarterin 2008.  As interest bearing liability balances increased, rates paid onthese liabilities decreased by 79 basis points on a quarter over quarter basis. As a result of both the decrease in interest rates and the volume and mix of interest bearing liabilities,interest expense was $705,000 (38.9%) lower in the second quarter versus thesame period in 2008.  The averagebalances of interest bearing liabilities were $36,666,000 higher in the sixmonth period ended June 30, 2009 versus the same period in 2008. Ratespaid on interest bearing liabilities decreased 86 basis points compared to thesix month period ended June 30, 2008.

 

As a result of the above, the Company’s net interestmargin declined 105 basis points to 4.17% for the three months ended June 30,2009 from 5.22% for the same period in the prior year.  For the six months ended June 30, 2009,the net interest margin declined 121 basis points to 3.98% compared to 5.19%for the same period in the prior year.

 

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

** **
| **Three Months Ended  June 30, 2009 over 2008** | ** ** | ** ** | ** ** | ** **   | ** ** | ** **     | ** ** |
|------------------------------------------------------|------------|------------|------------|--------------|------------|----------------|------------|
| **(In thousands)**                                   | ** ** | **Volume** | ** ** | **Rate (2)** | ** ** | **Net Change** | ** ** |
| Increase  (decrease) due to change in:               |       |       |       |         |       |           |       |
| Interest-earning  assets:                            |       |       |       |         |       |           |       |
| Net  loans                                           |       | $          | 52         |         | $          | (1,645         | )          | $ | (1,593 | ) |
| Taxable  investment securities                       |       | (34        | )          | (19          | )          | (53            | )          |
| Tax  exempt investment securities (1)                |       | —     |       | —       |       | —         |       |
| Federal  funds sold                                  |       | 128        |       | (243         | )          | (115           | )          |
| Interest  bearing deposits in banks                  |       | (41        | )          | (11          | )          | (52            | )          |
| Total                                                |       | 105        |       | (1,918       | )          | (1,813         | )          |
|                                                 |       |       |       |         |       |           |       |
| Interest-bearing  liabilities:                       |       |       |       |         |       |           |       |
| NOW  and MMDA deposits                               |       | —     |       | (120         | )          | (120           | )          |
| Savings  deposits                                    |       | (46        | )          | (237         | )          | (283           | )          |
| Time  deposits                                       |       | 453        |       | (821         | )          | (368           | )          |
| Other  borrowings                                    |       | 69         |       | (3           | )          | 66             |       |
| Total                                                |       | 476        |       | (1,181       | )          | (705           | )          |
| Interest  differential                               |       | $          | (371       | )            | $          | (737           | )          | $ | (1,108 | ) |

 
| **Six Months Ended June 30,  2009 over 2008** | ** ** | ** ** | ** ** | ** **   | ** ** | ** **     | ** ** |
|----------------------------------------------------|------------|------------|------------|--------------|------------|----------------|------------|
| **(In thousands)**                                 | ** ** | **Volume** | ** ** | **Rate (2)** | ** ** | **Net Change** | ** ** |
| Increase  (decrease) due to change in:             |       |       |       |         |       |           |       |
| Interest-earning  assets:                          |       |       |       |         |       |           |       |
| Net  loans                                         |       | $          | 813        |         | $          | (4,304         | )          | $ | (3,491 | ) |
| Taxable  investment securities                     |       | (46        | )          | (53          | )          | (99            | )          |
| Tax  exempt investment securities (1)              |       | —     |       | —       |       | —         |       |
| Federal  funds sold                                |       | 174        |       | (575         | )          | (401           | )          |
| Interest  bearing deposits in banks                |       | (247       | )          | (16          | )          | (263           | )          |
| Total                                              |       | 694        |       | (4,948       | )          | (4,254         | )          |
|                                               |       |       |       |         |       |           |       |
| Interest-bearing  liabilities:                     |       |       |       |         |       |           |       |
| NOW  and MMDA deposits                             |       | 5          |       | (255         | )          | (250           | )          |
| Savings  deposits                                  |       | (82        | )          | (508         | )          | (590           | )          |
| Time  deposits                                     |       | 895        |       | (1,740       | )          | (845           | )          |
| Other  borrowings                                  |       | 123        |       | 8            |       | 131            |       |
| Total                                              |       | 941        |       | (2,495       | )          | (1,554         | )          |
| Interest  differential                             |       | $          | (247       | )            | $          | (2,453         | )          | $ | (2,700 | ) |

 

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

 

(2)        The rate/volumevariance has been included in the rate variance.

 

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**Non-interest Income**

 

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

 

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

 
| **Three months ended  June 30,** | ** ** | **2009** | ** ** | **% of Avg.  Assets** | ** ** | **2008** | ** ** | **% of Avg.  Assets** | ** ** |
|---------------------------------------|------------|----------|------------|-----------------------|------------|----------|------------|-----------------------|------------|
| Service  charges on deposit accounts  |       | $        | 982        |                  | 0.66       | %        | $          | 995                   |       | 0.63 | % |
| Loan  servicing fees                  |       | 122      |       | 0.08                  | %          | 112      |       | 0.08                  | %          |
| Fees  - alternative investment sales  |       | 145      |       | 0.10                  | %          | 154      |       | 0.11                  | %          |
| Merchant  fee income                  |       | —   |       | 0.00                  | %          | 108      |       | 0.08                  | %          |
| Gain  on the sale of loans            |       | 769      |       | 0.52                  | %          | 273      |       | 0.19                  | %          |
| Other                                 |       | 652      |       | 0.80                  | %          | 568      |       | 0.80                  | %          |
| Total  non-interest income            |       | $        | 2,670      |                  | 2.15       | %        | $          | 2,210                 |       | 1.89 | % |

