UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549


FORM
10-K


(Mark
one)





x
            Annual
      report under Section 13 or 15(d) of the Securities Exchange Act of
      1934





For
the Fiscal Year December 31, 2009





 ̈
            Transition
      report pursuant to Section 13 or 15(d) of the Securities Exchange Act of
      1934





Commission
file number: 000-51949





Valley
Commerce Bancorp


(Exact
name of registrant as specified in its charter)





California
            46-1981399(State
      or other jurisdiction of incorporation or organization)
            (I.R.S.  Employer
      Identification No.)





200
      South Court Street, Visalia,
California  93291(Address
      of principal executive offices and Zip
Code)





(559)
622-9000


(Issuer’s
telephone number, including area code)





[None]


(Former
name, former address and former fiscal year, if changed since last
report)





Securities
registered pursuant to Section 12(b) of the Act: None





Securities
registered pursuant to Section 12(g) of the Act:  Common Stock, No Par Value; Preferred
Stock Purchase Rights




Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.
 Yes  o  No  x
 
 Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Exchange Act.
 Yes  o  No  x
 
 Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
 Yes  x  No  o
 
 Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.  x
  Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definitions of “large accelerated filer,” “accelerated filer,” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act:


Large
      accelerated filer o
            
            Accelerated
      filer o
            
            Non-accelerated
      filer o
            
            Smaller
      reporting company x(Do
      not check if asmaller
      reporting company)





Indicate
      by check mark whether the registrant is a shell company (as defined in
      Rule 12b-2 of the Exchange Act).





Yes  o  No  x













As of
June 30, 2009, the
aggregate market value of the registrant’s common stock held by non-affiliates
of the Registrant was $28.9 million based on the average bid and asked price
reported to the Registrant on that date of $11.19 per share.




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





Class
            
            Outstanding
      at March 29, 2010Common
      Stock, no par value
            
            2,608,317
      shares




DOCUMENTS
INCORPORATED BY REFERENCE




Document
            
            Parts
      Into Which IncorporatedProxy
      Statement for the Annual Meeting of Shareholders to be held May 18, 2010,
      (Proxy Statement)
            
            Part
      III


2


TABLE OF CONTENTS





Part
I





PageItem
      1.
              
              Business
              5Item
      1A.
              
              Risk Factors
              19Item
      1B.
              
              Unresolved Staff Comments
              22Item
      2.
              
              Properties
              22Item
      3.
              
              Legal Proceedings
              23Item
      4.
              
              Reserved
              23Part
      IIItem
      5.
              
              Market For Registrant’s Common Equity, Related Stockholder
      Matters and Issuer Purchases of
      Equity  Securities
              24Item
      6.
              
              Selected Financial Data
              27Item
      7.
              
              Management’s Discussion and Analysis of Financial Condition and
      Results of Operations
              29Item
      7A.
              
              Quantitative and Qualitative Disclosure About Market
      Risk
              45Item
      8.
              
              Financial Statements and Supplementary Data
              46Item
      9.
              
              Changes in and Disagreements With Accountants on Accounting and
      Financial Disclosure
              91Item
      9A.
              
              Controls and Procedures
              91Item
      9B.
              
              Other Information
              91Part
      IIIItem
      10.
              
              Directors, Executive Officers, and Corporate
      Governance.
              92Item
      11.
              
              Executive Compensation
              92Item
      12.
              
              Security Ownership of Certain Beneficial Owners and Management
      and Related Stockholder Matters
              92Item
      13.
              
              Certain Relationships and Related Transactions and Director
      Independence
              92Item
      14.
              
              Principal Accountant Fees and Services
              92Part
      IVItem
      15.
              
              Exhibits, Financial Statement Schedules
              92Signatures


3
 Table of Contents


PART
I





Forward-Looking
Information




Certain
matters discussed in this Annual Report on Form 10-K including, but not limited
to, those described in Item 7 - Management’s Discussion and Analysis of
Financial Condition and Results of Operations, are forward-looking statements
that are subject to risks and uncertainties that could cause actual results to
differ materially from those projected in the forward-looking statements. Such
risks and uncertainties include, among others: (1) significant increases in
competitive pressure in the banking and financial services industries; (2)
changes in the interest rate environment, which could reduce anticipated or
actual margins; (3) changes in the regulatory environment; (4) general economic
conditions, either nationally or regionally and especially in the Company’s
primary service area failing to improve or continuing to deteriorate and
resulting in, among other things, a deterioration in credit quality and
increases in the provision for loan loss; (5) operational risks, including data
processing systems failures or fraud; (6) changes in business conditions and
inflation; (7) changes in technology; (8) changes in monetary and tax policies;
and (9) changes in the securities markets; (10) civil disturbances or terrorist
threats or acts, or apprehension about the possible future occurrences or acts
of this type; (11) outbreak or escalation of hostilities in which the United
States is involved, any declaration of war by the U.S. Congress or any other
national or international calamity, crisis or emergency; (12)  changes
in laws and regulations; (13)  recently issued accounting
pronouncements; (14) government policies, regulations, and their enforcement
(including Bank Secrecy Act-related matters, taxing statutes and regulations;
(15) restrictions on dividends that our subsidiaries are allowed to pay to us;
(16) the ability to satisfy requirements related to the Sarbanes-Oxley Act and
other regulation on internal control; and (17) management’s ability to manage
these and other risks.  Therefore, the information set forth in such
forward-looking statements should be carefully considered when evaluating the
business prospects of the Company.




When
the Company uses in this Annual Report on Form 10-K the words “anticipate,”
“estimate,” “expect,” “project,” “intend,” “commit,” “believe” and similar
expressions, the Company intends to identify forward-looking
statements.  Such statements are not guarantees of performance and are
subject to certain risks, uncertainties and assumptions, including those
described in this Annual Report on Form 10-K.  Should one or more of
these risks or uncertainties materialize, or should underlying assumptions prove
incorrect, actual results may vary materially from those anticipated, estimated,
expected, projected, intended, committed or believed.  The future
results and shareholder values of the Company may differ materially from those
expressed in these forward-looking statements.  Many of the factors
that will determine these results and values are beyond the Company’s ability to
control or predict.  The Company undertakes no obligation to revise or
publicly release the results of any revision to these forward-looking
statements.  For those statements, the Company claims the protection
of the safe harbor for forward-looking statements contained in the Private
Securities Litigation Reform Act of 1995.


4
 Table of Contents


ITEM 1 – BUSINESS





General





The Company.  Valley
Commerce Bancorp (the “Company”) was incorporated on February 2, 2002 as a
California corporation, for the purpose of becoming the holding company for
Valley Business Bank (the “Bank), a California state chartered bank, through a
corporate reorganization.  In the reorganization, the Bank became the
wholly-owned subsidiary of the Company, and the shareholders of the Bank became
the shareholders of the Company.  The Company is registered as a bank
holding company under the Bank Holding Company Act of 1956, as amended (the “BHC
Act”), and is subject to supervision and regulation by the Board of Governors of
the Federal Reserve System (the “Board of Governors”).





The BHC
Act requires us to obtain the prior approval of the Board of Governors before
acquisition of all or substantially all of the assets of any bank or ownership
or control of the voting shares of any bank if, after giving effect to the
acquisition, we would own or control, directly or indirectly, more than 5% of
the voting shares of that bank. Amendments to the BHC Act expand the
circumstances under which a bank holding company may acquire control of all or
substantially all of the assets of a bank located outside the State of
California.





We may
not engage in any business other than managing or controlling banks or
furnishing services to our subsidiary, with the exception of certain activities
which, in the opinion of the Board of Governors, are so closely related to
banking or to managing or controlling banks as to be incidental to banking. In
addition, we are generally prohibited from acquiring direct or indirect
ownership or control of more than 5% of the voting shares of any company unless
that company is engaged in such authorized activities and the Board of Governors
approves the acquisition.





We and
our subsidiary are prohibited from engaging in certain tie-in arrangements in
connection with any extension of credit, sale or lease of property or provision
of services. For example, with certain exceptions, the bank may not condition an
extension of credit on a customer obtaining other services provided by us, the
bank or any other subsidiary of ours, or on a promise by the customer not to
obtain other services from a competitor. In addition, federal law imposes
certain restrictions on transactions between the bank and its affiliates. As
affiliates, the bank and we are subject, with certain exceptions, to the
provisions of federal law imposing limitations on and requiring collateral for
extensions of credit by the bank to any affiliate.





At
December 31, 2009, the Company had one banking subsidiary, the
Bank.  The Company’s principal source of income is dividends from the
Bank. The cash outlays of the Company, including operating expenses and debt
service costs, as well as any future cash dividends paid to Company shareholders
if and when declared by the Board of Directors, costs of repurchasing Company
stock, and the cost of servicing debt, will generally be paid from dividends
paid to the Company by the Bank.  Other sources of cash include
settlement of intercompany transactions and funds received from exercise of
stock options.




The
Company’s principal business is to provide, through its banking subsidiary,
financial services in its primary market area in California. The Company serves
Tulare and Fresno Counties and the surrounding area through the Bank. The
Company does not currently conduct any operations other than through the Bank.
Unless the context otherwise requires, references to the Company refer to the
Company and the Bank on a consolidated basis.





At
December 31, 2009, the Company’s assets totaled $340.2 million.  As of
December 31, 2009, the Company had a total of 81 employees and 77 full time
equivalent employees, including the employees of the Bank.





This
Annual Report on Form 10-K and other reports filed under the Securities Exchange
Act of 1934 with the Securities and Exchange Commission (SEC) will be accessible
on the Company’s website, www.valleybusinessbank.net,
as soon as practicable after the Company files the document with the
SEC.  These reports are also available through the SEC’s website at
www.sec.gov.





The
Bank.As a
California state-chartered bank that is not a member of the Federal Reserve Bank
(the “FRB”), Valley Business Bank is subject to primary supervision, examination
and regulation by the Federal Deposit Insurance Corporation (the “FDIC”), the
California Department of Financial Institutions (the “DFI”) and is subject to
applicable regulations of the FRB.  The Bank’s deposits are insured by
the FDIC to applicable limits.  As a consequence of the extensive
regulation of commercial banking activities in California and the United States,
banks are particularly susceptible to changes in California and federal
legislation and regulations, which may have the effect of increasing the cost of
doing business, limiting permissible activities or increasing
competition.


5
 Table of Contents








Various
other requirements and restrictions under the laws of the United States and the
State of California affect the operations of the Bank.  Federal and
California statutes and regulations relate to many aspects of the Bank’s
operations, including reserves against deposits, interest rates payable on
deposits, loans, investments, mergers and acquisitions, borrowings, dividends,
branching,
 capital requirements and disclosure obligations
to depositors and borrowers.  California law presently permits a bank
to locate a branch office in any locality in the state.  Additionally,
California law exempts banks from California usury laws.





The Bank
was organized in 1995 and commenced business as a California state chartered
bank in 1996.  The Bank’s deposit accounts are insured by the FDIC up
to maximum insurable amounts.  The Bank is participating in the FDIC’s
Transaction Account Guarantee Program.  Under the program, which the
FDIC has extended through June 30, 2010, all noninterest-bearing transaction
accounts, and negotiable order of withdrawal (NOW) accounts with interest rates
no higher than .50%, are fully guaranteed by the FDIC for the entire amount in
the account.  Coverage under the Transaction Account Guarantee Program
is in addition to and separate from the coverage under the FDIC’s general
deposit insurance rules.  The Bank is not a member of the Federal
Reserve System.





The
Bank’s target customers are local businesses, professionals and commercial
property owners.  The Bank’s income is derived primarily from interest
earned on loans, and, to a lesser extent, interest on investment securities,
fees for services provided to deposit customers, and fees from the brokerage of
loans.  The Bank’s major operating expenses are the interest paid on
deposits and borrowings, and general operating expenses.  In general,
the business of the Bank is not seasonal.





The Bank
conducts its business through its branch offices located in Visalia, Fresno,
Woodlake, Tipton and Tulare, all in California’s South San Joaquin
Valley.  The Visalia office opened in 1996 and the Visalia/Tulare
county area is the current principal market of the Bank.  The Woodlake
and Tipton branch offices were acquired from Bank of America in 1998, primarily
to obtain core deposits.  The Fresno Branch was acquired in 2003 to
allow the Bank to commence commercial banking operations in the Fresno
metropolitan area.  The full service Tulare branch office opened in
May 2008.  The new branch office replaced the Tulare loan production
office that had been operating in leased quarters since January
2005.





The Bank
intends to continue expanding within the South San Joaquin Valley by opening de
novo branches and loan production offices, and by acquiring branches from other
institutions.  New branches and loan production offices provide the
Bank with greater opportunity to expand its core deposit base and increase its
lending activities.  All future branches are subject to regulatory
approval.





Bank Lending Activities. The
Bank originates primarily commercial mortgage loans, secured and unsecured
commercial loans and construction loans.  It also originates a small
number of consumer and agricultural loans and brokers single-family residential
loans to other mortgage lenders.  The Bank targets small businesses,
professionals and commercial property owners in its market area for
loans.  It attracts and retains borrowers primarily on the basis of
personalized service, responsive handling of their needs, local promotional
activity, and personal contacts by officers, directors and staff.  The
majority of loans bear interest at adjustable rates tied to the Valley Business
Bank prime rate, which is administered by management and will not necessarily
change at the same time or by the same amount as the prevailing national prime
rate.  At December 31, 2009, Valley Business Bank’s prime rate was 1%
higher than the prevailing national prime rate as published in the Wall Street
Journal.  The remaining loans in the Bank’s portfolio either
bear interest at adjustable rates tied to the national prime rate or are priced
with fixed rates or under custom pricing programs.  For customers
whose loan demands exceed the Bank’s lending limits, the Bank seeks to make
those loans and concurrently sell participation interests in them to other
lenders.





No
individual or single group of related accounts is considered material in
relation to the Bank’s assets or in relation to the overall business of the
Bank.  At December 31, 2009 approximately 79% of the Bank’s loan
portfolio consisted of real estate-related loans, including construction loans,
real estate mortgage loans and commercial loans secured by real estate, while
20% of the loan portfolio was comprised of commercial
loans.   Currently, the business activities of the Bank are
mainly concentrated in Tulare County, California.  Consequently, the
results of operations and financial condition of the Bank are dependent upon the
general trends in this part of the California economy and, in particular, the
residential and commercial real estate markets. In addition, the concentration
of the Bank’s operations in this area of California exposes it to greater risk
than other banking companies with a wider geographic base.


6
 Table of Contents


Bank Deposit
Activities.  The Bank offers a full range of deposit products
including non-interest bearing demand deposit accounts and interest-bearing
money market, savings, and time deposit accounts.  The Bank also has
access to time deposits through deposit brokers.  The Bank’s deposits
are a combination of business and consumer accounts.  No individual
deposit account or group of related deposit accounts is considered material in
relation to the Bank’s total deposits.  The loss of any one account or
group of related accounts is not expected to have a material adverse effect on
the Bank.





Other Bank
Services.  The Bank has offered Internet banking services since
July 2002 and intends to continue expanding its Internet based banking services
for the benefit of its customers.  In recent years, new services
including remote deposit capture and mobile banking have been
implemented.  The Bank also offers courier services, travelers’
checks, safe deposit boxes, banking-by-mail, and other customary bank services.
The Bank provides certain services such as international banking transactions to
its customers through correspondent banks.  Bank management is
continually engaged in the evaluation of products and services to enable the
Bank to retain and improve its competitive position.  The Bank holds
no patents or licenses (other than licenses required by appropriate bank
regulatory agencies), franchises, or concessions.





Competition and
Growth.  The Company’s primary market area has been Tulare
County.  In California generally and in the Company’s market area
specifically, major banks and large regional banks dominate the commercial
banking industry.  Many of the Company’s competitors have
substantially greater lending limits than the Bank, as well as more locations,
more products and services, greater economies of scale and greater ability to
make investments in technology for the delivery of financial
services.





The
Company’s principal competitors for deposits and loans are major banks, other
local banks, savings and loan associations, credit unions, and
brokerages.  In addition, management anticipates that improved
technology and effective marketing strategies will enable nontraditional
competitors to effectively compete for loan and deposit business.





Despite a
very competitive banking environment, the Company has continued to grow over the
last three years.  Total assets grew from $263.8 million at December
31, 2006, to $340.2 million at December 31, 2009, an increase of
29%.  Growth in the regional economy and the Company’s success in
marketing to its target customers are primarily responsible for this
growth.





The
Company’s significant balance sheet components for the last four years are
detailed further in the following table:





December 31,(dollars
      in 000’s)
            
            2006
            
            
            2007
            
            
            2008
            
            
            2009Total
      assets
            
            $
            263,800
            
            
            $
            279,081
            
            
            $
            306,099
            
            
            $
            340,172Loans,
      net
            
            
            184,077
            
            
            
            199,514
            
            
            
            226,697
            
            
            
            234,823Deposits
            
            
            207,576
            
            
            
            215,386
            
            
            
            257,323
            
            
            
            294,282Shareholders’
      equity
            
            
            25,448
            
            
            
            28,873
            
            
            
            30,140
            
            
            
            36,869





As of
June 30, 2009 (date of latest available statistics from FDIC), there were 15
commercial banks and savings associations with a total of 67 offices in Tulare
County.  On this same date, the Company’s market share of FDIC-insured
deposits in Tulare County was approximately 7% of the total $39 billion in
deposits.  The Company believes that it can gain additional market
share in its principal market of Tulare County while it works to expand its core
customer base in the metropolitan Fresno area.





Regulation
and Supervision.





Capital
Standards.The FRB and the FDIC have risk-based capital
adequacy guidelines that are intended to provide a measure of capital adequacy
that reflects the degree of risk associated with a banking organization’s
operations for both transactions reported on the balance sheet as assets, and
transactions, such as letters of credit and recourse arrangements, which are
reported as off-balance-sheet items.  Under these guidelines, nominal
dollar amounts of assets and credit equivalent amounts of off-balance-sheet
items are multiplied by one of several risk adjustment percentages, which range
from 0% for assets with low credit risk, such as certain U.S. government
securities, to 100% for assets with relatively higher credit risk, such as
business loans.


7
 Table of Contents


A banking
organization’s risk-based capital ratios are obtained by dividing its qualifying
capital by its total risk-adjusted assets and off-balance-sheet
items.  The regulators measure risk-adjusted assets and
off-balance-sheet items against both total qualifying capital (the sum of Tier 1
capital and limited amounts of Tier 2 capital) and Tier 1
capital.  Tier 1 capital consists of common stock, retained earnings,
noncumulative perpetual preferred stock and minority interests in certain
subsidiaries, less most other intangible assets and certain non-qualifying
deferred tax assets.  Tier 2 capital may consist of a limited amount
of the allowance for loan losses and certain other instruments with some
characteristics of equity.  The inclusion of elements of Tier 2
capital is subject to certain other requirements and limitations of the federal
banking agencies.  Since December 31, 1992, the FRB and the FDIC have
required a minimum ratio of qualifying total capital to risk-adjusted assets and
off-balance-sheet items of 8%, and a minimum ratio of Tier 1 capital to
risk-adjusted assets and off-balance-sheet items of 4%.





In
addition to the risk-based guidelines, the FRB and FDIC require banking
organizations to maintain a minimum amount of Tier 1 capital to average total
assets, referred to as the leverage ratio.  Regulators generally
require banking organizations to maintain the leverage ratio well above the 3%
regulatory minimum.





In
addition to these uniform risk-based capital guidelines and leverage ratios that
apply across the industry, the FRB and FDIC have the discretion to set
individual minimum capital requirements for specific institutions at rates
significantly above the minimum guidelines and ratios.  A bank that
does not achieve and maintain the required capital levels may be issued a
capital directive by the FDIC to ensure the maintenance of required capital
levels.





As
discussed above, we are required to maintain certain levels of capital, as is
the Bank.  The regulatory capital guidelines as well as the actual
capitalization for the Bank and Bancorp as of December 31, 2009
follow:





Requirement
      for the
              Bank
      to be:Adequately
              Capitalized
            
            
            Well
              Capitalized
            
            
            Valley
              Business
              Bank
            
            
            Valley
      Commerce
              BancorpTier
      1 leverage capital ratio
            
            
            4.0
            %
            
            
            5.0
            %
            
            
            11.4
            %
            
            
            11.4
            %Tier
      1 risk-based capital ratio
            
            
            4.0
            %
            
            
            6.0
            %
            
            
            14.8
            %
            
            
            14.8
            %Total
      risk-based capital ratio
            
            
            8.0
            %
            
            
            10.0
            %
            
            
            16.0
            %
            
            
            16.0
            %








Prompt Corrective
Action.Federal banking agencies possess broad powers to take
corrective and other supervisory action to resolve the problems of insured
depository institutions, including those institutions that fall below one or
more prescribed minimum capital ratios described above.  An
institution that, based upon its capital levels, is classified as well
capitalized, adequately capitalized, or undercapitalized may be treated as
though it were in the next lower capital category if the appropriate federal
banking agency, after notice and opportunity for hearing, determines that an
unsafe or unsound condition or an unsafe or unsound practice warrants such
treatment.  At each successive lower capital category, an insured
depository institution is subject to more restrictions.





In
addition to measures taken under the prompt corrective action provisions,
commercial banking organizations may be subject to potential enforcement actions
by the federal regulators for unsafe or unsound practices in conducting their
businesses or for violations of any law, rule, regulation, or any condition
imposed in writing by the agency or any written agreement with the
agency.  Enforcement actions may include the imposition of a
conservator or receiver, the issuance of a cease-and-desist order that can be
judicially enforced, the termination of insurance of deposits (in the case of a
depository institution), the imposition of civil money penalties, the issuance
of directives to increase capital, the issuance of formal and informal
agreements, the issuance of removal and prohibition orders against
institution-affiliated parties and the enforcement of such actions through
injunctions or restraining orders based upon a judicial determination that the
agency would be harmed if such equitable relief was not
granted.  Additionally, a holding company’s inability to serve as a
source of strength to its subsidiary banking organizations could serve as an
additional basis for a regulatory action against the holding
company.


8
 Table of Contents


Premiums for Deposit
Insurance.The deposit insurance fund of the FDIC insures our
customer deposits up to prescribed limits for each depositor.  The
FDIC has developed a risk-based assessment system, which provides that the
assessment rate for an insured depository institution will vary according to the
level of risk incurred in its activities.  An institution’s risk
category is based upon whether the institution is well capitalized, adequately
capitalized or less than adequately capitalized.  Each insured
depository institution is also to be assigned to one of three “supervisory
subgroups”:  Subgroup A institutions are financially sound
institutions with a few minor weaknesses; Subgroup B institutions are
institutions that demonstrate weaknesses which, if not corrected, could result
in significant deterioration; and Subgroup C institutions are institutions for
which there is a substantial probability that the FDIC will suffer a loss in
connection with the institution unless effective action is taken to correct the
areas of weakness. The FDIC assigns each member institution an annual FDIC
assessment rate on insured deposits.





The FDIC
amended this assessment system in February 2009 and based an insured depository
institution’s assessment rate on different factors that pose a risk of loss to
the Deposit Insurance Fund, including the institution’s recent financial ratios
and supervisory ratings, and level of reliance on a significant amount of
secured liabilities or significant amount of brokered deposits (except that the
factor of brokered deposits will not be considered for well capitalized
institutions that are not accompanied by rapid growth).  The FDIC also
in February 2009 set the assessment base rates to range between $0.12 to $0.16
per $100 of insured deposits on an annual basis.  In May 2009, the
FDIC imposed a special assessment of 5 basis points on each insured depository
institution’s assets less its Tier 1 capital payable on September 30, 2009 with
a ceiling of 10 basis points of an institution’s domestic
deposits.  In November 2009, the FDIC approved a final rule to require
all insured depository institutions including the Bank to prepay three years of
FDIC assessments in the fourth quarter of 2009, except in the event such
prepayment is waived by the FDIC.  The amount of this prepaid
assessment was $3.6 million which the Bank paid on December 30,
2009.  While the prepaid assessments are not charged to income for
2009 but rather ratably over three years beginning in 2010, the quarterly amount
paid will reduce the cash and liquidity of the Bank at year end 2009 and
subsequent periods.  Due to the significant losses at failed banks and
expected losses for banks that will fail, it is likely that FDIC insurance fund
assessments on the Bank will increase, and such assessments may materially
adversely affect the profitability of the Bank.





Any
increase in assessments or the assessment rate could have a material adverse
effect on our business, financial condition, results of operations or cash
flows, depending on the amount of the increase.  Furthermore, the FDIC
is authorized to raise insurance premiums under certain
circumstances.





The FDIC
is authorized to terminate a depository institution’s deposit insurance upon a
finding by the FDIC that the institution’s financial condition is unsafe or
unsound or that the institution has engaged in unsafe or unsound practices or
has violated any applicable rule, regulation, order or condition enacted or
imposed by the institution’s regulatory agency.  The termination of
deposit insurance for the bank would have a material adverse effect on our
business, financial condition, results of operations and/or cash
flows.





Federal Home Loan Bank
System.The Bank is a member of the Federal Home Loan Bank of
San Francisco (the “FHLB-SF”).  Among other benefits, each Federal
Home Loan Bank (“FHLB”) serves as a reserve or central bank for its members
within its assigned region.  Each FHLB is financed primarily from the
sale of consolidated obligations of the FHLB system.  Each FHLB makes
available loans or advances to its members in compliance with the policies and
procedures established by the Board of Directors of the individual
FHLB.  The FHLB-SF utilizes a single class of stock with a par value
of $100 per share, which may be issued, exchanged, redeemed and repurchased only
at par value. As a member of the FHLB-SF, the Bank is required to own FHLB –SF
capital stock in an amount equal to the greater of:





§
            a
      membership stock requirement with an initial cap of $25 million (100% of
      “membership asset value” as defined),
or


§
            an
      activity based stock requirement (based on percentage of outstanding
      advances).




The FHLB
– SF capital stock is redeemable on five years written notice, subject to
certain conditions.  At December 31, 2009 the Bank owned 11,190 shares
of FHLB-SF capital stock.





Federal Reserve
System.The FRB requires all depository institutions to
maintain non-interest bearing reserves at specified levels against their
transaction accounts and non-personal time deposits.  At December 31,
2009, the Bank was in compliance with these requirements.


9
 Table of Contents


On July
2, 2009, the Board of Governors of the Federal Reserve System amended Regulation
D, Reserve Requirements of Depository Institutions, to authorize the
establishment of limited-purpose accounts at Federal Reserve Banks, called
excess balance accounts, for the maintenance of excess balances of
interest-eligible institutions. The authorization of excess balance accounts was
intended to address pressures on correspondent-respondent business
relationships.  The Bank placed funds in the FRB excess balance
account shortly after its inception and earned interest at a rate comparable to
the federal funds rate.





Impact of Monetary
Policies.The earnings and growth of the Company are subject
to the influence of domestic and foreign economic conditions, including
inflation, recession and unemployment.  The earnings of the Company
are affected not only by general economic conditions but also by the monetary
and fiscal policies of the United States and federal agencies, particularly the
FRB.  The FRB can and does implement national monetary policy, such as
seeking to curb inflation and combat recession, by its open market operations in
United States Government and other securities, and by its control of the
discount rates applicable to borrowings by banks from the FRB.  The
actions of the FRB in these areas influence the growth of bank loans and leases,
investments and deposits and affect the interest rates charged on loans and
leases and paid on deposits.  The FRB’s policies have had a
significant effect on the operating results of commercial banks and are expected
to continue to do so in the future.  The nature and timing of any
future changes in monetary policies are not predictable.





Extensions of Credit to Insiders and
Transactions with Affiliates.The Federal Reserve Act and FRB
Regulation O place
limitations and conditions on loans or extensions of credit to:





§
            a
      bank’s or bank holding company’s executive officers, directors and
      principal shareholders (i.e., in most cases,
      those persons who own, control or have power to vote more than 10% of any
      class of voting securities),


§
            any
      company controlled by any such executive officer, director or shareholder,
      or


§
            any
      political or campaign committee controlled by such executive officer,
      director or principal shareholder.




Loans and
leases extended to any of the above persons must comply with
loan-to-one-borrower limits, require prior full board approval when aggregate
extensions of credit to the person exceed specified amounts, must be made on
substantially the same terms (including interest rates and collateral) as, and
follow credit-underwriting procedures that are not less stringent than, those
prevailing at the time for comparable transactions with non-insiders, and must
not involve more than the normal risk of repayment or present other unfavorable
features.  In addition, Regulation O provides that the aggregate limit
on extensions of credit to all insiders of a bank as a group cannot exceed the
bank’s unimpaired capital and unimpaired surplus.  Regulation O also
prohibits a bank from paying an overdraft on an account of an executive officer
or director, except pursuant to a written pre-authorized interest-bearing
extension of credit plan that specifies a method of repayment or a written
pre-authorized transfer of funds from another account of the officer or director
at the bank.





Consumer Protection Laws and
Regulations.The banking regulatory agencies are focusing
greater attention on compliance with consumer protection laws and their
implementing regulations.  Examination and enforcement have become
more intense in nature, and insured institutions have been advised to monitor
carefully compliance with such laws and regulations.  The Company is
subject to many federal and state consumer protection and privacy statutes and
regulations, some of which are discussed below.





TheCommunity Reinvestment Act
(the “CRA”) is intended to encourage insured depository institutions, while
operating safely and soundly, to help meet the credit needs of their
communities.  The CRA specifically directs the federal regulatory
agencies, in examining insured depository institutions, to assess a bank’s
record of helping meet the credit needs of its entire community, including low-
and moderate-income neighborhoods, consistent with safe and sound banking
practices.  The CRA further requires the agencies to take a financial
institution’s record of meeting its community credit needs into account when
evaluating applications for, among other things, domestic branches, mergers or
acquisitions, or holding company formations.The agencies use
the CRA assessment factors in order to provide a rating to the financial
institution.  The ratings range from a high of “outstanding” to a low
of “substantial noncompliance.”  In its last examination for CRA
compliance, as of November 2007, the Bank was rated “satisfactory.”





TheEqual Credit Opportunity Act (the “ECOA”) generally prohibits
discrimination in any credit transaction, whether for consumer or business
purposes, on the basis of race, color, religion, national origin, sex, marital
status, age (except in limited circumstances), receipt of income from public
assistance programs, or good faith exercise of any rights under the Consumer
Credit Protection Act.


10
 Table of Contents








TheTruth in Lending Act (the
“TILA”) is designed to ensure that credit terms are disclosed in a meaningful
way so that consumers may compare credit terms more readily and
knowledgeably.  As a result of the TILA, all creditors must use the
same credit terminology to express rates and payments, including the annual
percentage rate, the finance charge, the amount financed, the total of payments
and the payment schedule, among other things.





TheFair Housing Act (the “FH
Act”) regulates many practices, including making it unlawful for any lender to
discriminate in its housing-related lending activities against any person
because of race, color, religion, national origin, sex, handicap or familial
status.  A number of lending practices have been found by the courts
to be, or may be considered, illegal under the FH Act, including some that are
not specifically mentioned in the FH Act itself.





TheHome Mortgage Disclosure Act
(the “HMDA”), in response to public concern over credit shortages in certain
urban neighborhoods, requires public disclosure of information that shows
whether financial institutions are serving the housing credit needs of the
neighborhoods and communities in which they are located.  The HMDA
also includes a "fair lending" aspect that requires the collection and
disclosure of data about applicant and borrower characteristics as a way of
identifying possible discriminatory lending patterns and enforcing
anti-discrimination statutes.





The Right to Financial Privacy
Act (the “RFPA”) imposes a new requirement for financial institutions to
provide new privacy protections to consumers.  Financial institutions
must provide disclosures to
 consumers of its privacy policy,
and state the rights of consumers to direct their financial institution not to
share their nonpublic personal information with third parties.


Finally,
the Real Estate Settlement
Procedures Act (the “RESPA”) requires lenders to provide noncommercial
borrowers with disclosures regarding the nature and cost of real estate
settlements.  Also, RESPA prohibits certain abusive practices, such as
kickbacks, and places limitations on the amount of escrow accounts.





Penalties
for noncompliance or violations under the above laws may include fines,
reimbursement and other penalties.  Due to heightened regulatory
concern related to compliance with CRA, ECOA, TILA, FH Act, HMDA, RFPA and RESPA
generally, the Company may incur additional compliance costs or be required to
expend additional funds for investments in its local communities.





Recent Legislation and Other
Changes.Federal and state laws affecting banking are enacted
from time to time, and similarly federal and state regulations affecting banking
are also adopted from time to time.  The following include some of the
recent laws and regulations affecting banking.





In May
2009 the Helping Families Save Their Homes Act of 2009 was enacted to help
consumers avoid mortgage foreclosures on their homes through certain loss
mitigation actions including special forbearance, loan modification,
pre-foreclosure sale, deed in lieu of foreclosure, support for borrower housing
counseling, subordinate lien resolution, and borrower relocation.  The
new law permits the Secretary of Housing and Urban Development (HUD), for
mortgages either in default or facing imminent default, to: (1) authorize the
modification of such mortgages; and (2) establish a program for payment of a
partial claim to a mortgagee who agrees to apply the claim amount to payment of
a mortgage on a 1- to 4-family residence.  In implementing the law,
the Secretary of HUD is authorized to (1) provide compensation to the mortgagee
for lost income on monthly mortgage payments due to interest rate reduction; (2)
reimburse the mortgagee from a guaranty fund in connection with activities that
the mortgagee is required to undertake concerning repayment by the mortgagor of
the amount owed to HUD; (3) make payments to the mortgagee on behalf of the
borrower, under terms defined by HUD; and (4) make mortgage modification with
terms extended up to 40 years from the modification date.  The new law
also authorizes the Secretary of HUD to: (1) reassign the mortgage to the
mortgagee; (2) act as a Government National Mortgage Association (GNMA, or
Ginnie Mae) issuer, or contract with an entity for such purpose, in order to
pool the mortgage into a Ginnie Mae security; or (3) resell the mortgage in
accordance with any program established for purchase by the federal government
of insured mortgages.  The new law also amends the Foreclosure
Prevention Act of 2008, with respect to emergency assistance for the
redevelopment of abandoned and foreclosed homes (neighborhood stabilization), to
authorize each state that has received certain minimum allocations and has
fulfilled certain requirements, to distribute any remaining amounts to areas
with homeowners at risk of foreclosure or in foreclosure without regard to the
percentage of home foreclosures in such areas.


11
 Table of Contents


Also in
May 2009, the Credit Card Act of 2009 was enacted to help consumers and ban
certain practices of credit card issuers.  The new law allows interest
rate hikes on existing balances only under limited conditions, such as when a
promotional rate ends, there is a variable rate or if the cardholder makes a
late payment.  Interest rates on new transactions can increase only
after the first year.  Significant changes in terms on accounts cannot
occur without 45 days' advance notice of the change.  The new law bans
raising interest rates on customers based on their payment records with other
unrelated credit issuers (such as utility companies and other creditors) for
existing credit card balances, though card issuers would still be allowed to use
universal default on future credit card balances if they give at least 45 days'
advance notice of the change.  
 The new law allows
consumers to opt out of certain significant changes in terms on their
accounts.  Opting out means cardholders agree to close their accounts
and pay off the balance under the old terms.  They have at least five
years to pay the balance.  
 Credit card issuers
will be banned from issuing credit cards to anyone under 21, unless they have
adult co-signers on the accounts or can show proof they have enough income to
repay the card debt.  Credit card companies must stay at least 1,000
feet from college campuses if they are offering free pizza or other gifts to
entice students to apply for credit cards.





The new
requires card issuers to give card account holders "a reasonable amount of time"
to make payments on monthly bills.  That means payments would be due
at least 21 days after they are mailed or delivered.  Credit card
issuers would no longer be able to set early morning or other arbitrary
deadlines for payments.  
 When consumers have
accounts that carry different interest rates for different types of
purchases  payments in excess of the minimum amount due must go to
balances with higher interest rates first.  

Consumers must "opt in" to over-limit fees. Those who opt out would have their
transactions rejected if they exceed their credit limits, thus avoiding
over-limit fees. Fees charged for going over the limit must be
reasonable.  
 Finance charges on outstanding
credit card balances would be computed based on purchases made in the current
cycle rather than going back to the previous billing cycle to calculate interest
charges.  Fees on credit cards cannot exceed 25 percent of the
available credit limit in the first year of the card. 
Credit
card issuers must disclose to cardholders the consequences of making only
minimum payments each month, namely how long it would take to pay off the entire
balance if users only made the minimum monthly payment.  Issuers must
also provide information on how much users must pay each month if they want to
pay off their balances in 36 months, including the amount of
interest.





