UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549




FORM
10-K




(Mark
      one)T
            Annual
      report under Section 13 or 15(d) of the Securities Exchange Act of
      1934For
      the Fiscal Year December 31, 2008£
            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  xIndicate
      by check mark if the registrant is not required to file reports pursuant
      to Section 13 or Section 15(d) of the
    ExchangeAct.
            
            Yes  o
            
            No  xIndicate
      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 filesuch
      reports), and (2) has been subject to such filing requirements for
      the past 90 days.
            Yes  x
            
            No  oIndicate
      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, 2008, 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 $11.75 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 16, 2009Common
      Stock, no par value
            
            2,473,739
      shares




DOCUMENTS
INCORPORATED BY REFERENCE




Document
            
            Parts
      Into Which IncorporatedProxy
      Statement for the Annual Meeting of Shareholders to be held May 19, 2009,
      (Proxy Statement)
            
            Part III







2





TABLE OF CONTENTS





PageItem
      1.
                            Business
                            5Item
      1A.
                            Risk Factors
                            19Item
      1B.
                            Unresolved Staff Comments
                            21Item
      2.
                            Properties
                            22Item
      3.
                            Legal Proceedings
                            23Item
      4.
                            Submission of Matters to a Vote of Security
      Holders
                            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 areafailing 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, 2008, 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, 2008, the Company’s assets totaled $306.1
million.  As of December 31, 2008, the Company had a total of 82
employees and 78 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,
Valley Business Bank is subject to primary supervision, examination and
regulation by 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





5
 Table of Contents





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.





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 Federal
Deposit Insurance Corporation (the “FDIC”) up to maximum insurable
amounts.  The Bank is participating in the FDIC’s Transaction Account
Guarantee Program.  Under the program, through December 31, 2009, 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.  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, 2008, 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, 2008 approximately 75% 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
25% 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





6
 Table of Contents





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.





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.  As new technology becomes available, the Bank intends to
continue expanding its Internet based banking services for the benefit of its
customers.  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.





During
2007, the Bank began offering Valley Express deposit, a remote deposit capture
product, to its customers.  These services allow customers to scan
deposit items and transmit the images to the Bank via the
Internet.  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 such as internet based financial services companies 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 $228 million at December 31,
2005, to $306 million at December 31, 2008, an increase of
34%.  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 growth over the last three years is detailed further in the following
table:





December 31,(dollars
      in 000’s)
                              
                              2005
                              
                              
                              2006
                              
                              
                              2007
                              
                              
                              2008Total
      assets
                              
                              $
                              228,011
                              
                              
                              $
                              263,800
                              
                              
                              $
                              279,081
                              
                              
                              $
                              306,099Loans,
      net
                              
                              
                              149,991
                              
                              
                              
                              184,077
                              
                              
                              
                              199,514
                              
                              
                              
                              226,697Deposits
                              
                              
                              192,581
                              
                              
                              
                              207,576
                              
                              
                              
                              215,386
                              
                              
                              
                              257,323Shareholders’
      equity
                              
                              
                              21,909
                              
                              
                              
                              25,448
                              
                              
                              
                              28,873
                              
                              
                              
                              30,140








As of
June 30, 2008 (date of latest available statistics from FDIC), there were 17
commercial banks and savings associations with a total of 69 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 $36 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.





7
 Table of Contents





Regulation and Supervision.





Capital
Standards.The FRB and the FDIC have risk-based capital
adequacy guidelines 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.





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.  Tier 2 capital may
consist of a limited amount of the allowance for loan and lease 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.  For a banking organization
rated in the highest of the five categories used by regulators to rate banking
organizations, the minimum leverage ratio of Tier 1 capital to total assets is
3%.  It is improbable; however, that an institution with a 3% leverage
ratio would receive the highest rating by the regulators since a strong capital
position is a significant part of the regulators’ ratings.  For all
banking organizations not rated in the highest category, the minimum leverage
ratio is at least 100 to 200 basis points above the 3% minimum.  Thus,
the effective minimum leverage ratio, for all practical purposes, is at least 4%
or 5%.  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,
2008 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
                                        %
                                        
                                        
                                        10.8
                                        %
                                        
                                        
                                        10.9
                                        %Tier
      1 risk-based capital ratio
                                        
                                        
                                        4.0
                                        %
                                        
                                        
                                        6.0
                                        %
                                        
                                        
                                        12.6
                                        %
                                        
                                        
                                        12.7
                                        %Total
      risk-based capital ratio
                                        
                                        
                                        8.0
                                        %
                                        
                                        
                                        10.0
                                        %
                                        
                                        
                                        13.9
                                        %
                                        
                                        
                                        14.0
                                        %





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.