 
| **Six months ended June 30,**     | ** ** | **2009** | ** ** | **% of Avg.  Assets** | ** ** | **2008** | ** ** | **% of Avg.  Assets** | ** ** |
|----------------------------------------|------------|----------|------------|-----------------------|------------|----------|------------|-----------------------|------------|
| Sale  of merchant processing portfolio |       | $        | 2,640      |                  | 0.89       | %        | $          | —                |       | 0.00 | % |
| Loss  on sale of investment security   |       | (172     | )          | (0.06                 | )%         | —   |       | 0.00                  | %          |
| Service  charges on deposit accounts   |       | 1,898    |       | 0.64                  | %          | 1,851    |       | 0.65                  | %          |
| Loan  servicing fees                   |       | 262      |       | 0.09                  | %          | 223      |       | 0.08                  | %          |
| Fees  - alternative investment sales   |       | 254      |       | 0.09                  | %          | 299      |       | 0.11                  | %          |
| Merchant  fee income                   |       | 86       |       | 0.03                  | %          | 209      |       | 0.07                  | %          |
| Gain  on the sale of loans             |       | 1,272    |       | 0.43                  | %          | 501      |       | 0.18                  | %          |
| Other                                  |       | 1,257    |       | 0.43                  | %          | 1,087    |       | 0.38                  | %          |
| Total  non-interest income             |       | $        | 7,497      |                  | 2.54       | %        | $          | 4,170                 |       | 1.47 | % |

 

Non-interestincome increased by $460,000 (20.8%) to $2,670,000 for the three months ended June 30,2009 as compared to $2,210,000 for the three months ended June 30,2008.  Increases in non-interest income were realized primarily from gainson the sale of loans (up 181.7%), loan servicing fees (up 8.9%), and otherincome (up 14.8%). Decreases were realized in fees from alternative investmentsales (down 5.8%), fees from services charges (down 1.3%) and merchant feeincome due to the sale of the merchant processing portfolio in the firstquarter. The gain on the sale of loans into the secondary market increasedcompared to the second quarter of 2008 as the loans sold by our governmentlending division and real estate division increased as homeowners tookadvantage of low mortgage rates and refinanced their homes. Loan servicing feesincreased as the volume of loans sold in the secondary market for which the Companyretains servicing rights increased due to refinancing activity. The increase inthe “Other” category was the result of a one time premium received for renewalof our check printing contract. The Alternative Investment Department, whichsells third-party mutual funds and annuities, experienced a decrease in fees of$9,000 due to fewer sales of investments during the second quarter as theuncertainty in the equities market continued.

 

Non-interestincome increased by $3,327,000 (79.8%) to $7,497,000 for the six months ended June 30,2009 as compared to $4,170,000 for the six months ended June 30,2008.  Increases in non-interest income were realized primarily from thegain on the sale of the merchant portfolio of $2,640,000 in addition to feesfrom service charges (up 2.5%), loan servicing fees (up 17.5%), gains on thesale of loans (up 153.9%), and other income (up 15.6%). Decreases were realizedin fees from alternative investment sales (down 15.1%), merchant fee income(down 58.9%) due to the sale of the merchant processing portfolio and a loss of$172,000 when the Company sold a trust preferred security it held forinvestment. The gain on the sale of loans into the secondary market increasedduring the first six months of 2009 compared to 2008 as the loans sold by ourgovernment lending division and real estate division increased. Loan servicingfees increased as the volume of loans sold in the secondary market for whichthe Company retains servicing rights increased due to refinancing activity. Theincrease in the “Other” category was the result of a one time premium receivedfor renewal of our check printing contract in addition to fees paid for payrollprocessing through our Business Services Division. The Alternative InvestmentDepartment, which sells third-party mutual funds and annuities, experienced adecrease in fees of $45,000 due to fewer sales of investments during the firstsix months of 2009 as the uncertainty in the equities market continued.

 

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**Non-interest Expense**

 

Non-interestexpense increased $1,336,000 (19.9%) from $6,722,000 in the second quarter of2008 to $8,058,000 in the second quarter of 2009.  Salary and employeebenefits decreased by $489,000 (13.4%), largely due to lower FTE (full timeequivalent) employees from reductions in staffing in the first quarter 2009. Ona quarter over quarter basis, occupancy expenses were lower by $33,000 (4.6%) whichis related to the efforts to reduce non-interest expense for utilities,landscape maintenance and janitorial services.  Furniture and equipmentexpense was $639,000 in the second quarter of 2009 compared to $651,000 in thesame period of 2008, representing a 1.8% decrease.  Other real estateexpenses increased $730,000 to $733,000 from $3,000 due to loan foreclosuresand subsequent write downs. FDIC assessments increased $865,000 to $955,000from $79,000. Other expenses increased $264,000 (16.3%) to $1,885,000 from$1,621,000 in the second quarter of 2009 versus the second quarter of 2008.Primarily due to loan related expenses.

 

Non-interestexpense increased $1,118,000 (8.2%) from $13,714,000 in the first six months of2008 to $14,832,000 in the first six months of 2009.  Salary and employeebenefits decreased by $787,000 (10.7%), largely due to lower FTE (full timeequivalent) employees from reductions in staffing in the first quarter 2009. Ona year over year basis, full time equivalent employees decreased by 36 to 229.Occupancy expenses were lower by $3,000 (0.2%).  Furniture and equipmentexpense was down $4,000 (0.3%) from the first six months of 2008 to the firstsix months of 2009.  Other real estate expenses increased $1,349,000 dueto loan foreclosures and subsequent write downs. FDIC assessments increased$892,000. Other expenses decreased $329,000 (9.4%) for the six months ended June 30,2009 versus the same period in 2008.

 

**Provision for Loan Losses**

 

TheCompany provided $4,000,000 for loan losses in the second quarter of 2009compared to $450,000 in the second quarter of 2008.  Net loan charge-offsfor the second quarter of 2009 and 2008 were $3,511,000 and $208,000,respectively. For the first six months of 2009 the Company recorded provisionsfor loan losses of $7,100,000 which compared to $675,000 for the first sixmonths of 2008. Net loan charge-offs for the six months ended June 30,2009 and June 30, 2008 were $5,792,000 and $220,000 respectively.  Management assesses its loan quality on amonthly basis to maintain an adequate allowance for loan losses.  TheCompany’s loan portfolio composition, non-performing assets and allowance forloan losses are further discussed under the Balance Sheet Analysis sectionbelow.