On
February 17, 2009, the American Recovery and Reinvestment Act of 2009 (“ARRA”)
was enacted to provide stimulus to the struggling US economy.  ARRA
authorizes spending of $787 billion, including about $288 billion for tax
relief, $144 billion for state and local relief aid, and $111 billion for
infrastructure and science.  In addition, ARRA includes additional
executive compensation restrictions for recipients of funds from the US Treasury
under the Troubled Assets Relief Program of the Emergency Economic Stimulus Act
of 2008 (“EESA”).  The provisions of EESA amended by the ARRA include
(i) expanding the coverage of the executive compensation limits to as many as
the 25 most highly compensated employees of a TARP funds recipient and its
affiliates for certain aspects of executive compensation limits and (ii)
specifically limiting incentive compensation of covered executives to one-third
of their annual compensation which is required to be paid in restricted stock
that does not vest until all of the TARP funds are no longer outstanding (note
that if TARP warrants remain outstanding and no other TARP instruments are
outstanding, then such warrants would not be considered outstanding for purposes
of this incentive compensation restriction.  In addition, the board of
directors of any TARP recipient is required under EESA, as amended to have a
company-wide policy regarding excessive or luxury expenditures, as identified by
the Treasury, which may include excessive expenditures on entertainment or
events; office and facility renovations; aviation or other transportation
services; or other activities or events that are not reasonable expenditures for
staff development, reasonable performance incentives, or other similar measures
conducted in the normal course of the business operations of the TARP
recipient.





EESA, as
amended by ARRA, provides for a new incentive compensation restriction for
financial institutions receiving TARP funds.  The number of executives
and employees covered by this new incentive compensation restriction depends on
the amount of TARP funds received by such entity.  For community banks
that have or will receive less than $25 million, the new incentive compensation
restriction applies only to the highest paid employee. This new incentive
compensation restriction prohibits a TARP recipient from paying or accruing any
bonus, retention award, or incentive compensation during the period in which any
TARP obligation remains outstanding, except that such prohibition shall not
apply to the payment of long-term restricted stock by such TARP recipient,
provided that such long-term restricted stock (i) does not fully vest during the
period in which any TARP obligation remains outstanding, (ii) has a value in an
amount that is not greater than 1/3 of the total amount of annual compensation
of the employee receiving the stock; and (iii) is subject to such other terms
and conditions as the Secretary of the Treasury may determine is in the public
interest.  In addition, this prohibition does not prohibit any bonus
payment required to be paid pursuant to a written employment contract executed
on or before February 11, 2009, as such valid employment contracts are
determined by the Treasury.


12
 Table of Contents


EESA was
amended by ARRA to also provide additional corporate governance provisions with
respect to executive compensation including the following:





·
            ESTABLISHMENT
      OF STANDARDS - During the period in which any TARP obligation remains
      outstanding, each TARP recipient shall be subject to the standards in the
      regulations issued by the Treasury with respect to executive compensation
      limitations for TARP recipients, and the provisions of section 162(m)(5)
      of the Internal Revenue Code of 1986, as applicable (non-deductibility of
      executive compensation in excess of
$500,000).





·
            COMPLIANCE
      WITH STANDARDS - The Treasury is required to see that each TARP recipient
      meet the required standards for executive compensation and corporate
      governance.





·
            SPECIFIC
      REQUIREMENTS FOR THE REQUIRED STANDARDS
-





§
            Limits
      on compensation that exclude incentives for senior executive officers of
      the TARP recipient to take unnecessary and excessive risks that threaten
      the value of the financial institution during the period in which any TARP
      obligation remains outstanding.





§
            A
      claw-back requirement by such TARP recipient of any bonus, retention
      award, or incentive compensation paid to a senior executive officer and
      any of the next 20 most highly-compensated employees of the TARP recipient
      based on statements of earnings, revenues, gains, or other criteria that
      are later found to be materially
inaccurate.





§
            A
      prohibition on such TARP recipient making any golden parachute payment to
      a senior executive officer or any of the next 5 most highly-compensated
      employees of the TARP recipient during the period in which any TARP
      obligation remains outstanding.





§
            A
      prohibition on any compensation plan that would encourage manipulation of
      the reported earnings of such TARP recipient to enhance the compensation
      of any of its employees.





§
            A
      requirement for the establishment of an independent Compensation Committee
      that meets at least twice a year to discuss and evaluate employee
      compensation plans in light of an assessment of any risk posed to the TARP
      recipient from such plans.  For a non SEC company that is a TARP
      recipient that has received $25,000,000 or less of TARP assistance, the
      duties of the compensation committee may be carried out by the board of
      directors of such TARP recipient.





In
addition, EESA as amended by ARRA provides that for any TARP recipient, its
annual meeting materials shall include a nonbinding shareholder approval
proposal of executive compensation for shareholders to vote.  The SEC
is to establish regulations to implement this provision.  While
nonpublic companies are required to include this proposal, it is not known what
the regulations will provide as to executive compensation disclosure
requirements of such TARP recipients, and whether they will be as extensive as
the existing SEC executive compensation requirements.  In addition,
shareholders are allowed to present other nonbinding proposals with respect to
executive compensation.





ARRA also
provides $730 million to the SBA and makes changes to the agency’s lending and
investment programs so that they can reach more small businesses that need help.
The funding includes:





·
            $375
      million for temporarily eliminating fees on SBA-backed loans and raising
      SBA's guarantee percentage on some loans to 90
  percent.


·
            $255
      million for a new loan program to help small businesses meet existing debt
      payments


·
            $30
      million for expanding SBA’s Microloan program, enough to finance up to $50
      million in new lending and $24 million in technical assistance grants to
      microlenders.





On
February 10, 2009, the U. S. Treasury, the Federal Reserve Board, the FDIC, the
Office of the Comptroller of the Currency, and the Office of Thrift Supervision
all announced a comprehensive set of measures to restore confidence in the
strength of U.S. financial institutions and restart the critical flow of credit
to households and businesses.  This program is intended to restore the
flows of credit necessary to support recovery.








13
 Table of Contents




The core
program elements include:


·
            A
      new Capital Assistance Program to help ensure that our banking
      institutions have sufficient capital to withstand the challenges ahead,
      paired with a supervisory process to produce a more consistent and
      forward-looking assessment of the risks on banks' balance sheets and their
      potential capital needs.


·
            A
      new Public-Private Investment Fund on an initial scale of up to $500
      billion, with the potential to expand up to $1 trillion, to catalyze the
      removal of legacy assets from the balance sheets of financial
      institutions. This fund will combine public and private capital with
      government financing to help free up capital to support new
      lending.


·
            A
      new Treasury and Federal Reserve initiative to dramatically expand – up to
      $1 trillion – the existing Term Asset-Backed Securities Lending Facility
      (TALF) in order to reduce credit spreads and restart the securitized
      credit markets that in recent years supported a substantial portion of
      lending to households, students, small businesses, and
    others.


·
            An
      extension of the FDIC's Temporary Liquidity Guarantee Program to October
      31, 2009. A new framework of governance and oversight to help ensure that
      banks receiving funds are held responsible for appropriate use of those
      funds through stronger conditions on lending, dividends and executive
      compensation along with enhanced reporting to the
  public.





In
October 2008, the President signed the Emergency Economic Stabilization Act of
2008 (“EESA”), in response to the global financial crisis of 2008 authorizing
the United States Secretary of the Treasury with authority to spend up to $700
billion to purchase distressed assets, especially mortgage-backed securities,
under the Troubled Assets Relief Program (“TARP”) and make capital injections
into banks under the Capital Purchase Program.  EESA gives the
government the unprecedented authority to buy troubled assets on balance sheets
of financial institutions under the Troubled Assets Relief Program and increases
the limit on insured deposits from $100,000 to $250,000 through December 31,
2009.  Some of the other provisions of EESA are as
follows:





·
            accelerated
      from 2011 to 2008 the date that the Federal Reserve Bank could pay
      interest on deposits of banks held with the Federal Reserve to meet
      reserve requirements;


·
            to
      the extent that the U. S. Treasury purchases mortgage securities as part
      of TARP, the Treasury shall implement a plan to minimize foreclosures
      including using guarantees and credit enhancements to support reasonable
      loan modifications, and to the extent loans are owned by the government to
      consent to the reasonable modification of such
  loans;


·
            limits
      executive compensation for executives for TARP participating financial
      institutions including a maximum corporate tax deduction limit of $500,000
      for each of the top five highest paid executives of such institution,
      requiring clawbacks of incentive compensation that were paid based on
      inaccurate or false information, limiting golden parachutes for
      involuntary and certain voluntary terminations to 2.99x their average
      annual salary and bonus for the last five years, and prohibiting the
      payment of incentive compensation that encourages management to take
      unnecessary and excessive risks with respect to the
      institution;


·
            extends
      the mortgage debt forgiveness provision of the Mortgage Forgiveness Debt
      Relief Act of 2007 by three years (2012) to ease the income tax burden on
      those involved with certain foreclosures;
and


·
            qualified
      financial institutions may count losses on FNMA and FHLMC preferred stock
      against ordinary income, rather than capital gain
  income.





On
February 10, 2009, the Treasury Secretary announced a new comprehensive
financial stability legislation (the “Financial Stability Plan”), which
earmarked the second $350 billion of unused funds originally authorized under
the EESA.  The major elements of the Financial Stability Plan
included: (i) a capital assistance program that has invested in convertible
preferred stock of certain qualifying institutions, (ii) a consumer and business
lending initiative to fund new consumer loans, small business loans and
commercial mortgage asset-backed securities issuances, (iii) a public/private
investment fund intended to leverage public and private capital with public
financing to purchase up to $500 billion to $1 trillion of legacy “toxic assets”
from financial institutions, and (iv) assistance for homeowners by providing up
to $75 billion to reduce mortgage payments and interest rates and establishing
loan modification guidelines for government and private programs.





On
October 22, 2009, the Federal Reserve Board issued a comprehensive proposal on
incentive compensation policies intended to ensure that the incentive
compensation policies of banking organizations do not undermine the safety and
soundness of such organizations by encouraging excessive
risk-taking.  The proposal, which covers all employees that have the
ability to materially affect the risk profile of an organization, either
individually or as part of a group, is based upon the key principles that a
banking organization’s incentive compensation arrangements should (i) provide
incentives that do not encourage risk-taking beyond the organization’s ability
to effectively identify and manage risks, (ii) be compatible with effective
internal controls and risk management, and (iii) be supported by strong
corporate governance, including active and effective oversight by the
organization’s board of directors. The proposal also contemplates a detailed
review by the Federal Reserve Board of the incentive compensation policies and
practices of a number of “large, complex banking organizations.” Any
deficiencies in compensation practices that are identified may be incorporated
into the organization’s supervisory ratings, which can affect its ability to
make acquisitions or perform other actions.  In addition, the proposal
provides that enforcement actions may be taken against a banking organization if
its incentive compensation arrangements or related risk-management control or
governance processes pose a risk to the organization’s safety and soundness and
the organization is not taking prompt and effective measures to correct the
deficiencies.  Similarly, on January 12, 2010, the FDIC announced that
it would seek public comment through advance notice of rule making on whether
banks with compensation plans that encourage risky behavior should be charged at
higher deposit assessment rates than such banks would otherwise be
charged.


14
 Table of Contents








On
September 3, 2009, the U.S. Treasury issued a policy statement entitled
“Principles for Reforming the U.S. and International Regulatory Capital
Framework for Banking Firms.”  The statement was developed in
consultation with the U.S. bank regulatory agencies and sets forth eight “core
principles” intended to shape a new international capital accord.  Six
of the core principles relate directly to bank capital requirements. The
statement contemplates changes to the existing regulatory capital regime that
would involve substantial revisions to, if not replacement of, major parts of
the Basel I and Basel II and affect all regulated banking organizations and
other systemically important institutions.  The statement calls for
higher and stronger capital requirements for bank and non-bank financial firms
that are deemed to pose a risk to financial stability due to their combination
of size, leverage, interconnectedness and liquidity risk.  The
statement suggested that changes to the regulatory capital framework be phased
in over a period of several years with a recommended schedule providing for a
comprehensive international agreement by December 31, 2010, with the
implementation of reforms by December 31, 2012, although it does remain possible
that U.S. bank regulatory agencies could officially adopt, or informally
implement, new capital standards at an earlier date.  Following the
issuance of the statement, on December 17, 2009, the Basel committee issued a
set of proposals (the “Capital Proposals”) that would significantly revise the
definitions of Tier 1 capital and Tier 2 capital, with the most significant
changes being to Tier 1 capital.  Most notably, the Capital Proposals
would disqualify certain structured capital instruments, such as trust preferred
securities, from Tier 1 capital status.  The Capital Proposals would
also re-emphasize that common equity is the predominant component of Tier 1
capital by adding a minimum common equity to risk-weighted assets ratio and
requiring that goodwill, general intangibles and certain other items that
currently must be deducted from Tier 1 capital instead be deducted from common
equity as a component of Tier 1 capital. The Capital Proposals also leave open
the possibility that the Basel committee will recommend changes to the minimum
Tier 1 capital and total capital ratios of 4.0% and 8.0%,
respectively.  Concurrently with the release of the Capital Proposals,
the Basel committee also released a set of proposals related to liquidity risk
exposure (the “Liquidity Proposals”).  The Liquidity Proposals have
three key elements, including the implementation of (i) a “liquidity coverage
ratio” designed to ensure that a bank maintains an adequate level of
unencumbered, high-quality assets sufficient to meet the bank’s liquidity needs
over a 30-day time horizon under an acute liquidity stress scenario, (ii) a “net
stable funding ratio” designed to promote more medium and long-term funding of
the assets and activities of banks over a one-year time horizon, and (iii) a set
of monitoring tools that the Basel committee indicates should be considered as
the minimum types of information that banks should report to supervisors and
that supervisors should use in monitoring the liquidity risk profiles of
supervised entities.





In June
2009, the Administration proposed a wide range of regulatory reforms that, if
enacted, may have significant effects on the financial services industry in the
United States.  Significant aspects of the Administration’s proposals
included, among other things, proposals (i) that any financial firm whose
combination of size, leverage and interconnectedness could pose a threat to
financial stability be subject to certain enhanced regulatory requirements, (ii)
that federal bank regulators require loan originators or sponsors to retain part
of the credit risk of securitized exposures, (iii) that there be increased
regulation of broker-dealers and investment advisers, (iv) for the creation of a
federal consumer financial protection agency that would, among other things, be
charged with applying consistent regulations to similar products (such as
imposing certain notice and consent requirements on consumer overdraft lines of
credit), (v) that there be comprehensive regulation of OTC derivatives, (vi)
that the controls on the ability of banking institutions to engage in
transactions with affiliates be tightened, and (vii) that financial holding
companies be required to be “well-capitalized” and “well-managed” on a
consolidated basis.  The Congress, state lawmaking bodies and federal
and state regulatory agencies continue to consider a number of wide-ranging and
comprehensive proposals for altering the structure, regulation and competitive
relationships of the nation’s financial institutions, including rules and
regulations related to the broad range of reform proposals set forth by the
Obama administration described above.  Along with amendments to the
Administration’s proposal there are separate comprehensive financial reform
bills intended to address in part or whole or vary in part or in whole from the
proposals set forth by the Administration were introduced in both houses of
Congress in the second half of 2009 and in 2010 and remain under review by both
the U.S. House of Representatives and the U.S. Senate.


15
 Table of Contents


The
Temporary Liquidity Guarantee Program was implemented by the FDIC on October 14,
2008 to mitigate the lack of liquidity in the financial markets.  The
Temporary Liquidity Guarantee Program has two primary components: the Debt
Guarantee Program, by which the FDIC will guarantee the payment of certain
newly-issued senior unsecured debt, and the Transaction Account Guarantee
Program, by which the FDIC will guarantee certain noninterest-bearing and low
interest-bearing transaction accounts.  The Debt Guarantee Program
provides for an FDIC guarantee as to the payment of all senior unsecured debt
(with a term of more than 30 days) issued by a qualified participating entity
(insured depository institutions, bank and financial holding companies, and
certain savings and loan holding companies) up to a limit of 125 percent of all
senior unsecured debt outstanding on September 30, 2008, and maturing by June
30, 2009.  The FDIC guarantee is until June 30, 2012, and the fee for
such guarantee depends on the term with a maximum of 100 basis points for terms
in excess of 365 days.  The Transaction Account Guarantee Program is
the second part of the FDIC’s Temporary Liquidity Guarantee
Program.  The FDIC provides for a temporary full guarantee held at a
participating FDIC-insured depository institution of noninterest-bearing and low
interest-bearing transaction accounts above the existing deposit insurance limit
at the additional cost of 10 basis points per annum.  This coverage
became effective on October 14, 2008, and will continue through June 30,
2010.





On July
30, 2008, the Housing and Economic Recovery Act was was signed the
President.  It authorizes the Federal Housing Administration to
guarantee up to $300 billion in new 30-year fixed rate mortgages for subprime
borrowers if lenders write-down principal loan balances to 90 percent of current
appraisal value.  It is also intended to restore confidence in Fannie
Mae and Freddie Mac by strengthening regulations and injecting capital into
them.  States will be authorized to refinance subprime loans using
mortgage revenue bonds.  It also establishes the Federal Housing
Finance Agency out of the Federal Housing Finance Board and Office of Federal
Housing Enterprise Oversight.





In 2008,
the Federal Reserve Board, the FDIC, the Office of the Comptroller of the
Currency, and the Office of Thrift Supervision amended their regulatory capital
rules to permit banks, bank holding companies, and savings associations (as to
any of these a “financial institution”) to reduce the amount of goodwill that a
banking organization must deduct from tier 1 capital by the amount of any
deferred tax liability associated with that goodwill.  However, a
financial institution that reduces the amount of goodwill deducted from tier 1
capital by the amount of the deferred tax liability is not permitted to net this
deferred tax liability against deferred tax assets when determining regulatory
capital limitations on deferred tax assets.  For these financial
institutions, the amount of goodwill deducted from tier 1 capital will reflect
each institution’s maximum exposure to loss in the event that the entire amount
of goodwill is impaired or derecognized, an event which triggers the concurrent
derecognition of the related deferred tax liability for financial reporting
purposes.





On
October 7, 2008 the FDIC adopted a restoration plan that would increase the
rates banks pay for deposit insurance, and proposed rules for adjusting the
system that determines what deposit insurance premium rate a bank pays the
FDIC.  Currently, banks pay anywhere from five basis points to 43
basis points for deposit insurance. Under the proposal rule, the assessment rate
schedule would be raised uniformly by 7 basis points (annualized) beginning on
January 1, 2009.  Beginning with the second quarter of 2009, changes
would be made to the deposit insurance assessment system to make the increase in
assessments fairer by requiring riskier institutions to pay a larger
share.  Together, the proposed changes would improve the way the
system differentiates risk among insured institutions and help ensure that the
reserve ratio returns to at least 1.15 percent by the end of
2013.  The proposed changes to the assessment system include assessing
higher rates to institutions with a significant reliance on secured liabilities,
which generally raises the FDIC's loss in the event of failure without providing
additional assessment revenue.  The proposal also would assess higher
rates for institutions with a significant reliance on brokered deposits but, for
well-managed and well-capitalized institutions, only when accompanied by rapid
asset growth.  Brokered deposits combined with rapid asset growth have
played a role in a number of costly failures, including some recent
ones.  The proposal also would provide incentives in the form of a
reduction in assessment rates for institutions to hold long-term unsecured debt
and, for smaller institutions, high levels of Tier 1 capital.  The
FDIC also voted to maintain the Designated Reserve Ratio at 1.25 percent as a
signal of its long term target for the fund.





The
Federal Reserve Board in October 2008 approved final amendments to Regulation C
that revise the rules for reporting price information on higher-priced mortgage
loans.  The changes are intended to improve the accuracy and
usefulness of data reported under the Home Mortgage Disclosure
Act.  Regulation C currently requires lenders to collect and report
the spread between the annual percentage rate (APR) on a mortgage loan and the
yield on a Treasury security of comparable maturity if the spread is greater
than 3.0 percentage points for a first lien loan or greater than 5.0 percentage
points for a subordinate lien loan.  This difference is known as a
rate spread.  Under the final rule, a lender will report the spread
between the loan's APR and a survey-based estimate of APRs currently offered on
prime mortgages of a comparable type ("average prime offer rate") if the spread
is equal to or greater than 1.5 percentage points for a first lien loan or equal
to or greater than 3.5 percentage points for a subordinate-lien
loan.  The Board will publish average prime offer rates based on the
Primary Mortgage Market Survey® currently published by Freddie
Mac.  In setting the rate spread reporting threshold, the Board sought
to cover subprime mortgages and generally avoid covering prime
mortgages.  The changes to Regulation C conform the threshold for rate
spread reporting to the definition of higher-priced mortgage loans adopted by
the Board under Regulation Z (Truth in Lending) in July of
2008.


16
 Table of Contents








The
Federal Reserve Board in July 2008 approved a final rule for home mortgage loans
to better protect consumers and facilitate responsible lending.  The
rule prohibits unfair, abusive or deceptive home mortgage lending practices and
restricts certain other mortgage practices.  The final rule also
establishes advertising standards and requires certain mortgage disclosures to
be given to consumers earlier in the transaction.  The final rule,
which amends Regulation Z (Truth in Lending) and was adopted under the Home
Ownership and Equity Protection Act (HOEPA), largely follows a proposal released
by the Board in December 2007, with enhancements that address ensuing public
comments, consumer testing, and further analysis.





The final
rule adds four key protections for a newly defined category of "higher-priced
mortgage loans" secured by a consumer's principal dwelling.  For loans
in this category, these protections will:





·
            Prohibit
      a lender from making a loan without regard to borrowers' ability to repay
      the loan from income and assets other than the home's value.  A
      lender complies, in part, by assessing repayment ability based on the
      highest scheduled payment in the first seven years of the
      loan.  To show that a lender violated this prohibition, a
      borrower does not need to demonstrate that it is part of a "pattern or
      practice."


·
            Require
      creditors to verify the income and assets they rely upon to determine
      repayment ability.


·
            Ban
      any prepayment penalty if the payment can change in the initial four
      years.  For other higher-priced loans, a prepayment penalty
      period cannot last for more than two
years.


·
            Require
      creditors to establish escrow accounts for property taxes and homeowner's
      insurance for all first-lien mortgage
loans.





In
addition to the rules governing higher-priced loans, the rules adopt the
following protections for loans secured by a consumer's principal dwelling,
regardless of whether the loan is higher-priced:





·
            Creditors
      and mortgage brokers are prohibited from coercing a real estate appraiser
      to misstate a home's value.


·
            Companies
      that service mortgage loans are prohibited from engaging in certain
      practices, such as pyramiding late fees.  In addition, servicers
      are required to credit consumers' loan payments as of the date of receipt
      and provide a payoff statement within a reasonable time of
      request.


·
            Creditors
      must provide a good faith estimate of the loan costs, including a schedule
      of payments, within three days after a consumer applies for any mortgage
      loan secured by a consumer's principal dwelling, such as a home
      improvement loan or a loan to refinance an existing
      loan.  Currently, early cost estimates are only required for
      home-purchase loans.  Consumers cannot be charged any fee until
      after they receive the early disclosures, except a reasonable fee for
      obtaining the consumer's credit
history.





For all
mortgages, the rule also sets additional advertising
standards.  Advertising rules now require additional information about
rates, monthly payments, and other loan features.  The final rule bans
seven deceptive or misleading advertising practices, including representing that
a rate or payment is "fixed" when it can change.  The rule's
definition of "higher-priced mortgage loans" will capture virtually all loans in
the subprime market, but generally exclude loans in the prime
market.  To provide an index, the Federal Reserve Board will publish
the "average prime offer rate," based on a survey currently published by Freddie
Mac.  A loan is higher-priced if it is a first-lien mortgage and has
an annual percentage rate that is 1.5 percentage points or more above this
index, or 3.5 percentage points if it is a subordinate-lien
mortgage.  The new rules take effect on October 1,
2009.  The single exception is the escrow requirement, which will be
phased in during 2010 to allow lenders to establish new systems as
needed.





In
California, the enactment of AB329 in 2009, the Reverse Mortgage Elder
Protection Act of 2009 prohibits a lender or any other person who participates
in the origination of the mortgage from participation in, being associated with,
or employing any party that participates in or is associated with any other
financial or insurance activity or referring a prospective borrower to anyone
for the purchase of other financial or insurance products; and imposes certain
disclosure requirements on the lender.





The
enactment of AB1160 in 2009, requires a supervised financial institution in
California that negotiates primarily in any of a number of specified languages
in the course of entering into a contract or agreement for a loan or extension
of credit secured by residential real property, to deliver, prior to the
execution of the contract or agreement, and no later than 3 business days after
receiving the written application, a specified form in that language summarizing
the terms of the contract or agreement; provides for administrative penalties
for violations; and requires the California Department of Corporations and the
Department of Financial Institutions to create a form for providing translations
and make it available in Spanish, Chinese, Tagalog, Vietnamese and
Korean.  The statute becomes operative on July 1, 2010, or 90 days
after issuance of the form, whichever occurs later.


17
 Table of Contents








The
enactment of AB 1291 in 2009 makes changes to the California Unclaimed Property
Law including (among other things): allowing electronic notification to
customers who have consented to electronic notice; requiring that notices
contain certain information and allow the holder to provide electronic means to
enable the owner to contact the holder in lieu of returning the prescribed form
to declare the owner’s intent; authorizing the holder to give additional
notices; and requiring, beginning January 1, 2011, a banking or financial
organization to provide a written notice regarding escheat at the time a new
account or safe deposit box is opened.





The
enactment of SB306 makes specified changes to clarify existing law related to
filing a notice of default on residential real property in California, including
(among other things): clarifying that the provisions apply to mortgages and
deeds of trust recorded from January 1, 2003 through December 31, 2007, secured
by owner-occupied 3 4 residential real property containing no more than 4
dwelling units; revising the declaration to be filed with the notice of default;
specifying how the loan servicers have to maximize net present value under their
pooling and servicing agreements applies to certain investors; specifying how
and when the notice to residents of property subject to foreclosure is to be
mailed; and extending the time during which the notice of sale must be recorded
from 14 to 20 days.  The bill also makes certain changes related to
short-pay agreements and short-pay demand statements.





On
February 20, 2009, Governor Schwarzenegger signed ABX2 7 and SBX2 7, which
established the California Foreclosure Prevention Act.  The California
Foreclosure Prevention Act modifies the foreclosure process to provide
additional time for borrowers to work out loan modifications while providing an
exemption for mortgage loan servicers that have implemented a comprehensive loan
modification program. Civil Code Section 2923.52 requires an additional 90 day
period beyond the period already provided before a Notice of Sale can be given
in order to allow all parties to pursue a loan modification to prevent
foreclosure of loans meeting certain criteria identified in that
section.





A
mortgage loan servicer who has implemented a comprehensive loan modification
program may file an application for exemption from the provisions of Civil Code
Section 2923.52.  Approval of this application provides the mortgage
loan servicer an exemption from the additional 90-day period before filing the
Notice of Sale when foreclosing on real property covered by the new
law.





California
Assembly Bill 1301 was signed by the Governor on July 16, 2008 and became law on
January 1, 2009.  Among other things, the bill eliminated unnecessary
applications that consume time and resources of bank licensees and which in many
cases are now perfunctory.  All of current Article 5 – “Locations of
Head Office” of Chapter 3, and all of Chapter 4 – “Branch Offices, Other Places
of Business and Automated Teller Machines” were repealed.  A new
Chapter 4 – “Bank Offices” was added.  The new Chapter 4 requires
notice to the California Department of Financial Institutions (“DFI”) the
establishment of offices, rather than the current application
process.  Many of the current branch applications are perfunctory in
nature and/or provide for a waiver of application.  Banks, on an
exception basis, may be subject to more stringent requirements as deemed
necessary.  As an example, new banks, banks undergoing a change in
ownership and banks in less than satisfactory condition may be required to
obtain prior approval from the DFI before establishing offices if such activity
is deemed to create an issue of safety and soundness.  The bill
eliminated unnecessary provisions in the Banking Law that are either outdated or
have become undue restrictions to bank licensees.  Chapter 6 – “Powers
and Miscellaneous Provisions” was repealed.  A new Chapter 6 -
“Restrictions and Prohibited Practices” was added.  This chapter
brings together restrictions in bank activities as formerly found in Chapter 18
– “Prohibited Practices and Penalties.”  However, in bringing the
restrictions into the new chapter, various provisions were updated to remove the
need for prior approval by the DFI Commissioner.  The bill renumbered
current Banking Law sections to align like sections.  Chapter 4.5 –
“Authorizations for Banks” was added. The purpose of the chapter is to provide
exceptions to certain activities that would otherwise be prohibited by other
laws outside of the Financial Code.  The bill added Article 1.5 -
“Loan and Investment Limitations” to Chapter 10 – “Commercial
Banks.”  This article is new in concept and acknowledges that
investment decisions are business decisions – so long as there is a
diversification of the investments to spread any risk.  The risk is
diversified in this article by placing a limitation on the loans and investments
that can be made to any one entity.  This section is a trade-off for
elimination of applications to the DFI for approval of investments in
securities, which were repealed.


18
 Table of Contents


Other
changes AB 1301 made to the Banking Law:





•
      Authorized a bank or trust acting in any capacity under a court or private
      trust to arrange for the deposit of securities in a securities depository
      or federal reserve bank, and provided how they may be held by the
      securities depository;


•
      Reduced from 5% to 1% the amount of eligible assets to be maintained at an
      approved depository by an office of a foreign (other nation) bank for the
      protection of the interests of creditors of the bank’s business in this
      state or for the protection of the public
  interest;


•
      Enabled the DFI to issue an order against a bank licensee parent or
      subsidiary;


•
      Provided that the examinations may be conducted in alternate examination
      periods if the DFI concludes that an examination of the state bank by the
      appropriate federal regulator carries out the purpose of this section, but
      the DFI may not accept two consecutive examination reports made by federal
      regulators;


•
      Provided that the DFI may examine subsidiaries of every California state
      bank, state trust company, and foreign (other nation) bank to the extent
      and whenever and as often as the DFI shall deem
  advisable;


•
      Enabled the DFI issue an order or a final order to now include any bank
      holding company or subsidiary of the bank, trust company, or foreign
      banking corporation that is violating or failing to comply with any
      applicable law, or is conducting activities in an unsafe or injurious
      manner;


•
      Enabled the DFI to take action against a person who has engaged in or
      participated in any unsafe or unsound act with regard to a bank, including
      a former employee who has left the
bank.





Recent
Accounting Pronouncements





See Note
2 – “Summary of Significant Accounting Policies – Adoption of New Financial
Accounting Standards” of the Company’s Consolidated Financial Statements in Item
8 – Financial Statements and Supplementary Data of this Annual Report on Form
10K for information related to recent accounting pronouncements.





ITEM 1A - RISK FACTORS





Continued deterioration of local real
estate values could reduce our profitability.  At December 31,
2009, approximately 79% of the Company’s loan portfolio was secured by real
estate.  There was a rapid increase in real estate values in our
market area in recent years which peaked in mid-2007. Subsequently, our market
area has experienced significant declines in real estate values.  A
continued downturn in such values would likely reduce the security for many of
our loans and adversely affect the ability of many of our borrowers to repay
their loan from us.





Deterioration of local economic
conditions could reduce our profitability. Our lending operations and
customer base are concentrated in Tulare and Fresno Counties which are located
in the Central Valley region of California.  General recessionary
conditions in our market area could directly affect the Company by causing us to
incur losses associated with higher default rates and decreased collateral
values in our loan portfolio.  In addition, Tulare and Fresno Counties
are among the leading counties in the United States for agricultural production
and a significant downturn in the local agricultural economy due to commodity
prices, real estate prices, public policy decisions, natural disaster, or other
factors could result in a decline in the local economy in general, which could
in turn negatively impact the Company.





The Company’s strategies for growth
may prove to be unsuccessful and reduce profitability. The Company
intends to continue expanding within the South San Joaquin Valley by opening de
novo branches and loan production offices, and by acquiring branches from other
institutions.  The success of such expansion is dependent upon the
Company’s ability to attract and retain qualified personnel, negotiate
effectively, manage a growing number of customer relationships, and maintain
cost controls and asset quality while attracting additional loans and deposits
on favorable terms.  If the Company is unsuccessful in any of these
areas, its financial performance could be adversely affected. In addition,
future expansion may result in compliance and operational deficiencies which may
require less aggressive growth or additional expenditures to expand the
operational infrastructure.





If the Company’s allowance for loan
losses is not sufficient to absorb actual loan losses, our profitability could
be reduced.The risk of loan losses is inherent in the lending
business.The
Company maintains an allowance for loan losses (ALL) based upon the Company’s
actual losses over a relevant time period and management’s assessment of all
relevant qualitative factors that may cause future loss experience to differ
from its historical loss experience.  Although the Company maintains a
rigorous process for determining the ALL, it can give no assurance that it will
be sufficient to cover future loan losses.  If the allowance for loan
losses is not adequate to absorb future losses, or if bank regulatory agencies
require the Company to increase its ALL, earnings could be significantly and
adversely impacted.


19
 Table of Contents


Fluctuations in interest rates could
reduce profitability.The Company’s earnings depend largely
upon net interest income, which is the difference between the total interest
income earned on interest earning assets (primarily loans and investment
securities) and the total interest expense incurred on interest bearing
liabilities (primarily deposits and borrowed funds).  The interest
earned on assets and paid on liabilities are affected principally by direct
competition, and general economic conditions at the state and national level and
other factors beyond the Company’s control such as actions of the Federal
Reserve Board, the general supply of money in the economy, legislative tax
policies, governmental budgetary matters, and other state and federal economic
policies.  Although the Company maintains a rigorous process for
managing the impact of possible interest rate fluctuations on earnings, the
Company can provide no assurance that its management efforts will prevent
earnings from being significantly and adversely impacted by changes in interest
rates.





Disruptions in market conditions may
adversely impact the fair value of available-for-sale investment
securities.  Generally Accepted Accounting Principles (GAAP)
require the Company to carry its available-for-sale investment securities at
fair value on its balance sheet. Unrealized gains or losses on these securities,
reflecting the difference between the fair market value and the amortized cost,
net of its tax effect, are reported as a component of shareholders’
equity.  In certain instances GAAP requires recognition through
earnings of declines in the fair value of securities that are deemed to be other
than temporarily impaired.  The disruptions that may be of most
consequence to the Company include the financial condition of government
sponsored enterprises and insurers of municipal bonds, which reduced market
liquidity and fair value for the Company’s holdings of mortgage-backed
securities and municipal bonds, respectively.  Although certain of
these financial disruptions have subsided, management expects continued
volatility in the fair value of the Company’s available-for-sale investment
securities and is not able to predict when or if the fair value of such
securities will regain, relative to interest rates, the valuations that existed
prior to the 2008 financial market disruptions, or if any of its
available-for-sale investment securities will become other than temporarily
impaired.





Further deterioration in the
financial condition of the Federal Home Loan Bank (FHLB) of San Francisco may
adversely impact the Company’s investment in FHLB.The Company
is a voluntary member of the FHLB of San Francisco, and is required to make an
equity investment in the FHLB as a condition of borrowing money from
it.  In the fourth quarter of 2008, the FHLB of San Francisco
announced certain weaknesses in its financial condition and suspended payment of
dividends on its stock and retirement of excess stock held by member
institutions.  If there are any further developments that cause the
value of the Company’s stock investment in the FHLB of San Francisco to become
impaired, the Company would be required to write down the value of its
investment, which in turn could affect the Company’s net income and
shareholder’s equity.  At December 31, 2009 our investment in FHLB
stock was approximately $1.1 million.





Strong competition may reduce
profitability. Along with larger national and regional banks and other
local banks, the Company competes for customers with finance companies,
brokerage firms, insurance companies, credit unions, and internet-based
banks.  Certain of these competitors have advantages over the Company
in accessing funding and in providing various services, or, in the case of
credit unions, are significantly tax advantaged.  Major banks have
substantially larger lending limits than the Company and can perform certain
functions for their customers which the Company is not presently able to offer
directly.  Other existing single or multi-branch community banks, or
new community bank start-ups, have marketing strategies similar to the Company’s
and compete for the same management personnel and the same potential acquisition
and merger candidates. Ultimately, competition can reduce our profitability, as
well as make it more difficult to increase the size of our loan portfolio and
deposit base.