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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.





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.





Effective
January 1, 2009, banks pay from 12 basis points to 50 basis points on deposits
annually for deposit insurance.  The FDIC has proposed changes to the
deposit insurance assessment system beginning with the second quarter of 2009 to
make the increase in assessments fairer by requiring riskier institutions to pay
a larger share.  Together, the 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.  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.  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.  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 has proposed special
assessments on insured institutions to be collected during 2009 for the purpose
of restoring the Deposit Insurance Fund which had been depleted due to bank
failures.  One such proposed assessment was for 20 basis points of an
insured institution’s total deposits.  Unless rescinded, it is
expected that this special assessment would increase the Company’s 2009 FDIC
expense by over $500,000.  The FDIC is also proposing that it be
granted authority to impose additional special assessments of 10 basis points if
necessary to maintain public confidence in federal deposit
insurance.





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 an FHLB member, the Bank is required to own FHLB –SF capital
stock in an amount equal to the greater of:





9
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§      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, 2008 the Bank owned 11,042 shares of the 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,
2008, we were in compliance with these requirements.





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 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 August 2005, the Bank was rated “satisfactory.”





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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.





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
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;





11
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·
            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.





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 December 31,
2009.





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 EESA.





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.





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 (nondeductibility of
      executive compensation in excess of
$500,000).





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





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·
            SPECIFIC
      REQUIREMENTS FOR THE REQUIRED STANDARDS
-





§
            Prohibitions
      on 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 clawback 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.





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.





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.








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.





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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.





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.





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





14
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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 May
2008, the Federal Reserve Board proposed rules to prohibit unfair practices
regarding credit cards and overdraft services that would, among other
provisions, protect consumers from unexpected increases in the rate charged on
pre-existing credit card balances.   The rules, proposed for
public comment under the Federal Trade Commission Act (FTC Act), also would
forbid banks from imposing interest charges using the "two-cycle" billing
method, would require that consumers receive a reasonable amount of time to make
their credit card payments, and would prohibit the use of payment allocation
methods that unfairly maximize interest charges.  They also include
protections for consumers that use overdraft services offered by their
bank.  The proposed changes to the Board’s Regulation AA (Unfair or
Deceptive Acts or Practices) would be complemented by separate proposals that
the Board is issuing under the Truth in Lending Act (Regulation Z) and the Truth
in Savings Act (Regulation DD).





The
provisions addressing credit card practices are part of the Board’s ongoing
effort to enhance protections for consumers who use credit cards, and follow the
Board's 2007 proposal to improve the credit card disclosures under the Truth in
Lending Act. The FTC Act proposal includes five key protections for consumers
that use credit cards:





·
            Banks
      would be prohibited from increasing the rate on a pre-existing credit card
      balance (except under limited circumstances) and must allow the consumer
      to pay off that balance over a reasonable period of
  time.


·
            Banks
      would be prohibited from applying payments in excess of the minimum in a
      manner that maximizes interest
charges.


·
            Banks
      would be required to give consumers the full benefit of discounted
      promotional rates on credit cards by applying payments in excess of the
      minimum to any higher-rate balances first, and by providing a grace period
      for purchases where the consumer is otherwise
  eligible.


·
            Banks
      would be prohibited from imposing interest charges using the "two-cycle"
      method, which computes interest on balances on days in billing cycles
      preceding the most recent billing
cycle.


·
            Banks
      would be required to provide consumers a reasonable amount of time to make
      payments.