 

**Income Taxes**

 

Thebenefit for income taxes for the second quarter and first six months of 2009was $1,280,000 and $1,348,000 as compared to a provision for income taxes of$711,000 and $1,300,000 for the same periods in 2008.  The effective benefit rate for state andfederal income taxes was 33.9% and 36.0% for the three and six months ended June 30,2009 compared to an effective tax rate of 40.5% and 41.0% for the same periodsin 2008.  The difference in the effectivetax rate compared to the statutory tax rate (approximately 42.05%) is primarilythe result of the Company’s investment in municipal securities andCompany-owned life insurance policies whose income is exempt from Federaltaxes. In addition, the Company receives special tax benefits from the State ofCalifornia Franchise Tax Board for operating and providing loans in designated ‘EnterpriseZones’. Managementhas reviewed the deferred tax assets recorded at June 30, 2009 and hasdetermined that a valuation allowance was not needed for book purposes.

 

**Balance Sheet Analysis**

 

TheCompany’s total assets were $581,695,000 at June 30, 2009, down$13,549,000 (2.3%) from $595,244,000 at December 31, 2008.  On a yearover year basis, the average balance of total assets for the six months ended June 30,2009 was $595,718,000, which represents an increase of $25,902,000 (4.5%) overthe $569,816,000 during the six month period ended June 30, 2008.

 

**Loans**

 

TheCompany concentrates its lending activities in the following areas: 1)commercial; 2) real estate mortgage; 3) residential real estate and real estateconstruction (both commercial and residential); 4) agriculture; and 5) consumerloans.  Commercial and residential real estate loans are generally securedby improved property, with original maturities of 3-10 years.  At June 30,2009, these areas accounted for approximately 18%, 52%, 8%, 8% and 14%,respectively, of the Company’s loan portfolio.  The mix at December 31,2008 was 17%, 51%, 13%, 6% and 13%.

 

Loanbalances have declined in the current quarter mainly in the real estateconstruction category as these types of loans are generally not being made as aresult of the economic downturn and the risk associated with these loans.Further reductions have also been the result of foreclosures andreclassification to other real estate (ORE). Decreases in loan balances from December 31, 2008 consist ofcommercial loans of $337,000 or (0.4%), real estate mortgage of $6,615,000 or(2.6%), real 

 

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estateconstruction of $27,148,000 or (41.8%), and consumer loans of $1,045,000 or(1.6%).  Agricultural loans increased$11,960,000 or (41.8%) which is normal due to the timing of loan disbursementsduring the growing and harvest season of the summer months. These changes tothe mix and reduction of real estate construction loans are consistent with theplan to reduce our dependency on real estate related lending and furtherdiversify the loan portfolio to mitigate risk. Table Five below summarizes thecomposition of the loan portfolio as of June 30, 2009 and December 31,2008.

 

**Table Five: Loan Portfolio Composition**

 
| **(In thousands)**         | ** ** | **June 30, 2009** | ** ** | **December 31, 2008** | ** ** |
|----------------------------|------------|------------------------|------------|----------------------------|------------|
| Commercial                 |       | $                      | 83,449     |                       | $          | 83,786 |   |
| Real  estate:              |       |                   |       |                       |       |
| Mortgage                   |       | 245,403                |       | 252,018                    |       |
| Construction               |       | 37,856                 |       | 65,004                     |       |
| Agriculture                |       | 40,588                 |       | 28,628                     |       |
| Consumer                   |       | 64,345                 |       | 65,390                     |       |
| Total  loans               |       | 471,640                |       | 494,826                    |       |
| Allowance  for loan losses |       | (9,218                 | )          | (7,826                     | )          |
| Deferred  loan fees, net   |       | (223                   | )          | (478                       | )          |
| Total  net loans           |       | $                      | 462,199    |                       | $          | 486,522 |   |

 

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

 

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

 

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

 

**Risk Elements**

 

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

 

Ultimately,underlying trends in economic and business cycles influence creditquality.  The Company’s business is concentrated in the Butte, Sutter andShasta County areas. The economy of these three counties is diversified withprofessional services, manufacturing, agriculture and real estate investmentand construction.  The real estateelement has been impacted by the current economic downturn with constructionactivity slowing dramatically.  Othersectors of the local economy are maintaining with agriculture being affected theleast.

 

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

 

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

 

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

 

Inmanagement’s judgment, a concentration exists in real estate loans, whichrepresented approximately 60.1% of the Company’s loan portfolio at June 30,2009, which has decreased from the 64.1% concentration level at December 31,2008.  Management believes the concentration may have more than the normalrisk of collectability due to the substantial decline in the economy in generaland the continuing decline in real estate values in the Company’s primarymarket areas. As the Company has been impacted by the slowdown in the economy,we have increased the provision for loan losses and may have to furtherincrease the provision which could adversely affect the Company’s futureprospects, results of operations, profitability and stock price. Management believes that its lending policies and underwriting standards followstrict regulatory guidelines; however, there is no assurance that losses willnot continue to occur under such circumstances.  The Company’s loanpolicies and underwriting standards include, but are not limited to, thefollowing: (1) maintaining a thorough understanding of the Company’sservice area and originating a significant majority of its loans within thatarea, (2) maintaining a thorough understanding of borrowers’ knowledge,capacity, and market position in their field of expertise, (3) basing realestate loan approvals not only on market demand for the project, but also onthe borrowers’ capacity to support the project financially in the event it doesnot perform to expectations (whether sale or income performance), and (4) maintainingconforming and prudent loan to value and loan to cost ratios based onindependent outside appraisals and ongoing inspection and analysis by theCompany’s lending officers.  The Companydoes not participate in any sub-prime lending activities nor is it exposed tosub-prime lending in its investment portfolio.

 

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

 

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

 

TableSix below sets forth nonaccrual loans as of June 30, 2009 and December 31,2008.   There were no loans past due90 days or more and still accruing interest at June 30, 2009 or December 31,2008.