Security breaches and technological
disruptions could damage the Company’s reputation and
profitability.  The Company’s electronic banking activities
expose it to possible liability and loss of reputation should an unauthorized
party gain access to confidential customer information.  Despite it’s
considerable efforts and investment to provide the security and authentication
necessary to effect secure transmission of data, the Company cannot fully
guarantee that these precautions will protect it’s systems from future
compromises or breaches of its security measures.  Additionally, the
Company outsources a large portion of its data processing to third parties which
may encounter technological or other difficulties that may significantly affect
the Company’s ability to process and account for customer
transactions.





Loss of executive officers or key
personnel could reduce the Company’s future profitability.  The
Company depends upon the skills and reputations of its executive officers and
other key employees for its future success. The loss of any of these key persons
could adversely affect the Company. No employment or non-compete agreements have
been executed with any Company employee and therefore no assurance can be given
that the Company will be able to retain its existing key personnel or that key
personnel will not, upon leaving the Company’s employment, become employed by a
competing institution.


20
 Table of Contents


Preferred
Stock





On
January 30, 2009, the Company entered into a letter Agreement (the “Purchase
Agreement”) with the United States Department of the Treasury (“Treasury”),
pursuant to which the Company issued and sold (i) 7,700 shares of the Company’s
Fixed Rate Cumulative Preferred Stock, Series B (the “Series B Preferred Stock”)
and (ii) a warrant to purchase 385 shares of the Company’s Fixed Rate Cumulative
Perpetual Preferred Stock Series C stock, (the “Warrant Preferred” or “Series C
Preferred Stock”) for a combined purchase price of $7,700,000 and were recorded
net of $25,783 in offering costs.  The Treasury exercised the Warrant
immediately upon issuance.





The
Series B Preferred Stock will Qualify as Tier 1 capital and will pay cumulative
dividends quarterly at a rate of 5% per annum for the first five years, and 9%
per annum thereafter.  The Warrant Preferred will pay cumulative
dividends at a rate of 9% per annum until redemption.  The terms
governing the Series B Preferred Stock and the Series C Preferred Stock provide
that either series may be redeemed by the Company after three years; however,
the Warrant Preferred may not be redeemed until after all the Series B Preferred
stock has been redeemed, and prior to the end of three years, the Series B
Preferred stock and the Warrant Preferred may be redeemed by the Company only
with proceeds from the sale of Qualifying equity securities of the Company (a”
Qualified Equity Offering”).  The American Recovery and Reinvestment
Act of 2009, which was enacted on February 17, 2009 permits the Company to
redeem the Series B Preferred stock and the Warrant Preferred without a
Qualified Equity Offering, subject to the Company’s consultation with the Board
of Governors of the Federal Reserve System.





The
Series B Preferred Stock and the Warrant Preferred were issued in a private
placement exempt from registration pursuant to Section 4(2) of the Securities
Act of 1933, as amended.  Neither the Series B Preferred Stock nor the
Warrant Preferred will be subject to any contractual restrictions on transfer,
except that Treasury and its transferees shall not effect any transfer of the
Preferred which would require the Company to become subject to the periodic
reporting requirements of Section 13 or 15(d) of the Exchange Act.





In the
Purchase Agreement, the Company agreed that, until such time as Treasury ceases
to own any debt or equity securities of the Company acquired pursuant to the
Purchase Agreement, the Company will take all necessary action to ensure that
its benefit plans with respect to its senior executive officers comply with
Section 111(b) of the Emergency Economic Stabilization Act of 2008 (the “EESA”)
as implemented by any guidance or regulation under the EESA that has been issued
and is in effect as of the date of issuance of the Series B Preferred Stock and
the Warrant, and has agreed to not adopt any benefit plans with respect to, or
which covers, its senior executive officers that do not comply with the EESA,
and the applicable executives have consented to the
foregoing.  Furthermore, the Purchase Agreement allows Treasury to
unilaterally amend the terms of the agreement.





With
respect to dividends on the Company’s common stock, Treasury’s consent shall be
required for any increase in common dividends per share until the third
anniversary of the date of its investment unless prior to such third anniversary
the Series B Preferred Stock and the Warrant Preferred is redeemed in whole or
the Treasury has transferred all of the Senior Preferred Series B Preferred
Stock and Warrant Preferred to third parties.  After the third
anniversary and prior to the tenth anniversary, the Treasury’s consent shall be
required for any increase in aggregate common dividends per share provided that
no increase in common dividends may be made as a result of any dividend paid in
common shares, any stock split or similar transaction.  From and after
the tenth anniversary, the Company shall be prohibited from paying common
dividends or repurchasing any equity securities or trust preferred securities
until all equity securities held by the Treasury are redeemed in whole or the
Treasury has transferred all of such equity securities to third
parties.


21
 Table of Contents


ITEM 1B – UNRESOLVED STAFF COMMENTS





The
Company has no unresolved staff comments with the Securities and Exchange
Commission.




ITEM 2 – PROPERTIES





The
following table summarizes certain information about the Company’s main office
and branch offices:





Office location
            Year opened
            Approximate
              square footage
            Owned or leasedVisalia
      branch office (prior location)
              200
      South Court Street
              Visalia,
      California
            1996
            8,700
            LeasedVisalia
      branch and Administrative offices
              701
      W. Main Street
              Visalia,
      California
            2009
            18,700
            OwnedFresno
      branch
              7391
      N.  Palm Avenue
              Fresno,
      California
            2003
            4,654
            LeasedWoodlake
      branch
              232
      North Valencia
              Woodlake,
      California
            1998
            5,000
            OwnedTipton
      branch
              174
      South Burnett
              Tipton,
      California
            1998
            5,610
            OwnedTulare
      branch
              1901
      E. Prosperity
              Tulare,
      California
            2008
            4,135
            Owned





In
February 2009, the Company purchased an 18,700 square foot office building to
house both the Visalia Branch and Administration Offices.  The new
building is located at 701 W. Main Street, Visalia, California which is in close
proximity to the leased Visalia branch location.  The new building was
fully occupied in January 2010.  The Company ended its lease
agreements for its former administrative and Visalia branch facilities at the
end of November 2009 and February 2010, respectively.  The Visalia
main office lease was extended until February 28, 2010 at $19,167 per
month.





The
Fresno branch is leased under a noncancelable operating lease with a
nonaffiliated third party with no option to extend.  The primary
operating area consists of approximately 4,654 square feet of space in a
single-story building.  The lease arrangement for the primary
operating area is a “triple net lease” expiring September 30,
2017.  Monthly rent under the lease is $7,911 through the fifth year
and $9,541 for the last five years.





The
Woodlake and Tipton branch offices were purchased from Bank of America in
1998.  The Tulare Branch was constructed by the Company and opened in
May 2008.  It replaced the Tulare Loan Production Office which had
operated in a leased facility.





At
December 31, 2009, the total net book value of the Company’s land, buildings,
leasehold improvements and equipment was approximately
$8,042,000.  Each of the Company’s facilities is considered to be in
good condition and adequately covered by insurance.


22
 Table of Contents


The
Company maintains insurance coverage on its premises, leaseholds and equipment,
including business interruption and record reconstruction coverage.
 
  The branch
properties and non-branch offices are adequate, suitable, in good condition and
have adequate parking facilities for customers and employees.  The
Company and Bank are limited in their investments in real property under Federal
and state banking laws.  Generally, investments in real property are
either for the Company and Bank use or are in real property and real property
interests in the ordinary course of the Bank’s business.





ITEM 3 – LEGAL PROCEEDINGS





From time
to time the Company may be subject to legal proceedings and claims in the
ordinary course of business. These claims, even if not meritorious, could result
in the expenditure of significant financial and managerial resources. Management
is not aware of any legal proceedings or claims that it believes could
materially harm the Company’s business or revenues.





ITEM 4 – RESERVED








23
 Table of Contents


PART
II





ITEM5 – MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES





General





The
Company’s common stock is traded on the OTC Bulletin Board under the symbol
“VCBP.OB.”  Historically, there has been a limited over-the-counter
market for the Company’s common stock.  Wedbush Morgan Securities Inc.
and Howe Barnes Hoefer & Arnett Inc. have acted as market makers for the
Company’s common stock.  These market makers have no obligation to
make a market in the Company’s common stock, and they may discontinue making a
market at any time.





The
information in the following table indicates the high and low “bid” quotations
for the Company’s common stock for each quarterly period since January 1, 2008,
and is based upon information provided by market makers.  These
quotations reflect inter-dealer prices, without retail mark-up, mark-down, or
commission, do not reflect actual transactions, which have been very sporadic,
and do not include nominal amounts traded directly by shareholders or through
other dealers who are not market makers.  In addition, the quotations
have been adjusted for 5% stock dividends paid in June 2009 and June
2008.





High and low bid quotationsHigh
            
            
            Low2009Fourth
      quarter
            
            $
            7.50
            
            
            $
            5.64Third
      quarter
            
            
            9.01
            
            
            
            6.50Second
      quarter
            
            
            9.99
            
            
            
            5.00First
      quarter
            
            
            10.00
            
            
            
            3.002008Fourth
      quarter
            
            $
            11.90
            
            
            $
            6.71Third
      quarter
            
            
            12.38
            
            
            
            9.53Second
      quarter
            
            
            14.29
            
            
            
            9.53First
      quarter
            
            
            14.01
            
            
            
            12.47





As of
February 18, 2010, there were 379 record holders of the Company’s common stock
and approximately 467 beneficial holders.





Dividend Policy. The
Securities Purchase Agreement between the Company and the Treasury, which become
effective on January 30, 2009 and pursuant to which the Company sold $7.7
million of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series
B and Fixed Rate Cumulative Perpetual Preferred Stock, Series C Preferred Stock
(the “Treasury Preferred Stock”) and the terms governing the Treasury Preferred
Stock, provides that prior to the earlier of (i) January 30, 2012 and (ii) the
date on which all of the shares of the Treasury Preferred Stock have been
redeemed by the Company, the Company may not, without the consent of the
Treasury, pay cash dividends on the Company’s common stock or (b) subject to
limited exceptions, redeem, repurchase or otherwise acquire shares of the
Company’s common stock.  In addition, the Company is unable to pay any
dividends on the Company’s common stock unless the Company is current in the
Company’s dividend payments on the Treasury Preferred Stock.  Holders
of the Company’s common stock are entitled to receive dividends only when and if
declared by the Company’s Board of Directors.





Cumulative
dividends accrue on the 7,700 outstanding shares of the Company’s Series B
Preferred Stock at the rate of 5% per annum on the aggregate liquidation
preference of $7.7 million for the first five years and then 9% per annum
thereafter.  Dividends accrue on the 385 outstanding shares of the
Company’s Series C Preferred Stock at the rate of 9% on the aggregate
liquidation preference of $385,000 per annum.  The dividends will be
paid only as declared by the Board of Directors of the
Company.  However, in the event dividends on either series of the
Treasury Preferred Stock have not been paid for six or more quarters, whether or
not consecutive, the holders of such shares will have the right to elect two
members to the Company’s Board of Directors.  As of December 31, 2009
the Company has paid $304,792 in Series B Preferred Stock dividends and $27, 431
in Series C Preferred Stock dividends.





The
Company has not paid any cash dividends on common stock since its inception in
1996.  The Company intends to retain any future earnings for the
development and operations of its business and accordingly does not anticipate
paying cash dividends on its common stock in the foreseeable
future.


24
 Table of Contents


Holders
of the Company’s common stock will be entitled to receive such cash dividends as
may be declared by the board of directors out of funds legally available for
that purpose.  The Company is also subject to certain restrictions on
dividends under the California General Corporation Law.  Generally,
California law permits the Company to pay dividends not exceeding its retained
earnings.  In the alternative, the Company may pay a greater amount as
dividends if its tangible assets after the dividends would be at least 125% of
its liabilities (other than certain deferred items) and certain financial ratio
tests are met.  However, a bank holding company ordinarily cannot meet
these alternative requirements.  In addition, the Company has agreed
not to pay cash dividends if it is in default or deferring interest payments on
trust preferred securities.





The
Company’s ability to pay cash dividends will also depend to a large extent upon
the amount of cash dividends paid by the Bank to Valley Commerce
Bancorp.  The ability of the Bank to pay cash dividends will depend
upon its earnings and financial condition.  Under California law, a
California-chartered bank may pay dividends not exceeding the lesser of its
retained earnings or its net income for the last three fiscal years (less any
previous dividends; provided, with the prior regulatory approval, a bank may pay
dividends not exceeding the greatest of (a) its retained earnings, (b) its net
income for the previous fiscal year or (c) its net income for the current fiscal
year).  The Company’s ability to pay dividends is also subject to
certain covenants contained in the indentures related to its trust preferred
securities and the terms of the Securities Purchase Agreement and those
governing the Treasury Preferred Stock.  However, the Bank has no
formal dividend policy, and dividends are issued in the sole discretion of the
Bank’s board of directors.  There can be no assurance as to when or
whether a dividend will be paid or the amount of any dividend.  The
Bank currently has a policy of retaining earnings to support the growth of the
Bank except as necessary to enable Valley Commerce Bancorp to pay its direct
expenses and amounts due under subordinated debentures issued in connection with
trust preferred securities.





The
Company paid 5% stock dividends in each year from 2000 to 2009, except for
2005.  The Company also issued a three-for-two stock split in
September 2004.





Repurchases.  On
November 13, 2007, the Company announced that its Board of Directors authorized
a common stock repurchase plan.  The plan calls for the repurchase of
up to an aggregate of $3,000,000 of the Company’s Common Stock.  The
repurchase program commenced in November of 2007 and will continue for a period
of twelve months thereafter, subject to earlier termination at the Company’s
discretion.  The number price and timing of the repurchase shall be at
the Company’s sole discretion and the plan may be re-evaluated depending on
market conditions, liquidity needs or other factors.  The Board, based
on such re-evaluations, may suspend, terminate, modify or cancel the plan at any
time without notice.  On October 21, 2009, the Board of Directors
extended the share repurchase program until November 30, 2010.





As
discussed above, the Securities Purchase Agreement between the Company and the
Treasury contains provisions that restrict the Company’s ability to repurchase
Valley Commerce Bancorp common stock.  Under the Purchase Agreement,
prior to January 30, 2012, unless the Company has redeemed the Preferred Shares,
or the Treasury has transferred the Preferred Shares to a third party, the
consent of the Treasury will be required for the Company to redeem, purchase or
acquire any shares of Common Stock or other equity or capital securities, other
than in connection with benefit plans consistent with past practice and certain
other circumstances specified in the Purchase Agreement.


25
 Table of Contents


Share
repurchases are summarized in the following table:








Period
            
            (a)
              Total
              number
      of
              shares
              purchased
            
            (b)
              Average
              price
      paid
              per
      share
            
            (c)
              Total
      number of
              shares
      purchased as
              part
      of publicly
              announced
      plans or
              programs
            
            
            (d)
              Maximum
      number (or
              approximate
      dollar value)
              of
      shares that may yet be
              purchased
      under the plans
              or
      programsNovember
      2007
            
            
            30,251
            (1)
            
            $
            12.62
            (1)
            
            
            30,251
            
            
            $
            2,618,191February
      2008
            
            
            51,118
            (1)
            
            
            13.76
            (1)
            
            
            51,118
            
            
            
            1,914,690March
      2008
            
            
            7,348
            (1)
            
            
            13.70
            (1)
            
            
            7,348
            
            
            
            1,814,073November
      2008
            
            
            1,787
            (2)
            
            
            9.47
            (2)
            
            
            1,767
            
            
            
            1,797,154Total
            
            
            90,504
            
            
            $
            13.29
            
            
            
            90,504
            
            
            $
            1,797,154





(1)
            Restated
      for June 2009 and 2008 stock dividends.  No shares were
      repurchased in any month except those listed
  above.


(2)
            Restated
      for June 2009 stock dividend.





Equity
Compensation Plan Information





In 1997
and 2007, the Company established Stock Option Plans for which shares of stock
are reserved for issuance to employees and directors under incentive and
nonstatutory agreements.  During 2009, non-statutory stock options for
11,168 shares of common stock were exercised.  No incentive stock
options were exercised and no stock options were granted.  During
2008, incentive stock options for 380 shares of common stock and non-statutory
stock options for 15,513 shares of common stock were exercised, and no stock
options were granted.





The
information in the following table is provided as of the end of the fiscal year
ended December 31, 2009, with respect to compensation plans (including
individual compensation arrangements) under which equity securities are
issuable:





Plan category
            
            Column
      (a)
              Number
      of securities to be issued upon exercise of outstanding options,
      warrants
              and rights
            
            
            Weighted-average
      exercise price of outstanding options, warrants and rights
            
            
            Number
      of securities remaining
              available
      for future issuance under equity compensation plans (excluding
      securities
              reflected in Column (a))Equity
      compensation plans approved by security holders
            
            
            162,320
            
            
            $
            9.67
            
            
            
            96,476Equity
      compensation plans not approved by security holders
            
            None
            
            
            Not
      applicable.
            
            
            None


26
 Table of Contents


ITEM 6 – SELECTED FINANCIAL DATA





The
following table presents a five year summary of selected financial information
which should be read in conjunction with the Company’s consolidated financial
statements and notes thereto included in Item 8, Financial Statements, and with
the Management’s Discussion and Analysis of Financial Condition and Results of
Operations which is included as Item 7.  The financial information
contained in the table is unaudited.  The results of operations for
2009 are not necessarily indicative of the results of operations that may be
expected for future years.








(dollars
      in thousands
            
            As of and for the year ended December
      31,except
      per share data)
            
            2009
            
            
            2008
            
            
            2007
            
            
            2006
            
            
            2005Statement
      of IncomeInterest
      income
            
            $
            16,929
            
            
            $
            17,784
            
            
            $
            18,470
            
            
            $
            16,750
            
            
            $
            12,504Interest
      expense
            
            
            4,089
            
            
            
            5,719
            
            
            
            7,131
            
            
            
            5,561
            
            
            
            2,683Net
      interest income
            
            
            12,840
            
            
            
            12,065
            
            
            
            11,339
            
            
            
            11,189
            
            
            
            9,821Provision
      for loan losses
            
            
            7,000
            
            
            
            1,600
            
            
            
            -
            
            
            
            -
            
            
            
            369Net
      interest income after provision for loan losses
            
            
            5,840
            
            
            
            10,465
            
            
            
            11,339
            
            
            
            11,189
            
            
            
            9,452Non-interest
      income
            
            
            2,037
            
            
            
            1,283
            
            
            
            1,155
            
            
            
            996
            
            
            
            888Non-interest
      expense
            
            
            9,659
            
            
            
            9,153
            
            
            
            8,699
            
            
            
            7,653
            
            
            
            6,810(Loss)
      income before (tax benefit) income taxes
            
            
            (1,782
            )
            
            
            2,595
            
            
            
            3,795
            
            
            
            4,532
            
            
            
            3,530(Tax
      benefit) income taxes
            
            
            (1,195
            )
            
            
            746
            
            
            
            1,134
            
            
            
            1,576
            
            
            
            1,367Net
      (loss) income
            
            
            (587
            )
            
            
            1,849
            
            
            
            2,661
            
            
            
            2,956
            
            
            
            2,163Per
      Share Data (4):Basic
      (loss) earnings per common share
            
            $
            (0.36
            )
            
            $
            0.71
            
            
            $
            1.02
            
            
            $
            1.16
            
            
            $
            0.86Diluted
      (loss) earnings per common share
            
            $
            (0.36
            )
            
            $
            0.70
            
            
            $
            0.99
            
            
            $
            1.10
            
            
            $
            0.81Book
      value per common share
            
            $
            11.17
            
            
            $
            11.60
            
            
            $
            11.48
            
            
            $
            10.94
            
            
            $
            10.00Avg.
      common shares outstanding-basic
            
            
            2,602,228
            
            
            
            2,595,128
            
            
            
            2,600,084
            
            
            
            2,549,134
            
            
            
            2,507,188Avg.
      common shares outstanding-diluted
            
            
            2,602,228
            
            
            
            2,623,301
            
            
            
            2,699,901
            
            
            
            2,678,061
            
            
            
            2,654,382Total
      common shares outstanding
            
            
            2,608,317
            
            
            
            2,473,739
            
            
            
            2,396,435
            
            
            
            2,215,765
            
            
            
            2,087,508Balance
      SheetAvailable-for-sale
      investment securities
            
            $
            42,566
            
            
            $
            42,018
            
            
            $
            56,615
            
            
            $
            55,298
            
            
            $
            50,391Total
      loans, net
            
            
            234,823
            
            
            
            226,697
            
            
            
            199,514
            
            
            
            182,332
            
            
            
            149,991Allowance
      for loan losses
            
            
            6,231
            
            
            
            3,244
            
            
            
            1,758
            
            
            
            1,746
            
            
            
            1,766Total
      assets
            
            
            340,172
            
            
            
            306,099
            
            
            
            279,081
            
            
            
            263,800
            
            
            
            228,011Total
      deposits
            
            
            294,282
            
            
            
            257,323
            
            
            
            215,386
            
            
            
            207,576
            
            
            
            192,581Total
      shareholders' equity
            
            
            36,869
            
            
            
            30,140
            
            
            
            28,873
            
            
            
            25,448
            
            
            
            21,909Selected
      Performance Ratios:(Loss)
      return on average assets
            
            
            (0.18
            %)
            
            
            0.62
            %
            
            
            0.99
            %
            
            
            1.22
            %
            
            
            1.05
            %(Loss)
      return on average equity
            
            
            (1.53
            %)
            
            
            6.30
            %
            
            
            9.83
            %
            
            
            12.59
            %
            
            
            10.44
            %Net
      interest margin (1)
            
            
            4.43
            %
            
            
            4.52
            %
            
            
            4.71
            %
            
            
            5.15
            %
            
            
            5.23
            %Average
      net loans as a percentage of average deposits
            
            
            85.3
            %
            
            
            89.7
            %
            
            
            91.0
            %
            
            
            85.8
            %
            
            
            78.3
            %Efficiency
      ratio
            
            
            64.9
            %
            
            
            68.6
            %
            
            
            69.6
            %
            
            
            62.8
            %
            
            
            63.6
            %


27
 Table of Contents


Selected
Financial Data (continued)





As of and for the year ended December
      31,2009
            
            
            2008
            
            
            2007
            
            
            2006
            
            
            2005Selected
      Asset Quality Ratios:Nonperforming
      assets to total assets
            
            
            2.2
            %
            
            
            1.6
            %
            
            
            ----
            (2)
            
            
            ----
            (2)
            
            
            0.0
            %(3)Nonperforming
      loans to total loans
            
            
            3.1
            %
            
            
            2.2
            %
            
            
            ----
            (2)
            
            
            ----
            (2)
            
            
            0.0
            %(3)Net
      loan charge-offs to average loans
            
            
            1.7
            %
            
            
            0.1
            %
            
            
            0.0
            %
            
            
            0.0
            %(3)
            
            
            0.0
            %(3)Allowance
      for loan losses to total loans
            
            
            2.58
            %
            
            
            1.41
            %
            
            
            0.87
            %
            
            
            0.95
            %
            
            
            1.16
            %Allowance
      for loan losses to nonperforming loans
            
            
            84.6
            %
            
            
            65.7
            %
            
            
            ----
            (2)
            
            
            ----
            (2)
            
            
            8409.5
            %Capital
      Ratios:BankLeverage
            
            
            11.4
            %
            
            
            10.8
            %
            
            
            11.4
            %
            
            
            11.0
            %
            
            
            11.3
            %Tier
      1 Risk-Based
            
            
            14.8
            %
            
            
            12.6
            %
            
            
            13.7
            %
            
            
            13.4
            %
            
            
            14.6
            %Total
      Risk-Based
            
            
            16.0
            %
            
            
            13.9
            %
            
            
            14.4
            %
            
            
            14.2
            %
            
            
            15.6
            %ConsolidatedLeverage
            
            
            11.4
            %
            
            
            10.9
            %
            
            
            11.5
            %
            
            
            11.1
            %
            
            
            11.5
            %Tier
      1 Risk-Based
            
            
            14.8
            %
            
            
            12.7
            %
            
            
            13.8
            %
            
            
            13.5
            %
            
            
            14.8
            %Total
      Risk-Based
            
            
            16.0
            %
            
            
            14.0
            %
            
            
            14.6
            %
            
            
            14.3
            %
            
            
            15.9
            %





Notes:
            (1)
            Interest
      income is not presented on a taxable-equivalent basis, however, the net
      interest margin was calculated on a taxable-equivalent basis by using a
      marginal tax rate of 34%


(2)
            There
      were no nonperforming assets or loans at December 31, 2007 and
      2006


(3)
            Less
      than .05%


(4)
            All
      share and per share data has been retroactively restated to reflect the 5%
      stock
      dividends issued in June 2009, June 2008, June 2007, and May
      2006.





28
 Table of Contents


ITEM 7 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS





The
following discussion and analysis should be read together with the selected
financial data appearing in Item 1, Business, and the financial statements and
notes thereto appearing in  Item 8, Financial Statements and
Supplementary Data, included in this Annual Report on Form 10-K.





Overview





The
Company is the holding company for Valley Business Bank, a California state
chartered bank.  The Company’s principal business is to provide,
through its banking subsidiary, financial services in its primary market area in
California. The Company serves Tulare and Fresno Counties and the surrounding
area through the Bank. The Company derives its income primarily from interest
earned on loans, and, to a lesser extent, interest on investment securities,
fees for services provided to deposit customers, and fees from the brokerage of
loans.  The Bank’s major operating expenses are the interest paid on
deposits and borrowings, and general operating expenses, including salaries and
employee benefits and, to a lesser extent, occupancy and equipment, data
processing and operations.  The Company does not currently conduct any
operations other than through the Bank.





Critical
Accounting Policies





The
Company’s financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America
(GAAP).  The Company’s accounting policies are integral to
understanding the financial results reported.  The most complex of
these accounting policies require management’s judgment to ascertain the
valuation of assets, liabilities, commitments and contingencies.  The
Company has established detailed policies and internal control procedures that
are intended to ensure valuation methods are well controlled and consistently
applied from period to period.  In addition, the policies and
procedures are intended to ensure that the process for changing methodologies
occurs in an appropriate manner.  The accounting areas where
management’s judgment is most likely to materially impact the Company’s
financial results are:





Allowance for Loan
Losses.The allowance for loan losses is maintained to provide
for estimated credit losses that it is probable the Company will incur as of the
balance sheet date.  Loans determined to be impaired are evaluated
individually by management for determination of the specific loss, if any, that
exists as of the balance sheet date.  In addition, reserve factors are
assigned to currently performing loans by loan type based on historical loss
rates and adjusted for various qualitative factors such as economic and market
conditions, concentrations and other trends within the loan
portfolio.  When management believes that additional reserves are
needed, the allowance for loan losses is increased by recording a charge to
operations through the provision for loan losses.  The allowance is
decreased as loans are charged-off, net of recoveries.





Management
believes the allowance for loan losses is a “critical accounting estimate”
because management’s estimate of loan losses on loans not already identified as
impaired; i.e., loans that are currently performing, requires management to
carefully evaluate the pertinent facts and circumstances as of the balance sheet
date to determine how much, if any, adjustment is required to the historical
loss rate for each loan type.  In addition, estimates of loan losses
on currently performing loans are subject to change in future reporting periods
as facts and circumstances change.  For example, a continued decline
in the California real estate market may result in management raising its
estimate of loan losses if such estimated losses are considered probable at the
balance sheet date.  Furthermore, the FDIC and California Department
of Financial Institutions, as an integral part of their examination process,
review the allowance for loan losses. These agencies may require additions to
the allowance for loan losses based on their judgment about information at the
time of their examinations.





Management
reviews the adequacy of the allowance for loan losses at least
quarterly.  Further information is provided in the “Provision for Loan
Losses” and “Allowance for Loan Losses” sections of this discussion and
analysis.





Available for Sale Securities.Available-for-sale securities are required to be carried at fair
value.  Management believes this is a “critical accounting estimate”
in that the fair value of a security is based on quoted market prices or if
quoted market prices are not available, fair values are extrapolated from the
quoted prices of similar instruments.  Changes in the fair value of
available-for-sale securities impact the consolidated financial statements by
increasing or decreasing assets and shareholders’ equity.


29
 Table of Contents


At least
quarterly and more frequently when economic or market conditions warrant such an
evaluation, investment securities are evaluated for impairment to determine
whether a decline in their value is other than temporary.  Management
utilizes criteria such as the magnitude and duration of the decline and the
intent and ability of the Company to retain its investment in the securities for
a period of time sufficient to allow for an anticipated recovery in fair value,
in addition to the reasons underlying the decline, to determine whether the loss
in value is other than temporary.  Once a decline in value is
determined to be other-than-temporary, and we do not intend to sell the security
or it is more likely than not that we will not be required to sell the security
before recovery, only the portion of the impairment loss representing credit
exposure is recognized as a charge to earnings, with the balance recognized as a
charge to other comprehensive income.  If management intends to sell
the security or it is more likely than not that we will be required to sell the
security before recovering its forecasted cost, the entire impairment loss is
recognized as a charge to earnings.





Income Taxes.The Company files its income taxes on a consolidated basis with its
subsidiary.  The allocation of income tax expense (benefit) represents
each entity's proportionate share of the consolidated provision for income
taxes.





Deferred
income taxes reflect the estimated future tax effects of temporary differences
between the reported amount of assets and liabilities for financial reporting
purposes and such amounts as measured by tax laws and
regulations.  Management believes this is a “critical accounting
estimate” in that an estimate of future earnings is required to support its
position that the benefit of the Company’s deferred tax assets will be
realized.  If future income should prove non-existent or less than the
amount of the deferred tax assets within the tax years to which they may be
applied, the asset may not be realized and the Company’s net income will be
reduced.





When tax
returns are filed, it is highly certain that some positions taken would be
sustained upon examination by the taxing authorities, while others are subject
to uncertainty about the merits of the position taken or the amount of the
position that would be ultimately sustained.  The benefit of a tax
position is recognized in the financial statements in the period during which,
based on all available evidence, management believes it is more likely than not
that the position will be sustained upon examination, including the resolution
of appeals or litigation processes, if any.  Tax positions taken are
not offset or aggregated with other positions.  Tax positions that
meet the more-likely-than-not recognition threshold are measured as the largest
amount of tax benefit that is more than 50 percent likely of being realized upon
settlement with the applicable taxing authority.  The portion of the
benefits associated with tax positions taken that exceeds the amount measured as
described above is reflected as a liability for unrecognized tax benefits in the
accompanying balance sheet along with any associated interest and penalties that
would be payable to the taxing authorities upon examination.





Stock-Based
Compensation.  Share based compensation cost is recognized for
all awards that vest based on the estimated grant-date fair value  We
believe this is a “critical accounting estimate” since the grant-date fair value
is estimated using the Black-Scholes-Merton option-pricing formula, which
involves making estimates of the assumptions used, including the expected term
of the option, expected volatility over the option term, expected dividend yield
over the option term and risk-free interest rate.  In addition, when
determining the compensation expense to amortize over the vesting period,
management makes estimates about the expected forfeiture rate of
options.





Results
of Operations





Overview





The
Company had a net loss of $587,000, or a $0.36 loss per share, for the year
ended December 31, 2009, compared to net income of $1.85 million, or $0.70
earnings per diluted share, for the year ended December 31, 2008.  Net
income was $2.66 million, or $0.99 earnings per diluted share, for the year
ended December 31, 2007.  The (loss) return on average assets was
(0.18)% for 2009, 0.62% for 2008, and 0.99% for 2007.  The (loss)
return on average shareholders’ equity for 2009, 2008, and 2007 was (1.53)%,
6.30%, and 9.83%, respectively.





The
decrease in earnings for 2009 resulted from a $5.4 million increase in the
provision for loan losses, from $1.6 million in 2008 to $7.0 million in
2009.  The increase was necessitated primarily by a significant credit
loss and an increased probability of loan losses due to continuing adverse
economic conditions.  The elevated loan loss provision was partially
offset by increases in both net interest income and non-interest income in 2009
when compared to 2008.  Net interest income increased by $0.8 million
due to loan and deposit growth.  Non-interest income increased by $0.8
million due to an increase in gain on sale of securities of $0.4 million and
officer life insurance benefits of $0.3 million.  The net loss for
2009 was also mitigated by a $1.9 million decrease in provision for income taxes
that primarily represented the tax benefits arising from the current year net
loss.


30
 Table of Contents


The
Company’s non-interest expense increased by $505,000 in 2009 due primarily to a
$352,000 increase in Federal Deposit Insurance Corporation premiums and
assessments.  The ratio of non-interest expense to net operating
revenue (efficiency ratio) improved to 64.9% for 2009 when compared to 68.6% for
2008 and 69.6% for 2007.  This ratio reflects changes in non-interest
expense as well as changes in revenue from interest and non-interest
sources.  The improvement in the efficiency ratio for 2009 resulted
from net interest income and non-interest income growing more rapidly than
non-interest expense.





At
December 31, 2009, the Company’s total assets were $340.2 million, an increase
of $34.1 million or 11% compared to December 31, 2008.  Total loans,
net of the allowance for loan losses, were $234.8 million at December 31, 2009,
representing an increase of $8.1 million or 4% compared to December 31,
2008.  Total deposits were $294.3 million at December 31, 2009,
representing an increase of $37.0 million or 14% compared to December 31,
2008.  Deposit growth primarily resulted from the Company’s ongoing
efforts to attract deposits in its local market, including strategies to attract
core deposits from failed or acquired banks in the area.





At
December 31, 2009, the Company’s leverage ratio was 11.4% while its tier 1
risk-based capital ratio and total risk-based capital ratios were 14.8% and
16.0%, respectively.  The leverage, tier 1 risk-based capital and
total risk-based capital ratios at December 31, 2008 were 10.9%, 12.7% and
14.0%, respectively. The increase in the Company’s capital ratios in 2009
resulted from the issuance of $7.7 million in preferred stock to the United
States Department of the Treasury under the Capital Purchase Program during
January of 2009.  This increase in capital was offset by the 2009
loss, dividends paid on the preferred stock in 2009, and the Company’s growth in
risk based assets in 2009.





A
detailed presentation of the Company’s financial results as of, and for the
years ended December 31, 2009, 2008, and 2007 follows.