The
proposal would also address subprime credit cards by limiting the fees that
reduce the available credit.  In addition, banks that make firm offers
of credit advertising multiple rates or credit limits would be required to
disclose in the solicitation the factors that determine whether a consumer will
qualify for the lowest rate and highest credit limit.  The Board's
proposal under the FTC Act also addresses acts or practices in connection with a
bank’s payment of overdrafts on a deposit account, whether the overdraft is
created by check, a withdrawal at an automated teller machine, a debit card
purchase, or other transactions.  The proposal requires institutions
to provide consumers with notice and an opportunity to opt out of the payment of
overdrafts, before any overdraft fees or charges may be imposed on consumers'
accounts.





In
December 2007, the FDIC issued a proposed rule to improve the process for
determining uninsured depositors at larger institutions in the event of a
failure.  The measure is intended to allow the FDIC to make funds
promptly available to insured deposit customers in the unlikely event that a
large financial institution is closed.  The proposal is broken into
two parts. One section relates to so-called covered institutions, those that
have at least $2 billion in domestic deposits, have more than 250,000 deposit
accounts, or have total assets of more than $20 billion, regardless of the
number of deposits or accounts.  A covered institution would be
required to adopt mechanisms that, in the event of a failure, would place
provisional holds on large deposit accounts in a percentage specified by the
FDIC; provide the FDIC with deposit account data in a standard format; and allow
automatic removal of provisional holds once the FDIC makes an insurance
determination.  The second part applies to all FDIC-insured
institutions, regardless of size, and governs the specific time and circumstance
under which account balances will be determined in the event of a
failure.  The FDIC is proposing to





15
 Table of Contents





use the
end-of-day ledger balance as normally calculated by the
institution.  By using the end-of-day ledger, the FDIC will be able to
apply a single standard across all failed banks in order to treat every
transaction equally. This is also the same deposit balance used for Call Report
and assessment purposes.  There would be no requirements placed on
open institutions as a result of this provision.  The FDIC places a
high priority on providing access to insured deposits promptly and, in the past,
has usually been able to allow most depositors access to their deposits on the
next business day.  If adopted, the proposed rule would better enable
the FDIC to continue this practice, especially for the larger, more complex
institutions it insures.




In
September 2007, the SEC and Federal Reserve Board adopted final rules to
implement the bank “broker” provisions of the Gramm-Leach-Bliley
Act.  The rules define the scope of securities activities that banks
may conduct without registering with the SEC as a securities broker and
implement the most important “broker” exceptions for banks adopted by the GLB
Act.  Specifically, the rules implement the statutory exceptions that allow
a bank, subject to certain conditions, to continue to conduct securities
transactions for its customers as part of the bank’s trust and fiduciary,
custodial and deposit “sweep” functions, and to refer customers to a securities
broker-dealer pursuant to a networking arrangement with the broker-dealer. 
The rules are designed to accommodate the business practices of banks and to
protect investors.  The effective date for compliance is the first day of
the bank’s fiscal year commencing after September 30, 2008.





The
federal financial regulatory agencies in December 2006 issued a new interagency
policy statement on the allowance for loan and lease losses (ALLL) along with
supplemental frequently asked questions.  The policy statement revises
and replaces a 1993 policy statement on the ALLL.  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 with generally accepted accounting principles
(GAAP) and post-1993 supervisory guidance.  The 1993 policy statement
described the responsibilities of the boards of directors, management, and
banking examiners regarding the ALLL; factors to be considered in the estimation
of the ALLL; and the objectives and elements of an effective loan review system,
including a sound credit grading system.  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 ALLL and the provision for
loan and lease losses and states that each





16
 Table of Contents





institution
should ensure controls are in place to consistently determine the ALLL 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 ALLL 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 policystatement 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.





The
Office of the Comptroller of the Currency, the Federal Reserve System, and the
FDIC in December 2006 issued final guidance on sound risk management practices
for concentrations in commercial real estate lending.  The agencies
observed that the commercial real estate is an area in which some banks are
becoming increasingly concentrated, especially with small- to medium- sized
banks that face strong competition in their other business lines.  The
agencies support banks serving a vital role in their communities by supplying
credit for business and real estate development.  However, the
agencies are concerned that rising commercial real estate loan concentrations
may expose institutions to unanticipated earnings and capital volatility in the
event of adverse changes in commercial real estate markets.  The
guidance provides supervisory criteria, including numerical indicators to assist
in identifying institutions with potentially significant commercial real estate
loan concentrations that may warrant greater supervisory scrutiny, but such
criteria are not limits on commercial real estate lending.