 

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

** **
| **(In thousands)**          | ** ** | **June 30, 2009** | ** ** | **December 31, 2008** | ** ** |
|-----------------------------|------------|------------------------|------------|----------------------------|------------|
| Nonaccrual:                 |       |                   |       |                       |       |
| Commercial                  |       | $                      | 6,930      |                       | $          | 395 |   |
| Real  estate                |       | 19,730                 |       | 14,490                     |       |
| Consumer  and other         |       | 346                    |       | —                     |       |
| Total  non-performing loans |       | $                      | 27,006     |                       | $          | 14,885 |   |

 

Non-performing loans(defined as non-accrual loans and loans 90 days or more past due and stillaccruing interest) totaled $27,006,000 at June 30, 2009, an increase of$12,121,000 from $14,885,000 at December 31, 2009 primarily as a result ofincreasing problem loans in the Company’s real estate/development portfolio andcommercial loan portfolios.  Specificreserves on the non-performing loans of $570,094 have been recorded at June 30,2009.  Nonperforming loans as apercentage of total loans were 5.7% at June 30, 2009 compared to 3.0% at December 31,2009.

 

Nonperforming assets,(nonperforming loans and ORE) totaled $39,584,000 at June 30, 2009, anincrease of $22,631,000 from $16,953,000 at December 31, 2008.  Nonperforming assets as a percentage of totalassets were 6.8% at June 30, 2009 compared to 2.9% at December 31,2008.

 

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Total non-performingassets consist of thirty nine loans for a total of $27,006,000 classified asimpaired and on non-accrual and forty three properties for a total of$12,600,000 classified as other real estate (ORE).  Other than the loans included asnon-performing assets at June 30, 2009, the Company has not identified anypotential problem loans that would result in any loan being included as anon-performing assets at the current date.

 

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

 

Adevelopment loan for the construction of an eight unit condominium project inthe Yuba City area for $1,646,000 was included in our classified loans and riskrated Substandard at December 31, 2008 based on the lack of cash flow andweakening real estate market. Construction of the project was completed and as of December 31, 2008five units had been leased and continue to be leased at June 30, 2009. In Juneof 2008, the Company received an updated appraisal on the units and found theestimated fair market value of the collateral to be below the carrying amountof the loan balance.  The Company metwith the borrower and requested additional collateral which the borrower was unableto provide.  All payments were paid asagreed until October 2008.  In Novemberof 2008, the borrower notified the Company that they would no longer be able tomake the payments.  The loan was placedon non-accrual on December 30, 2008.  Dueto the continued decline in the real estate market, the Company ordered anotherappraisal to understand the potential loss exposure and properly value thecollateral.  A new appraisal was receivedin December 2008 with an appraised value for the 8 units of $1,050,000.   At that time, the bank was reviewing takinglegal action against the borrower and established a specific reserve of$660,000 for this loan at December 31, 2008. When it became apparent that aresolution was going to be a lengthy process, a charge-off of $501,000 againstthe allowance for loan losses was recorded on March 18, 2009. At June 30, 2009the loan carrying balance was $1,145,000 with a specific reserve of $186,000.

 

A single familyresidential loan for the construction of a home located at Shaver Lake, CA. for$1,260,000 was included in our classified loans and risk rated Substandard at June 30,2009 based on the borrower’s lack of cash flow and the weakening real estatemarket. Construction of the home is complete and the borrower continues to tryand market the home.   In February 2009,the borrower notified the Bank that he could no longer make payments.  To identify the Company’s potential lossexposure and properly value the collateral support provided by the property, anew appraisal was ordered and received in March 2009.  This new appraisal reflected the downturn inreal estate values and demonstrated the continuing decline in the value of theunderlying project.  The new appraisalvalued the house at $1,475,000 and put the loan to value (LTV) at 85%.  The Company had no additional write-downs asof June 30, 2009.

 

Another significantnon-performing loan is a commercial real estate loan for the refinance oftwenty-eight cottages located in Fortuna, California for $4,326,000.  This loan was included in our classifiedloans and risk rated substandard at June 30, 2009 due to lack of paymentand pending bankruptcy of the borrower. This loan is a government guaranteed loan under the USDA program with an80% guarantee and maximum exposure to the Company of $743,000.  In October of 2008, the Bank receivednotice that our borrower had filed Bankruptcy under Chapter 11.  It was at this time that the Bank stoppedreceiving payments.   On the advice ofour attorney, the Company placed the loan on non-accrual on January 7,2009.  To identify the Company’spotential loss exposure and properly value the collateral support provided bythe property, a new appraisal was ordered in January 2009 and received on April 9,2009.  The new appraisal put the value at$4,129,000 and reflects the downturn in real estate values as it wassignificantly lower than the original appraisal.  On April 29, 2009 a charge-off of$152,000 against the allowance for loan losses was recorded. The Company isprevented from pursuing any additional legal action due to the pendingBankruptcy. The Company has allocated a specific reserve of $5,000 for thisloan at June 30, 2009.

 

A development propertyserves as collateral for two separate loans totaling $8,094,000. Both loans areto the same borrower.  The collateral forthe two loans consists of 155 finished lots, a 24.95 acre parcel and a 5 acreparcel all built and located around a golf course at Lake Almanor.  This loan was included in our classifiedloans and risk rated Substandard at June, 30, 2009 based on the borrower’s lackof sales and cash flow due to the weakening real estate market. To identify theCompany’s potential loss exposure and properly value the collateral supportprovided by the property, an appraisal was received September 26,2008.  The appraisal demonstrated thecontinuing decline in the value of the underlying project. The September appraisedvalue for the various properties was $10,980,000 compared to the combined loanbalances of $8,094,000 resulting in a combined loan to value (LTV) of 77%.  Due to the lack of sales activity, the loanwas placed on non-accrual in June 2009. A new appraisal has been ordered and is still pending.  The Company had no additional write-downs asof June 30, 2009.