Net
Interest Income





The
following table presents the Company’s average balance sheet, including weighted
average yields calculated on a daily average basis and rates on a
taxable-equivalent basis, for the years indicated:





Average balances and
weighted average yields and rates





Years
      ended December 31,2009
            
            
            2008
            
            
            2007(dollars
      in thousands)
            
            AverageBalance
            
            
            Interest
      Income/Expense
            
            
            Average
      Yield/Cost
            
            
            AverageBalance
            
            
            Interest
      Income/Expense
            
            
            Average
      Yield/Cost
            
            
            AverageBalance
            
            
            Interest
      Income/Expense
            
            
            Average
      Yield/CostASSETSDue
      from banks
            
            $
            10,155
            
            
            $
            26
            
            
            
            0.26
            %
            
            $
            -
            
            
            $
            -
            
            
            
            -
            %
            
            $
            -
            
            
            $
            -
            
            
            
            -
            %Federal
      funds sold
            
            
            4,392
            
            
            
            10
            
            
            
            0.23
            %
            
            
            10,921
            
            
            
            170
            
            
            
            1.56
            %
            
            
            78
            
            
            
            4
            
            
            
            4.74
            %Available-for-sale
      investment securities:Taxable
            
            
            26,477
            
            
            
            1,196
            
            
            
            4.52
            %
            
            
            26,238
            
            
            
            1,305
            
            
            
            4.97
            %
            
            
            35,438
            
            
            
            1,582
            
            
            
            4.46
            %Exempt
      from Federal income taxes
            
            
            17,876
            
            
            
            738
            
            
            
            6.26
            %
            
            
            19,607
            
            
            
            799
            
            
            
            6.17
            %
            
            
            19,012
            
            
            
            771
            
            
            
            6.14
            %Total
      securities (1)
            
            
            44,353
            
            
            
            1,934
            
            
            
            5.22
            %
            
            
            45,845
            
            
            
            2,104
            
            
            
            5.49
            %
            
            
            54,450
            
            
            
            2,353
            
            
            
            5.05
            %Loans
      (2) (3)
            
            
            239,428
            
            
            
            14,959
            
            
            
            6.25
            %
            
            
            219,431
            
            
            
            15,510
            
            
            
            7.07
            %
            
            
            194,734
            
            
            
            16,113
            
            
            
            8.27
            %Total
      interest-earning assets (1)
            
            
            298,328
            
            
            
            16,929
            
            
            
            5.80
            %
            
            
            276,197
            
            
            
            17,784
            
            
            
            6.60
            %
            
            
            249,262
            
            
            
            18,470
            
            
            
            7.57
            %Noninterest-earning
      assets, net of allowance for loan losses
            
            
            28,769
            
            
            
            
            
            
            
            
            
            
            
            19,906
            
            
            
            
            
            
            
            
            
            
            
            18,363Total
      assets
            
            $
            327,097
            
            
            
            
            
            
            
            
            
            
            $
            296,103
            
            
            
            
            
            
            
            
            
            
            $
            267,625LIABILITIES
      AND SHAREHOLDERS’ EQUITYDeposits:Interest
      bearing
            
            $
            112,057
            
            
            $
            1,269
            
            
            
            1.13
            %
            
            $
            90,560
            
            
            $
            1,650
            
            
            
            1.82
            %
            
            $
            83,020
            
            
            $
            2,382
            
            
            
            2.87
            %Time
      deposits less than $100,000
            
            
            24,982
            
            
            
            565
            
            
            
            2.26
            %
            
            
            24,014
            
            
            
            836
            
            
            
            3.48
            %
            
            
            20,717
            
            
            
            968
            
            
            
            4.67
            %Time
      deposits $100,000 or more
            
            
            71,640
            
            
            
            1,887
            
            
            
            2.63
            %
            
            
            64,017
            
            
            
            2,415
            
            
            
            3.77
            %
            
            
            49,400
            
            
            
            2,453
            
            
            
            4.97
            %Total
      interest-bearing deposits
            
            
            208,679
            
            
            
            3,721
            
            
            
            1.78
            %
            
            
            178,591
            
            
            
            4,901
            
            
            
            2.74
            %
            
            
            153,137
            
            
            
            5,803
            
            
            
            3.79
            %FHLB
      advances
            
            
            1,975
            
            
            
            11
            
            
            
            0.56
            %
            
            
            10,915
            
            
            
            296
            
            
            
            2.71
            %
            
            
            13,608
            
            
            
            695
            
            
            
            5.11
            %FHLB
      term borrowing
            
            
            4,198
            
            
            
            227
            
            
            
            5.41
            %
            
            
            6,290
            
            
            
            303
            
            
            
            4.82
            %
            
            
            8,289
            
            
            
            362
            
            
            
            4.37
            %Junior
      subordinated deferrable interest debentures
            
            
            3,093
            
            
            
            130
            
            
            
            4.20
            %
            
            
            3,093
            
            
            
            219
            
            
            
            7.08
            %
            
            
            3,093
            
            
            
            271
            
            
            
            8.76
            %Total
      interest-bearing liabilities
            
            
            217,945
            
            
            
            4,089
            
            
            
            1.88
            %
            
            
            198,889
            
            
            
            5,719
            
            
            
            2.88
            %
            
            
            178,127
            
            
            
            7,131
            
            
            
            4.00
            %Noninterest
      bearing deposits
            
            
            68,509
            
            
            
            
            
            
            
            
            
            
            
            66,106
            
            
            
            
            
            
            
            
            
            
            
            60,465Other
      liabilities
            
            
            2,245
            
            
            
            
            
            
            
            
            
            
            
            1,821
            
            
            
            
            
            
            
            
            
            
            
            1,964Total
      liabilities
            
            
            288,699
            
            
            
            
            
            
            
            
            
            
            
            266,816
            
            
            
            
            
            
            
            
            
            
            
            240,556Shareholders’
      equity
            
            
            38,398
            
            
            
            
            
            
            
            
            
            
            
            29,287
            
            
            
            
            
            
            
            
            
            
            
            27,069Total
      liabilities and shareholders’ equity
            
            $
            327,097
            
            
            
            
            
            
            
            
            
            
            $
            296,103
            
            
            
            
            
            
            
            
            
            
            $
            267,625Net
      interest income and margin (1)
            
            
            
            
            
            $
            12,840
            
            
            
            4.43
            %
            
            
            
            
            
            $
            12,065
            
            
            
            4.52
            %
            
            
            
            
            
            $
            11,339
            
            
            
            4.71
            %





(1)
            Interest
      income is not presented on a taxable-equivalent basis, however, the
      average yield was calculated on a taxable-equivalent basis by using a
      marginal tax rate of 34%.





(2)
            Nonaccrual
      loans are included in total loans.  Interest income is included
      on nonaccrual loans only to the extent cash payments have been
      received.   Interest received on a cash basis was $37 and
      $52 for 2009 and 2008, respectively.  No interest was received
      on nonaccrual loans for 2007.





(3)
            Interest
      income includes net amortized loan fees of $ 619, $621, and $305 for 2009,
      2008, and 2007, respectively.


31
 Table of Contents


The
following table sets forth a summary of the changes in interest income and
interest expense from changes in average earning assets and interest-bearing
liabilities (volume) and changes in average interest rates for the years
indicated.





Changes in net interest
income due to changes in volumes and rates





2009
      vs 2008
            
            
            2008
      vs 2007Increase
      (decrease) due to change in:
            
            
            Increase
      (decrease) due to change in:Average
      Volume
            
            
            Average
      Rate (1)
            
            
            Total
            
            
            Average
      Volume
            
            
            Average
      Rate (1)
            
            
            Total(In
      thousands)Increase
      (decrease) in interest income:Due
      from banks
            
            $
            -
            
            
            $
            26
            
            
            $
            26
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -Federal
      funds sold
            
            
            (102
            )
            
            
            (58
            )
            
            
            (160
            )
            
            
            514
            
            
            
            (348
            )
            
            
            166Investment
      securitiesTaxable
            
            
            12
            
            
            
            (121
            )
            
            
            (109
            )
            
            
            (411
            )
            
            
            134
            
            
            
            (277
            )Exempt
      from Federal Income taxes
            
            
            (107
            )
            
            
            46
            
            
            
            (61
            )
            
            
            37
            
            
            
            (9
            )
            
            
            28Total
      securities
            
            
            (95
            )
            
            
            (75
            )
            
            
            (170
            )
            
            
            (374
            )
            
            
            125
            
            
            
            (249
            )Loans
            
            
            1,413
            
            
            
            (1,964
            )
            
            
            (551
            )
            
            
            2,044
            
            
            
            (2,647
            )
            
            
            (603
            )Total
      interest income
            
            
            1,216
            
            
            
            (2,071
            )
            
            
            (855
            )
            
            
            2,184
            
            
            
            (2,870
            )
            
            
            (686
            )(Decrease)
      increase  in interest expense:Interest-bearing
      deposits
            
            
            392
            
            
            
            (773
            )
            
            
            (381
            )
            
            
            216
            
            
            
            (948
            )
            
            
            (732
            )Time
      deposits less than $100,000
            
            
            34
            
            
            
            (305
            )
            
            
            (271
            )
            
            
            154
            
            
            
            (286
            )
            
            
            (132
            )Time
      certificates $100,000 or more
            
            
            288
            
            
            
            (816
            )
            
            
            (528
            )
            
            
            726
            
            
            
            (764
            )
            
            
            (38
            )Total
      interest-bearing deposits
            
            
            714
            
            
            
            (1,894
            )
            
            
            (1,180
            )
            
            
            1,096
            
            
            
            (1,998
            )
            
            
            (902
            )FHLB
      advances
            
            
            (242
            )
            
            
            (43
            )
            
            
            (285
            )
            
            
            (138
            )
            
            
            (261
            )
            
            
            (399
            )FHLB
      term borrowing
            
            
            (101
            )
            
            
            25
            
            
            
            (76
            )
            
            
            (87
            )
            
            
            28
            
            
            
            (59
            )Junior
      subordinated deferrable interest debentures
            
            
            -
            
            
            
            (89
            )
            
            
            (89
            )
            
            
            -
            
            
            
            (52
            )
            
            
            (52
            )Total
      interest expense
            
            
            371
            
            
            
            (2,001
            )
            
            
            (1,630
            )
            
            
            871
            
            
            
            (2,283
            )
            
            
            (1,412
            )Increase
      (decrease) in net interest income
            
            $
            845
            
            
            $
            (70
            )
            
            $
            775
            
            
            $
            1,313
            
            
            $
            (587
            )
            
            $
            726





(1)
Factors contributing to both changes in rate and volume have been attributed to
changes in rates.





2009 compared to 2008.Total
interest income decreased by $0.9 million or 5%, from $17.8 million in 2008 to
$16.9 million in 2009, due primarily to an 80 basis point decline in the yield
earned on average interest-earning assets, primarily in the category of
loans.  The average yield on loans was 6.25% and 7.07% for 2009 and
2008, respectively.  The 82 basis point decrease in average yield on
loans resulted primarily from interest rates moving downward during 2008 and
remaining low during 2009.  Competitive pressures for high quality
loans also contributed to lower yields in 2009, as did an increase in the
average volume of nonaccrual loans in 2009. Average nonaccrual loans were $5.6
million in 2009 compared to $1.5 million in 2008, an increase of $4.1 million or
273%.  This decline in yield on loans was partially offset by a $20.0
million or 9% increase in average loans outstanding.  The increase in
average loans was due to the Company’s continued marketing efforts which
resulted in growth primarily in the real estate mortgage segment of the loan
portfolio.





The
decline in yield on average interest-earning assets was also attributable to a
decrease in the average tax equivalent yield on investment securities, which was
5.22% and 5.49% for 2009 and 2008, respectively.  The decrease in
yield resulted primarily from the Company’s repositioning of the portfolio to
protect against the adverse impact of rising interest rates.  The
repositioning strategy involved selling $11.6 million in fixed rate securities
with weighted average yield of 5.30% and purchasing $16.1 million in variable
rate securities with weighted average yield of 1.60%.





During
2009, the Company carried a greater amount of low-yielding liquid funds, such as
due from banks and Fed funds sold, on its balance sheet compared to
2008.  This precautionary liquidity position was maintained due to
instability in the financial markets, however, the lower yields on those earning
assets further contributed to the decrease in average yield on interest earning
assets.  The portion of the due from banks account that earned
interest was comprised of funds placed in the Federal Reserve Bank’s excess
balance account.


32
 Table of Contents


Total
interest expense decreased $1.6 million or 28%, from $5.7 million in 2008 to
$4.1 million in 2009, due primarily to a 100 basis point decline in the cost of
interest-bearing liabilities, primarily in the category of interest-bearing
deposits.  The average cost of interest-bearing deposits was 1.78% and
2.74% for 2009 and 2008, respectively.  The decrease in average cost
resulted from the Company aggressively lowering the interest rates paid on
deposits.  The decline in cost of interest-bearing deposits was
partially offset by a $30.1 million or 17% increase in average interest bearing
deposits outstanding, which was attributable to the Company’s continued efforts
to attract deposits in the local market.  Average noninterest-bearing
deposits increased by $2.4 million or 4% in 2009, and represented 25% of average
total deposits during 2009, compared with 27% of average total deposits during
2008.





Interest
expense on short-term advances from the Federal Home Loan Bank of San Francisco
(FHLB) decreased from $296,000 in 2008 to $11,000 in 2009.  This was
due primarily to average volume of this debt being lowered from $10.9 million in
2008 to $2.0 million in 2009 as the Company was able to utilize deposit growth
to replace this debt.  Interest expense on FHLB term borrowing
decreased from $303,000 in 2008 to $227,000 in 2009 due to scheduled repayment
and maturation.  The interest expense on junior subordinated interest
debentures decreased in 2009 due to lower interest rates on these variable rate
instruments.





Net
interest income before provision for loan losses increased to $12.8 million for
2009 from $12.1 million for 2008, an increase of $775,000 or 6%.  The
increase generally resulted from growth of interest-earning assets and lower
cost of funds offset by lower asset yields and growth of interest-bearing
liabilities.  The increase in net interest income attributable to
higher volume of average interest-earning assets in 2009 was $1.2 million while
the decrease attributable to higher volume of average interest-bearing
liabilities was $0.4 million.  The decrease in net interest income
attributable to lower interest rates on average interest-earning assets was $2.1
million; this was offset by a $2.0 million increase in net interest income
resulting from lower interest rates on average interest-bearing
liabilities.





The
Company’s net interest margin on a tax equivalent basis for 2009 was 4.43%
compared to 4.52% in 2008.  The 9 basis point decrease in net interest
margin resulted from the $775,000 increase in net interest income being slightly
outweighed by the $22.1 million increase in interest-earning
assets.





2008 compared to
2007.  Total interest income decreased $0.7 million from $18.5
million in 2007 to $17.8 million in 2008 due to primarily to a 97 basis point
decline in the yield earned on average interest-earning assets partially off-set
by an increase in average interest earning assets.  Average earning
assets in 2008 were $26.9 million or 11% greater than in 2007 due to an increase
of $24.7 million or 13% in average loans outstanding.  The average
yield on loans was 7.07% and 8.27% for the year ended December 31, 2008 and
2007, respectively, while the average tax equivalent yield on investment
securities was 5.49% and 5.05%, respectively.  The increase in average
loans was due to the Company’s continued marketing efforts which resulted in
growth in real estate mortgage and commercial segments of the loan
portfolio.  The decrease in weighted average yield on loans resulted
primarily from the 425 basis points of Federal funds rate decreases that
occurred during 2008.  In addition, competitive pressures for high
quality lending opportunities contributed to lower yields. The increase in
weighted average tax equivalent yield on investment securities resulted
primarily from the maturation or sale of lower yielding
investments.





Total
interest expense decreased $1.4 million or 20% from $7.1 million in 2007 to $5.7
million in 2008.  Average total interest-bearing deposits increased by
$25.5 million or 17% in 2008 and average noninterest-bearing deposits increased
by $5.6 million or 9% in 2008.  During 2008 and in conjunction with
the reductions by the FRB, the Company aggressively lowered the interest rates
paid on its interest-bearing deposits compared with rates paid in
2007.





Interest
expense on short-term borrowings from the Federal Home Loan Bank of San
Francisco (FHLB) decreased from $0.7 million in 2007 to $0.3 million in
2008.  This was due primarily to average volume of this debt being
lowered from $13.6 million in 2007 to $10.9 million in 2008 and the overall
lower costs of this debt as the Company relied more heavily on other sources,
such as brokered deposits, to fund asset growth and ensure adequate
liquidity.





As noted
above, non-interest bearing deposits increased with average balances of $66.1
million and $60.5 million in 2008 and 2007, respectively.  These
deposits represented 27% of average total deposits during 2008, compared with
28% of average total deposits during 2007.


33
 Table of Contents


Net
interest income before provision for loan losses increased to $12.1 million for
2008 from $11.3 million for 2007, an increase of $726,000 or 6%.  The
increase generally resulted from growth of earning assets and lower cost of
funds offset by lower asset yields.  The increase in net interest
income attributable to higher volume of average interest-earning assets in 2008
was $2.2 million while the decrease attributable to higher volume of average
interest-bearing liabilities was $871,000, a net increase of $1.3
million.  The decrease in net interest income attributable to lower
interest rates on average interest-earning assets was $2.9 million that was
offset by a $2.3 million increase in net interest income resulting from lower
interest rates on average interest-bearing liabilities.





The
Company’s net interest margin on a tax equivalent basis for 2008 was 4.52%
compared to 4.71% in 2007.    The 19 basis point decrease in
net interest margin resulted from the $726,000 increase in net interest income
being outweighed by the $26.9 million increase in average interest-earning
assets.





Provision
for Loan Losses





The
provision for loan losses, which is included in operations to support the
required level of the allowance for loan losses, is based on credit experience
and management’s ongoing evaluation of loan portfolio risk and economic
conditions.  The provision for loan losses was $7.0 million and $1.6
million in 2009 and 2008, respectively.  The increase in provision for
loan losses increased in 2009 primarily due to one significant credit loss and
an increased probability of loan losses due to adverse economic
conditions.  See the sections below titled “Nonperforming Assets,”
“Impaired Loans” and “Allowance for Loan Losses.”  The Company did not
record a provision for loan losses in 2007 based on management’s assessment of
the loan portfolio and related credit quality for that year.





Non-Interest
Income





Non-interest
income for 2009 totaled $2.0 million compared with $1.3 million in 2008 and $1.2
million in 2007.  The components of non-interest income during each
year were as follows:





Non-interest
income




Years
      Ended December 31,
            
            
            Change
      during year(in
      thousands)
            
            2009
            
            
            2008
            
            
            2007
            
            
            2009
            
            
            2008Service
      charges
            
            $
            766
            
            
            $
            716
            
            
            $
            591
            
            
            $
            50
            
            
            $
            125Gain
      (loss) on sale of available-for-sale investment securities
            
            
            416
            
            
            
            46
            
            
            
            (1
            )
            
            
            370
            
            
            
            47Gain
      on sale of other real estate
            
            
            16
            
            
            
            -
            
            
            
            -
            
            
            
            16
            
            
            
            -Mortgage
      loan brokerage fees
            
            
            43
            
            
            
            53
            
            
            
            77
            
            
            
            (10
            )
            
            
            (24
            )Earnings
      on cash surrender value of life insurance policies
            
            
            288
            
            
            
            253
            
            
            
            258
            
            
            
            35
            
            
            
            (5
            )Officer
      life insurance proceeds
            
            
            317
            
            
            
            -
            
            
            
            -
            
            
            
            317
            
            
            
            -Other
            
            
            191
            
            
            
            215
            
            
            
            230
            
            
            
            (24
            )
            
            
            (15
            )Total
      non-interest income
            
            $
            2,037
            
            
            $
            1,283
            
            
            $
            1,155
            
            
            $
            754
            
            
            $
            128





2009 Compared to
2008.Non-interest income increased during 2009 primarily due
to an increase in the gain on sale of available-for-sale investment securities
which increased by $370,000 in 2009 as the Company executed a strategy to
reposition the investment portfolio for higher interest rates which involved
selling some higher-yielding investment securities at a gain.  In
addition, the Company received officer life insurance benefits of $317,000 in
2009 compared to none in 2008.  Income from service charges on deposit
accounts increased by $50,000 in 2009 due mainly to a $71,000 increase in
account analysis charges, which was offset by a $17,000 decrease in NSF and
overdraft charges.  Earnings on bank-owned life insurance policies
increased by $35,000 due to improved earnings performance.  Other
non-interest income included FHLB dividend income which was $2,000 in 2009 and
$71,000 in 2008.  Continued slowing of the residential real estate
market caused a $10,000 decrease in mortgage loan brokerage fees in
2009.





2008 Compared to
2007.Non-interest income increased by $128,000 in 2008 as a
result of increased deposits and a higher fee structure that resulted in a
$64,000 increase in account analysis charges and a $55,000 increase in NSF and
overdraft charges.  In addition, the Company recorded a $46,000 gain
on sale of investment securities in 2008 compared to a slight loss in
2007.  Illiquid market conditions and lower volumes of refinance
activity in the residential real estate market caused a $24,000 decrease in
mortgage loan brokerage fees.


34
 Table of Contents








Non-Interest
Expense





Total
non-interest expense was $9.7 million in 2009, an increase of $505,000 or 6%,
from the $9.2 million in non-interest expense in 2008.  The following
table presents the major components of non-interest expense for the years
indicated.





Non-interest
expense





Years
      Ended December 31,
            
            
            Change
      during year(in
      thousands)
            
            2009
            
            
            2008
            
            
            2007
            
            
            2009
            
            
            2008Salaries
      and employee benefits
            
            $
            4,866
            
            
            $
            5,128
            
            
            $
            4,770
            
            
            $
            (262
            )
            
            $
            358Occupancy
      and equipment
            
            
            1,565
            
            
            
            1,259
            
            
            
            1,073
            
            
            
            306
            
            
            
            186Data
      processing
            
            
            617
            
            
            
            524
            
            
            
            495
            
            
            
            93
            
            
            
            29Assessment
      and insurance
            
            
            614
            
            
            
            259
            
            
            
            197
            
            
            
            355
            
            
            
            62Professional
      and legal
            
            
            549
            
            
            
            394
            
            
            
            508
            
            
            
            155
            
            
            
            (114
            )Operations
            
            
            455
            
            
            
            509
            
            
            
            480
            
            
            
            (54
            )
            
            
            29Telephone
      and postal
            
            
            220
            
            
            
            216
            
            
            
            213
            
            
            
            4
            
            
            
            3Advertising
      and business development
            
            
            219
            
            
            
            273
            
            
            
            305
            
            
            
            (54
            )
            
            
            (32
            )Supplies
            
            
            159
            
            
            
            181
            
            
            
            188
            
            
            
            (22
            )
            
            
            (7
            )Other
      real estate owned
            
            
            13
            
            
            
            -
            
            
            
            -
            
            
            
            13
            
            
            
            -Amortization
      expense
            
            
            -
            
            
            
            8
            
            
            
            63
            
            
            
            (8
            )
            
            
            (55
            )Other
      expenses
            
            
            382
            
            
            
            403
            
            
            
            407
            
            
            
            (21
            )
            
            
            (4
            )Total
      non-interest expense
            
            $
            9,659
            
            
            $
            9,154
            
            
            $
            8,699
            
            
            $
            505
            
            
            $
            455





2009 Compared to
2008.  Salaries and employee benefits decreased by $262,000 in
2009 due to decreased incentive compensation payments and actions taken by
management to reduce employee costs.  Assessment and insurance costs
increased $355,000 due to an increase in FDIC insurance premiums, higher levels
of insured deposits, and an FDIC special assessment.  Occupancy and
equipment costs increased by $306,000 in 2009 due to depreciation and other
expenses related to the Company’s relocation of its Visalia offices to an office
facility that was purchased in early 2009 and occupied in early
2010.  Professional and legal costs increased $155,000 in 2009
primarily due to the incurred professional fees related to a settlement of a
lawsuit.





2008 Compared to
2007.The increase in non-interest expense resulted primarily
from increased employee and occupancy costs associated with the Company’s growth
initiatives including the opening of a full service branch in the City of Tulare
in May 2008.  Salary and employee benefits increased by $358,000
including $323,000 for incentives associated with loan and deposit growth and
normal pay raises, and $83,000 for health and post retirement
benefits.  These increases were partially offset by a decrease in the
salary continuation plan of $27,000 and a $43,000 decrease in vacation
expense.  The average full time equivalent employees remained
consistent at approximately 79 during the years ended December 31, 2008 and
2007.





Occupancy
and equipment costs increased $186,000 in 2008 due primarily to increased
depreciation on owned facilities and leasehold improvements. Assessment and
insurance costs increased $62,000 due to an increase in the FDIC assessment rate
for deposit insurance.  Professional and legal costs decreased
$114,000 in 2008 primarily due to the reduction in professional fees related to
the 2007 preparatory activities associated with the requirements of Section 404
of the Sarbanes-Oxley Act.  Amortization expenses decreased $55,000
due to the deposit premium from the acquisition of the Woodlake and Tipton
branches being fully amortized early in 2008.





Provision
for (Benefit from) Income Taxes





There was
a benefit from income taxes of $1.2 million for 2009 compared to provisions for
income taxes of $746,000 in 2008 and $1.13 million in 2007.  The $1.9
million change in provision for (benefit from) income taxes from 2008 to 2009
primarily represented the tax benefits arising from the current year net
loss.  The Company’s effective tax rate was 67.1% for 2009 compared to
28.8% and 29.9% in 2008 and 2007, respectively.  The changes in
provision as a percentage of pre-tax income also related to an increase in tax
exempt income as a percentage of pretax income including earnings from municipal
investment securities and Bank owned life insurance policies.


35
 Table of Contents








Financial
Condition





Investment
Securities





The
Company purchases investment securities to maintain liquidity and manage
interest rate risk within board approved parameters, as well as to generate
interest revenues.  The investment security portfolio consists of
obligations of U.S. Treasury and government agencies, mortgage-backed securities
of U.S. government sponsored enterprises, obligations of states and political
subdivisions, and other investment grade securities.  The Company’s
investments in mortgage-backed securities typically provide both an increase in
yields over U.S. Treasury and agency securities and cash flows for liquidity and
reinvestment opportunities.  Obligations of states and political
subdivisions (municipal securities) typically provide attractive tax equivalent
yields for the Company.  Since the interest earnings on municipal
securities are generally not taxable for Federal purposes the investment in
municipal securities results in a reduction in the effective tax rate of the
Company.





At
December 31, 2009 and 2008, all investment securities were classified as
available-for-sale.  In classifying its investments as
available-for-sale, securities are reported at fair value, with unrealized gains
and losses excluded from earnings and reported, net of taxes, as accumulated
other comprehensive income or loss within shareholders’ equity.





The
percentage of investment portfolio balances in U.S. treasuries, U.S. government
agency bonds, mortgage-backed securities and municipal securities to total
investment securities were 0%, 7%, 58%, and 35%, respectively, at December 31,
2009 versus 1%, 17%, 37%, and 45%, respectively, at December 31,
2008.  The significant percentage increase in mortgage-backed
securities at December 31, 2009 was due to the purchase of adjustable rate
securities issued by the United States Small Business Administration (SBA)
during 2009 as part of the Company’s strategy to reposition the investment
portfolio for higher interest rates.  Mortgage-backed securities at
December 31, 2008 were comprised of fixed rate securities issued by U.S.
government agencies, primarily the Federal National Mortgage Association (FNMA)
and the Federal Home Loan Mortgage Corporation (FHLMC).





The
following tables set forth the estimated market value of available-for-sale
investment securities at the dates indicated:





December
      31, 2009(in
      thousands)
            
            Amortized
      Cost
            
            
            Unrealized
      Gains
            
            
            Unrealized
      Losses
            
            
            Fair
              ValueU.S.
      government  agencies
            
            $
            2,910
            
            
            $
            105
            
            
            $
            -
            
            
            $
            3,015Mortgage-backed
      securities:Agency
      MBS
            
            
            8,986
            
            
            
            295
            
            
            
            -
            
            
            
            9,281SBA
      MBS
            
            
            15,326
            
            
            
            27
            
            
            
            (46
            )
            
            
            15,307Municipal
      securities
            
            
            15,338
            
            
            
            49
            
            
            
            (424
            )
            
            
            14,963Total
            
            $
            42,560
            
            
            $
            476
            
            
            $
            (470
            )
            
            $
            42,566








December
      31, 2008Amortized
      Cost
            
            
            Unrealized
      Gains
            
            
            Unrealized
      Losses
            
            
            Fair
              ValueU.S.
      Treasury
            
            $
            247
            
            
            $
            33
            
            
            $
            -
            
            
            $
            280U.S.
      government agencies
            
            
            6,753
            
            
            
            225
            
            
            
            -
            
            
            
            6,978Mortgage-backed
      securities:Agency
      MBS
            
            
            15,102
            
            
            
            554
            
            
            
            (2
            )
            
            
            15,654SBA
      MSB
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Municipal
      securities
            
            
            19,753
            
            
            
            98
            
            
            
            (745
            )
            
            
            19,106Total
            
            $
            41,855
            
            
            $
            910
            
            
            $
            (747
            )
            
            $
            42,018


36
 Table of Contents





December
      31, 2007Amortized
      Cost
            
            
            Unrealized
      Gains
            
            
            Unrealized
      Losses
            
            
            Fair
              ValueU.S.
      Treasury
            
            $
            246
            
            
            $
            18
            
            
            $
            -
            
            
            $
            264U.S.
      government  agencies
            
            
            17,298
            
            
            
            62
            
            
            
            (70
            )
            
            
            17,290Mortgage-backed
      securities:Agency
      MBS
            
            
            16,853
            
            
            
            192
            
            
            
            (85
            )
            
            
            16,960SBA
      MSB
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Municipal
      securities
            
            
            19,304
            
            
            
            42
            
            
            
            (227
            )
            
            
            19,119Corporate
      debt securities
            
            
            3,005
            
            
            
            1
            
            
            
            (24
            )
            
            
            2,982Total
            
            $
            56,706
            
            
            $
            315
            
            
            $
            (406
            )
            
            $
            56,615





Management
periodically evaluates each investment security for other than temporary
impairment, relying primarily on industry analyst reports, observation of market
conditions, credit ratings of the security’s issuer and interest rate
fluctuations.  For investment securities that are considered impaired,
management determines the reason for the unrealized loss and whether the Company
will be able to collect all amounts due according to the contractual
terms.  After evaluating the investment portfolio at December 31,
2009, management determined that it was probable that the Company would collect
all contractual cash flows from each impaired security.  Management
further determined that the Company has the intent and ability to hold each
impaired security until it is no longer impaired.





The
following table summarizes the amounts and distribution of investment securities
and their weighted average yields as of December 31, 2009.  Expected
maturities may differ from contractual maturities where the issuers of the
securities have the right to call or prepay obligations without
penalty.








Maturities
      of securities available for saleWithin
            
            
            After
      one but within
            
            
            After
      five but within
            
            
            Afterone year
            
            
            five years
            
            
            ten years
            
            
            ten years
            
            
            Total(dollars
      in  thousands)
            
            Amount
            
            
            Yield
            
            
            Amount
            
            
            Yield
            
            
            Amount
            
            
            Yield
            
            
            Amount
            
            
            Yield
            
            
            Amount
            
            
            YieldU.S.
      Government agencies
            
            $
            -
            
            
            
            -
            %
            
            $
            1,032
            
            
            
            5.25
            %
            
            $
            1,551
            
            
            
            5.52
            %
            
            $
            435
            
            
            
            5.35
            %
            
            $
            3,018
            
            
            
            5.40
            %Mortgage-backed
      securities:Agency
      MSB
            
            
            453
            
            
            
            3.92
            %
            
            
            1,767
            
            
            
            4.29
            %
            
            
            1,041
            
            
            
            4.76
            %
            
            
            6,020
            
            
            
            4.78
            %
            
            
            9,281
            
            
            
            4.64
            %Agency
      SBA
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            10,965
            
            
            
            1.58
            %
            
            
            4,342
            
            
            
            1.68
            %
            
            
            15,307
            
            
            
            1.61
            %Municipal
      securities (1)
            
            
            -
            
            
            
            -
            
            
            
            20
            
            
            
            7.23
            %
            
            
            2,208
            
            
            
            6.10
            %
            
            
            12,735
            
            
            
            5.69
            %
            
            
            14,963
            
            
            
            5.76
            %Total
            
            $
            453
            
            
            
            3.92
            %
            
            $
            2,819
            
            
            
            4.66
            %
            
            $
            15,765
            
            
            
            2.81
            %
            
            $
            23,532
            
            
            
            4.71
            %
            
            $
            42,569
            
            
            
            4.00
            %





(1)
Yields shown are not computed on a tax equivalent basis.


37
 Table of Contents


Loan
Portfolio





The
Company’s lending activities are geographically concentrated in the South San
Joaquin Valley, primarily in Tulare and Fresno counties.  The Company
offers both fixed and floating rate loans and obtains collateral in the form of
real property, business assets and deposit accounts but looks to business and
personal cash flows as the primary source of repayment.





The
following table sets forth the breakdown of loans outstanding by type at the
dates indicated by amount and percentage of the portfolio:





LOAN
      PORTFOLIO(in
      thousands)
            
            December
      31, 2009
            
            
            December
      31, 2008
            
            
            December
      31, 2007
            
            
            December
      31, 2006
            
            
            December
      31, 2005Commercial
            
            $
            49,443
            
            
            
            21
            %
            
            $
            58,325
            
            
            
            25
            %
            
            $
            41,824
            
            
            
            21
            %
            
            $
            41,104
            
            
            
            22
            %
            
            $
            40,271
            
            
            
            26
            %Real
      estate – mortgage (1)
            
            
            162,772
            
            
            
            67
            %
            
            
            129,267
            
            
            
            56
            %
            
            
            106,873
            
            
            
            53
            %
            
            
            92,639
            
            
            
            50
            %
            
            
            72,753
            
            
            
            48
            %Real
      estate – construction
            
            
            22,582
            
            
            
            9
            %
            
            
            35,113
            
            
            
            15
            %
            
            
            44,896
            
            
            
            22
            %
            
            
            44,273
            
            
            
            24
            %
            
            
            32,560
            
            
            
            21
            %Agricultural
            
            
            4,727
            
            
            
            2
            %
            
            
            4,011
            
            
            
            2
            %
            
            
            4,988
            
            
            
            3
            %
            
            
            4,693
            
            
            
            3
            %
            
            
            4,432
            
            
            
            3
            %Consumer
      and other
            
            
            1,937
            
            
            
            1
            %
            
            
            3,566
            
            
            
            2
            %
            
            
            2,995
            
            
            
            1
            %
            
            
            1,805
            
            
            
            1
            %
            
            
            2,376
            
            
            
            2
            %Subtotal
            
            
            241,461
            
            
            
            100
            %
            
            
            230,282
            
            
            
            100
            %
            
            
            201,576
            
            
            
            100
            %
            
            
            184,514
            
            
            
            100
            %
            
            
            152,392
            
            
            
            100
            %Deferred
      loan fees, net
            
            
            (407
            )
            
            
            
            
            
            
            (341
            )
            
            
            
            
            
            
            (304
            )
            
            
            
            
            
            
            (436
            )
            
            
            
            
            
            
            (635
            )Allowance
      for loan losses
            
            
            (6,231
            )
            
            
            
            
            
            
            (3,244
            )
            
            
            
            
            
            
            (1,758
            )
            
            
            
            
            
            
            (1,746
            )
            
            
            
            
            
            
            (1,766
            )Total
      loans, net
            
            $
            234,823
            
            
            
            
            
            
            $
            226,697
            
            
            
            
            
            
            $
            199,514
            
            
            
            
            
            
            $
            182,332
            
            
            
            
            
            
            $
            149,991





(1)
            Consists
      primarily of commercial mortgage
loans.





Retail
loan products are offered primarily for the benefit of commercial business
owners and professionals who typically maintain depository and other lending
relationships with the Company.  Loans outstanding at December 31,
2009 increased by $8.1 million or 4% compared to December 31,
2008.  While the Company’s marketing efforts are focused primarily on
commercial loans, the majority of the growth for 2009 occurred in the real
estate mortgage segment of the portfolio, which was indicative of the economic
slowdown that commenced in the latter part of 2008.  Tulare and Fresno
counties are two of the top counties in the United States for agricultural
production, but most agricultural commodities were adversely impacted by the
domestic and global economic recession.





The
following table presents the maturity distribution of the loan portfolio as of
December 31, 2009.  The table shows the distribution of such loans
between those loans with fixed interest rates and those with floating (variable)
interest rates.  Floating rates generally fluctuate with changes in
the prime rate.  A majority of the Company’s floating rate loans have
rate floors.  Management considers the risk associated with fixed
interest rate loans in its periodic analysis of interest rate
risk.


38
 Table of Contents





Maturity of loans(in
      thousands)
            
            Within
              one year
            
            
            After
      one but within fiveyears
            
            
            After
              five years
            
            
            TotalCommercial
            
            $
            23,521
            
            
            $
            15,296
            
            
            $
            10,626
            
            
            $
            49,443Real
      estate – mortgage (1)
            
            
            1,522
            
            
            
            33,921
            
            
            
            127,329
            
            
            
            162,772Real
      estate – construction
            
            
            9,915
            
            
            
            8,083
            
            
            
            4,584
            
            
            
            22,582Agriculture
            
            
            2,827
            
            
            
            470
            
            
            
            1,430
            
            
            
            4,727Consumer
      and other
            
            
            875
            
            
            
            977
            
            
            
            85
            
            
            
            1,937Total
            
            $
            38,660
            
            
            $
            58,747
            
            
            $
            144,054
            
            
            $
            241,461Loans
      with fixed interest rates
            
            
            1,970
            
            
            
            41,214
            
            
            
            99,462
            
            
            
            142,646Loans
      with floating interest rates
            
            
            36,690
            
            
            
            17,533
            
            
            
            44,592
            
            
            
            98,815Total
            
            $
            38,660
            
            
            $
            58,747
            
            
            $
            144,054
            
            
            $
            241,461





(1)
Consists primarily of commercial mortgage loans.





Nonperforming
Assets.There were $7.4 million in nonaccrual loans at
December 31, 2009, which comprised the Company’s total nonperforming
assets.  As of December 31, 2008 there was $4.9 million in nonaccrual
loans.  As of December 31, 2009 and 2008 the Company had none of the
other types of nonperforming assets; i.e., loans past due 90 days and still
accruing interest, restructured loans in accrual status, and other real estate
owned.  Nonperforming assets increased during 2009 due primarily to
one commercial real estate relationship totaling $5.9 million that was
transferred to nonaccrual status during the second quarter of 2009.