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.





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% of adjusted liabilities 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;


·
            Provided
      that 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;





17
 Table of Contents





·
            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.





In 2007
California, a new Section 691.1 was added to the Financial Code that exempts a
bank from obtaining a securities permit for the following
transactions:





·
            any
      offer (but not a sale) not involving a public offering by a bank organized
      under the laws of this state of its
securities


·
            the
      execution and delivery of any agreement for the sale of the securities
      pursuant to the offer if no part of the consideration for the securities
      is paid to or received by the bank and none of the securities are issued
      until the sale of the securities is authorized by the commissioner or
      exempted from authorization.


·
            any
      stock split by a bank organized under the laws of this state that is
      effected pursuant to an amendment to its articles, an agreement of merger,
      or a certificate of ownership that has been approved by the commissioner,
      unless this exemption is withheld by order of the
    commissioner


·
            any
      offer or sale of securities by a bank organized under the laws of this
      state that is either (1) to a person actually approved by the commissioner
      pursuant to Section 702 of the Financial Code to acquire control of the
      bank if all of the material terms and conditions of the offer and sale of
      securities are disclosed in the application for approval specified in
      Section 702 and the offer and sale of securities is in accordance with the
      terms and subject to the conditions of the approval to acquire control or
      (2) in a transaction exempted from the approval requirement of Section 701
      by a regulation or an order of the commissioner, unless this exemption is
      withheld by order of the
commissioner.




A 2007
California law makes it easier for California banks to accept deposits from
local government agencies.  Under the old law, local agency deposits
over $100,000 had to be secured by collateral.  Pursuant to the
enactment of Assembly Bill 2011, banks would be able to acquire surplus public
deposits exceeding $100,000 without pledging collateral if they participate in a
deposit placement service where excess amounts are placed in certificates of
deposit at other institutions within a network.  Such a network (of
which currently there is only one available in the market) permits the entire
amount of a customer’s deposit to be FDIC-insured, and the bank taking the
original deposit retains the benefit of the full amount of the deposit for
lending or other purposes.  AB 2011 clarifies that a local agency may
deposit up to 30% of its surplus funds in certificates of deposit at a bank,
savings association, savings bank, or credit union that participates in such a
deposit-sharing network.  Since the entire amount of the deposits
would be FDIC-insured, a bank would not be required to pledge
collateral.  The bill permits agencies to make these deposits until
January 1, 2012. It is
impossible to predict what effect the enactment of certain of the
above-mentioned legislation will have on the Company.  Moreover, it is
likely that other bills affecting the business of bank holding companies and
banks may be introduced in the future by the United States Congress or
California legislature.





18
 Table of Contents





Recent
Accounting Pronouncements





Business
Combinations.  In December 2007, the Financial Accounting
Standards Board (“FASB”) issued Statement of Financial Accounting Standards No.
141 (revised 2007), Business Combinations (“SFAS No. 141R”).  SFAS No.
141(R), among other things, establishes principles and requirements for how the
acquirer in a business combination (i) recognizes and measures in its financial
statements the identifiable assets acquired, the liabilities assumed, and any
noncontrolling interest in the acquired business, (ii) recognizes and measures
the goodwill acquired in the business combination or a gain from a bargain
purchase, and (iii) determines what information to disclose to enable users of
the financial statements to evaluate the nature and financial effects of the
business combination.  The Bank is required to adopt SFAS No. 141(R) for
all business combinations for which the acquisition date is on or after January
1, 2009. This standard will change the Bank’s accounting treatment for
business combinations on a prospective basis.