 

A commercial real estateloan was identified as non-performing and is a loan to finance the purchase ofa 15,120 sq. ft. building located in Chico, California for $1,602,000. The loanwas included in our classified loans and risk rated substandard at June 30,2009 due to lack of cash flow.  This loanis a government guaranteed loan under the USDA program with an 80% guaranteeand maximum exposure to the Company of $320,000.  The borrower manufactures SFR trusses and dueto the slowdown in the real estate market sales have been much slower thanexpected. Payments on this loan have been deferred to October 31,2009.  At that point, the borrower willstart making payments over an extended period of time.  To identify the Company’s potential lossexposure and properly value the collateral support provided by the property andequipment, a new appraisal was ordered in February 2009 and received April 9,2009. The new appraisal put the value at $1,700,000 resulting in a loan tovalue (LTV) of 94%.  The company hasallocated a specific reserve of $13,000 for this loan at June 30, 2009.

 

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Another significantnon-performing loan is a development loan to purchase 7.5 acres of property alongthe Sacramento River located in Anderson, California for $1,287,000.  The original plans were to develop a fishinglodge and restaurant. The collateral for the loan consists of the 7.5 acresplus six 20 acre parcels located in Red Bluff. This loan was included in ourclassified loans and risk rated Substandard at June 30, 2009 due to theinability to find additional investors and the weakening real estate market.The loan was placed on non-accrual on May 22, 2009.  Due to the continued decline in the realestate market the Company ordered an updated appraisal to understand thepotential loss exposure and property value the collateral.  A new appraisal was received June 2009with a combined value of $1,430,000.  On June 29,2009 a charge-off of $184,000 against the allowance for loan losses wasrecorded.  The Company had no additionalwrite-downs on this loan.

 

The last largenon-performing loan is for the construction of a commercial retail center inChester, Ca. for $1,887,000 that was included in our classified loans and riskrated Substandard at June 30, 2009 based on lack of cash flow. Theexterior of the 24,850 foot project is complete with the infill to be completedupon the acceptance of signed leases. To date, the borrowers have beenunsuccessful in obtaining any lease agreements. Original appraisal dated November 2007put the value at $3,250,000 for a LTV of 57%. To identify the Company’s potential loss exposure and properly value thecollateral support provided by the property a new appraisal was ordered in April 2009and is still pending. The loan was placed on non-accrual on June 3,2009.  The company had no additionalwrite-downs on this loan.

 

The remainder of thenon-performing loans consists primarily of eight impaired single family homeloans that total $2,287,000 of which two homes are currently underconstruction, sixteen impaired lot loans that total $3,809,000, one commercialreal estate loan that totals $306,000, three commercial/industrial loans thattotal $658,000, three single family home loans secured with 2nd deeds of trustfor $292,000, and one consumer loan that totals $54,000. These loans are toborrowers who are located throughout Northern California from the Sacramentoarea to Redding.  The current appraisedvalues provide the Company with an adequate margin and no specific reserveswere allocated to these loans.

 

Other Real Estate

 

The largest of our ORE atJune 30, 2009 consists of two development loan properties to the sameborrower for a total of $2,976,478.  Theproperties were transferred to ORE on March 16, 2009. The project consistsof 46 finished lots and 61 paper lots. To identify the Company’s potential loss exposure and properly value thecollateral support provided by the property, an appraisal was received on October 8,2008.  The appraisal demonstrated thecontinuing decline in the value of the underlying project.  A new appraisal was ordered in May 2009and is still pending. The Company charged off an additional $56,000 against theallowance for loan losses at the date of transfer.  The October appraised value for the 61paper lots was $945,000 compared to the ORE balance of $752,000 resulting inloan to value (LTV) of 81%.  As thisprovides the Company with an adequate margin, no additional funds were chargedoff at this time.

 

Another developmentproperty with a fair value of $1,476,000 at June 30, 2009 is included inour ORE assets.  This loan represents a37% participation interest in a loan originated by another bank. The projectconsists of 46 lots of an original 49 lot subdivision located in Nevada County,California.  The borrower made thedecision to “Deed in Lieu” the property back to the participating bank due toslow sales and the continued weak real estate market.  To identify the Company’s potential lossexposure and properly value the collateral support provided by the property, anappraisal was ordered and received in December 2008.  This appraisal reflected the downturn in realestate values and demonstrated the continuing decline in the value of the underlyingproject.  The appraisal for the entireproject supported a value of $4,400,000 of which our 37% interest representsapproximately $1,628,000 resulting in a LTV of approximately 100%.  The Company recorded a Deed in Lieu ofForeclosure in February, 2009.  After theDeed in Lieu was completed, the Company charged-off an additional $167,000against the allowance for loan losses upon transferring the property to ORE.

 

The last significant OREasset has a fair value of $1,227,881 at June 30, 2009. The property wastransferred to ORE on June 5, 2009. The project consists of a 227 unitmini-storage located in Orland, California. The asset has a governmentguarantee under the USDA program with an 80% guarantee and a maximum exposureto the Company of $254,000.  To identifythe Company’s potential loss exposure and properly value the collateral supportprovided by the property, an appraisal was received on January 9,2009.  The appraisal demonstrated thecontinuing decline in the value of the underlying project.  This appraisal valued the property at$1,490,000 for a LTV of 82%.  Noadditional charge off was recorded when this loan was transferred to ORE.

 

The remainder of thenon-performing assets includes twenty-three SFR lots that have a current valueof $3,838,000 and are in ORE.  There areeleven single family homes that are included in ORE at a combined balance of$2,709,000.  The amounts included in OREare supported by current appraisals received by the Company, all within thepast 12 months. In addition, there 

 

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are five commercial realestate properties that are included in ORE at June 30, 2009 at a combinedbalance of $2,162,000 supported by current appraisals.  When loans are placed into ORE, the Companydetermines the fair market value less the estimated selling costs.  The shortfalls are charged to the allowancefor loan losses at the time of transfer. Properties placed in ORE are reviewed continuously and the Company willreappraise the property if it is deemed necessary.  At a minimum, properties are appraised atleast annually.  If values have dropped,the Company will establish a valuation allowance for the ORE through a separateprovision for losses on ORE.