Generally,
loans are placed on nonaccrual status when full collectibility of principal or
interest is uncertain or when principal or interest is past due for 90 days
(unless the loan is well secured and in the process of
collection).  At the time a loan is placed on nonaccrual status,
interest previously accrued but not collected is reversed from interest
income.  There was $435,000 and $27,000 in foregone interest on
nonaccrual loans during the years ended December 31, 2009 and 2008,
respectively.  There was no interest foregone on nonaccrual loans for
the year ended December 31, 2007.  Any interest or principal payments
received on a nonaccrual loan are normally applied as a principal reduction
unless the nonaccrual loan balance is deemed sufficiently collectible for cash
payments to be recognized as income.  Interest income recognized on a
cash basis for nonaccrual loans totaled $37,000 and $52,000 during the years
ended December 31, 2009 and 2008, respectively.  There was no interest
income recognized on a cash basis for nonaccrual loans during the years ended
December 31, 2007.  A nonaccrual loan may be restored to accrual
status when none of its principal and interest is past due and unpaid, and
certain other factors are satisfied.  Classification of a loan as
nonaccrual does not necessarily result in principal and interest becoming
uncollectible in whole or in part.  The Company is actively pursuing
collection of all the contractual amounts due for the nonaccrual loans at
December 31, 2009.  Those collection efforts include but are not
limited to identification of additional sources of collateral or borrower cash
flows, modification of loan terms, and when necessary the foreclosure and sale
of loan collateral.





Impaired Loans.A
loan is considered impaired when collection of all amounts due according to the
original contractual terms is not probable.  The category of impaired
loans is not coextensive with the category of nonaccrual loans, although the two
categories may overlap in part or in full and did overlap in full at December
31, 2008 and 2007.  At December 31, 2009 and 2008, the recorded
investment in loans that were considered to be impaired totaled $12.5 million
and $4.9 million, respectively.  The specific allowance for loan
losses for impaired loans at December 31, 2009 and 2008 totaled $2.7 million and
$425,000, respectively.  There were no impaired loans at December 31,
2007.  The average recorded investment in impaired loans for the year
ended December 31, 2009 and 2008 totaled $5.7 and $1.5 million, respectively.
The average recorded investment in impaired loans for the year ended December
31, 2007 was not considered significant for reporting purposes.





Allowance for Loan
Losses.The Company attempts to minimize credit risk through
its underwriting and credit review policies.  The Company’s credit
review process includes internally prepared credit reviews as well as
contracting with an outside firm to conduct periodic credit
reviews.  The Company’s management and lending officers evaluate the
loss exposure of classified and impaired loans on a quarterly basis, or more
frequently as loan conditions change.  The Board of Directors, through
the loan committee, reviews the asset quality of new and criticized loans on a
monthly basis and reports the findings to the full Board of
Directors.  In management's opinion, this loan review system
facilitates the early identification of potential criticized
loans.


39
 Table of Contents


The
allowance for loan losses is established through charges to earnings in the form
of the provision for loan losses.  Loan losses are charged to and
recoveries are credited to the allowance for loan losses.  The
allowance for loan losses is maintained at a level deemed appropriate by
management to provide for known and inherent risks in loans.  The
adequacy of the allowance for loan losses is based upon management's continuing
assessment of various factors affecting the collectibility of loans; including
current economic conditions, maturity of the portfolio, size of the portfolio,
industry concentrations, borrower credit history, collateral, the existing
allowance for loan losses, independent credit reviews, current charges and
recoveries to the allowance for loan losses and the overall quality of the
portfolio as determined by management, regulatory agencies, and independent
credit review consultants retained by the Company.  There is no
precise method of predicting specific losses or amounts which may ultimately be
charged off on particular segments of the loan portfolio.  The
collectibility of a loan is subjective to some degree, but must relate to the
borrower’s financial condition, cash flow, quality of the borrower’s management
expertise, collateral and guarantees, and state of the local
economy.





The
federal financial regulatory agencies issued an interagency policy statement in
December 2006 on the allowance for loan and lease losses along with supplemental
frequently asked questions. When determining the adequacy of the allowance for
loan losses, the Company follows these guidelines.  The agencies
issued the revised policy statement in view of today’s uncertain economic
environment and the presence of concentrations in untested loan products in the
loan portfolios of insured depository institutions.  The policy
statement has also been revised to conform to accounting principles generally
accepted in the United States of America (“GAAP”) and other supervisory
guidance.   The policy statement reiterates that each institution
has a responsibility for developing, maintaining and documenting a
comprehensive, systematic, and consistently applied process appropriate to its
size and the nature, scope, and risk of its lending activities for determining
the amounts of the allowance for loan and lease losses  and the
provision for loan and lease losses and states that each institution should
ensure controls are in place to consistently determine the allowance for loan
and lease losses  in accordance with GAAP, the institution’s stated
policies and procedures, management’s best judgment and relevant supervisory
guidance.





The
policy statement also restates that insured depository institutions must
maintain an allowance for loan and lease losses  at a level that is
appropriate to cover estimated credit losses on individually evaluated loans
determined to be impaired as well as estimated credit losses inherent in the
remainder of the loan and lease portfolio, and that estimates of credit losses
should reflect consideration of all significant factors that affect the
collectibility of the portfolio as of the evaluation date.  The policy
statement states that prudent, conservative, but not excessive, loan loss
allowances that represent management’s best estimate from within an acceptable
range of estimated losses are appropriate.  In addition, the Company
incorporates the Securities and Exchange Commission Staff Accounting Bulletin
No. 102, which represents the SEC staff’s view related to methodologies and
supporting documentation for the Allowance for Loan and Lease Losses that should
be observed by all public companies in complying with the federal securities
laws and the Commission’s interpretations.





The
Company’s methodology for assessing the adequacy of the allowance for loan
losses consists of several key elements, which include but are not limited
to:





§
            specific
      allocation for problem graded loans, if any (“impaired
      loans”),


§
            general
      or formula allocation,


§
            and
      discretionary allocation based on loan portfolio
    segmentation.





Specific
allocations are established based on management’s periodic evaluation of loss
exposure inherent in impaired and other loans in which management believes that
the collection of principal and interest under the original terms of the loan
agreement are in question.  For purposes of this analysis, loans are
grouped by internal risk classifications which are “special mention”,
“substandard”, “doubtful”, and “loss”.  Special mention loans are
currently performing but are potentially weak, as the borrower has begun to
exhibit deteriorating trends, which if not corrected could jeopardize repayment
of the loan and result in further downgrade.  Substandard loans have
well-defined weaknesses which, if not corrected, could jeopardize the full
satisfaction of the debt.  A loan classified as “doubtful” has
critical weaknesses that make full collection of the obligation
improbable.  Classified loans, as defined by the Company, include
loans categorized as substandard and doubtful.  Loans classified as
loss are immediately charged off.





Formula
allocations are calculated by applying loss factors to outstanding loans with
similar characteristics.  Loss factors are based on the Company’s
historical loss experience as adjusted for changes in the business cycle and on
the internal risk grade of those loans and may be adjusted for significant
factors that, in management's judgment, affect the collectibility of the
portfolio as of the evaluation date.  The formula allocation analysis
incorporates loan losses over the past several years adjusted for changes in the
business cycle.  Loss factors are adjusted to recognize and quantify
the estimated loss exposure resulting from changes in market conditions and
trends in the Company’s loan portfolio.


40
 Table of Contents








The
discretionary allocation is based upon management’s evaluation of various loan
segment conditions that are not directly measured in the determination of the
formula and specific allowances.  The conditions may include, but are
not limited to, general economic and business conditions affecting the key
lending areas of the Company, credit quality trends, collateral values, loan
volumes and concentrations, and other business conditions.





The
allowance for loan losses totaled $6.2 million or 2.58% of total loans at
December 31, 2009 compared to $3.2 million or 1.41% at December 31, 2008, and
$1.76 million or 0.87% at December 31, 2007.  The Company’s loan loss
provisions recorded during 2009 and 2008 totaled $7.0 million and $1.6 million,
respectively.  No provision for loan losses was recorded in 2007. The
loss provisions recorded during 2009 and 2008 included approximately $6.4
million and $0.5 million, respectively, related to specific reserves for
impaired loans.   The remaining amount of the loss provisions for
each year added to general reserves related to the overall trends in credit
quality of the loan portfolio including an increase in the number and amount of
classified and past due loans, and deterioration in the general economic
environment in the Company’s primary market area.  Management believes
that the allowance for loan losses was adequate at December 31,
2009.  However, no prediction of the ultimate level of loans charged
off in future years can be made with any certainty.





The
following table summarizes the changes in the allowance for loan losses for the
periods indicated:





Changes in allowance for loan
      lossesYear ended December 31,(dollars
      in thousands)
            
            2009
            
            
            2008
            
            
            2007
            
            
            2006
            
            
            2005Balance,
      beginning
            
            $
            3,244
            
            
            $
            1,758
            
            
            $
            1,746
            
            
            $
            1,766
            
            
            $
            1,401Provision
      for  loan losses
            
            
            7,000
            
            
            
            1,600
            
            
            
            -
            
            
            
            -
            
            
            
            369Charge-offs(1)
            
            
            (4,013
            )
            
            
            (142
            )
            
            
            -
            
            
            
            (21
            )
            
            
            (4
            )Recoveries
            
            
            -
            
            
            
            28
            
            
            
            12
            
            
            
            1
            
            
            
            -Balance,
      ending
            
            $
            6,231
            
            
            $
            3,244
            
            
            $
            1,758
            
            
            $
            1,746
            
            
            $
            1,766Net
      charge-offs to average loans outstanding
            
            
            1.67
            %
            
            
            .05
            %
            
            
            (.01
            )%
            
            
            .01
            %
            
            
            --
            (2)Average
      loans outstanding
            
            $
            239,428
            
            
            $
            219,431
            
            
            $
            194,734
            
            
            $
            166,620
            
            
            $
            134,008Ending
      allowance to total loans outstanding
            
            
            2.58
            %
            
            
            1.41
            %
            
            
            0.87
            %
            
            
            0.95
            %
            
            
            1.16
            %





(1)
            Charge-off
      recorded in the years ended 2009 and 2005 related primarily to commercial
      real estate loans while all other charge-offs related primarily to
      consumer loans


(2)
            Less
      than .01%





Deposits





Deposits
are obtained primarily from local businesses and residents.  The
average deposits and the average rates paid for 2009, 2008, and 2007 are
presented in the “Results of Operations” section under the heading “Net Interest
Income.”  Average total deposits for 2009 were $277.2 million compared
to $244.7 million for 2008, an increase of $32.5 million or
13%.  Average brokered deposits included in these totals were $20.7
million in 2009, $15.9 million in 2008 and $8.8 million in 2007.





The
Company has utilized brokered deposits since December 2006 primarily as a way of
diversifying its funding sources.  Total brokered deposits at December
31, 2009, 2008 and 2007 were $17.8 million, $15.6 million and $2.9 million,
respectively.  The brokered deposits held by the Company at December
31, 2009 were acquired to increase liquidity in an unstable economic environment
and as a way of extending liabilities to reposition the balance sheet for rising
interest rates.  All brokered deposits at December 31, 2009 mature in
either 2013 or 2014 and are callable on a quarterly basis should they no longer
be necessary for risk management purposes.





In 2009,
the Company continued its strong marketing effort to attract local
deposits.  Total deposits at December 31, 2009 were $294.3 million
compared to $257.3 million at December 31, 2008, an increase of $37.0 million or
14%.  If the brokered time deposits are excluded, total deposits at
December 31, 2009 increased by $35.0 million or 15% from December 21,
2008.


41
 Table of Contents


The
following chart sets forth the distribution of the Company’s average daily
deposits for the periods indicated.





For
      the Year ended December 31,2009
            
            
            2008
            
            
            2007(dollars
      in thousands)
            
            AverageBalance
            
            
            AverageYield/Rate
            
            
            AverageBalance
            
            
            Average
                  Yield/Rate
            
            
            AverageBalance
            
            
            AverageYield/RateDeposits:Non-interest
      bearing deposits
            
            $
            68,509
            
            
            
            
            
            $
            66,106
            
            
            
            
            
            $
            60,465Interest-bearing
      deposits:Interest
      bearing demand deposits
            
            
            36,689
            
            
            
            1.37
            %
            
            
            29,324
            
            
            
            1.74
            %
            
            
            27,052
            
            
            
            2.84
            %Money
      market accounts
            
            
            65,265
            
            
            
            1.13
            %
            
            
            52,349
            
            
            
            2.12
            %
            
            
            47,308
            
            
            
            3.27
            %Savings
            
            
            10,103
            
            
            
            0.25
            %
            
            
            8,887
            
            
            
            0.37
            %
            
            
            8,660
            
            
            
            0.80
            %Time
      deposits
            
            
            96,621
            
            
            
            2.54
            %
            
            
            88,031
            
            
            
            3.69
            %
            
            
            70,117
            
            
            
            4.64
            %Total
      interest-bearing deposits
            
            
            208,678
            
            
            
            1.78
            %
            
            
            178,591
            
            
            
            2.74
            %
            
            
            153,137
            
            
            
            3.68
            %Total
      deposits
            
            $
            277,187
            
            
            
            
            
            
            $
            244,697
            
            
            
            
            
            
            $
            213,602





The
following table summarizes by time remaining to maturity, the amount of
certificates of deposit issued in amounts of $100,000 or more as of December 31,
2009.





Maturities of certificates of deposit of $100,000
      or more(dollars
      in thousands)
            
            Balance
            
            
            Percent
      of totalThree
      months or less
            
            $
            14,734
            
            
            
            21
            %Over
      three months through nine months
            
            
            15,861
            
            
            
            22
            %Over
      nine months through twelve months
            
            
            21,154
            
            
            
            30
            %Over
      twelve months
            
            
            19,359
            
            
            
            27
            %Total
      certificates of deposit of $100,000 and more
            
            $
            71,108
            
            
            
            100
            %





Borrowings





Federal Home Loan
Bank.  The Company maintains a borrowing relationship with the
Federal Home Loan Bank of San Francisco (FHLB) which offers both long-term and
short-term borrowing facilities.  The Company has pledged investment
securities and qualifying loans as collateral for its borrowing lines as
required by FHLB.





At
December 31, 2009, term borrowing outstanding from the FHLB totaled $3.7 million
compared to $5.2 million at December 31, 2008.  The Company incurred
term borrowing from FHLB at various times to match the cash flow characteristics
of certain fixed rate loans made by the Company.  There was no new
term borrowing during 2009 and the reduction from the prior year was
attributable to scheduled principal repayments and
maturities.  Average total term borrowings from FHLB totaled $4.2
million for 2009 at an average cost of 5.41% compared to average term borrowings
of $6.3 million at an average cost of 4.82% for 2008.  The increase in
average cost was due to the maturation during 2009 of lower cost
borrowings.





There
were no short-term borrowings from FHLB at December 31, 2009 compared to $8.0
million at December 31, 2008.  The Company utilized short-term
borrowings from FHLB to fund a portion of its asset growth in 2008 due to
competitive market conditions for deposits, but paid off these borrowings in
2009 due to increased local deposit growth.  Average total short-term
borrowings from FHLB totaled $10.9 million in 2008 at an average cost of
2.71%.





Federal Reserve Discount
Window.At December 31, 2009, the Bank could borrow
approximately 46% of pledged loans from the Federal Reserve Bank of San
Francisco.  The Bank’s discount window borrowing line was
approximately $31.4 million at December 31, 2009 and there were no outstanding
borrowings.





Other Borrowing
Arrangements.  In addition to FHLB and FRB borrowing lines, the
Company maintains a short-term unsecured borrowing arrangement with a
correspondent bank to meet unforeseen cash needs.  This borrowing line
totaled $10.0 million at both December 31, 2009 and 2008.  The
borrowing line is utilized infrequently and there was no balance outstanding at
either December 31, 2009 or 2008.


42
 Table of Contents


Junior Subordinated Deferrable
Interest Debentures.During 2003, the Company formed Valley
Commerce Trust I with a capital investment of $93,000 for the sole purpose of
issuing trust preferred securities.  During the second quarter of
2003, Valley Commerce Trust I issued trust preferred securities for gross
proceeds of $3.0 million and invested this amount plus the $93,000 of capital
proceeds in floating rate junior subordinated deferrable interest debentures
issued by the Company.  The Subordinated Debentures mature on April 7,
2033 and are repriced quarterly to an interest rate that is the sum of 3-month
Libor plus 3.30%.  The interest rate at December 31, 2009 and December
31, 2008 was 4.20% and 7.08%, respectively.





Trust
preferred securities are includable in the Company’s Tier 1 capital for
regulatory purposes subject to certain limitations.  The action taken
to form Valley Commerce Trust I and issue trust preferred securities was made
for the purpose of enhancing the Company’s capital position and to provide for
the continued growth of the Bank.





Off-Balance
Sheet Items





As of
December 31, 2009 and December 31, 2008, commitments to extend credit and
letters of credit were the only financial instruments with off-balance sheet
risk.  As of December 31, 2009 and December 31, 2008, commitments to
extend credit totaled $41.2 million and $47.4 million, respectively, and letters
of credit totaled $72,000 and $337,000, respectively.  The Company has
not entered into any contracts for financial derivative instruments such as
futures, swaps, options or similar instruments.





Contractual
Obligations





The
Company’s contractual obligations are comprised of junior subordinated
deferrable interest debentures, operating leases for office space in Visalia and
Fresno which expire at various dates through 2017, and post-retirement benefit
plans.





Capital
Resources





Federal
regulations establish guidelines for calculating leverage and risk-based capital
ratios.  The guidelines for risk-based capital ratios, which apply to
banks and bank holding companies, establish a systematic approach of assigning
risk weights to assets and commitments making capital requirements more
sensitive to differences in risk profiles.  For these purposes, “Tier
1” capital consists of common equity, non-cumulative perpetual preferred stock,
trust preferred securities subject to regulatory limitation, and minority
interests in the equity accounts of consolidated subsidiaries and excludes
goodwill and certain deferred tax assets.  “Tier 2” capital consists
of cumulative perpetual preferred stock, limited-life preferred stock, mandatory
convertible securities, subordinated debt and (subject to a limit of 1.25% of
risk-weighted assets) general loan loss reserves.  In calculating the
relevant ratio, a company’s assets and off-balance sheet commitments are
risk-weighted; thus, for example, loans are included at 100% of their book value
while assets considered less risky are included at a percentage of their book
value (20%, for example, for U. S. Government Agency securities, and 0% for
vault cash and U. S. Government Treasury securities).


43
 Table of Contents


The Board
of Directors regularly reviews the Company’s capital ratios to ensure that
capital exceeds the prescribed regulatory minimums and is otherwise adequate to
meet future needs.  The following table summarizes the Company’s
risk-based capital ratios as of December 31, 2009 and December 31,
2008:





Capital and capital adequacy
      ratiosYear ended December 31,2009
            
            
            2008(dollars
      in thousands)
            
            Amount
            
            
            Ratio
            
            
            Amount
            
            
            RatioLeverage RatioValley
      Commerce Bancorp and Subsidiary
            
            $
            39,865
            
            
            
            11.4
            %
            
            $
            33,044
            
            
            
            10.9
            %Minimum
      regulatory requirement
            
            $
            13,982
            
            
            
            4.0
            %
            
            $
            12,150
            
            
            
            4.0
            %Valley
      Business Bank
            
            $
            39,845
            
            
            
            11.4
            %
            
            $
            32,751
            
            
            
            10.8
            %Minimum
      requirement for “Well- Capitalized” institution
            
            $
            17,478
            
            
            
            5.0
            %
            
            $
            15,181
            
            
            
            5.0
            %Minimum
      regulatory requirement
            
            $
            13,977
            
            
            
            4.0
            %
            
            $
            12,145
            
            
            
            4.0
            %Tier 1 Risk-Based Capital
    RatioValley
      Commerce Bancorp and Subsidiary
            
            $
            39,865
            
            
            
            14.8
            %
            
            $
            33,044
            
            
            
            12.7
            %Minimum
      regulatory requirement
            
            $
            10,804
            
            
            
            4.0
            %
            
            $
            10,367
            
            
            
            4.0
            %Valley
      Business Bank
            
            $
            39,845
            
            
            
            14.8
            %
            
            $
            32,751
            
            
            
            12.6
            %Minimum
      requirement for “Well- Capitalized” institution
            
            $
            16,201
            
            
            
            6.0
            %
            
            $
            15,548
            
            
            
            6.0
            %Minimum
      regulatory requirement
            
            $
            10,801
            
            
            
            4.0
            %
            
            $
            10,363
            
            
            
            4.0
            %Total Risk-Based Capital
    RatioValley
      Commerce Bancorp and Subsidiary
            
            $
            43,277
            
            
            
            16.0
            %
            
            $
            35,284
            
            
            
            14.0
            %Minimum
      regulatory requirement
            
            $
            21,608
            
            
            
            8.0
            %
            
            $
            20,734
            
            
            
            8.0
            %Valley
      Business Bank
            
            $
            43,256
            
            
            
            16.0
            %
            
            $
            35,990
            
            
            
            13.9
            %Minimum
      requirement for “Well- Capitalized” institution
            
            $
            27,002
            
            
            
            10.0
            %
            
            $
            25,909
            
            
            
            10.0
            %Minimum
      regulatory requirement
            
            $
            21,601
            
            
            
            8.0
            %
            
            $
            20,728
            
            
            
            8.0
            %





At
December 31, 2009 and December 31, 2008, all of the Company’s capital ratios
were in excess of minimum regulatory requirements, and Valley Business Bank
exceeded the minimum requirements of a “well capitalized”
institution.





In the
second quarter of 2003, Valley Commerce Trust I issued $3.0 million of trust
preferred securities.  Trust preferred securities are includable in
Tier 1 capital, subject to regulatory limitation.  At December 31,
2009, and December 31, 2008, the entire $3.0 million was included in Tier 1
capital.





The
Company’s average equity as a percentage of average assets was 11.7% for 2009
and 9.89% for 2008.  Year-end shareholders’ equity as a percentage of
year-end assets was 10.84% and 9.85% at December 31, 2009 and 2008,
respectively.  The increase in these ratios reflects preferred stock
issued to the United States Treasury offset by the 2009 loss, 2009 asset growth,
and cash dividends paid on preferred stock.





The
Company issued a 5% stock dividend in 2009 and 2008.  The Company has
not declared or paid cash dividends since inception.  Stock splits and
dividends are not dilutive to capital ratios.


44
 Table of Contents


The
Company commenced a stock repurchase program as of November 2007.  The
program is subject to restrictions contained in the Securities Purchase
Agreement between the Company and the Treasury under which the Company issued
$7.7 million of preferred stock to the Treasury on January 30,
2009.  The Purchase Agreement contains provisions that restrict the
Company’s ability to repurchase Valley Commerce Bancorp common
stock.  Under the Purchase Agreement, prior to January 30, 2012,
unless the Company has redeemed the Preferred Shares, or the Treasury has
transferred the Preferred Shares to a third party, the consent of the Treasury
will be required for the Company to redeem, purchase or acquire any shares of
Common Stock or other equity or capital securities, other than in connection
with benefit plans consistent with past practice and certain other circumstances
specified in the Purchase Agreement.





The
amount of preferred stock issued to the Treasury represents approximately 3% of
the Company’s risk adjusted assets.  Accordingly, the impact to the
Company’s risk-based capital ratios is an increase of approximately 300 basis
points.





Liquidity
Management





Liquidity
is the ability to provide funds to meet customers’ loan and deposit needs and to
fund operations in a timely and cost effective manner.  The Company’s
primary source of funds is deposits.  On an ongoing basis, management
anticipates funding needs for loans, asset purchases, maturing deposits, and
other needs and initiates deposit promotions as needed.  Management
measures the Company’s liquidity position monthly through the use of short-term
and medium-term internal liquidity calculations.  These are monitored
on an ongoing basis by the Board of Directors and the Company’s Asset Liability
Management Committee.





The
Company has a successful history of establishing and retaining deposit
relationships with local business customers.  It periodically utilizes
collateralized borrowing lines and wholesale funding resources to supplement
local deposit growth.  These include borrowing lines with FHLB, FRB,
and correspondent banks, and utilization of brokered time
deposits.  At December 31, 2009, the Company had available credit of
$40.6 million from the FHLB, $31.4 million from the Federal Reserve Bank, and
$10.0 million from correspondent banks.





The
Company’s off-balance sheet financing arrangements are primarily limited to
commitments to extend credit and standby letters of credit, which totaled $41.2
million and $72,000, respectively, at December 31, 2009.  Management
monitors these arrangements monthly in the overall assessment of the Company’s
liquidity needs. The Company has no other off-balance sheet arrangements that
are likely to have a material effect on its financial condition, results of
operations, liquidity, capital expenditures or capital resources.  The
Company does not retain a repurchase option or contingent interest in any of its
loan participations.





As
discussed above, the Company’s wholly-owned subsidiary, Valley Commerce Trust I,
issued trust preferred securities for gross proceeds of $3.0 million on April 7,
2003.  Quarterly interest payments on these securities are considered
in management’s normal evaluation of liquidity needs.  Although the
trust preferred securities do not mature until April 7, 2033, Valley Commerce
Trust I has the option to redeem the trust preferred securities at any time
after April 7, 2008.  The Company will carefully evaluate the impact
on capital and liquidity if and when consideration is given to redemption of
trust preferred securities.





In
addition, as discussed above, the Company issued $7.7 million of preferred stock
to the Treasury on January 30, 2009 and pays quarterly cash dividends on this
stock.  The Company will carefully evaluate the impact on capital and
liquidity if and when consideration is given to redemption of the preferred
stock.





The
Company’s strategic objectives include expanding through opening of “de novo”
branches and loan production offices and acquiring branch offices from other
institutions.   The addition of branch offices is expected to
involve significant cash outlays; e.g., for buildings, improvements, and
equipment.  The Company’s planning efforts consider the impact of
known and anticipated cash outlays so that sufficient liquidity is maintained
for both capital and operational needs.




ITEM 7A – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK





Not
applicable.


45
 Table of Contents


ITEM 8 – FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA





The
report of the independent registered public accounting firm and financial
statements listed below are included herein:





PageI.
            Report
      of Independent Registered Public Accounting Firm
            47II.
            Consolidated
      Balance Sheet as of December 31, 2009 and 2008
            48III.
            Consolidated
      Statement of Operations for the years ended December 31, 2009, 2008 and
      2007
            49IV.
            Consolidated
      Statement of Changes in Shareholders’ Equity for the years ended December
      31, 2009, 2008 and 2007
            50V.
            Consolidated
      Statement of Cash Flows for the years ended December 31, 2008, 2008 and
      2007
            52VI.
            Notes
      to Consolidated Financial Statements
            54




46
 Table of Contents


REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM








The
Shareholders and


Board
of Directors


Valley
Commerce Bancorp





We have
audited the accompanying consolidated balance sheet of Valley Commerce Bancorp
and subsidiary (the "Company") as of December 31, 2009 and 2008, and the related
consolidated statements of operations, changes in shareholders' equity and cash
flows for each of the years in the three-year period ended December 31,
2009.  These consolidated financial statements are the responsibility
of the Company's management.  Our responsibility is to express an
opinion on these consolidated financial statements based on our
audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audits to obtain reasonable assurance about whether
the consolidated financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the consolidated financial
statements.  An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation.  We believe
that our audits provide a reasonable basis for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Valley Commerce
Bancorp and subsidiary as of December 31, 2009 and 2008, and the consolidated
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2009, in conformity with accounting
principles generally accepted in the United States of America.





We were
not required or engaged to examine the effectiveness of the Valley Commerce
Bancorp and subsidiary’s internal control over financial reporting as of
December 31, 2009 and, accordingly, we do not express an opinion
thereon.




/s/
      Perry-Smith LLP








Sacramento,
California


March 30,
2010


47
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


CONSOLIDATED
BALANCE SHEET





December
31, 2009 and 2008








2009
            
            
            2008ASSETSCash
      and due from banks
            
            $
            39,077,786
            
            
            $
            8,755,867Federal
      funds sold
            
            
            -
            
            
            
            13,390,000Cash
      and cash equivalents
            
            
            39,077,786
            
            
            
            22,145,867Available-for-sale
      investment securities, at fair value (Notes 3 and 4)
            
            
            42,566,000
            
            
            
            42,018,000Loans,
      less allowance for loan losses of $6,231,065in 2009
      and $3,244,454 in 2008 (Notes 2, 3, 5 and 10)
            
            
            234,822,963
            
            
            
            226,696,838Bank
      premises and equipment, net (Note 6)
            
            
            8,041,905
            
            
            
            3,974,845Cash
      surrender value of bank-owned life insurance(Note
      15)
            
            
            6,354,871
            
            
            
            6,421,863Accrued
      interest receivable and other assets (Note 13)
            
            
            9,307,998
            
            
            
            4,841,565Total
      assets
            
            $
            340,171,523
            
            
            $
            306,098,978LIABILITIES
      AND SHAREHOLDERS' EQUITYDeposits:Non-interest
      bearing
            
            $
            76,574,651
            
            
            $
            77,405,517Interest
      bearing (Note 7)
            
            
            217,707,492
            
            
            
            179,917,916Total
      deposits
            
            
            294,282,143
            
            
            
            257,323,433Accrued
      interest payable and other liabilities
            
            
            2,265,842
            
            
            
            2,357,915FHLB
      advances (Note 8)
            
            
            -
            
            
            
            8,000,000FHLB
      term borrowing (Note 8)
            
            
            3,661,999
            
            
            
            5,184,346Junior
      subordinated deferrable interest debentures (Note 9)
            
            
            3,093,000
            
            
            
            3,093,000Total
      liabilities
            
            
            303,302,984
            
            
            
            275,958,694Commitments
      and contingencies (Note 10)Shareholders'
      equity (Note 11):Serial
      preferred stock - no par value; 10,000,000 shares authorized; issued and
      outstanding 7,700 shares Class B and 385 Class C warrants in 2009 and none
      in 2008
            
            
            7,744,800
            
            
            
            -Common
      stock - no par value; 30,000,000 shares authorized; issued and outstanding
      – 2,608,317 shares in 2009 and 2,597,425 shares in 2008
            
            
            25,953,290
            
            
            
            24,684,529Retained
      earnings
            
            
            3,166,732
            
            
            
            5,359,535Accumulated
      other comprehensive income, net of taxes (Notes 4 and 7)
            
            
            3,717
            
            
            
            96,220Total
      shareholders' equity
            
            
            36,868,539
            
            
            
            30,140,284Total
      liabilities and shareholders’ equity
            
            $
            340,171,523
            
            
            $
            306,098,978








The
accompanying notes are an integral


part of
these consolidated financial statements.


48
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


CONSOLIDATED
STATEMENT OF OPERATIONS





For
the Years Ended December 31, 2009, 2008 and 2007








2009
            
            
            2008
            
            
            2007Interest
      income:Interest
      and fees on loans
            
            $
            14,959,057
            
            
            $
            15,509,954
            
            
            $
            16,113,423Interest
      on investment securities:Taxable
            
            
            1,222,449
            
            
            
            1,304,535
            
            
            
            1,581,892Exempt
      from Federal income taxes
            
            
            737,506
            
            
            
            798,960
            
            
            
            771,368Interest
      on Federal funds sold
            
            
            9,972
            
            
            
            170,389
            
            
            
            3,658Total
      interest income
            
            
            16,928,984
            
            
            
            17,783,838
            
            
            
            18,470,341Interest
      expense:Interest
      on deposits (Note 7)
            
            
            3,721,414
            
            
            
            4,900,988
            
            
            
            5,802,852Interest
      on FHLB advances (Note 8)
            
            
            10,560
            
            
            
            296,170
            
            
            
            695,062Interest
      on FHLB term borrowings (Note 8)
            
            
            227,463
            
            
            
            302,670
            
            
            
            362,665Interest
      on junior subordinated deferrable interest debentures (Note
    9)
            
            
            129,795
            
            
            
            218,672
            
            
            
            270,690Total
      interest expense
            
            
            4,089,232
            
            
            
            5,718,500
            
            
            
            7,131,269Net
      interest income before provision for loan losses
            
            
            12,839,752
            
            
            
            12,065,338
            
            
            
            11,339,072Provision
      for loan losses (Note 5)
            
            
            7,000,000
            
            
            
            1,600,000
            
            
            
            -Net
      interest income after provision for loan losses
            
            
            5,839,752
            
            
            
            10,465,338
            
            
            
            11,339,072Non-interest
      income:Service
      charges
            
            
            766,122
            
            
            
            715,651
            
            
            
            590,900Gain
      (loss) on sale of available-for-sale investment securities, net (Note
      4)
            
            
            416,248
            
            
            
            46,412
            
            
            
            (1,145
            )Gain
      on sale of other real estate
            
            
            16,055
            
            
            
            -
            
            
            
            -Mortgage
      loan brokerage fees
            
            
            43,224
            
            
            
            52,535
            
            
            
            76,636Earnings
      on cash surrender value of life insurance policies (Note
    15)
            
            
            288,154
            
            
            
            252,796
            
            
            
            258,134Officer
      life insurance benefits
            
            
            317,488
            
            
            
            -
            
            
            
            -Other
            
            
            189,489
            
            
            
            215,386
            
            
            
            230,140Total
      non-interest income
            
            
            2,036,780
            
            
            
            1,282,780
            
            
            
            1,154,665Non-interest
      expense:Salaries
      and employee benefits (Notes 5 and 15)
            
            
            4,866,197
            
            
            
            5,127,725
            
            
            
            4,770,498Occupancy
      and equipment (Notes 6 and 10)
            
            
            1,565,225
            
            
            
            1,259,491
            
            
            
            1,073,196Other
      (Note 12)
            
            
            3,227,373
            
            
            
            2,766,313
            
            
            
            2,855,193Total
      non-interest expense
            
            
            9,658,795
            
            
            
            9,153,529
            
            
            
            8,698,887(Loss)
      income before provision for income taxes
            
            
            (1,782,263
            )
            
            
            2,594,589
            
            
            
            3,794,850(Benefit
      from) provision for income taxes (Note 13)
            
            
            (1,195,000
            )
            
            
            746,000
            
            
            
            1,134,000Net
      (loss) income
            
            $
            (587,263
            )
            
            $
            1,848,589
            
            
            $
            2,660,850Dividends
      accrued and discount accreted on preferred shares
            
            $
            (352,917
            )
            
            $
            -
            
            
            $
            -Net
      (loss) income available to common shareholders
            
            $
            (940,180
            )
            
            $
            1,848,589
            
            
            $
            2,660,850Basic
      (loss) earnings per share (Note 11)
            
            $
            (0.36
            )
            
            $
            0.71
            
            
            $
            1.02Diluted
      (loss) earnings per share (Note 11)
            
            $
            (0.36
            )
            
            $
            0.70
            
            
            $
            0.99








The
accompanying notes are an integral


part of
these consolidated financial statements.