The Hierarchy of Generally Accepted
Accounting Principles.  In May 2008, the FASB issued SFAS
No. 162, The Hierarchy of Generally Accepted Accounting Principles (SFAS No.
162). This standard identifies a consistent framework, or hierarchy, for
selecting accounting principles to be used in preparing financial statements
that are presented in conformity with U.S. generally accepted accounting
principles for nongovernmental entities. It establishes that the GAAP hierarchy
should be directed to entities because it is the entity (not the auditor) that
is responsible for selecting accounting principles for financial statements that
are presented in conformity with GAAP. SFAS 162 was effective November 15, 2008.
The adoption of SFAS No. 162 did not have any effect on the Company’s
consolidated financial statements.





Employers’ Disclosures about
Postretirement Benefit Plan Assets.  In December 2008, the FASB
issued FSP SFAS No. 132R-1, Employers’ Disclosures about Postretirement Benefit
Plan Assets (“FSP 132(R)-1). This standard provides guidance on an employer’s
disclosures about plan assets of a defined benefit pension or other
postretirement plan.  It also includes a technical amendment to
Statement 132(R) that requires a nonpublic entity to disclose net periodic
benefit cost for each annual period for which a statement of income is
presented.  The objectives of the disclosures about plan assets in an
employer’s defined benefit pension or other postretirement plan are to provide
users of financial statements with an understanding of how investment allocation
decisions are made, including the factors that are pertinent to an understanding
of investment policies and strategies, the major categories of plan assets, the
inputs and valuation techniques used to measure the fair value of plan assets,
the effect of fair value measurements using significant unobservable inputs
(Level 3) on changes in plan assets for the period, and significant
concentrations of risk within plan assets.  The disclosures about plan
assets required by this FSP is effective for fiscal years ending after December
15, 2009. Early adoption is permitted.  The adoption of FSP 132(R)-1
is not expected to have a material impact on the Bank’s financial position,
results of operations or cash flows.





ITEM1A - RISK FACTORS





Continued deterioration of local real
estate values could reduce our profitability.  At December 31,
2008, approximately 71% 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





19
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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 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.





Fluctuations in interest rates could
reduce profitability.From June 2003 through June 2006 the
Federal Reserve Federal Open Market Committee (“FOMC”) increased the federal
funds target rate 17 times from 1.00% to 5.25%. Beginning in September 2007, it
decreased the federal funds target rate eleven times from 5.25% to a range of
0.00% to 0.25%.  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.  Although market interest rates decreased
significantly in 2008, financial market disruptions during 2008 prevented the
Company’s available-for-sale investment securities from gaining value as would
normally occur.  The disruptions of most consequence to the Company
included the worsening financial condition of government sponsored enterprises,
certain large corporations, and insurers of municipal bonds, which reduced
market liquidity and fair value for the Company’s holdings of mortgage-backed
securities, commercial paper, 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, 2008 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





20
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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.





Recent and future legislation and
regulatory changes, including increased FDIC assessments, may reduce the
Company’s future profitability.Significant legislation has
been enacted in the past few months which will significantly affect financial
institutions and holding companies, including the Company. This legislation
includes the recently adopted federal stimulus legislation and the federal
government’s financial stability plan, the effects of which are not yet fully
determinable. During 2008, the federal government enacted the Emergency Economic
Stabilization Act of 2008 under which the U.S. Department of the Treasury
established the Troubled Assets Relief Program (“TARP”).  The TARP
included the Capital Purchase Program in which the Company elected to
participate. The Company also elected to participate in the Temporary Liquidity
Guarantee Program (“TLGP”) created during the fourth quarter of 2008 which
provides full coverage for non-interest-bearing transaction deposit
accounts.  In 2008, the FDIC adopted substantial increases to its
insurance premiums, and in 2009, the FDIC proposed additional increases,
including a special assessment to bolster the FDIC’s reserves that has the
potential to materially and adversely impact the earnings of the Company and
other FDIC-insured institutions.  The initial proposed special
assessment was for 20 basis points of an insured institution’s total deposits
that would increase the Company’s 2009 FDIC expense by over
$500,000.  The FDIC is also proposing that it be granted authority to
impose additional special assessments of 10 basis points if necessary to
maintain public confidence in federal deposit insurance.  It is widely
expected that there will be additional potential legislation and regulations
affecting the financial services industry. At this time, management cannot fully
determine the extent of these effects, as well as any future laws and
regulations that may be enacted as a result of the current economic
crisis.  The current economic turmoil has also increased the potential
for federal or state governments to legislate foreclosure forbearance, forced
loan modifications, or “cram downs” of losses to lenders in bankruptcy
proceedings. Such efforts could lead to increased loan charge-offs or loan loss
provisions and/or reduced income.