 

Restructured Loans

 

Restructured loanstotaled $16,905,000 at June 30, 2009, a decrease of $3,894,000 from thetotal at March 31, 2009. Restructured loans consist of eightland/development loans for a total of $10,493,330.  Five of these land/development loans areconsidered impaired and are carried at $2,472,000, the fair value of theunderlying collateral, and are included as part of the non-performing loans.Four other restructured loans were construction loans that rolled over to longterm SFR mortgage loans for a total of $3,009,000.  There are also three restructured commercialreal estate loans totaling $3,703,000. One of these real estate loans is considered impaired, carried at$1,601,788, and is included as part of the non-performing loans. All of thesecommercial real estate loans have guarantees under the USDA guaranteeprogram.  Except for the loans mentionedabove, the remaining restructured loans are performing as agreed and were all currentat June 30, 2009.  No additionalfunds were lent to the borrowers of the restructured loans.

 

**Allowance for Loan Losses Activity**

 

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

 

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

 

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

 

Ourmethodology is, and has been, consistently followed.  However, as we addnew products, increase in complexity, and expand our geographic coverage, weexpect to enhance our methodology to keep pace with the size and complexity ofthe loan portfolio.  On an ongoing basis we engage outside firms toindependently assess our methodology, and to perform independent credit reviewsof our loan portfolio.  The FDIC and the California Department ofFinancial Institutions review the allowance for loan losses as an integral partof the examination process.  Management believes that our currentmethodology is appropriate given our size and level of complexity. Further, management believes that the allowance for loan losses is adequate asof June 30, 2009 to cover known and inherent risks in the loanportfolio.  However, fluctuations in credit quality, or changes ineconomic conditions or other factors could cause management to increase ordecrease the allowance for loan losses as necessary.

 

TheBoard of Directors of the Bank reviews the adequacy of the allowance for loanlosses at least quarterly to include consideration of the relative risks in theportfolio and current economic conditions.  The allowance is adjustedbased on that review if, in the judgment of the loan committee and management,changes are warranted.  The allowance for loan losses totaled $9,218,000or 1.95% of total loans at June 30, 2009 and $7,826,000 or 1.58% at December 31,2008.  Net charge-offs for the three and six months ended June 30,2009 were $3,511,000 and $5,792,000, respectively. The Company has a separatereserve for unfunded loan commitments of $209,000 as of June 30, 2009 and$293,000 as of December 31, 2008 that is included in other liabilities onthe balance sheet.

 

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

 

**Table Seven: Allowance for Loan Losses**

 
| ** **                                                                | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **(In thousands, except for  percentages)**                               | ** ** | **2009**                              | ** ** | **2008**                            | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                      |       |                                  |       |                                |       |   |   |   |   |
| Average  loans outstanding                                                |       | $                                     | 480,272    |                                | $          | 447,500 |   | $ | 484,880 |   | $ | 463,743 |   |
|                                                                      |       |                                  |       |                                |       |   |   |   |   |
| Allowance  for possible loan losses at beginning of period                |       | $                                     | 8,697      |                                | $          | 6,025 |   | $ | 7,826 |   | $ | 6,092 |   |
|                                                                      |       |                                  |       |                                |       |   |   |   |   |
| Loans  charged off:                                                       |       |                                  |       |                                |       |   |   |   |   |
| Commercial                                                                |       | (317                                  | )          | (36                                 | )          | (402 | ) | (43 | ) |
| Real  estate                                                              |       | (3,014                                | )          | (173                                | )          | (4,864 | ) | (173 | ) |
| Consumer                                                                  |       | (181                                  | )          | —                              |       | (528 | ) | (5 | ) |
| Total                                                                     |       | (3,512                                | )          | (209                                | )          | (5,794 | ) | (221 | ) |
| Recoveries  of loans previously charged off:                              |       |                                  |       |                                |       |   |   |   |   |
| Commercial                                                                |       | 1                                     |       | —                              |       | 1 |   | — |   |
| Real  estate                                                              |       | —                                |       | —                              |       | — |   | — |   |
| Consumer                                                                  |       | —                                |       | 1                                   |       | 1 |   | 1 |   |
| Total                                                                     |       | 1                                     |       | 1                                   |       | 2 |   | 1 |   |
| Net  loan charge offs                                                     |       | (3,511                                | )          | (208                                | )          | (5,792 | ) | (220 | ) |
|                                                                      |       |                                  |       |                                |       |   |   |   |   |
| Additions  to allowance charged to operating expenses                     |       | 4,000                                 |       | 450                                 |       | 7,100 |   | 675 |   |
| Additions  to allowance from reserve for unfunded commitments             |       | 32                                    |       | (26                                 | )          | 84 |   | (306 | ) |
|                                                                      |       |                                  |       |                                |       |   |   |   |   |
| Gross  allowance for loan losses at end of period                         |       | $                                     | 9,218      |                                | $          | 6,241 |   | $ | 9,218 |   | $ | 6,241 |   |
|                                                                      |       |                                  |       |                                |       |   |   |   |   |
|                                                                      |       |                                  |       |                                |       |   |   |   |   |
| Ratio  of net charge-offs to average loans outstanding                    |       | 0.73                                  | %          | 0.04                                | %          | 1.19 | % | 0.05 | % |
| Provision  for possible loan losses to average loans outstanding          |       | 0.83                                  | %          | 0.09                                | %          | 1.46 | % | 0.15 | % |
| Allowance  for loan losses to loans net of deferred fees at end of period |       | 1.95                                  | %          | 1.26                                | %          | 1.95 | % | 1.26 | % |

 

Itis the policy of management to maintain the allowance for loan losses at alevel adequate for known and inherent risks in the portfolio.  Based oninformation currently available to analyze inherent credit risk, includingeconomic factors, overall credit quality, historical delinquencies and ahistory of actual charge-offs, management believes that the provision for loanlosses and the allowance are adequate.  The Company generally makesmonthly allocations to the allowance for loan losses.  The budgeted allocationis based on estimates of loss risk and loan growth.  Adjustments may bemade based 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 levelof loans charged off in future periods can be made with any certainty.