49
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


CONSOLIDATED
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY





For
the Years Ended December 31, 2009, 2008 and 2007





Preferred
              Shares
            
            
            Common Stock
            
            
            Retained
            
            
            Accumulated
              Other
              Compre-
              hensive
              Income
      (Loss)
            
            
            Total
              Share-
              holders’
            
            
            Total
              Compre-
              hensiveStock
            
            
            Amount
            
            
            Shares
            
            
            Amount
            
            
            Earnings
            
            
            (Net of Taxes)
            
            
            Equity
            
            
            Income (Loss)Balance,
      December 31, 2006
            
            
            
            
            
            
            
            
            2,215,765
            
            
            $
            20,683,720
            
            
            $
            5,040,381
            
            
            $
            (276,002
            )
            
            $
            25,448,099
            
            
            
            2,660,850Comprehensive
      income (Note 16):Net
      income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2,660,850
            
            
            
            
            
            
            
            2,660,850
            
            
            $
            2,660,850Other
      comprehensive income, net of tax:Net
      change in unrealized gains (losses) on available-for-saleInvestment
      securities
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            214,823
            
            
            
            214,823
            
            
            
            214,823Total
      comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            2,875,673Stock
      dividend
            
            
            
            
            
            
            
            
            110,603
            
            
            
            2,158,974
            
            
            
            (2,158,974
            )Cash
      paid for fractional shares
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (5,392
            )
            
            
            
            
            
            
            (5,392
            )Stock
      repurchase
            
            
            
            
            
            
            
            
            (27,440
            )
            
            
            (268,267
            )
            
            
            (113,541
            )
            
            
            
            
            
            
            (381,808
            )Stock
      options exercised and relatedTax
      benefit
            
            
            
            
            
            
            
            
            97,507
            
            
            
            892,229
            
            
            
            
            
            
            
            
            
            
            
            892,229Stock-based
      compensation expense
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            44,410
            
            
            
            
            
            
            
            
            
            
            
            44,410Balance,
      December 31, 2007
            
            
            
            
            
            
            
            
            
            
            2,396,435
            
            
            
            23,511,066
            
            
            
            5,423,324
            
            
            
            (61,179
            )
            
            
            228,873,211Cumulative
      effect of change in accounting principal, adoption ofEITF
      06-4 (Note 15)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (102,116
            )
            
            
            
            
            
            
            (102,116
            )Comprehensive
      income (Note 16):Net
      income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,848,589
            
            
            
            
            
            
            
            1,848,589
            
            
            $
            1,848,589Other
      comprehensive income, net of tax:Net
      change in unrealized gains (losses) on available-for-saleInvestment
      securities
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            157,399
            
            
            
            157,399
            
            
            
            157,399Total
      comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            2,005,988Stock
      dividend
            
            
            
            
            
            
            
            
            
            
            116,919
            
            
            
            1,519,947
            
            
            
            (1,519,947
            )Cash
      paid for fractional shares
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (3,489
            )
            
            
            
            
            
            
            (3,489
            )Stock
      repurchase
            
            
            
            
            
            
            
            
            
            
            (54,734
            )
            
            
            (534,211
            )
            
            
            (286,826
            )
            
            
            
            
            
            
            (821,037
            )Stock
      options exercised and relatedTax
      benefit
            
            
            
            
            
            
            
            
            
            
            15,119
            
            
            
            127,844
            
            
            
            
            
            
            
            
            
            
            
            127,844Stock-based
      compensation expense
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            59,883
            
            
            
            
            
            
            
            
            
            
            
            59,883Balance,
      December 31, 2008
            
            
            
            
            
            
            
            
            
            
            2,473,739
            
            
            
            24,684,529
            
            
            
            5,359,535
            
            
            
            96,220
            
            
            
            30,140,284




The
accompanying notes are an integral


part of
these consolidated financial statements.


50
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


CONSOLIDATED
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY


(Continued)


For
the Years Ended December 31, 2009, 2008 and 2007





Preferred
              Shares
            
            
            Common Stock
            
            
            Retained
            
            
            Accumulated
              Other
              Compre-
              hensive
              Income
      (Loss)
            
            
            Total
              Share-
              holders’
            
            
            Total
              Compre-
              hensiveStock
            
            
            Amount
            
            
            Shares
            
            
            Amount
            
            
            Earnings
            
            
            (Net of Taxes)
            
            
            Equity
            
            
            Income (Loss)Balance,
      December 31, 2008
            
            
            
            
            
            
            
            
            2,473,739
            
            
            $
            24,684,529
            
            
            $
            5,359,535
            
            
            $
            96,220
            
            
            $
            30,140,284Comprehensive
      loss (Note 16):Net
      loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (587,263
            )
            
            
            
            
            
            
            (587,263
            )
            
            $
            (587,263
            )Other
      comprehensive loss, net of tax:Net
      change in unrealized gains (losses) on available-for-sale Investment
      securities
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (92,503
            )
            
            
            (92,503
            )
            
            
            (92,503
            )Total
      comprehensive loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            (679,766
            )Issuance
      of preferred shares, net of costs $25,783 (Note 11)
            
            
            8,085
            
            
            
            7,674,217
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            7,674,217Dividend
      and accretion on preferred stock
            
            
            
            
            
            
            70,583
            
            
            
            
            
            
            
            
            
            
            
            (455,261
            )
            
            
            
            
            
            
            (384,678
            )Stock
      dividend
            
            
            
            
            
            
            
            
            
            
            123,410
            
            
            
            1,147,702
            
            
            
            (1,147,702
            )
            
            
            
            
            
            
            -Cash
      paid for fractional shares
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (2,577
            )
            
            
            
            
            
            
            (2,577
            )Stock
      options exercised and related tax benefit
            
            
            
            
            
            
            
            
            
            
            11,168
            
            
            
            67,718
            
            
            
            
            
            
            
            
            
            
            
            67,718Stock-based
      compensation expense
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            53,341
            
            
            
            
            
            
            
            
            
            
            
            53,341Balance,
      December 31, 2009
            
            
            8,085
            
            
            $
            7,744,800
            
            
            
            2,608,317
            
            
            $
            25,953,290
            
            
            $
            3,166,732
            
            
            $
            3,717
            
            
            $
            36,868,539





2009
            
            
            2008
            
            
            2007Disclosure
      of reclassification amount, net of taxes (Note 16):Unrealized
      holding gains arising during the year
            
            $
            152,422
            
            
            $
            184,713
            
            
            $
            214,054Less:
      reclassification adjustment for gains (losses) included in net
      income
            
            
            244,925
            
            
            
            27,314
            
            
            
            (769
            )Net
      change in unrealized gains on available-for-sale investment
      securities
            
            $
            (92,503
            )
            
            $
            157,399
            
            
            $
            214,823








The
accompanying notes are an integral


part of
these consolidated financial statements.


51
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


CONSOLIDATED
STATEMENT OF CASH FLOWS








For
the Years Ended December 31, 2009, 2008 and 2007





2009
            
            
            2008
            
            
            2007Cash
      flows from operating activities:Net
      (loss) income
            
            $
            (587,263
            )
            
            $
            1,848,589
            
            
            $
            2,660,850Adjustments
      to reconcile net (loss) income to net cash provided by operating
      activities:Provision
      for loan losses
            
            
            7,000,000
            
            
            
            1,600,000
            
            
            
            -Increase
      (decrease) in deferred loan origination fees, net
            
            
            66,049
            
            
            
            36,969
            
            
            
            (131,895
            )Depreciation
            
            
            665,066
            
            
            
            466,069
            
            
            
            315,365Amortization
      of intangibles
            
            
            -
            
            
            
            7,718
            
            
            
            62,538(Gain)
      loss on sale of available-for-sale investment securities,
    net
            
            
            (416,248
            )
            
            
            (46,412
            )
            
            
            1,145Dividends
      on Federal Home Loan Bank stock
            
            
            (14,800
            )
            
            
            (82,100
            )
            
            
            (79,100
            )Accretion
      (Amortization) of investment securities, net
            
            
            31,579
            
            
            
            (31,620
            )
            
            
            (23,459
            )Loss
      on disposition of premises and equipment
            
            
            120
            
            
            
            1,198
            
            
            
            16,470Provision
      for deferred income taxes
            
            
            (1,003,000
            )
            
            
            (935,000
            )
            
            
            (77,000
            )Tax
      benefits on stock-based compensation
            
            
            (7,720
            )
            
            
            (30,338
            )
            
            
            (335,893
            )Increase
      in cash surrender value of bank owned life insurance
            
            
            (278,358
            )
            
            
            (237,332
            )
            
            
            (249,968
            )Stock-based
      compensation expense
            
            
            53,341
            
            
            
            59,883
            
            
            
            44,410Gain
      from officer life insurance benefits
            
            
            (317,488
            )
            
            
            -
            
            
            
            -Gain
      from sale of other real estate
            
            
            (16,055
            )
            
            
            -
            
            
            
            -(Increase)
      decrease in accrued interest receivable and other assets
            
            
            (3,437,913
            )
            
            
            (35,637
            )
            
            
            627,659(Decrease)
      increase in accrued interest payable and other liabilities
            
            
            (27,393
            )
            
            
            409,971
            
            
            
            378,761Net
      cash provided by operating activities
            
            
            1,709,917
            
            
            
            3,031,958
            
            
            
            3,209,883Cash
      flows from investing activities:Proceeds
      from matured and called available-for-sale investment
      securities
            
            
            3,864,361
            
            
            
            10,000,000
            
            
            
            7,615,000Proceeds
      from sales of available-for-sale investment securities
            
            
            13,559,130
            
            
            
            4,537,315
            
            
            
            1,533,619Purchases
      of available-for-sale investment securities
            
            
            (23,798,247
            )
            
            
            (2,949,149
            )
            
            
            (12,530,396
            )Proceeds
      from principal repayments from available- for-sale mortgage-backed
      securities
            
            
            6,051,242
            
            
            
            3,341,502
            
            
            
            2,427,545Net
      increase in loans
            
            
            (15,176,119
            )
            
            
            (28,819,536
            )
            
            
            (17,050,870
            )Redemption
      of Federal Home Loan Bank stock, net
            
            
            -
            
            
            
            636,500
            
            
            
            246,400Purchase
      of premises and equipment
            
            
            (4,732,461
            )
            
            
            (1,407,299
            )
            
            
            (1,544,749
            )Proceeds
      from sale of premises and equipment
            
            
            215
            
            
            
            2,250
            
            
            
            8,028Proceeds
      from bank owned life insurance
            
            
            662,838
            
            
            
            -
            
            
            
            -Net
      cash used in investing activities
            
            
            (19,569,041
            )
            
            
            (14,658,417
            )
            
            
            (19,295,423
            )








(Continued)


52
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


CONSOLIDATED
STATEMENT OF CASH FLOWS


(Continued)


For
the Years Ended December 31, 2009, 2008 and 2007








2009
            
            
            2008
            
            
            2007Cash
      flows from financing activities:Net
      increase in noninterest bearing and  interest-bearing
      deposits
            
            $
            32,830,168
            
            
            $
            11,873,611
            
            
            $
            14,956,957Net
      increase (decrease) in time deposits
            
            
            4,128,542
            
            
            
            30,063,754
            
            
            
            (7,147,058
            )Proceeds
      from issuance of preferred stock
            
            
            7,674,217
            
            
            
            -
            
            
            
            -Proceeds
      from exercised stock options
            
            
            59,998
            
            
            
            97,506
            
            
            
            556,336Cash
      paid to repurchase common stock
            
            
            -
            
            
            
            (821,037
            )
            
            
            (381,808
            )Tax
      benefits from stock-based compensation
            
            
            7,720
            
            
            
            30,338
            
            
            
            335,893Cash
      dividends paid on preferred stock
            
            
            (384,678
            )
            
            
            -
            
            
            
            -Proceeds
      from FHLB advances
            
            
            -
            
            
            
            8,000,000
            
            
            
            4,204,000Payments
      on FHLB advances
            
            
            (8,000,000
            )
            
            
            (21,804,000
            )
            
            
            -Net
      decrease in FHLB term borrowings
            
            
            (1,522,347
            )
            
            
            (2,961,703
            )
            
            
            (401,589
            )Cash
      paid to repurchase fractional shares
            
            
            (2,577
            )
            
            
            (3,489
            )
            
            
            (5,392
            )Net
      cash provided by financing activities
            
            
            34,791,043
            
            
            
            24,474,980
            
            
            
            12,117,339Increase
      (decrease) in cash and cash equivalents
            
            
            16,931,919
            
            
            
            12,848,521
            
            
            
            (3,968,291
            )Cash
      and cash equivalents at beginning of year
            
            
            22,145,867
            
            
            
            9,297,346
            
            
            
            13,265,547Cash
      and cash equivalents at end of year
            
            $
            39,077,786
            
            
            $
            22,145,867
            
            
            $
            9,297,256Supplemental
      disclosure of cash flow information:Cash
      paid during the year for:Interest
      expense
            
            $
            4,246,023
            
            
            $
            5,653,063
            
            
            $
            7,184,869Income
      taxes
            
            $
            1,475,000
            
            
            $
            1,727,000
            
            
            $
            740,000Non-cash
      investing activities:Net
      change in unrealized gain/loss on available-for-sale investment
      securities
            
            $
            (157,183
            )
            
            $
            254,636
            
            
            $
            340,454Non-cash
      Financing Activity:Accrued
      dividends on preferred stock
            
            $
            52,456
            
            
            $
            -
            
            
            $
            -Cumulative
      effect of adopting EITF 06-04
            
            $
            -
            
            
            $
            102,115
            
            
            $
            -Real
      estate owned acquired through foreclosure
            
            $
            1,397,310
            
            
            $
            -
            
            
            $
            -








The
accompanying notes are an integral


part of
these consolidated financial statements.


53
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





1.
            THE
      BUSINESS OF VALLEY COMMERCE BANCORP





On
February 2, 2002, Valley Commerce Bancorp (the "Company") was incorporated as a
bank holding company for the purpose of acquiring Valley Business Bank (the
"Bank) in a bank holding company reorganization.  This corporate
structure gives the Company and the Bank greater flexibility to expand and
diversify.





The Bank
commenced operations in 1996 and operates branches in Visalia, Fresno, Woodlake,
Tipton and Tulare.  The Bank's primary source of revenue is generated
from providing loans to customers who are predominately small and middle market
businesses and individuals residing in the surrounding areas.





The
Bank's deposits are insured by the Federal Deposit Insurance Corporation (FDIC)
up to applicable legal limits.  The Bank is participating in the
Federal Deposit insurance Corporation (FDIC) Transaction Account Guarantee
Program.  Under the program, through June 30, 2010, all
noninterest-bearing transaction accounts are fully guaranteed by the FDIC for
the entire amount in the account.  Coverage under the Transaction
Account Guarantee Program is in addition to and separate from the coverage under
the FDIC’s general deposit insurance rules.




2.
            SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES





Consolidation and Basis of
Presentation





The
consolidated financial statements include the accounts of the Company and the
accounts of its wholly-owned subsidiary, Valley Business Bank.  All
significant intercompany balances and transactions have been
eliminated.





Valley
Commerce Trust I, a wholly-owned subsidiary formed for the exclusive purpose of
issuing trust preferred securities, is not consolidated into the Company's
consolidated financial statements and, accordingly, is accounted for under the
equity method.  The Company’s investment in the Trust is included in
accrued interest receivable and other assets in the consolidated balance
sheet.  The junior subordinated debentures issued and guaranteed by
the Company and held by the Trust are reflected as debt in the consolidated
balance sheet.





The
accounting and reporting policies of Valley Commerce Bancorp and subsidiary
conform with accounting principles generally accepted in the United States of
America and prevailing practices within the banking industry.





Use of
Estimates





The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions.  These estimates and assumptions affect the
reported amounts of assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period.  Actual results could differ from these
estimates.


54
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





2.
            SUMMARY OF SIGNIFICANT
      ACCOUNTING POLICIES(Continued)





Segment
Information





Management
has determined that since all of the banking products and services offered by
the Company are available in each branch of the Bank, all branches are located
within the same economic environment and management does not allocate resources
based on the performance of different lending or transaction activities, it is
appropriate to aggregate the Bank branches and report them as a single operating
segment.  No customer accounts for more than 10 percent of revenues
for the Company or the Bank.





Reclassifications





Certain
reclassifications have been made to prior years’ balances to conform to
classifications used in 2009.





Stock
Dividends





On April
21, 2009 and May 20, 2008 the Board of Directors declared a 5% stock dividend
payable on June 25, 2009 and June 25, 2008, respectively, to shareholders of
record on June 10, 2009 and June 11, 2008, respectively.  All per
share and stock option data in the consolidated financial statements have been
retroactively restated to reflect the stock dividends.





Cash and Cash
Equivalents





For the
purpose of the statement of cash flows, cash, due from banks and Federal funds
sold are considered to be cash equivalents.  Generally, Federal funds
are sold for one day periods.  There was no cash held with other
federally insured institutions in excess of FDIC insured limits as of December
31, 2009.





Investment
Securities





Investments
are classified as available-for-sale.  Available-for-sale securities
are reported at fair value, with unrealized gains and losses excluded from
earnings and reported, net of taxes, as accumulated other comprehensive income
(loss) within shareholders' equity.





Gains or
losses on the sale of securities are computed on the specific identification
method.  Interest earned on investment securities is reported in
interest income, net of applicable adjustments for accretion of discounts and
amortization of premiums.





An
investment security is impaired when its fair value is less than its amortized
cost.  Investment securities are evaluated for other-than-temporary
impairment on at least a quarterly basis and more frequently when economic or
market conditions warrant such an evaluation to determine whether a decline in
their value is other than temporary.  Management utilizes criteria
such as the magnitude and duration of the decline and the intent and ability of
the Company to retain its investment in the issues for a period of time
sufficient to allow for an anticipated recovery in fair value, in addition to
the reasons underlying the decline, to determine whether the loss in value is
other than temporary.  The term "other than temporary" is not intended
to indicate that the decline is permanent, but indicates that the prospects for
a near-term recovery of value is not necessarily favorable, or that there is a
lack of evidence to support a realizable value equal to or greater than the
carrying value of the investment.


55
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





2.
            SUMMARY OF SIGNIFICANT
      ACCOUNTING POLICIES
(Continued)





Once a
decline in value is determined to be other-than-temporary and we do not intend
to sell the security or it is more likely than not that we will not be required
to sell the security before recover, only the portion of the impairment loss
representing credit exposure is recognized as a charge to earnings, with the
balance recognized as a charge to other comprehensive income.  If
management intends to sell the security or it is more likely than not that we
will be required to sell the security before recovering its forecasted cost, the
entire impairment loss is recognized as a charge to earnings.





Loans





Loans are
stated at principal balances outstanding.  Interest is accrued daily
based upon outstanding loan balances.  However, when, in the opinion
of management, loans are considered to be impaired and the future collectibility
of interest and principal is in serious doubt, loans are placed on nonaccrual
status and the accrual of interest income is suspended.  Any interest
accrued but unpaid is charged against income.  Payments received are
applied to reduce principal to the extent necessary to ensure
collection.  Subsequent payments on these loans, or payments received
on nonaccrual loans for which the ultimate collectibility of principal is not in
doubt, are applied first to earned but unpaid interest and then to
principal.





A loan is
considered impaired when, based on current information and events, it is
probable that the Bank will be unable to collect all amounts due (including both
principal and interest) in accordance with the contractual terms of the loan
agreement.  An impaired loan is measured based on the present value of
expected future cash flows discounted at the loan's effective interest rate or,
as a practical matter, at the loan's observable market price or the fair value
of collateral if the loan is collateral dependent.





Substantially
all loan origination fees, commitment fees, direct loan origination costs and
purchased premiums and discounts on loans are deferred and recognized as an
adjustment of yield, to be amortized to interest income over the contractual
term of the loan.  The unamortized balance of deferred fees and costs
is reported as a component of net loans.





The
Company may acquire loans through a business combination or a purchase for which
differences may exist between the contractual cash flows and the cash flows
expected to be collected due, at least in part, to credit
quality.  When the Company acquires such loans, the yield that may be
accreted (accretable yield) is limited to the excess of the Company's estimate
of undiscounted cash flows expected to be collected over the Company's initial
investment in the loan.  The excess of contractual cash flows over
cash flows expected to be collected may not be recognized as an adjustment to
yield, loss, or a valuation allowance.  Subsequent increases in cash
flows expected to be collected generally are recognized prospectively through
adjustment of the loan's yield over its remaining life.  Decreases in
cash flows expected to be collected are recognized as an
impairment.  The Company may not "carry over" or create a valuation
allowance in the initial accounting for loans acquired under these
circumstances.  At December 31, 2009 and 2008, there were no loans
being accounted for under this policy method.


56
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





2.
            SUMMARY OF SIGNIFICANT
      ACCOUNTING POLICIES
(Continued)





Allowance for Loan
Losses





The
allowance for loan losses is maintained to provide for losses related to
impaired loans and other losses that can be expected to occur in the normal
course of business.  The determination of the allowance is based on
estimates made by management, to include consideration of the character of the
loan portfolio, specifically identified problem loans, potential losses inherent
in the portfolio taken as a whole and economic conditions in the Company's
service area.  In addition, the FDIC and California Department of
Financial Institutions, as an integral part of their examination process, review
the allowance for credit losses. These agencies may require additions to the
allowance for credit losses based on their judgment about information at the
time of their examinations.





Classified
loans and loans determined to be impaired are evaluated by management for
specific risk of loss. In addition, reserve factors are assigned to currently
performing loans based on historical loss rates as adjusted by management’s
assessment of for each identified loan type to reflect current economic and
market conditions.





The
allowance is established through a provision for loan losses which is charged to
expense.  Management reviews the adequacy of the allowance for loan
losses at least quarterly, to include consideration of the relative risks in the
portfolio and current economic conditions. The allowance is adjusted based on
that review if, in management’s judgment, changes are warranted.





Allowance for Losses Related
to Undisbursed Loan Commitments





The
Company maintains a separate allowance for losses related to undisbursed loan
commitments.  Management estimates the amount of probable losses by
applying a loss reserve factor to the unused portion of undisbursed lines of
credit.  The allowance totaled $40,000 at December 31, 2009 and 2008,
respectively and is included in accrued interest payable and other liabilities
in the consolidated balance sheet.





Other Real
Estate





Other
real estate includes real estate acquired in full or partial settlement of loan
obligations.  When property is acquired, any excess of the Bank's
recorded investment in the loan balance and accrued interest income over the
estimated fair market value of the property is charged against the allowance for
loan losses.  Subsequent gains or losses on sales or write downs
resulting from impairment are recorded in other income or expenses as
incurred.  The Company did not hold any other real estate as of
December 31, 2009 and 2008.





Bank Premises and
Equipment





Bank
premises and equipment are carried at cost.  Depreciation is
determined using the straight-line method over the estimated useful lives of the
related assets.  The useful lives of premises are estimated to be
twenty to thirty years.  The useful lives of furniture, fixtures and
equipment are estimated to be two to ten years.  Leasehold
improvements are amortized over the life of the asset or the life of the related
lease, whichever is shorter.  When assets are sold or otherwise
disposed of, the cost and related accumulated depreciation or amortization are
removed from the accounts, and any resulting gain or loss is recognized in
income or loss for the period.  The cost of maintenance and repairs is
charged to expense as incurred.


57
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





2.
            SUMMARY OF SIGNIFICANT
      ACCOUNTING POLICIES
(Continued)





Investment in Federal Home
Loan Bank Stock





As a
member of the Federal Home Loan Bank System, the Bank is required to maintain an
investment in the capital stock of the Federal Home Loan Bank.  The
investment is carried at cost.  At December 31, 2009, 2008, and 2007,
Federal Home Loan Bank stock totaled $1,119,000, $1,104,200, and $1,658,600
respectively.  On the consolidated balance sheet, Federal Home Loan
Bank stock is included in accrued interest receivable and other
assets.





Intangible
Assets





Intangible
assets consisted of core deposit intangibles related to branch acquisitions and
were amortized using the straight-line method over ten
years.  Amortization expense totaled $7,718 for December 31,
2008.  The core deposit intangible was fully amortized during the year
ended December 31, 2008.





Income
Taxes





The
Company files its income taxes on a consolidated basis with its
subsidiary.  The allocation of income tax expense (benefit) represents
each entity's proportionate share of the consolidated provision for income
taxes.





Deferred
tax assets and liabilities are recognized for the tax consequences of temporary
differences between the reported amount of assets and liabilities and their tax
bases.  Deferred tax assets and liabilities are adjusted for the
effects of changes in tax laws and rates on the date of enactment.  On
the consolidated balance sheet, net deferred tax assets are included in accrued
interest receivable and other assets.





The
determination of the amount of deferred income tax assets which are more likely
than not to be realized is primarily dependent on projections of future
earnings, which are subject to uncertainty and estimates that may change given
economic conditions and other factors.  The realization of deferred
income tax assets is assessed and a valuation allowance is recorded if it is
“more likely than not” that all or a portion of the deferred tax asset will not
be realized.  “More likely than not” is defined as greater than a 50%
chance.  All available evidence, both positive and negative is
considered to determine whether, based on the weight of that evidence, a
valuation allowance is needed.  Based upon our analysis of available
evidence, we have determined that it is “more likely than not” that all of our
deferred income tax assets as of December 31, 2009 and 2008 will be fully
realized and therefore no valuation allowance was recorded.


58
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





2.
            SUMMARY OF SIGNIFICANT
      ACCOUNTING POLICIES
(Continued)





Accounting for Uncertainty
in Income Taxes





We use a
comprehensive model for recognizing, measuring, presenting and disclosing in the
financial statements tax positions taken or expected to be taken on a tax
return.  A tax position is recognized as a benefit only if it is “more
likely than not” that the tax position would be sustained in a tax examination,
with a tax examination being presumed to occur.  The amount recognized
is the largest amount of tax benefit that is greater than 50% likely of being
realized on examination.  For tax positions not meeting the “more
likely than not” test, no tax benefit is recorded.





Interest
expense and penalties associated with unrecognized tax benefits, if any, are
classified as income tax expense in the consolidated statement of
income.





Earnings (Loss) Per
Share





Basic
earnings (loss) per share (EPS), which excludes dilution, is computed by
dividing income (loss) available to common stockholders by the weighted-average
number of common shares outstanding for the period.  Diluted EPS
reflects the potential dilution that could occur if securities or other
contracts to issue common stock, such as stock options, result in the issuance
of common stock.  The treasury stock method has been applied to
determine the dilutive effect of stock options in computing diluted
EPS.  However, diluted EPS is not presented when a net loss occurs
because the conversion of potential common stock is anti-dilutive.





Stock-Based
Compensation





At
December 31, 2007, the Company had two stock-based compensation plans, the
Valley Commerce Bancorp Amended and Restated 1997 Stock Option Plan and the
Valley Commerce Bancorp 2007 Equity Incentive Plan, which are more fully
described in Note 11.





During
the years ended December 31, 2009, 2008 and 2007, the Company recorded
compensation expense of $53,342, $59,883, and $44,410,
respectively.  As a result of recognizing the compensation expense,
the Company’s net income was reduced by $45,622, $52,971, and $31,402, for years
ended December 31, 2009, 2008 and 2007, respectively.  For the years
ended December 31, 2009, 2008 and 2007 basic and diluted earnings per were not
impacted as a result of recognizing the compensation expense.





As of
December 31, 2009, there was $129,890 of total unrecognized compensation cost
related to non-vested share-based compensation arrangements granted under
Incentive and Stock Options Plans described more fully in Note
11.  That cost is expected to be recognized over a weighted average
period of 1.41 years.


59
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)


2.
            SUMMARY OF SIGNIFICANT
      ACCOUNTING POLICIES
(Continued)





The
Company determines the fair value of the options previously granted on the date
of grant using a Black-Scholes-Merton option pricing model that uses assumptions
based on expected option life, expected stock volatility and the risk-free
interest rate. The expected volatility assumptions used by the Company are based
on the historical volatility of the Company’s common stock over the most recent
period commensurate with the estimated expected life of the Company’s stock
options.  The Company bases its expected life assumption on its
historical experience and on the terms and conditions of the stock options it
grants to employees. The risk-free rate is based on the U.S. Treasury yield
curve for the periods within the contractual life of the options in effect at
the time of the grant. The Company also makes assumptions regarding estimated
forfeitures that will impact the total compensation expenses recognized under
the Plans.





There
were no stock options granted in 2009 or 2008. There were 42,446 stock options
granted in 2007.  The fair value of each option granted in 2007 was
estimated on the date of grant using an option-pricing model with the following
assumptions:





2007Weighted
      average fair value of options granted
            
            $
            7.07Dividend
      yield
            
            
            N/AExpected
      volatility
            
            
            28.22%Risk-free
      interest rate
            
            
            3.49%Expected
      option life
            
            7.5
      years





Adoption of New Financial
Accounting Standards





FASB
Accounting Standards Codification





In June
2009, the Financial Accounting Standards Board (FASB) issued new accounting
standards ASC 105-10 (previously SFAS No. 168), The FASB Accounting Standards
CodificationTM and the Hierarchy of Generally Accepted Accounting
Principles. With the issuance of ASC 105-10, the FASB Accounting
Standards Codification (“the Codification” or “ASC”) becomes the single source
of authoritative U.S. accounting and reporting standards applicable for all
nongovernmental entities.  Rules and interpretive releases of the SEC
under the authority of federal securities laws are also sources of authoritative
GAAP for SEC registrants.  This change is effective for financial
statements issued for interim or annual periods ended after September 15,
2009.  Accordingly, all specific references to generally accepted
accounting principles (GAAP) refer to the Codification.


60
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





2.
            SUMMARY OF SIGNIFICANT
      ACCOUNTING POLICIES
(Continued)





Adoption of New Financial
Accounting Standards (continued)





Noncontrolling
Interests in Consolidated Financial Statements





In
December 2007, the FASB issued ASC 810-10-65-1, (previously SFAS No. 160), Noncontrolling Interests in
Consolidated Financial Statements.This standard requires that
a noncontrolling interest in a subsidiary be reported separately within equity
and the amount of consolidated net income specifically attributable to the
noncontrolling interest be identified in the consolidated financial
statements.  It also calls for consistency in the manner of reporting
changes in the parent’s ownership interest and requires fair value measurement
of any noncontrolling equity investment retained in a
deconsolidation.  This standard was effective for fiscal years, and
interim periods within those fiscal years, beginning on or after December 15,
2008.  Management adopted the provisions of this standard on January
1, 2009 without a material impact on the Company’s financial condition or
results of operations.





FASB
Clarifies Other-Than-Temporary Impairment





In April
2009, the FASB issued ASC 320-10-35 (previously FSP 115-2 and 124-2 and EITF
99-20-2), Recognition and
Presentation of Other-Than-Temporary-Impairment.  This standard
(i) changes previously existing guidance for determining whether an impairment
to debt securities is other than temporary and (ii) replaces the previously
existing requirement that the entity’s management assert it has both the intent
and ability to hold an impaired security until recovery with a requirement that
management assert: (a) it does not have the intent to sell the security; and (b)
it is more likely than not it will not have to sell the security before recovery
of its cost basis.  Under this standard, declines in fair value below
cost that are deemed to be other than temporary are reflected in earnings as
realized losses to the extent the impairment is related to credit losses for
both held-to-maturity and available-for-sale securities.  The amount
of impairment related to other factors is recognized in other comprehensive
income.  These changes were effective for interim and annual periods
ended after June 15, 2009.  Management adopted the provisions of this
standard on April 1, 2009 and they did not have a material impact on the
Company’s financial condition or results of operations.





FASB
Clarifies Application of Fair Value Accounting





In April
2009, the FASB issued ASC 820-10 (previously FSP FAS 157-4), Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not
Orderly.This standard affirms the objective of fair value
when a market is not active, clarifies and includes additional factors for
determining whether there has been a significant decrease in market activity,
eliminates the presumption that all transactions are distressed unless proven
otherwise, and requires an entity to disclose a change in valuation
technique.  This standard was effective for interim and annual periods
ended after June 15, 2009.  Management adopted the provisions of this
standard on April 1, 2009 and they did not have a material impact on the
Company’s financial condition or results of operations.


61
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)




2.
              SUMMARY OF SIGNIFICANT
      ACCOUNTING POLICIES
(Continued)


Adoption of New Financial
Accounting Standards (continued)





Measuring
Liabilities at Fair Value





In August
2009, the FASB issued Accounting Standards Update (ASU) 2009-05, Fair Value Measurements and
Disclosures (ASC Topic 820) – Measuring Liabilities at Fair
Value.This update provides amendments for the fair value
measurement of liabilities.  It provides clarification that in
circumstances in which a quoted price in an active market for the identical
liability is not available, a reporting entity is required to measure fair value
using one or more techniques.  It also clarifies that when estimating
the fair value of a liability, a reporting entity is not required to include a
separate input or adjustment to other inputs relating to the existence of a
restriction that prevents the transfer of the liability.  This update
was effective for the first reporting period (including interim periods)
beginning after August 2009.  Management adopted these provisions on
October 1, 2009 and they did not have a material impact on the Company’s
financial condition or results of operations.





Business
Combinations





In
December 2007, the FASB issued ASC Topic 805 (previously SFAS 141(R)), Business
Combinations.  This standard broadens the guidance for business
combinations and extends its applicability to all transactions and other events
in which one entity obtains control over one or more other
businesses.  It broadens the fair value measurement and recognition of
assets acquired, liabilities assumed, and interests transferred as a result of
business combinations.  The acquirer is no longer permitted to
recognize a separate valuation allowance as of the acquisition date for loans
and other assets acquired in a business combination.  It also requires
acquisition-related costs and restructuring costs that the acquirer expected but
was not obligated to incur to be expensed separately from the business
combination.  It also expands on required disclosures to improve the
ability of the users of the financial statements to evaluate the nature and
financial effects of business combinations.  This standard was
effective for the first annual reporting period beginning on or after December
15, 2008.  Management adopted these provisions on January 1, 2009 and
there were no transactions that created an impact on the Company’s financial
condition or result of operations.


62
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





2.
            SUMMARY OF SIGNIFICANT
      ACCOUNTING POLICIES
(Continued)





Impact of New Financial
Accounting Standards





Accounting
for Transfers of Financial Assets





In June
2009, the FASB issued ASC Topic 860 (previously SFAS No. 166), Accounting for Transfers of
Financial Assets, an amendment of SFAS NO. 140.This standard
amends the derecognition accounting and disclosure guidance included in
previously issued standards.  This standard eliminates the exemption
from consolidation for qualifying special-purpose entities (SPEs) and also
requires a transferor to evaluate all existing qualifying SPEs to determine
whether they must be consolidated in accordance with ASC Topic
810.  This standard also provides more stringent requirements for
derecognition of a portion of a financial asset and establishes new conditions
for reporting the transfer of a portion of a financial asset as a
sale.  This standard is effective as of the beginning of the first
annual reporting period that begins after November 15,
2009.  Management is assessing the impact this standard may have on
the Company’s financial condition and results of operations.





Transfers
and Servicing





In
December 2009, the FASB issued Accounting Standards Update (ASU) No. 2009-16,
Transfers and Servicing (ASC Topic 860):
Accounting for Transfers of
Financial Assets, which updates the derecognition guidance in ASC Topic
860 for previously issued SFAS No. 166.  This update reflects the
Board’s response to issues entities have encountered when applying ASC 860,
including: (1) requires that all arrangements made in connection with a transfer
of financial assets be considered in the derecognition analysis, (2) clarifies
when a transferred asset is considered legally isolated from the transferor, (3)
modifies the requirements related to a transferee’s ability to freely pledge or
exchange transferred financial assets, and (4) provides guidance on when a
portion of a financial asset can be derecognized.  This update if
effective for financial asset transfers occurring after the beginning of an
entity’s first fiscal year that begins after November 15, 2009.  Early
adoption is prohibited.  Management is assessing the impact this
standard may have on the Company’s financial condition and results of
operations.





Improvements
to Financial Reporting of Interests in Variable Interest Entities





In June
2009, the FASB issued ASC Topic 810 (previously SAFAS No. 167), Improvements to Financial Reporting
by Enterprises Involved with Variable Interest Entities.This
standard amends the consolidation guidance applicable to variable interest
entities.  The amendments to the consolidation guidance affect all
entities currently within the scope of ASC Topic 810, as well as qualifying
special-purpose entities that are currently excluded form the scope of ASC Topic
810.  This standard is effective as of the beginning of the first
annual reporting period that begins after November 15,
2009.  Management does not expect the adoption of this standard to
have a material impact on the Company’s financial position or results of
operations.