ITEM 1B – UNRESOLVED STAFF COMMENTS





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





21
 Table of Contents





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 leasedMain
      office
                200
      South Court Street
                Visalia,
      California
              1996
              8,700
              LeasedAdministrative
      office
                100
      Willow Plaza, Suites 101 & 105
                Visalia,
      California
              2003
              4,972
              LeasedFresno
      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





The
Visalia main office is leased under a noncancelable operating lease with a
nonaffiliated third party expiring November 30, 2009. The primary operating area
consists of approximately 8,700 square feet of space comprising the entire
usable space in a single-story building.  The lease arrangement for
the primary operating area is a “triple net lease” with monthly rent of $11,200
until the term expires.





In close
proximity to the main office is the Willow Plaza administrative office housing
credit and finance personnel which is comprised of two connected office suites
of approximately 4,972 square feet located in a four-story office
building.  These premises are leased from a related party under a
month to month operating lease.  The lease arrangement is a “triple
net lease” with combined monthly rent of $7,707.





In
January 2009, the Company opened escrow to purchase an 18,700 square foot office
building to house both the Visalia Branch and Administration
Offices.  The purchase price was $3.8 million.  Escrow
closed on February 20, 2009.  The new building is located at 701 W.
Main Street, Visalia, California and is in close proximity to the current
Visalia branch and administrative offices which will be relocated prior to
November 30, 2009.





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, 2008, the total net book value of the Company’s land, buildings,
leasehold improvements and equipment was approximately
$3,975,000.  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 – SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS





No matter
was submitted to a vote of shareholders during the fourth quarter of the fiscal
year covered by this annual report. The 2009 Annual Meeting of Shareholders will
be held at 6 p.m., local time, on May 19, 2009, at the offices of Valley
Commerce Bancorp, 200 S. Court Street, Visalia, California 93291.





23
 Table of Contents





PART
II





ITEM 5 – 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, 2007,
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 2008 and June
2007.







High
      and low bid quotationsHigh
                      
                      
                      Low2008Fourth
      quarter
                      
                      $
                      12.50
                      
                      
                      $
                      7.05Third
      quarter
                      
                      
                      13.00
                      
                      
                      
                      10.01Second
      quarter
                      
                      
                      15.00
                      
                      
                      
                      10.00First
      quarter
                      
                      
                      14.71
                      
                      
                      
                      13.332007Fourth
      quarter
                      
                      $
                      14.71
                      
                      
                      $
                      12.86Third
      quarter
                      
                      
                      16.19
                      
                      
                      
                      13.33Second
      quarter
                      
                      
                      20.71
                      
                      
                      
                      17.86First
      quarter
                      
                      
                      20.71
                      
                      
                      
                      19.43





As of
February 20, 2009, there were 382 record holders of the Company’s common stock
and approximately 474 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 the will have the right to elect two
members to the Company’s Board of Directors.





24
 Table of Contents





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.





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 2008, 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, 2008, the Board of Directors
extended the share repurchase program until November 30, 2009.





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
                                            
                                            
                                            28,811
                                            (1)
                                            
                                            $
                                            13.25
                                            (1)
                                            
                                            
                                            28,811
                                            
                                            
                                            $
                                            2,618,191February
      2008
                                            
                                            
                                            48,684
                                            (1)
                                            
                                            
                                            14.45
                                            (1)
                                            
                                            
                                            48,684
                                            
                                            
                                            
                                            1,914,690March
      2008
                                            
                                            
                                            6,999
                                            (1)
                                            
                                            
                                            14.38
                                            (1)
                                            
                                            
                                            6,999
                                            
                                            
                                            
                                            1,814,073November
      2008
                                            
                                            
                                            1,702
                                            
                                            
                                            
                                            9.94
                                            
                                            
                                            
                                            1,702
                                            
                                            
                                            
                                            1,797,154Total
                                            
                                            
                                            86,196
                                            
                                            
                                            $
                                            13.95
                                            
                                            
                                            
                                            86,196
                                            
                                            
                                            $
                                            1,797,154





(1)
Restated for June 25, 2008 stock dividend.  No shares were repurchased
in any month except those listed above.