 

**Deposits**

 

AtJune 30, 2009, total deposits were $514,545,000 representing a decrease of$11,940,000 (2.26%) over the December 31, 2008 balance of$526,485,000.  Non-interest bearing demand deposits decreased in the firstsix months of 2009 by $9.9 million (12.1%) to $72.2 million. Interest bearingdemand deposits decreased by $2 million (1.3%) to $147.3 million while savingsdeposits increased $3.8 million (3.5%) to $110.9 million. Certificate ofdeposit balances decreased by $3.7 million (2.0%) to $184.2 million. Brokereddeposits totaled $35.5 million of which $22.5 million are from existing Bankcustomers who elected to participate in the Certificate of Deposit AccountRegistry Service (CDARS) reciprocal deposits program.

 

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

 

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**Capital Resources**

 

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

 

AtJune 30, 2009 shareholders’ equity was $37,651,000 representing a decreaseof $2,488,000 over the December 31, 2008 balance of $40,139,000.

 

On June 30, 2008 theCompany borrowed $4 million from one of its correspondent banks which wasdown-streamed to Butte Community Bank in the form of additional common stockissued to the holding company.  This note has a current principal balanceof $3.5 million, is for a two year period with a maturity date of June 30,2010 and an interest rate equal to the three month LIBOR rate plus 8.125%adjusted quarterly, or 8.72% at June 30, 2009.

 

TheBoard of Directors of the Company authorized the payment of quarterly cashdividends of $0.08, $0.04 and $0.04 per share for the first, second, and thirdquarters, respectively, in 2008 and chose to suspend paying dividends in thefourth quarter of 2008 and the first and second quarters of 2009. The paymentof dividends in the future is subject to the discretion of the Board ofDirectors of the Company and will depend on earnings, the financial conditionof the Company and other relevant factors.

 

The Company andits subsidiary Bank are subject to certain regulations issued by the Board ofGovernors of the Federal Reserve System and the FDIC which require maintenanceof certain levels of capital.  The Bank’s ratio of total risk-basedcapital to risk adjusted assets was 10.0% at June 30, 2009 and 10.4% at December 31,2008.  Tier 1 risk-based capital to risk-adjusted assets was 8.8% at June 30,2009 and 9.1% at December 31, 2008.

 

TableEight below lists the Company’s and the Bank’s capital ratios at June 30,2009 and December 31, 2008, as well as the minimum ratios required underregulatory definitions of capital adequacy.

 

**TableEight: Capital Ratios**

** **
| **Capital to Risk-Adjusted Assets** | ** ** | **At June 30, 2009** | ** ** | **At December 31,  2008** | ** ** | **Minimum Regulatory  Requirement** | ** ** |
|-------------------------------------|------------|---------------------------|------------|--------------------------------|------------|-------------------------------------|------------|
| ** **                          |       |                      |       |                           |       |                                |       |
| Company                             |       |                      |       |                           |       |                                |       |
| Leverage  ratio                     |       | 7.3                       | %          | 8.1                            | %          | 4.0                                 | %          |
|                                |       |                      |       |                           |       |                                |       |
| Tier  1 Risk-Based Capital          |       | 8.5                       | %          | 8.8                            | %          | 4.0                                 | %          |
|                                |       |                      |       |                           |       |                                |       |
| Total  Risk-Based Capital           |       | 9.8                       | %          | 10.0                           | %          | 8.0                                 | %          |
| ** **                          |       |                      |       |                           |       |                                |       |
| Bank                                |       |                      |       |                           |       |                                |       |
| Leverage  ratio                     |       | 7.6                       | %          | 8.2                            | %          | 4.0                                 | %          |
|                                |       |                      |       |                           |       |                                |       |
| Tier  1 Risk-Based Capital          |       | 8.8                       | %          | 9.1                            | %          | 4.0                                 | %          |
|                                |       |                      |       |                           |       |                                |       |
| Total  Risk-Based Capital           |       | 10.0                      | %          | 10.4                           | %          | 8.0                                 | %          |

 

Capitalratios are reviewed on a regular basis to ensure that capital exceeds theprescribed regulatory minimums and is adequate to meet future needs.  Allratios exceeded the regulatory definition of “Minimum” at June 30, 2009and December 31, 2008.  In addition, the Bank was considered “well-capitalized”under regulatory definitions at June 30, 2009 and December 31, 2008.

 

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

 

As a result of a recentregulatory examination, the Bank must obtain the prior written consent of itsprimary regulators before paying dividends and has agreed to increase itsLeverage Ratio to 10.0% by October 31, 2009.  In addition, the Bank is to maintain othercapital ratios above well capitalized thresholds.   Management is currently adjusting itscapital plan in order to conform to this requirement through restructuring ofthe balance sheet and the addition of new capital in the form of common stock.  There is a Private Placement Offeringcurrently underway to raise additional capital. In addition, an amendment to the Company bylaws to allow issuance ofpreferred stock was approved by the shareholders at the annual meeting that washeld June 4, 2009.

 

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

 

**Market Risk Management**

 

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

 

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

 

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

 

Simulationof earnings is the primary tool used to measure the sensitivity of earnings tointerest rate changes.  Using computer-modeling techniques, the Company isable to estimate the potential impact of changing interest rates onearnings.  A balance sheet forecast is prepared monthly using inputs ofactual loans, securities and interest bearing liability (i.e.deposits/borrowings) positions as the beginning base.  The forecastbalance sheet is processed against seven interest rate scenarios.  Thesescenarios include a 100, 200 and 300 basis point rising rate forecast, a flatrate forecast and a 100, 200 and 300 basis point falling rate forecast whichtake place within a one year time frame.