63
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





3.
            FAIR
      VALUE MEASUREMENTS





Fair Value of Financial
Instruments





The
estimated fair values of the Company's financial instruments are as
follows:





December 31, 2009
            
            
            December 31, 2008CarryingAmount
            
            
            FairValue
            
            
            CarryingAmount
            
            
            FairValueFinancial
      assets:Cash
      and cash equivalents
            
            $
            39,077,786
            
            
            $
            39,077,786
            
            
            $
            8,755,867
            
            
            $
            8,755,867Federal
      funds sold
            
            
            -
            
            
            
            -
            
            
            
            13,390,000
            
            
            
            13,390,000Investment
      securities
            
            
            42,566,000
            
            
            
            42,566,000
            
            
            
            42,018,000
            
            
            
            42,018,000Loans,
      net
            
            
            234,822,963
            
            
            
            232,495,909
            
            
            
            226,696,838
            
            
            
            220,628,940Cash
      surrender value of life insurance policies
            
            
            6,354,871
            
            
            
            6,354,871
            
            
            
            6,421,863
            
            
            
            6,421,863Accrued
      interest receivable
            
            
            1,241,412
            
            
            
            1,241,412
            
            
            
            1,351,939
            
            
            
            1,351,939FHLB
      stock
            
            
            1,119,000
            
            
            
            1,119,000
            
            
            
            1,104,200
            
            
            
            1,104,200Financial
      liabilities:Deposits
            
            $
            294,282,143
            
            
            $
            294,833,469
            
            
            $
            257,323,433
            
            
            $
            256,576,304FHLB
      advances
            
            
            -
            
            
            
            -
            
            
            
            8,000,000
            
            
            
            8,000,000FHLB
      term borrowing
            
            
            3,661,999
            
            
            
            2,974,335
            
            
            
            5,184,246
            
            
            
            4,976,558Junior
      subordinated deferrable interest debentures
            
            
            3,093,000
            
            
            
            959,000
            
            
            
            3,093,000
            
            
            
            866,000Accrued
      interest payable
            
            
            139,988
            
            
            
            139,988
            
            
            
            296,779
            
            
            
            296,779





These
estimates do not reflect any premium or discount that could result from offering
the Company's entire holdings of a particular financial instrument for sale at
one time, nor do they attempt to estimate the value of anticipated future
business related to the instruments.  In addition, the tax
ramifications related to the realization of unrealized gains and losses can have
a significant effect on fair value estimates and have not been considered in any
of these estimates.





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





The
following methods and assumptions were used by management to estimate the fair
value of its financial instruments at December 31, 2009 and 2008:





Cash and cash
equivalents:  For cash and cash equivalents, the carrying
amount is estimated to be fair value.





Investment
securities:  For investment securities, fair values are based
on quoted market prices, where available.  If quoted market prices are
not available, fair values are estimated using quoted market prices for similar
securities and indications of value provided by brokers.





Loans:  For
variable-rate loans that reprice frequently with no significant change in credit
risk, fair values are based on carrying values.  The fair values for
other loans are estimated using discounted cash flow analyses, using interest
rates currently being offered at each reporting date for loans with similar
terms to borrowers of comparable creditworthiness.  The carrying
amount of accrued interest receivable approximates its fair
value.


64
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





3.
            FAIR VALUE MEASUREMENTS(Continued)





Fair Value of Financial
Instruments (Continued)





Cash surrender value of
bank-owned life insurance:  The fair values of life insurance
policies are based on current cash surrender values at each reporting date
provided by the insurers.





Federal Home Loan Bank
stock:  For Federal Home Loan Bank stock, cost approximates
fair value.





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





FHLB advances and term
borrowings:  The fair values of fixed-rate borrowings are
estimated by discounting their future cash flows using rates at each reporting
date for similar instruments.  The fair values of variable rate
borrowings are based on carrying value.





Junior subordinated
deferrable interest debentures:  The fair value of junior
subordinated deferrable interest debentures was determined based on the current
market value for the like kind instruments of a similar maturity and
structure.





Commitments to extend
credit:  Commitments to extend credit are primarily for
variable rate loans and standby letters of credit.  For these
commitments, there is no difference between the committed amounts and their fair
values.  Commitments to fund fixed rate loans and standby letters of
credit are at rates which approximate fair value at each reporting
date.  The fair value of the commitments at each reporting date were
not significant and not included in the accompanying table.





Fair Value
Hierarchy:





We group
our assets and liabilities measured at fair value in three levels, based on the
markets in which the assets and liabilities are traded and the reliability of
the assumptions used to determine fair value.  Valuations within these
levels are based upon:





Level 1:
Quoted prices (unadjusted) or identical assets or liabilities in active markets
that the entity has the ability to access as of the measurement
date.





Level 2:
Significant other observable inputs other than Level 1 prices such as quoted
prices for similar assets or liabilities; quoted prices in markets that are not
active; or other inputs that are observable or can be corroborated by observable
market data.





Level 3:
Significant unobservable inputs that reflect a reporting entity’s own
assumptions about the assumptions that market participants would use in pricing
an asset or liability.





In
certain cases, the inputs used to measure fair value may fall into different
levels of the fair value hierarchy. In such cases, the level in the fair value
hierarchy within which the fair value measurement in its entirety falls has been
determined based on the lowest level input that is significant to the fair value
measurement in its entirety. The Company’s assessment of the significance of a
particular input to the fair value measurement in its entirety requires
judgment, and considers factors specific to the asset or
liability.


65
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





3.
            FAIR VALUE MEASUREMENTS(Continued)





There
were no changes in the valuation techniques used during 2009.  Assets
and liabilities measured at fair value on a recurring basis are summarized
below:





Fair Value MeasurementsDescription
            
            Total
              Fair
      Value at
              December 31,
            
            
            Quoted
      Prices
              in
      Active
              Markets
      for
              for
      Identical
              Assets
              (Level 1)
            
            
            Other
              Observable
              Inputs
              (Level 2)
            
            
            Significant
              Unobservable
              Inputs
              (Level 3)Assets:Available-for-saleSecurities:2009
            
            $
            42,566,000
            
            
            $
            -
            
            
            $
            42,566,000
            
            
            $
            -2008
            
            $
            42,018,000
            
            
            $
            -
            
            
            $
            42,018,000
            
            
            $
            -





The fair
value of securities available for sale equals quoted market price, if
available.  If quoted market prices are not available, fair value is
determined using quoted market prices for similar securities. There were no
changes in the valuation techniques used during 2009. Changes in fair market
value are recorded in other comprehensive income.





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








Fair
      Value MeasurementsDescription
            
            Total
              Fair
      Value at
              December 31,
            
            
            Quoted
      Prices
              in
      Active
              Markets
      for
              for
      Identical
              Assets
              (Level 1)
            
            
            Other
              Observable
              Inputs
              (Level 2)
            
            
            Significant
              Unobservable
              Inputs
              (Level 3)
            
            
            Total
              LossesAssets:Impaired
      loans:2009
            
            $
            7,784,000
            
            
            $
            -
            
            
            $
            -
            
            
            $
            7,784,000
            
            
            $
            (2,227,000
            )2008
            
            $
            2,421,000
            
            
            $
            -
            
            
            $
            -
            
            
            $
            2,421,000
            
            
            $
            (555,000
            )








Impaired
loans, all of which are measured for impairment using the fair value of the
collateral because each loan is a collateral dependent loan, had a principal
balances of $10,436,000 and $2,846,000, respectively with a related valuation
allowances of $2,652,000 and $425,000, respectively at December 31, 2009 and
2008. There were no liabilities measured on a non-recurring basis as of December
31, 2009 or 2008.


66
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





4.
            AVAILABLE-FOR-SALE
      INVESTMENT SECURITIES





The
amortized cost and estimated fair value of available-for-sale investment
securities at December 31, 2009 and 2008 consisted of the
following:





2009Amortized
              Cost
            
            
            Gross
              Unrealized
              Gains
            
            
            Gross
              Unrealized
              Losses
            
            
            Estimated
              Fair
              ValueDebt
      securities:U.S.
      Government agencies
            
            $
            2,909,941
            
            
            $
            105,059
            
            
            $
            -
            
            
            $
            3,015,000Mortgage-backed
      securities:U.S.
      Government agencies
            
            
            8,985,716
            
            
            
            295,386
            
            
            
            (102
            )
            
            
            9,281,000Small
      Business administration
            
            
            15,326,055
            
            
            
            27,173
            
            
            
            (46,228
            )
            
            
            15,307,000Municipal
      securities
            
            
            15,337,972
            
            
            
            48,855
            
            
            
            (423,826
            )
            
            
            14,963,000$
            42,559,683
            
            
            $
            476,473
            
            
            $
            (470,156
            )
            
            $
            42,566,000








Net
unrealized gains on available-for-sale investment securities totaling $6,317
were recorded, net of $2,600 in tax benefits, as accumulated other
comprehensive income within shareholders' equity at December 31,
2009.  Proceeds and realized gains from the sale of available-for-sale
investment securities for the year ended December 31, 2009 totaled $13,559,130
and $416,248, respectively.





2008Amortized
              Cost
            
            
            Gross
              Unrealized
              Gains
            
            
            Gross
              Unrealized
              Losses
            
            
            Estimated
              Fair
              ValueDebt
      securities:U.S.
      Treasury securities
            
            $
            247,220
            
            
            $
            32,780
            
            
            $
            -
            
            
            $
            280,000U.S.
      Government agencies
            
            
            6,752,730
            
            
            
            225,270
            
            
            
            -
            
            
            
            6,978,000Mortgage-backed
      securities:U.S.
      Government agencies
            
            
            15,101,739
            
            
            
            553,862
            
            
            
            (1,601
            )
            
            
            15,654,000Municipal
      securities
            
            
            19,752,811
            
            
            
            98,080
            
            
            
            (744,891
            )
            
            
            19,106,000$
            41,854,500
            
            
            $
            909,992
            
            
            $
            (746,492
            )
            
            $
            42,018,000





Net
unrealized gains on available-for-sale investment securities totaling
$163,500 were recorded, net of $67,280 in tax benefits, as accumulated other
comprehensive income within shareholders' equity at December 31,
2008.  Proceeds and realized gains from the sale of available-for-sale
investment securities for the year ended December 31, 2008 totaled $4,537,315
and $46,112, respectively. Proceeds and realized losses from the sale of
available-for-sale investment securities for the year ended December 31, 2007
totaled $1,533,619 and $1,145, respectively.


67
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





4.
            AVAILABLE-FOR-SALE INVESTMENT
      SECURITIES (Continued)





Investment
securities with unrealized losses at December 31, 2009 are summarized and
classified according to the duration of the loss period as follows:





Less than 12 Months
            
            
            Less than 12 Months
            
            
            TotalFair
            
            
            Unrealized
            
            
            Fair
            
            
            Unrealized
            
            
            Fair
            
            
            UnrealizedValue
            
            
            Losses
            
            
            Value
            
            
            Losses
            
            
            Value
            
            
            LossesDebt
      securities:Mortgage-backedSecurities:Agency
            
            $
            132,000
            
            
            $
            (102
            )
            
            $
            -
            
            
            $
            -
            
            
            $
            132,000
            
            
            $
            (102
            )SBA
            
            
            9,567,000
            
            
            
            (46,228
            )
            
            
            -
            
            
            
            -
            
            
            
            9,567,000
            
            
            
            (46,228
            )Municipal
      securities
            
            
            6,449,000
            
            
            
            (179,802
            )
            
            
            2,789,000
            
            
            (244,024)
            
            
            9,238,000
            
            
            
            (423,826
            )$
            16,148,000
            
            
            $
            (226,132
            )
            
            $
            2,789,000
            
            
            $
            (244,024
            )
            
            $
            18,937,000
            
            
            $
            (470,156
            )





Investment
securities with unrealized losses at December 31, 2008 are summarized and
classified according to the duration of the loss period as follows:





Less than 12 Months
            
            
            12 Months or More
            
            
            TotalFair
            
            
            Unrealized
            
            
            Fair
            
            
            Unrealized
            
            
            Fair
            
            
            UnrealizedValue
            
            
            Losses
            
            
            Value
            
            
            Losses
            
            
            Value
            
            
            LossesDebt
      securities:Mortgage-backedSecurities:Agency
            
            $
            335,000
            
            
            $
            (1,601
            )
            
            $
            -
            
            
            $
            -
            
            
            $
            335,000
            
            
            $
            (1,601
            )Municipal
      securities
            
            12,252,000
            
            
            
            (528,257
            )
            
            
            1,906,000
            
            
            
            (216,634
            )
            
            
            14,158,000
            
            
            
            (744,891
            )$
            12,587,000
            
            
            $
            (529,858
            )
            
            $
            1,906,000
            
            
            $
            (216,634
            )
            
            $
            14,493,000
            
            
            $
            (746,492
            )





Mortgage-backed
Obligations





At
December 31, 2009, the Company held 53 mortgage-backed obligations of which ten
were in a loss position for less than twelve months. Management believes the
unrealized losses on the Company's investments in mortgage obligations were
caused primarily by limited market liquidity and perceived credit risk on the
part of investors.  The contractual cash flows of these investments
are guaranteed by an agency of the U.S. government.  Accordingly, it
is expected that the securities will not be settled at a price less than the
amortized cost of the Company's investment. Because the Company has the ability
and intent to hold those investments until a recovery of fair value, which may
be maturity, the Company does not consider those investments to be
other-than-temporarily impaired at December 31, 2009.





Municipal
Securities





At
December 31, 2009, the Company held 48 obligations of states and political
subdivision securities of which 20 were in a loss position for less than twelve
months and nine were in a loss position and had been in a loss position for
twelve months or more.  Management believes the unrealized losses on
the Company's investments in obligations of states and political subdivision
securities were due to the continued dislocation of the securities
market.  All of these securities have continued to pay as scheduled
despite their impairment due to current market conditions.  Because
the Company has the ability and intent to hold those investments until a
recovery of fair value, which may be maturity, the Company does not consider
those investments to be other-than-temporarily impaired at December 31,
2009.


68
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





4.
            AVAILABLE-FOR-SALE INVESTMENT
      SECURITIES (Continued)





The
amortized cost and estimated fair value of investment securities at December 31,
2009 by contractual maturity are shown below.  Expected maturities
will differ from contractual maturities because the issuers of the securities
may have the right to call or prepay obligations with or without call or
prepayment penalties.





AmortizedCost
            
            
            EstimatedFairValueWithin
      one year
            
            $
            -
            
            
            $
            -After
      one year through five years
            
            
            19,840
            
            
            
            20,000After
      five years through ten years
            
            
            3,776,984
            
            
            
            3,824,000After
      ten years
            
            
            14,451,758
            
            
            
            14,134,00018,248,582
            
            
            
            17,978,000Investment
      securities not due at a single maturity date:Mortgage-backed
      securities
            
            
            24,311,101
            
            
            
            24,588,000$
            42,559,683
            
            
            $
            42,566,000





At
December 31, 2009 and 2008, all investment securities were pledged to secure
either public deposits or borrowing arrangements.





5.
            LOANS
      AND THE ALLOWANCE FOR LOAN LOSSES





Outstanding
loans are summarized below:





December 31,2009
            
            
            2008Commercial
            
            $
            49,442,490
            
            
            $
            58,324,986Real
      estate - mortgage
            
            
            162,772,435
            
            
            
            129,267,195Real
      estate – construction
            
            
            22,581,964
            
            
            
            35,113,099Agricultural
            
            
            4,727,349
            
            
            
            4,010,551Consumer
      and other
            
            
            1,936,588
            
            
            
            3,566,210241,460,826
            
            
            
            230,282,041Deferred
      loan fees, net
            
            
            (406,798
            )
            
            
            (340,749
            )Allowance
      for loan losses
            
            
            (6,231,065
            )
            
            
            (3,244,454
            )$
            234,822,963
            
            
            $
            226,696,838





Certain
loans were pledged to secure borrowing arrangements (see Note
8).


69
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





5.
            LOANS AND THE ALLOWANCE FOR
      LOAN LOSSES (continued)





Changes
in the allowance for loan losses were as follows:





Year Ended December 31,2009
            
            
            2008
            
            
            2007Balance,
      beginning of year
            
            $
            3,244,454
            
            
            $
            1,757,591
            
            
            $
            1,745,582Provision
      charged to operations
            
            
            7,000,000
            
            
            
            1,600,000
            
            
            
            -Losses
      charged to allowance
            
            
            (4,013,611
            )
            
            
            (141,456
            )
            
            
            -Recoveries
            
            
            222
            
            
            
            28,319
            
            
            
            12,009Balance,
      end of year
            
            $
            6,231,065
            
            
            $
            3,244,454
            
            
            $
            1,757,591





The
recorded investment in loans that were considered to be impaired totaled
$12,485,248 and $4,932,424 of which $10,435,958 and $2,845,903 had a related
allowance for loan losses of $2,652,000 and $425,000 at December 31, 2009 and
2008, respectively.  At December 31, 2007, there were no loans
considered to be impaired.  The average recorded investment in
impaired loans for the year ended December 31, 2009, 2008 and 2007 was
$10,103,000, $1,453,620 and $8,680, respectively.  The Company
recognized $36,961 and $52,494 in interest income on a cash basis for impaired
loans during the years ended December 31, 2009 and 2008.  There was no
interest income recognized on a cash basis for impaired loans during the year
ended December 31, 2007.





There was
$7,364,347 and $4,932,424 in nonaccrual loans at December 31, 2009 and 2008,
respectively.  There were no nonaccrual loans at December 31,
2007.  There was $434,714 and $27,252 interest foregone on nonaccrual
loans for the year ended December 31, 2009 and 2008,
respectively.  There was no interest foregone on nonaccrual loans for
the years ended December 31, 2007.





The Bank
did not have any loans considered to be troubled debt restructurings at December
31, 2009 or 2008.





Salaries
and employee benefits totaling $711,290, $691,755 and $687,155 have been
deferred as loan origination costs during the years ended December 31, 2009,
2008 and 2007, respectively.





6.
            PREMISES
      AND EQUIPMENT





Premises
and equipment consisted of the following:





December 31,2009
            
            
            2008Furniture
      and equipment
            
            $
            2,955,097
            
            
            $
            2,805,728Construction
      in progress
            
            
            4,567,346
            
            
            
            5,957Premises
            
            
            2,095,490
            
            
            
            2,094,517Leasehold
      improvements
            
            
            550,548
            
            
            
            550,548Land
            
            
            605,060
            
            
            
            601,53010,773,541
            
            
            
            6,058,280Less
      accumulated depreciation and amortization
            
            
            (2,731,636
            )
            
            
            (2,083,435
            )$
            8,041,905
            
            
            $
            3,974,845


70
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





6.
            PREMISES AND EQUIPMENT(Continued)





Depreciation
and amortization included in occupancy and equipment expense totaled $665,066,
$466,069 and $315,365 for the years ended December 31, 2009, 2008 and 2007,
respectively.





7.
            INTEREST-BEARING
      DEPOSITS





Interest-bearing
deposits consisted of the following:





December 31,2009
            
            
            2008Savings
            
            $
            10,602,996
            
            
            $
            8,617,400Money
      market
            
            
            67,290,689
            
            
            
            46,369,197NOW
      accounts
            
            
            43,505,079
            
            
            
            32,751,133Time,
      $100,000 or more
            
            
            53,258,559
            
            
            
            50,882,933Brokered
      Time, $100,000 or more
            
            
            17,849,000
            
            
            
            15,899,000Other
      time
            
            
            25,201,169
            
            
            
            25,398,253$
            217,707,492
            
            
            $
            179,917,916





Aggregate
annual maturities of time deposits are as follows:





Year
      EndingDecember 31,2010
            
            $
            75,931,0882011
            
            
            1,943,9202012
            
            
            401,8032013
            
            
            10,484,8422014
            
            
            7,547,075$
            96,308,728





Interest
expense recognized on interest-bearing deposits consisted of the
following:





Year Ended December 31,2009
            
            
            2008
            
            
            2007Savings
            
            $
            24,680
            
            
            $
            32,431
            
            
            $
            68,879Money
      market
            
            
            739,665
            
            
            
            1,108,286
            
            
            
            1,545,160NOW
      accounts
            
            
            504,533
            
            
            
            510,100
            
            
            
            767,979Time,
      $100,000 or more
            
            
            1,154,220
            
            
            
            1,832,627
            
            
            
            1,985,985Brokered
      Time, $100,000 or more
            
            
            732,786
            
            
            
            581,972
            
            
            
            467,332Other
      time
            
            
            565,530
            
            
            
            835,572
            
            
            
            967,517$
            3,721,414
            
            
            $
            4,900,988
            
            
            $
            5,802,852


71
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





7.
            INTEREST-BEARING
      DEPOSITS (Continued)





At
December 31, 2009, the contractual maturities of time deposits with a
denomination of $100,000 and over were as follows: $14,734,182 in 3 months or
less, $15,860,617 over 3 months through 6 months, $21,153,746 over 6 months
through 12 months, and $19,359,014 over 12 months.





Deposit
overdrafts reclassified as loan balances were $87,996 and $1,243,000 at December
31, 2009 and 2008, respectively.





8.
            BORROWING
      ARRANGEMENTS





Lines of
Credit





The Bank
had an unsecured line of credit with one correspondent bank in the amount of
$10,000,000 at December 31, 2009 and at December 31, 2008. There were no
borrowings outstanding under this borrowing arrangement as of December 31, 2009
and 2008.





Federal Home Loan Bank
Advances and Term Borrowings





At
December 31, 2009 and 2008 the Bank could borrow up to 47% of pledged real
estate mortgage loans from the Federal Home Loan Bank of San Francisco
(FHLB).  As of December 31, 2009 and 2008, the Bank had pledged
investment securities with total carrying market values of $1,076,000 and
$9,163,000 respectively.  As of December 31, 2009 and 2008, the Bank
had pledged loans with total carrying values of $91,244,000 and $83,918,000,
respectively.  At December 31, 2009 borrowings were comprised of
$3,662,000 of term borrowing fixed rate debt with a weighted average interest
rate and maturity of 5.41% and 1.6 years, respectively. There were no short term
advances (less than twelve months).  At December 31, 2008, the Company
had $8,000,000 in short term advances with fixed rate debt with a weighted
average interest rate of 2.71% and term borrowings totaling $5,184,000 with a
weighted average interest rate and maturity of 5.16% and 1.93 years,
respectively.  The Bank had remaining borrowing capacity of
$40,598,000 at December 31, 2009.





As of
December 31, 2009 and 2008, outstanding term borrowings from the FHLB consisted
of the following:





2009
            
            2008Amount
            
            
            Rate
            
            Maturity Date
            
            Amount
            
            
            Rate
            
            Maturity Date$
            900,000
            
            
            3.94
            %
            April
      27, 2009400,000
            
            
            4.51
            %
            May
      12, 2009$
            897,995
            
            
            
            7.41
            %
            June
      22, 2010
            
            
            926,878
            
            
            
            7.41
            %
            June
      22, 2010100,000
            
            
            
            5.09
            %
            May
      12, 2011
            
            
            100,000
            
            
            
            5.09
            %
            May
      12, 2011414,004
            
            
            
            4.01
            %
            December
      6, 2011
            
            
            607,468
            
            
            
            4.01
            %
            December
      6, 20111,250,000
            
            
            
            4.44
            %
            December
      6, 2011
            
            
            1,250,000
            
            
            
            4.44
            %
            December
      6, 20111,000,000
            
            
            
            6.02
            %
            January 2, 2012
            
            
            1,000,000
            
            
            
            6.02
            %
            January 2, 2012$
            3,661,999
            
            
            
            
            
            
            
            $
            5,184,346


72
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





8.
            BORROWING ARRANGEMENTS
      (Continued)





Federal Home Loan Bank
Advances and Term Borrowings (Continued)





Future
principal payments of outstanding FHLB advances are as follows:





Year
      EndingDecember 31,2010
            
            $
            1,100,3492011
            
            
            1,561,6502012
            
            
            1,000,000$
            3,661,999





Federal Reserve Discount
Window Borrowing Arrangement





At
December 31, 2009 the Bank could borrow up to 46% of pledged commercial loans
from the Federal Reserve Bank of San Francisco under the discount window
borrowing program.  As of December 31, 2009, the Bank had pledged
loans with total carrying values of $67,520,000 to achieve a credit line of
$31,372,000.  There were no borrowings with the Federal Reserve Bank
of San Francisco at December 31, 2009.





9.
            JUNIOR
      SUBORDINATED DEFERRABLE INTEREST
DEBENTURES





Valley
Commerce Trust I is a Delaware business trust formed by the Company with capital
of $93,000 for the sole purpose of issuing trust preferred securities fully and
unconditionally guaranteed by the Company.  Valley Commerce Trust I
(the "Trust") has issued 3,000 Floating Rate Capital Trust Pass-Through
Securities ("Trust Preferred Securities"), with a liquidation value of $1,000
per security, for gross proceeds of $3,000,000.  The entire proceeds
of the issuance were invested by the Trust in $3,093,000 of Floating Rate Junior
Subordinated Deferrable Interest Debentures (the "Subordinated Debentures")
issued by the Company, with identical maturity, repricing and payment terms as
the Trust Preferred Securities.  The Subordinated Debentures represent
the sole assets of the Trust. The Subordinated Debentures mature on April 7,
2033, bear a current interest rate of 4.20% (based on 3-month LIBOR plus 3.30%),
with repricing and payments due quarterly.  The Subordinated
Debentures are redeemable by the Company on any January 7, April 7, July 7 or
October 7 on or after April 7, 2008, subject to receipt by the Company of prior
approval from the Federal Reserve Board of Governors.  The redemption
price is par plus accrued interest, except in the case of redemption under a
special event which is defined in the debenture.  The Trust Preferred
Securities are subject to mandatory redemption to the extent of any early
redemption of the junior subordinated debentures and upon maturity of the junior
subordinated debentures on April 7, 2033.





Holders
of the Trust Preferred Securities are entitled to a cumulative cash distribution
on the liquidation amount of $1,000 per security at an initial rate per annum of
4.59%.  For each successive period beginning on January 7, April 7,
July 7 or October 7 of each year, the rate will be adjusted to equal the 3-month
LIBOR plus 3.30%.  As of December 31, 2009, the rate was
4.20%.  The Trust has the option to defer payment of the distributions
for a period of up to five years, as long as the Company is not in default on
the payment of interest on the junior subordinated debentures.  The
Trust Preferred Securities were sold and issued in private transactions pursuant
to an exemption from registration under the Securities Act of 1933, as
amended.  The Company has guaranteed, on a subordinated basis,
distributions and other payments due on the Trust Preferred
Securities.


73
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





10.
            COMMITMENTS
      AND CONTINGENCIES





Leases





The
Company leases its Fresno branch under a noncancelable operating lease which
expires in September 2017.  The administrative offices
and Visalia branch relocated from leased facilities to a purchased office
building in November 2009 and January 2010,, respectively.  The
Visalia branch extended its lease until February 2010 to facilitate its
move.  Future minimum lease payments, are as follows:





Year
      EndingDecember 31,2010
            
            $
            133,2752011
            
            
            94,9422012
            
            
            99,8282013
            
            
            114,4882014
            
            
            114,488Thereafter
            
            
            314,843871,864





Rental
expense included in occupancy and equipment expense totaled $315,053, $328,344,
and $309,657 for the years ended December 31, 2009, 2008 and 2007,
respectively.





Federal Reserve
Requirements





Banks are
required to maintain reserves with the Federal Reserve Bank equal to a
percentage of their reservable deposits.  The Company had no
reservable deposits at December 31, 2009.





Financial Instruments With
Off-Balance-Sheet Risk





The
Company is a party to financial instruments with off-balance-sheet risk in the
normal course of business in order to meet the financing needs of its
customers.  These financial instruments include commitments to extend
credit and letters of credit.  These instruments involve, to varying
degrees, elements of credit and interest rate risk in excess of the amount
recognized on the consolidated balance sheet.





The
Company's exposure to credit loss in the event of nonperformance by the other
party for commitments to extend credit and letters of credit is represented by
the contractual amount of those instruments.  The Company uses the
same credit policies in making commitments and letters of credit as it does for
loans included on the consolidated balance sheet.





The
following financial instruments represent off-balance-sheet credit
risk:





December 31,2009
            
            
            2008Commitments
      to extend credit
            
            $
            41,181,467
            
            
            $
            47,408,977Standby
      letters of credit
            
            $
            72,163
            
            
            $
            337,330


74
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





10.
            COMMITMENTS AND CONTINGENCIES(Continued)





Financial Instruments With
Off-Balance-Sheet Risk (Continued)





Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract.  Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee.  Since some of the commitments are expected
to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements.  The Bank evaluates
each customer's creditworthiness on a case-by-case basis.  The amount
of collateral obtained, if deemed necessary by the Company upon extension of
credit, is based on management's credit evaluation of the
borrower.  Collateral held varies, but may include real property, bank
deposits, debt or equity securities or business assets.





Standby
letters of credit are conditional commitments written to guarantee the
performance of a customer to a third party.  These guarantees are
primarily related to the purchases of inventory by commercial customers and are
typically short-term in nature.  Credit risk is similar to that
involved in extending loan commitments to customers and, accordingly, evaluation
and collateral requirements similar to those for loan commitments are
used.  The fair value of the liability related to the Company’s
stand-by-letters of credit, which represents the fees received for issuing the
guarantee, was not considered significant at December 31, 2009 or
2008.  The Company recognizes these fees as revenue over the term of
the commitment or when the commitment is used.





At
December 31, 2009, consumer loan commitments represent approximately 6% of total
commitments and are generally unsecured.  Commercial loan commitments
represent approximately 81% of total commitments and are generally secured by
various assets of the borrower.  Real estate loan commitments
represent the remaining 13% of total commitments and are generally secured by
property with a loan-to-value ratio not to exceed 80%.





Significant Concentrations
of Credit Risk





The
Company grants real estate mortgage, real estate construction, commercial,
agricultural and consumer loans to customers throughout the cities of Visalia,
Tulare, Fresno, Woodlake and Tipton, California.





Although
the Company has a diversified loan portfolio, a substantial portion of its
portfolio is secured by commercial and residential real
estate.  However, personal and business income represent the primary
source of repayment for a majority of these loans.





Contingencies





The
Company is subject to legal proceedings and claims which arise in the ordinary
course of business.  In the opinion of management, the amount of
ultimate liability with respect to such actions will not materially affect the
financial position or results of operations of the Company.


75
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





11.
            SHAREHOLDERS'
      EQUITY





Dividend
Restrictions





The
Company's ability to pay cash dividends is dependent on dividends paid to it by
the Bank and limited by California corporation law.  Under California
law, the holders of common stock of the Company are entitled to receive
dividends when and as declared by the Board of Directors, out of funds legally
available, subject to certain restrictions.  The California general
corporation law prohibits the Company from paying dividends on its common stock
unless: (i) its retained earnings, immediately prior to the dividend payment,
equals or exceeds the amount of the dividend or (ii) immediately after giving
effect to the dividend, the sum of the Company's assets (exclusive of goodwill
and deferred charges) would be at least equal to 125% of its liabilities (not
including deferred taxes, deferred income and other deferred liabilities) and
the current assets of the Company would be at least equal to its current
liabilities, or, if the average of its earnings before taxes on income and
before interest expense for the two preceding fiscal years was less than the
average of its interest expense for the two preceding fiscal years, at least
equal to 125% of its current liabilities.





Dividends
from the Bank to the Company are restricted under California law to the lesser
of the Bank's retained earnings or the Bank's net income for the latest three
fiscal years, less dividends previously declared during that period, or, with
the approval of the Department of Financial Institutions, to the greater of the
retained earnings of the Bank, the net income of the Bank for its last fiscal
year, or the net income of the Bank for its current fiscal year.  As
of December 31, 2009, the maximum amount available for dividend distribution
under this restriction was approximately $3.2 million.  In addition,
the Company's ability to pay dividends is subject to certain covenants contained
in the indentures relating to the Trust Preferred Securities issued by the
business trust (see Note 9).





As
discussed more fully below, beginning in 2009 the Company was restricted from
paying dividends to shareholders of common stock without the consent of the
United States Department of the Treasury (“Treasury”) due to its issuance of
preferred stock to the Treasury in conjunction with the Company’s participation
in the Capital Purchase Program.


76
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





11.
            SHAREHOLDERS' EQUITY(Continued)





Earnings (loss) Per
Share





A
reconciliation of the numerators and denominators of the basic and diluted
earnings (loss) per share computations for the years ended December 31, 2009,
2008 and 2007 is as follows:




Net
                (Loss) Income
              
              
              Less
      Preferred
                Stock
                Dividends
                and Accretion
              
              
              Net
                (Loss)
      Income
                Available
      to
                Common
                Shareholders
              
              
              Weighted
                Average
                Number
      of
                Shares
                Outstanding
              
              
              Per
                Common
                Share
                AmountDecember 31, 2009Basic
      loss per share
              
              $
              (587,263
              )
              
              $
              (352,917
              )
              
              $
              (940,180
              )
              
              
              2,602,228
              
              
              $
              (0.36
              )December 31, 2008Basic
      earnings per share
              
              $
              1,848,589
              
              
              $
              -
              
              
              $
              1,848,589
              
              
              
              2,595,128
              
              
              $
              0.71Effect
      of dilutive stock options
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              28,173Diluted
      earnings per share
              
              $
              1,848,589
              
              
              $
              -
              
              
              $
              1,848,589
              
              
              
              2,623,301
              
              
              $
              0.70December 31, 2007Basic
      earnings per share
              
              $
              2,660,850
              
              
              $
              -
              
              
              $
              2,660,850
              
              
              
              2,600,085
              
              
              $
              1.02Effect
      of dilutive stock options
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              99,816Diluted
      earnings per share
              
              $
              2,660,850
              
              
              $
              -
              
              
              $
              2,660,850
              
              
              
              2,699,901
              
              
              $
              0.99





Shares of
common stock issuable under stock options for which the exercise prices are
greater than the average market prices are not included in the computation of
diluted earnings per share due to their anti-dilutive effect.  There
were 47,775 and 11,025 options excluded from the computation of diluted earnings
per share for the years ended December 31, 2008 and 2007,
respectively.


77
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





11.
            SHAREHOLDERS' EQUITY(Continued)





Stock-Based
Compensation





The
Company has one active share based compensation plan.  The purpose of
the plan is to promote the long-term success of the Company and the creation of
shareholder value.  The Board of Directors also believes that the
availability of stock options and other forms of stock awards will be a key
factor in the ability of the Company to attract and retain qualified
individuals.  On May 15, 2007, the Company’s shareholders approved the
Valley Commerce Bancorp 2007 Equity Incentive Plan (“Incentive
Plan”).  The Incentive Plan provides for awards of stock options,
restricted stock awards, qualified performance based awards and stock
grants.  Under the Incentive Plan, 96,476 and 42,446 shares of common
stock are reserved for future grant and issuance, respectively, to employees and
directors under incentive and nonstatutory agreements.  There were no
options granted during the years ended December 31, 2009 and 2008.  In
addition, there are 119,875 shares reserved for issuance and options outstanding
at December 31, 2009 related to the Valley Commerce Bancorp Amended and Restated
1997 Stock Option Plan (the “1997 Plan) which expired in February
2007.  No more options will be granted from the 1997
Plan.





The plans
require that the option price may not be less than the fair market value of the
stock at the date the option is granted, and that the stock must be paid in full
at the time the option is exercised.  Payment in full for the option
price must be made in cash, with Company common stock previously acquired by the
optionee and held by the optionee for a period of at least six months or by net
exercise in which options are surrendered for their ‘in-the-money”
value.  The plans do not provide for the settlement of awards in cash
and new shares are issued upon option exercise.  The options expire on
dates determined by the Board of Directors, but not later than ten years from
the date of grant.  Upon grant, options vest ratably over a one to
five year period.


78
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





11.
            SHAREHOLDERS' EQUITY(Continued)





Stock-Based Compensation
(Continued)





A summary
of the activity within the Plans follows:




For
      the Years Ended December 31, 2009, 2008 and 2007Shares
              
              
              Weighted
      Average Exercise Price
              
              Weighted
      Average Remaining Contractual Term
              
              Aggregate
      Intrinsic ValueIncentive:Options
      outstanding at January 1, 2007
              
              
              39,548
              
              
              $
              7.44Options
      granted
              
              
              42,446
              
              
              
              13.15Options
      exercised
              
              
              (2,109
              )
              
              
              6.16Options
      cancelled
              
              
              (670
              )
              
              
              10.45Options
      outstanding at December 31, 2007
              
              
              79,215
              
              
              
              10.50Options
      granted
              
              
              -
              
              
              
              -Options
      exercised
              
              
              (380
              )
              
              
              10.45Options
      cancelled
              
              
              (3,956
              )
              
              
              13.09Options
      outstanding at December 31, 2008
              
              
              74,879
              
              
              
              10.36Options
      granted
              
              
              -
              
              
              
              -Options
      exercised
              
              
              -
              
              
              
              -Options
      cancelled
              
              
              (522
              )
              
              
              13.15Options
      outstanding at December 31, 2009
              
              
              74,357
              
              
              
              10.34
              
              5.34
      years
              
              $
              -
              (1)Options
      vested or expected to vest at December 31, 2009
              
              
              51,538
              
              
              
              12.60
              
              3.59
      years
              
              $
              -
              (1)Options
      exercisable at December 31, 2009
              
              
              51,538
              
              
              
              9.10
              
              3.51
      years
              
              $
              -
              (1)Nonstatutory:Options
      outstanding at January 1, 2007
              
              
              220,136
              
              
              $
              7.11Options
      granted
              
              
              -
              
              
              
              -Options
      exercised
              
              
              (105,491
              )
              
              
              5.74Options
      cancelled
              
              
              -
              
              
              
              -Options
      outstanding at December 31, 2007
              
              
              114,645
              
              
              
              8.26Options
      granted
              
              
              -
              
              
              
              -Options
      exercised
              
              
              (15,513
              )
              
              
              5.59Options
      cancelled
              
              
              -
              
              
              
              -Options
      outstanding at December 31, 2008
              
              
              99,132
              
              
              
              8.67Options
      granted
              
              
              -
              
              
              
              -Options
      exercised
              
              
              (11,168
              )
              
              
              5.37Options
      cancelled
              
              
              -
              
              
              
              -Options
      outstanding at December 31, 2009
              
              
              87,964
              
              
              
              9.10
              
              3.04
      years
              
              $
              8,704
              (2)Options
      vested or expected to vest at December 31, 2009
              
              
              85,647
              
              
              
              8.89
              
              3.04
      years
              
              $
              8,704
              (2)Options
      exercisable at December 31, 2009
              
              
              85,647
              
              
              
              8.89
              
              2.54
      years
              
              $
              8,704
              (2)





(1)
            74,357
      options are excluded from intrinsic value because they are not in the
      money.