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 2008, incentive stock options for 364
shares of common stock and non-statutory stock options for 14,774 shares of
common stock were exercised, and no stock options were
granted.  During 2007, incentive stock options for 1,823 shares of
common stock and non-statutory stock options for 95,684 shares of common stock
were exercised, and 10,000 stock options were granted.





The
information in the following table is provided as of the end of the fiscal year
ended December 31, 2008, 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,
                                warrantsand rights
                              
                              
                              Weighted-average
                                exercise
      price of
                                outstanding
      options,
                                warrants
      and rights
                              
                              
                              Number
      of securities remaining
                                available
      forfuture
      issuance
                                underequity
      compensation
                                plans
      (excluding securities
                                reflected in Column (a))Equity
      compensation plans approved by security holders
                              
                              
                              165,734
                              
                              
                              $
                              9.87
                              
                              
                              
                              91,357Equity
      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
2008 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)
                          
                          2008
                          
                          
                          2007
                          
                          
                          2006
                          
                          
                          2005
                          
                          
                          2004Statement
      of IncomeInterest
      income
                          
                          $
                          17,784
                          
                          
                          $
                          18,470
                          
                          
                          $
                          16,750
                          
                          
                          $
                          12,504
                          
                          
                          $
                          8,737Interest
      expense
                          
                          
                          5,719
                          
                          
                          
                          7,131
                          
                          
                          
                          5,561
                          
                          
                          
                          2,683
                          
                          
                          
                          1,622Net
      interest income
                          
                          
                          12,065
                          
                          
                          
                          11,339
                          
                          
                          
                          11,189
                          
                          
                          
                          9,821
                          
                          
                          
                          7,115Provision
      for loan losses
                          
                          
                          1,600
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          369
                          
                          
                          
                          138Net
      interest income after provision forloan
      losses
                          
                          
                          10,465
                          
                          
                          
                          11,339
                          
                          
                          
                          11,189
                          
                          
                          
                          9,452
                          
                          
                          
                          6,977Non-interest
      income
                          
                          
                          1,283
                          
                          
                          
                          1,155
                          
                          
                          
                          996
                          
                          
                          
                          888
                          
                          
                          
                          1,341Non-interest
      expense
                          
                          
                          9,153
                          
                          
                          
                          8,699
                          
                          
                          
                          7,653
                          
                          
                          
                          6,810
                          
                          
                          
                          5,662Income
      before income taxes
                          
                          
                          2,595
                          
                          
                          
                          3,795
                          
                          
                          
                          4,532
                          
                          
                          
                          3,530
                          
                          
                          
                          2,656Income
      taxes
                          
                          
                          746
                          
                          
                          
                          1,134
                          
                          
                          
                          1,576
                          
                          
                          
                          1,367
                          
                          
                          
                          1,027Net
      income
                          
                          
                          1,849
                          
                          
                          
                          2,661
                          
                          
                          
                          2,956
                          
                          
                          
                          2,163
                          
                          
                          
                          1,629Per
      Share Data (4):Basic
      earnings per share
                          
                          $
                          0.75
                          
                          
                          $
                          1.07
                          
                          
                          $
                          1.22
                          
                          
                          $
                          0.91
                          
                          
                          $
                          0.98Diluted
      earnings per share
                          
                          $
                          0.74
                          
                          
                          $
                          1.03
                          
                          
                          $
                          1.16
                          
                          
                          $
                          0.86
                          
                          
                          $
                          0.92Book
      value - end of period
                          
                          $
                          12.18
                          
                          
                          $
                          11.48
                          
                          
                          $
                          10.42
                          
                          
                          $
                          9.07
                          
                          
                          $
                          7.89Average
      shares outstanding-basic
                          
                          
                          2,471,550
                          
                          
                          
                          2,476,271
                          
                          
                          
                          2,427,747
                          
                          
                          