 

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

 

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

 

**TableNine:  Interest Rate Risk Simulation of Net Interest as of June 30,2009 and December 31, 2008**

** **
| **(In thousands)**                       | ** ** | **$ Change in NII  from Current  12 Month Horizon  June 30, 2009** | ** ** | **$ Change in NII  from Current  12 Month Horizon  December 31, 2008** | ** ** |
|------------------------------------------|------------|------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| Variation  from a constant rate scenario |       |                                                                         |       |                                                                             |       |
| +200bp                                   |       | $                                                                            | 2,603      |                                                                             | $          | 3,522 |   |
| -  200bp                                 |       | $                                                                            | 215        |                                                                             | $          | 328 |   |

 

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

 

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**Inflation**

 

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

 

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

 

**Liquidity**

 

Liquiditymanagement refers to the Company’s ability to provide funds on an ongoing basisto meet fluctuations in deposit levels as well as the credit needs andrequirements of its clients.  Both assets and liabilities contribute tothe Company’s liquidity position.  Federal funds lines, short-terminvestments and securities, and loan repayments contribute to liquidity, alongwith deposit increases, while loan funding and deposit withdrawals decreaseliquidity.  The Company assesses the likelihood of projected funding requirementsby reviewing historical funding patterns, current and forecasted economicconditions and individual client funding needs.

 

TheCompany’s sources of liquidity consist of cash and due from correspondentbanks, overnight funds sold to correspondent banks, unpledged marketableinvestments and loans held for sale.  On June 30, 2009, consolidatedliquid assets totaled $55.5 million or 9.5% of total assets compared to $58.3million or 9.8% of total assets on December 31, 2008.  In addition toliquid assets, the Company maintains short-term lines of credit in the amountof $15,000,000 with correspondent banks.  There were no borrowingsoutstanding under these arrangements at June 30, 2009.

 

TheBank also has informal agreements with various other banks to sell participationsin loans, if necessary.  The Company serves primarily a business andprofessional customer base and, as such, its deposit base is susceptible toeconomic fluctuations.  Accordingly, management strives to maintain abalanced position of liquid assets to volatile and cyclical deposits.

 

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

 

**Off-Balance Sheet Items**

 

TheCompany has certain ongoing commitments under operating leases.  Thesecommitments do not significantly impact operating results. As of June 30,2009 and December 31, 2008, commitments to extend credit and letters ofcredit were the only financial instruments with off-balance sheet risk. The Company has not entered into any contracts for financial derivativeinstruments such as futures, swaps, options or similar instruments.   Commitments to fund loans and stand-byletters of credit at June 30, 2009 and December 31, 2008 wereapproximately $120,941,000 and $154,482,000, respectively.  Such loansrelate primarily to revolving lines of credit and other commercial loans, and toreal estate construction loans.  As apercentage of net loans, these off-balance sheet items represent 26.2% and31.7%, respectively. Of the loan commitments outstanding at June 30, 2009,$31,128,000 are real estate construction loan commitments  that are not expected to fund within the nexttwelve months due to the current downturn in the real estate market. Theremaining commitments primarily relate to revolving lines of credit or othercommercial loans, and many of these are expected to expire without being drawnupon. Therefore, the total commitments do not necessarily represent future cashrequirements.

 

**Other Matters**

 

**Item 4.  Controls andProcedures**

 

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

 

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endof the Company’s fiscal quarter ended June 30, 2009. The Company’s ChiefExecutive Officer and Chief Financial Officer concluded that the Company’sdisclosure controls and procedures as currently in effect are effective inensuring that the information required to be disclosed by the Company in thereports it files or submits under the Exchange Act is (i) accumulated andcommunicated to the Company’s management (including the Chief Executive Officerand Chief Financial Officer) to allow timely decisions regarding requireddisclosure, and (ii) recorded, processed, summarized and reported withinthe time periods specified in the Commission’s rules and forms.

 

(b) InternalControl Over Financial Reporting: An evaluation of any changes in the Company’sinternal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and15d-15(f)), that occurred during the Company’s fiscal quarter ended June 30,2009, was carried out under the supervision and with the participation of theCompany’s Chief Executive Officer, Chief Financial Officer and other members ofthe Company’s senior management. The Company’s Chief Executive Officer andChief Financial Officer concluded that no change identified in connection withsuch evaluation has materially affected, or is reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

 

**Item 5.  Subsequent Events**

 

None.

 

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**PART II— OTHER INFORMATION**

 

Item 1.  Legal Proceedings.

 

None.

 

Item 1A. Risk Factors

 

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

 

Item 2.  Changes in Securities and Use ofProceeds.

 

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

 

Duringthe six months ended June 30, 2009, no shares of common stock wererepurchased under the share repurchase program. There is approximately$5,671,796 remaining that may yet be purchased under the plan.

 

Item3.  Defaults Upon Senior Securities.

 

None.

 

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

 

The Annual Shareholdermeeting of the Registrant was held on June 4, 2009.

 

5,268,497 shares or78.64% of the outstanding voting stock was available for quorum.

 

Proposal #1   5,215,143 shares, or 77.84%, voted for theelection of twelve directors named in the proxy statement for terms expiring onthe date of the annual meeting in 2010.

 

Proposal #2   3,617,715 shares, or 54.0%, voted in favorof a bylaw amendment to add preferred stock as an additional class ofauthorized capital shares.

 

None.

 

Item 5.  Other Information.

 

None.

 

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Item 6.  Exhibits

 

(a) Exhibits

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

 

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**SIGNATURES**

 

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

 
|                  |   | COMMUNITY  VALLEY BANCORP          |
|-----------------------|--------|------------------------------------|
|                  |   |                               |
| August 14,  2009 |   | * *                           | *By:* | */s/  Keith C. Robbins* |
|                  |   |                               |   |   |
|                  |   |                               |   | Keith C. Robbins |
|                  |   |                               |   |   |
|                  |   |                               | President,  Chief Executive Officer |
|                  |   |                               |   |   |
| August 14,  2009 |   | * *                           | *By:* | */s/  John F. Coger* |
|                  |   |                               |   |   |
|                  |   |                               |   | John F. Coger |
|                  |   |                               |   |   |
|                  |   | Executive Vice President, CFO, COO |

 

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