(2)
            53,698
      options are excluded from intrinsic value because they are not in the
      money.


79
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





11.
            SHAREHOLDERS' EQUITY(Continued)





Stock-Based Compensation
(Continued)





The
aggregate intrinsic value is calculated as the difference between the exercise
price of the underlying awards and the quoted price of the Company’s common
stock for options that were in-the-money at December 31, 2009.  There
were 11,168, 15,893 and 107,600 options exercised during the years ended
December 31, 2009, 2008 and 2007, respectively.  The total intrinsic
value of options exercised during the years ended December 31, 2009, 2008, and
2007 was $19,295, $76,958, and $1,152,962, respectively.  The total
fair value of shares vested during the years ended December 31, 2009, 2008, and
2007 was $8,704, $155,492, and $219,283, respectively.





Cash
received from option exercise for the years ended December 31, 2009, 2008, and
2007 was $59,998, $90,644, and $556,335, respectively.  The total tax
benefit of the non-qualified options exercised in 2009 and 2008, and 2007 was
$7,718, $30,338 and $335,894, respectively.




Regulatory
Capital





The
Company and the Bank are subject to certain regulatory capital requirements
administered by the Board of Governors of the Federal Reserve System and the
Federal Deposit Insurance Corporation (FDIC).  Failure to meet these
minimum capital requirements can initiate certain mandatory, and possibly
additional discretionary, actions by regulators that, if undertaken, could have
a direct material effect on the Company's consolidated financial
statements.  Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Bank must meet specific capital
guidelines that involve quantitative measures of the Bank's assets, liabilities
and certain off-balance-sheet items as calculated under regulatory accounting
practices.  The Company's and the Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings and other factors.





Quantitative
measures established by regulation to ensure capital adequacy require the
Company and the Bank to maintain minimum amounts and ratios of total and Tier 1
capital to risk-weighted assets and of Tier 1 capital to average
assets.  Each of these components is defined in the
regulations.  Management believes that the Company and the Bank met
all their capital adequacy requirements as of December 31, 2009 and
2008.


80
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





11.
            SHAREHOLDERS' EQUITY(Continued)





Regulatory Capital
(Continued)





In
addition, the most recent notification from the FDIC categorized the Bank as
well capitalized under the regulatory framework for prompt corrective
action.  To be categorized as well capitalized, the Bank must maintain
minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set
forth below.  There are no conditions or events since that
notification that management believes have changed the Bank's
category.





December 31,2009
            
            
            2008Amount
            
            
            Ratio
            
            
            Amount
            
            
            RatioLeverage RatioValley
      Commerce Bancorp and Subsidiary
            
            $
            39,865,000
            
            
            
            11.4
            %
            
            $
            33,044,000
            
            
            
            10.9
            %Minimum
      regulatory requirement
            
            $
            13,982,000
            
            
            
            4.0
            %
            
            $
            12,150,000
            
            
            
            4.0
            %Valley
      Business Bank
            
            $
            39,845,000
            
            
            
            11.4
            %
            
            $
            32,751,000
            
            
            
            10.8
            %Minimum
      requirement for "Well-Capitalized" institution
            
            $
            17,472,000
            
            
            
            5.0
            %
            
            $
            15,181,000
            
            
            
            5.0
            %Minimum
      regulatory requirement
            
            $
            13,977,000
            
            
            
            4.0
            %
            
            $
            12,145,000
            
            
            
            4.0
            %Tier 1 Risk-Based Capital
    RatioValley
      Commerce Bancorp and Subsidiary
            
            $
            39,865,000
            
            
            
            14.8
            %
            
            $
            33,044,000
            
            
            
            12.7
            %Minimum
      regulatory requirement
            
            $
            10,804,000
            
            
            
            4.0
            %
            
            $
            10,367,000
            
            
            
            4.0
            %Valley
      Business Bank
            
            $
            39,845,000
            
            
            
            14.8
            %
            
            $
            32,751,000
            
            
            
            12.6
            %Minimum
      requirement for "Well-Capitalized"institution
            
            $
            16,201,000
            
            
            
            6.0
            %
            
            $
            15,545,000
            
            
            
            6.0
            %Minimum
      regulatory requirement
            
            $
            10,801,000
            
            
            
            4.0
            %
            
            $
            10,363,000
            
            
            
            4.0
            %Total Risk-Based Capital
    RatioValley
      Commerce Bancorp and Subsidiary
            
            $
            43,277,000
            
            
            
            16.0
            %
            
            $
            36,284,000
            
            
            
            14.0
            %Minimum
      regulatory requirement
            
            $
            21,608,000
            
            
            
            8.0
            %
            
            $
            20,734,000
            
            
            
            8.0
            %Valley
      Business Bank
            
            $
            43,256,000
            
            
            
            16.0
            %
            
            $
            35,990,000
            
            
            
            13.9
            %Minimum
      requirement for "Well-Capitalized"institution
            
            $
            27,002,000
            
            
            
            10.0
            %
            
            $
            25,909,000
            
            
            
            10.0
            %Minimum
      regulatory requirement
            
            $
            21,601,000
            
            
            
            8.0
            %
            
            $
            20,728,000
            
            
            
            8.0
            %


81
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





11.
            SHAREHOLDERS'
      EQUITY(Continued)





On
January 30, 2009, the Company entered into a letter Agreement (the “Purchase
Agreement”) with the United States Department of the Treasury (“Treasury”),
pursuant to which the Company issued and sold (i) 7,700 shares of the Company’s
Fixed Rate Cumulative Preferred Stock, Series B (the “Series B Preferred Stock”)
and (ii) a warrant to purchase 385 shares of the Company’s Fixed Rate Cumulative
Perpetual Preferred Stock Series C stock, (the “Warrant Preferred” or “Series C
Preferred Stock”) for a combined purchase price of $7,700,000 and were recorded
net of $25,783 in offering costs.  The Treasury exercised the Warrant
immediately upon issuance.





The
Series B Preferred Stock will Qualify as Tier 1 capital and will pay cumulative
dividends quarterly at a rate of 5% per annum for the first five years, and 9%
per annum thereafter.  The Warrant Preferred will pay cumulative
dividends at a rate of 9% per annum until redemption.  The terms
governing the Series B Preferred Stock and the Series C Preferred Stock provide
that either series may be redeemed by the Company after three years; however,
the Warrant Preferred may not be redeemed until after all the Series B Preferred
stock has been redeemed, and prior to the end of three years, the Series B
Preferred stock and the Warrant Preferred may be redeemed by the Company only
with proceeds from the sale of Qualifying equity securities of the Company (a”
Qualified Equity Offering”).  The American Recovery and Reinvestment
Act of 2009, which was enacted on February 17, 2009 permits the Company to
redeem the Series B Preferred stock and the Warrant Preferred without a
Qualified Equity Offering, subject to the Company’s consultation with the Board
of Governors of the Federal Reserve System.





The
Series B Preferred Stock and the Warrant Preferred were issued in a private
placement exempt from registration pursuant to Section 4(2) of the Securities
Act of 1933, as amended.  Neither the Series B Preferred Stock nor the
Warrant Preferred will be subject to any contractual restrictions on transfer,
except that Treasury and its transferees shall not effect any transfer of the
Preferred which would require the Company to become subject to the periodic
reporting requirements of Section 13 or 15(d) of the Exchange Act.





In the
Purchase Agreement, the Company agreed that, until such time as Treasury ceases
to own any debt or equity securities of the Company acquired pursuant to the
Purchase Agreement, the Company will take all necessary action to ensure that
its benefit plans with respect to its senior executive officers comply with
Section 111(b) of the Emergency Economic Stabilization Act of 2008 (the “EESA”)
as implemented by any guidance or regulation under the EESA that has been issued
and is in effect as of the date of issuance of the Series B Preferred Stock and
the Warrant, and has agreed to not adopt any benefit plans with respect to, or
which covers, its senior executive officers that do not comply with the EESA,
and the applicable executives have consented to the
foregoing.  Furthermore, the Purchase Agreement allows Treasury to
unilaterally amend the terms of the agreement.





With
respect to dividends on the Company’s common stock, Treasury’s consent shall be
required for any increase in common dividends per share until the third
anniversary of the date of its investment unless prior to such third anniversary
the Series B Preferred Stock and the Warrant Preferred is redeemed in whole or
the Treasury has transferred all of the Senior Preferred Series B Preferred
Stock and Warrant Preferred to third parties.  After the third
anniversary and prior to the tenth anniversary, the Treasury’s consent shall be
required for any increase in aggregate common dividends per share that no
increase in common dividends may be made as a result of any dividend paid in
common shares, any stock split or similar transaction.  From and after
the tenth anniversary, the Company shall be prohibited from paying common
dividends or repurchasing any equity securities or trust preferred securities
until all equity securities held by the Treasury are redeemed in whole of the
Treasury has transferred all of such equity securities to third
parties.


82
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





11.
            SHAREHOLDERS'
      EQUITY(Continued)





Stock
Repurchase





In 2007,
the Board of Directors approved a plan to incrementally repurchase up to an
aggregate of $3,000,000 of the Company’s common stock.  The program
commenced in November of 2007 and, based on the October 2008 and October 2009
plan extensions approved by the Board of Directors, will continue until its
expiration on November 30, 2010, subject to earlier termination at the Company’s
discretion.  Beginning January 30, 2009, the Company was restricted
from repurchasing its common stock due to its issuance of preferred stock to the
United States Department of the Treasury in conjunction with the Company’s
participation in the Capital Purchase Program as described above. The number,
price and timing of the repurchase shall be at the Company’s sole discretion and
the plan may be re-evaluated depending on market conditions, liquidity needs or
other factors.  The Board, based on such re-evaluations, may suspend,
terminate, modify or cancel the plan at any time without
notice.  There were no shares repurchased during the year ended
December 31, 2009.  During the year ended December 31, 2008, the
Company repurchased 57,385 shares for a total cost of $821,037 or an average
price of $14.31 per share.  Since the plan adoption the Company has
repurchased 86,196 shares for a total cost of $1,202,845 at an average price of
$14.74 per share.








12.
            OTHER
      EXPENSES





Other
expenses consisted of the following:





Year Ended December 31,2009
            
            
            2008
            
            
            2007Data
      processing
            
            $
            617,112
            
            
            $
            523,943
            
            
            $
            494,863Assessment
      and insurance
            
            
            614,101
            
            
            
            258,843
            
            
            
            197,225Professional
      and legal
            
            
            548,915
            
            
            
            393,924
            
            
            
            507,920Operations
            
            
            455,032
            
            
            
            508,533
            
            
            
            479,803Telephone
      and postal
            
            
            220,316
            
            
            
            215,689
            
            
            
            213,401Promotional
            
            
            219,377
            
            
            
            273,259
            
            
            
            304,774Supplies
            
            
            158,569
            
            
            
            180,925
            
            
            
            187,834OREO
      expense
            
            
            12,879
            
            
            
            -
            
            
            
            -Amortization
      expense
            
            
            -
            
            
            
            7,718
            
            
            
            62,538Other
      expenses
            
            
            381,072
            
            
            
            403,479
            
            
            
            406,835Total
            
            $
            3,227,373
            
            
            $
            2,766,313
            
            
            $
            2,855,193


83
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





13.
            INCOME
      TAXES





The
(benefit from) provision for income taxes for the years ended December 31, 2009,
2008 and 2007 consisted of the following:





Federal
            
            
            State
            
            
            Total2009Current
            
            $
            (240,000
            )
            
            $
            48,000
            
            
            $
            (192,000
            )Deferred
            
            
            (693,000
            )
            
            
            (310,000
            )
            
            
            (1,003,000
            )Benefit
      from income taxes
            
            $
            (933,000
            )
            
            $
            (262,000
            )
            
            $
            (1,195,000
            )2008Current
            
            $
            1,206,000
            
            
            $
            475,000
            
            
            $
            1,681,000Deferred
            
            
            (707,000
            )
            
            
            (228,000
            )
            
            
            (935,000
            )Provision
      for income taxes
            
            $
            499,000
            
            
            $
            247,000
            
            
            $
            746,0002007Current
            
            $
            809,000
            
            
            $
            402,000
            
            
            $
            1,211,000Deferred
            
            
            (40,000
            )
            
            
            (37,000
            )
            
            
            (77,000
            )Provision
      for income taxes
            
            $
            769,000
            
            
            $
            365,000
            
            
            $
            1,134,000





Deferred
tax assets (liabilities) consisted of the following:





December 31,2009
            
            
            2008Deferred
      tax assets:Allowance
      for loan losses
            
            $
            2,569,000
            
            
            $
            1,454,000Deferred
      compensation
            
            
            822,000
            
            
            
            721,000Intangible
      assets
            
            
            58,000
            
            
            
            76,000Premises
      and equipment
            
            
            133,000
            
            
            
            30,000Total
      deferred tax assets
            
            
            3,582,000
            
            
            
            2,281,000Deferred
      tax liabilities:Loan
      costs
            
            
            (334,000
            )
            
            
            (293,000
            )Unrealized
      gain on available-for-saleinvestment
      securities
            
            
            (3,000
            )
            
            
            (67,000
            )Future
      liability of state tax benefit
            
            
            (258,000
            )
            
            
            (3,000
            )Other
            
            
            (31,000
            )
            
            
            (29,000
            )Total
      deferred tax liabilities
            
            
            (625,000
            )
            
            
            (392,000
            )Net
      deferred tax assets
            
            $
            2,956,000
            
            
            $
            1,889,000


84
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





13.
            INCOME TAXES(Continued)





Management
believes that it is more likely than not that it will realize the above deferred
tax assets in future periods; therefore, no valuation allowance has been
provided against its deferred tax assets.





The
provision for income taxes differs from amounts computed by applying the
statutory Federal income tax rate to operating (loss) income before income
taxes.  The items comprising these differences consisted of the
following:





Year Ended December 31,2009
            
            
            2008
            
            
            2007Rate
            
            
            Rate
            
            
            RateFederal
      income tax, at statutory rate
            
            
            34.0
            %
            
            
            34.0
            %
            
            
            34.0
            %State
      franchise tax, net of Federal tax effect
            
            
            7.2
            %
            
            
            6.4
            %
            
            
            7.2
            %Interest
      on obligations of states and political subdivisions
            
            
            13.5
            %
            
            
            (8.6
            )%
            
            
            (6.0
            )%Net
      increase in cash surrender value of bank-owned life
    insurance
            
            
            5.2
            %
            
            
            (3.1
            )%
            
            
            (2.2
            )%Life
      Insurance proceeds
            
            
            6.1
            %
            
            
            -
            
            
            
            -Other
            
            
            1.1
            %
            
            
            (0.1
            )%
            
            
            (3.1
            )%Total
      income tax (benefit) expense
            
            
            67.1
            %
            
            
            28.8
            %
            
            
            29.9
            %





The
Company and its subsidiary file income tax returns in the U.S. federal and
California jurisdictions.  There are currently no pending U.S.
federal, state, and local income tax or non-U.S. income tax examinations by tax
authorities.  With few exceptions, the Company is no longer subject to
tax examinations by U.S. Federal taxing authorities for years ended before
December 31, 2006, and by state and local taxing authorities for years ended
before December 31, 2005.





The
Company has federal net operating loss carry forwards of $588,000 which expire
in 2029.





The
unrecognized tax benefits and the interest and penalties accrued by the Company
as of December 31, 2009 and 2008 were not significant.








14.
            RELATED
      PARTY TRANSACTIONS





During
the normal course of business, the Company enters into transactions with related
parties, including executive officers and directors.  These
transactions include borrowings from the Company with substantially the same
terms, including rates and collateral, as loans to unrelated
parties.  The following is a summary of the aggregate activity
involving related party borrowers during 2009:





Balance,
      January 1, 2009
            
            $
            13,400,376Disbursements
            
            
            1,100,312Amounts
      repaid
            
            
            (3,899,651
            )Balance,
      December 31, 2009
            
            $
            10,601,037Undisbursed
      commitments to related parties, December 31, 2009
            
            $
            3,212,107


85
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





15.
            EMPLOYEE
      BENEFIT PLANS





Employee Retirement
Plan





The
Company adopted the Valley Business Bank 401(k) Profit Sharing Plan, effective
January 1, 1997.  All employees that work 30 or more hours per week
with more than 3 months of service are eligible to participate in the
plan.  Eligible employees may elect to make tax deferred contributions
of their salary up to the maximum amount allowed by law.  From April
1, 2006 to February 27, 2009, the Company matched 70% of the employees’
contributions, applicable to contributions of up to 6% of the employees’ annual
salary. For all other periods the Company matched 50% of the employees’
contributions, applicable to contributions of up to 6% of the employees annual
salary.  Company contributions vest at a rate of 20%
annually.  Bank contributions for the years ended December 31, 2009,
2008, and 2007 totaled $79,930, $117,036, and $112,583
respectively.





Salary Continuation and
Retirement Plans





Salary
continuation plans are in place for three executives. Under these plans, the
executives will receive monthly payments after retirement until
death.  These benefits are substantially equivalent to those available
under split-dollar life insurance policies purchased by the Bank on the lives of
the executives.  In addition, the estimated present value of these
future benefits, including the monthly payments and insurance premium costs, is
accrued over the period from the effective dates of the plans until the
participants' expected retirement dates.  The expense recognized under
these plans for the years ended December 31, 2009, 2008, and 2007 totaled
$184,153, $273,442, and $229,774, respectively. Income earned on these policies,
net of expenses, totaled $142,229, $97,228, and $111,813 for the years ended
December 31, 2009, 2008 and 2007, respectively. Accrued compensation payable
under the salary continuation plan totaled $1,818,195 and $1,528,921 at December
31, 2009 and 2008, respectively.





In
connection with these agreements, and non-executive officer retirement plans
offering limited benefits, the Bank purchased single premium life insurance
policies with cash surrender values totaling $6,354,871 and $6,421,863 at
December 31, 2009 and 2008, respectively.  Income earned on these
policies, net of expenses, totaled $270,253, $237,332 and $249,968 for the years
ended December 31, 2009, 2008 and 2007, respectively.  Income earned
on these policies is not subject to Federal and state income tax.  The
Bank received $317,000 in officer life insurance benefits during
2009.





16.
            COMPREHENSIVE
      INCOME





Comprehensive
(loss) income is reported in addition to net income for all periods
presented.  Comprehensive income (loss) is a more inclusive financial
reporting methodology that includes disclosure of other comprehensive income
(loss) that historically has not been recognized in the calculation of net
income.  The unrealized gains and losses on the Company's
available-for-sale investment securities are included in other comprehensive
income (loss).  Total comprehensive income (loss) and the components
of accumulated other comprehensive income (loss) are presented in the
consolidated statement of changes in shareholders’ equity.


86
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





16.
            COMPREHENSIVE INCOME
      (Continued)





At
December 31, 2009, 2008 and 2007, the Company held securities classified as
available-for-sale which had unrealized gains as follows:





Tax
      BeforeTax
            
            
            Benefit(Expense)
            
            
            AfterTaxFor the Year Ended December 31, 2009Other
      comprehensive income:Unrealized
      holding gains
            
            $
            259,065
            
            
            $
            (106,643
            )
            
            $
            152,422Reclassification
      adjustment for gains included in net income
            
            
            416,248
            
            
            
            (171,323
            )
            
            
            244,925Total
      other comprehensive loss
            
            $
            (157,183
            )
            
            $
            64,680
            
            
            $
            (92,503
            )For the Year Ended December 31, 2008Other
      comprehensive income:Unrealized
      holding gains
            
            $
            301,048
            
            
            $
            (116,335
            )
            
            $
            184,713Reclassification
      adjustment for gains included in net income
            
            
            46,412
            
            
            
            (19,098
            )
            
            
            27,314Total
      other comprehensive income
            
            $
            254,636
            
            
            $
            (97,237
            )
            
            $
            157,399For the Year Ended December 31, 2007Other
      comprehensive income:Unrealized
      holding gains
            
            $
            339,309
            
            
            $
            (125,255
            )
            
            $
            214,054Reclassification
      adjustment for losses included in net income
            
            
            (1,145
            )
            
            
            376
            
            
            
            (769
            )Total
      other comprehensive income
            
            $
            340,454
            
            
            $
            (125,631
            )
            
            $
            214,823


87
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





17.
            PARENT
      ONLY FINANCIAL STATEMENTS





CONDENSED
      BALANCE SHEET


December
      31, 2009 and 2008





2009
            
            
            2008ASSETSCash
      and due from banks
            
            $
            53,072
            
            
            $
            207,831Investment
      in bank subsidiary
            
            
            39,849,030
            
            
            
            32,847,042Other
      assets
            
            
            193,055
            
            
            
            287,430Total assets
            
            $
            40,095,157
            
            
            $
            33,342,303LIABILITIES
      AND SHAREHOLDERS' EQUITYOther
      liabilities
            
            $
            133,618
            
            
            $
            109,019Junior
      subordinated debentures due to subsidiary grantor trust
            
            
            3,093,000
            
            
            
            3,093,000Total
      liabilities
            
            
            3,226,618
            
            
            
            3,202,019Shareholders'
      equity:Preferred
      stock
            
            
            7,744,800
            
            
            
            -Common
      stock
            
            
            25,953,290
            
            
            
            24,684,529Retained
      earnings
            
            
            3,166,732
            
            
            
            5,359,535Accumulated
      other comprehensive income, net of taxes
            
            
            3,717
            
            
            
            96,220Total
      shareholders' equity
            
            
            36,868,539
            
            
            
            30,140,284$
            40,095,157
            
            
            $
            33,342,303


88
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





17.
            PARENT ONLY FINANCIAL
      STATEMENTS (Continued)





CONDENSED
STATEMENT OF INCOME





For
the Years Ended December 31, 2009, 2008 and 2007





2009
            
            
            2008
            
            
            2007Income:Dividends
      declared by bank subsidiary
            
            $
            350,000
            
            
            $
            1,000,000
            
            
            $
            -Earnings
      from investment in Valley CommerceTrust I
            
            
            3,903
            
            
            
            6,575
            
            
            
            8,139Miscellaneous
      other income
            
            
            -
            
            
            
            96
            
            
            
            -Total
      income
            
            
            353,903
            
            
            
            1,006,671
            
            
            
            8,139Expenses:Interest
      on junior subordinated deferrable interest debentures
            
            
            129,795
            
            
            
            218,672
            
            
            
            270,690Other
      expenses
            
            
            543,516
            
            
            
            483,637
            
            
            
            531,689Total
      expenses
            
            
            673,311
            
            
            
            702,309
            
            
            
            802,379(Loss)
      income before equity in undistributed (loss) income of
      subsidiary
            
            
            (319,408
            )
            
            
            304,362
            
            
            
            (794,240
            )(Excess
      distributions of) undistributed equity in income of
    subsidiary
            
            
            (536,855
            )
            
            
            1,264,227
            
            
            
            3,128,090(Loss)
      income before income taxes
            
            
            (856,263
            )
            
            
            1,568,589
            
            
            
            2,333,850Income
      tax benefit
            
            
            269,000
            
            
            
            280,000
            
            
            
            327,000Net
      (loss) income
            
            $
            (587,263
            )
            
            $
            1,848,589
            
            
            $
            2,660,850


89
 Table of Contents


VALLEY
COMMERCE BANCORP AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Continued)





17.
            PARENT ONLY FINANCIAL
      STATEMENTS (Continued)





STATEMENT
OF CASH FLOWS





For
the Years Ended December 31, 2009, 2008 and 2007





2009
            
            
            2008
            
            
            2007Cash
      flows from operating activities:Net
      (loss) income
            
            $
            (587,263
            )
            
            $
            1,848,589
            
            
            $
            2,660,850Adjustments
      to reconcile net income to net cash provided by (used in) operating
      activities:Excess
      distributions of (undistributed equity in) income of
      subsidiary
            
            
            536,855
            
            
            
            (1,264,227
            )
            
            
            (3,128,090
            )Stock-based
      compensation expense
            
            
            21,995
            
            
            
            17,152
            
            
            
            32,519Tax
      benefits on stock-based compensation
            
            
            (7,720
            )
            
            
            (30,338
            )
            
            
            (335,893
            )Decrease
      (increase) in other assets
            
            
            102,095
            
            
            
            (42,135
            )
            
            
            523,238Decrease
      (increase) in other liabilities
            
            
            24,599
            
            
            
            (3,300
            )
            
            
            8,041Net
      cash provided by (used in) operating activities
            
            
            90,561
            
            
            
            525,741
            
            
            
            (239,335
            )Cash
      flows from investing activities:Investment
      in Bank subsidiary
            
            
            (7,600,000
            )
            
            
            -
            
            
            
            -Cash
      flows from financing activities:Proceeds
      from issuance of preferred stock
            
            
            7,674,217
            
            
            
            -
            
            
            
            -Cash
      paid for fractional shares
            
            
            (2,577
            )
            
            
            (3,489
            )
            
            
            (5,392
            )Proceeds
      from the exercise of stock options
            
            
            59,998
            
            
            
            97,506
            
            
            
            556,336Tax
      benefits from stock-based compensation
            
            
            7,720
            
            
            
            30,338
            
            
            
            335,893Cash
      paid to repurchase common stock
            
            
            -
            
            
            
            (821,037
            )
            
            
            (381,808
            )Cash
      dividends paid on preferred stock
            
            
            (384,678
            )
            
            
            -
            
            
            
            -Net
      cash provided by (used in) financing activities
            
            
            7,354,680
            
            
            
            (696,682
            )
            
            
            505,029(Decrease)
      increase in cash and cash equivalents
            
            
            (154,759
            )
            
            
            (170,941
            )
            
            
            265,694Cash
      and cash equivalents at beginning of year
            
            
            207,831
            
            
            
            378,772
            
            
            
            113,078Cash
      and cash equivalents at end of year
            
            $
            53,072
            
            
            $
            207,831
            
            
            $
            378,772


90
 Table of Contents


ITEM 9 – CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE





There is
no information required to be disclosed under this Item.





ITEM 9A – CONTROLS AND PROCEDURES




Based on
their evaluation as of the end of the period covered by this Annual Report on
Form 10-K (as required by paragraph (b) of Rule 13a-15 under the Securities
Exchange Act of 1934 (the “Exchange Act”), the Registrant’s principal executive
officer and principal financial officer have concluded that the Registrant’s
disclosure controls and procedures (as defined in Rules 13a-15(e) under the
Exchange Act) were effective to ensure that information required to be disclosed
by the Company in reports that it files or submits under the Exchange Act was
recorded, processed, summarized and reported within the time periods specified
in Securities and Exchange Commission rules and forms.




REPORT
OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING




Management
of Valley Commerce Bancorp and its subsidiary (the Company) is responsible for
establishing and maintaining adequate internal control over financial reporting
for the Company, as such term is defined in Rule 13a-15(f) under the Securities
Exchange Act of 1934. The Company’s management, including the chief executive
officer and chief financial officer, has assessed the effectiveness of the
Company’s internal control over financial reporting as of December 31, 2009,
presented in conformity with accounting principles generally accepted in the
United States of America. In making this assessment, management used the
criteria set forth by the Committee of Sponsoring Organizations of the Treadway
Commission in Internal Control-Integrated Framework. Based on this assessment,
management concluded that, as of December 31, 2009, the Company’s internal
control over financial reporting was effective based on those
criteria.




This
annual report does not include an attestation report of the Company’s
independent registered public accounting firm regarding internal control over
financial reporting. Management’s report was not subject to attestation by the
Company’s independent registered public accounting firm pursuant to temporary
rules of the Securities and Exchange Commission that permit the Company to
provide only management’s report in this annual report.





Disclosure
controls and procedures





The
Company carried out an evaluation, under the supervision and with the
participation of the Company’s management, including the Company’s Chief
Executive Officer and Chief Financial Officer, of the effectiveness, as of
December 31, 2009, of the design and operation of the Company’s disclosure
controls and procedures pursuant to Rule 15d-15 of the Exchange
Act.  Based upon that evaluation, the Company’s principal executive
and financial officers concluded that the Company’s disclosure controls and
procedures were effective, as of December 31, 2009, in timely providing them
with material information relating to the Company, as required to be disclosed
by the Company in the reports that it files or submits under the Exchange Act,
within the time periods specified in the Securities and Exchange Commission’s
rules and forms.





Changes
in internal controls





There was
no change in the Company’s internal control over financial reporting identified
in connection with the evaluation required by Rule 15d-15 that occurred during
the year ended December 31, 2009 that has materially affected or is reasonably
likely to materially affect, the Company’s internal control over financial
reporting.





ITEM 9B – OTHER INFORMATION





There is
no information required to be disclosed under this Item.


91
 Table of Contents


PART
III





ITEM 10 - DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.




For
information concerning directors and executive officers of the Company, see
“ELECTION OF DIRECTORS OF THE COMPANY” in the definitive Proxy Statement for the
Company’s 2010 Annual Meeting of Shareholders to be filed pursuant to Regulation
14A (the “2010 Proxy Statement”), which section of the Proxy Statement is
incorporated herein by reference.




ITEM 11 - EXECUTIVE COMPENSATION





The
information required by Item 11 will be included in the 2010 Proxy Statement to
be filed pursuant to Regulation 14A under the Exchange Act, and is by this
reference incorporated herein.





ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER  MATTERS





The
information required by Items 12 will be included in the 2010 Proxy Statement to
be filed pursuant to Regulation 14A under the Exchange Act, and is by this
reference incorporated herein.





ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE





The
information required by Items 13 will be included in the 2010 Proxy Statement to
be filed pursuant to Regulation 14A under the Exchange Act, and is by this
reference incorporated herein.





ITEM 14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES





The
information required by Items 14 will be included in the 2010 Proxy Statement to
be filed pursuant to Regulation 14A under the Exchange Act, and is by this
reference incorporated herein.





PART
IV




ITEM 15 - EXHIBITS





Exhibits
required to be filed are listed on the “Exhibit Index” attached hereto, which is
incorporated herein by reference.


92
 Table of Contents


SIGNATURES





In
accordance with Section 13 or 15(d) of the Exchange Act, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.





VALLEY
      COMMERCE BANCORPBy:
            /s/
      Donald A. GillesDonald
      A. GillesPresident
      and Chief Executive OfficerBy:
            /s/
      Roy O. EstridgeRoy
      O. EstridgeExecutive
      Vice President and Chief Financial OfficerDate:
            March
      30, 2010








POWER
OF ATTORNEY





KNOW ALL
MEN BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints Donald A. Gilles or Roy O. Estridge as his true and
lawful attorneys-in-fact and agents, with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign any and all amendments to this Report on Form 10-K, and to
file the same, with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
connection therewith, as fully to all intents and purposes as he might or could
do in person, hereby ratifying and confirming all that said attorneys-in-fact
and agents, or any of them, or their or his substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.


93
 Table of Contents


In
accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.





Signature
            
            Title
            
            Date/s/ Donald A. Gilles
            
            Director
      and Chief Executive Officer (Principal Executive Officer)Donald
      A. Gilles
            
            
            
            March
      30, 2010/s/ Roy O. Estridge
            
            Chief
      Financial Officer (Principal Financial Officer and Principal Accounting
      Officer)Roy
      O. Estridge
            
            
            
            March
      30, 2010/s/ David B. Day
            
            DirectorDavid
      B. Day
            
            
            
            March
      30, 2010/s/ Walter A. Dwelle
            
            Chairman
      and DirectorWalter
      A. Dwelle
            
            
            
            March
      30, 2010/s/ Thomas A. Gaebe
            
            DirectorThomas
      A. Gaebe
            
            
            
            March
      30, 2010/s/ Philip R. Hammond, Jr.
            
            DirectorPhilip
      R. Hammond, Jr.
            
            
            
            March
      30, 2010/s/ Russell F. Hurley
            
            Vice
      Chairman and DirectorRussell
      F. Hurley
            
            
            
            March
      30, 2010/s/ Fred P. LoBue, Jr.
            
            Secretary
      and DirectorFred
      P. LoBue, Jr.
            
            
            
            March
      30, 2010/s/ Kenneth H. Macklin
            
            DirectorKenneth
      H. Macklin
            
            
            
            March
      30, 2010/s/ Barry R. Smith
            
            DirectorBarry
      R. Smith
            
            
            
            March
      30, 2010


94
 Table of Contents


EXHIBIT
INDEX





Exhibit
            
            Description of Document3.1
            
            Articles
      of Incorporation of the Company, as amended (1)3.2
            
            Bylaws
      of the Company (1)4.3
            
            Specimen
      Stock Certificate (2)4.4
            
            Certificates
      of Determination of Fixed Rate Cumulative Perpetual Preferred Stock,
      Series B and C (6)10.1
            
            Valley
      Commerce Bancorp Amended and Restated 1997 Stock Option Plan
      (1,3)10.2
            
            Lease
      of premises at 200 South Court Street, Visalia (1)10.3
            
            Executive
      Supplemental Compensation Agreement with Donald A.
      Gilles  (1,3)10.4
            
            Executive
      Supplemental Compensation Agreement with Roy O. Estridge
    (1,3)10.5
            
            Executive
      Supplemental Compensation Agreement with Allan W. Stone
    (1,3)10.7
            
            Valley
      Commerce Bancorp 2007 Equity Incentive Plan (4)10.8
            
            Indenture
      between Valley Commerce Bancorp and Wells Fargo Bank National Association
      as Trustee, Junior Subordinated Debt Securities Due April 7, 2033
      (1)10.9
            
            Junior
      Subordinated Debt Security Due 2003 of Valley Commerce Bancorp
      (1)10.10
            
            Guaranty
      Agreement of Valley Commerce Bancorp in favor of Wells Fargo Bank National
      Association as Trustee (1)10.12
            
            Letter
      Agreement dated January 30, 2009 by and between Valley Commerce Bancorp,
      Inc. and the United States Department of the Treasury and Securities
      Purchase Agreement – Standard Terms attached thereto
(6)10.13
            
            Side
      Letter Agreement between Valley Commerce Bancorp and the United States
      Department of the Treasury regarding authorized number of directors and
      amended Section 2.2 of Valley Commerce Bancorp by-laws
  (6)21
            
            Subsidiaries
      of the Company (1)23.2
            
            Consent
      of Independent Registered Public Accounting Firm dated March 27, 2009
      (5)24
            
            Powers
      of Attorney (included on signature pages)31
            
            Rule
      13a-14(a)/15d-14(a) Certifications32
            
            Section
      1350 Certifications99.1
            
            CEO
      TARP Certification99.2
            
            CFO
      TARP Certification


_______________________________________


(1)
            Incorporated
      by reference to the same-numbered exhibit to the Company’s Registration
      Statement on Form SB-2, filed September 9,
2004.


(2)
            Incorporated
      by reference to the same-numbered exhibit to the Company’s Registration
      Statement on Form SB-2/A, filed October 27,
  2004.


(3)
            Management
      contract or compensatory plan or
arrangement.


95
 Table of Contents


(4)
            Incorporated
      by reference to the Company’s definitive proxy statement for its 2007
      annual meeting of shareholders, filed on April 18,
  2007.


(5)
            Incorporated
      by reference to the same-numbered exhibit to the Company’s Registration
      Statement on Form S-8, filed on March 27,
2009.


(6)
            Incorporated
      by reference to the exhibits included with the Form 8-K that was filed by
      the Company on February 5, 2009.