                          2,387,798
                          
                          
                          
                          1,667,423Average
      shares outstanding-diluted
                          
                          
                          2,498,381
                          
                          
                          
                          2,571,333
                          
                          
                          
                          2,550,534
                          
                          
                          
                          2,527,983
                          
                          
                          
                          1,780,490Shares
      outstanding - end of period
                          
                          
                          2,473,739
                          
                          
                          
                          2,396,435
                          
                          
                          
                          2,215,765
                          
                          
                          
                          2,087,508
                          
                          
                          
                          1,971,554Balance
      SheetAvailable-for-saleinvestment
      securities
                          
                          $
                          42,018
                          
                          
                          $
                          56,615
                          
                          
                          $
                          55,298
                          
                          
                          $
                          50,391
                          
                          
                          $
                          38,099Total
      loans, net
                          
                          
                          226,697
                          
                          
                          
                          199,514
                          
                          
                          
                          182,332
                          
                          
                          
                          149,991
                          
                          
                          
                          114,834Allowance
      for loan losses
                          
                          
                          3,244
                          
                          
                          
                          1,758
                          
                          
                          
                          1,746
                          
                          
                          
                          1,766
                          
                          
                          
                          1,401Total
      assets
                          
                          
                          306,099
                          
                          
                          
                          279,081
                          
                          
                          
                          263,800
                          
                          
                          
                          228,011
                          
                          
                          
                          186,007Total
      deposits
                          
                          
                          257,323
                          
                          
                          
                          215,386
                          
                          
                          
                          207,576
                          
                          
                          
                          192,581
                          
                          
                          
                          156,424Total
      shareholders' equity
                          
                          
                          30,140
                          
                          
                          
                          28,873
                          
                          
                          
                          25,448
                          
                          
                          
                          21,909
                          
                          
                          
                          16,333Selected
      Performance Ratios:Return
      on average assets
                          
                          
                          0.62
                          %
                          
                          
                          0.99
                          %
                          
                          
                          1.22
                          %
                          
                          
                          1.05
                          %
                          
                          
                          1.04
                          %Return
      on average equity
                          
                          
                          6.30
                          %
                          
                          
                          9.83
                          %
                          
                          
                          12.59
                          %
                          
                          
                          10.44
                          %
                          
                          
                          13.84
                          %Net
      interest margin (1)
                          
                          
                          4.52
                          %
                          
                          
                          4.71
                          %
                          
                          
                          5.15
                          %
                          
                          
                          5.23
                          %
                          
                          
                          5.00
                          %Average
      net loans as a percentageof
      average deposits
                          
                          
                          89.7
                          %
                          
                          
                          91.0
                          %
                          
                          
                          85.8
                          %
                          
                          
                          78.3
                          %
                          
                          
                          80.2
                          %Efficiency
      ratio
                          
                          
                          68.6
                          %
                          
                          
                          69.6
                          %
                          
                          
                          62.8
                          %
                          
                          
                          63.6
                          %
                          
                          
                          66.2
                          %





27
 Table of Contents





Selected
Financial Data (continued)





As of and for the year ended December
      31,2008
                                                
                                                
                                                2007
                                                
                                                
                                                2006
                                                
                                                
                                                2005
                                                
                                                
                                                2004Selected
      Asset Quality Ratios:Nonperforming
      assets tototal
      assets
                                                
                                                
                                                1.6
                                                %
                                                
                                                
                                                ----
                                                (2)
                                                
                                                
                                                ----
                                                (2)
                                                
                                                
                                                0.0
                                                %(3)
                                                
                                                
                                                0.0
                                                %(3)Nonperforming
      loans tototal
      loans
                                                
                                                
                                                2.2
                                                %
                                                
                                                
                                                ----
                                                (2)
                                                
                                                
                                                ----
                                                (2)
                                                
                                                
                                                0.0
                                                %(3)
                                                
                                                
                                                0.1
                                                %Net
      loan charge-offs toaverage
      loans
                                                
                                                
                                                0.1
                                                %
                                                
                                                
                                                0.0
                                                %
                                                
                                                
                                                0.0
                                                %(3)
                                                
                                                
                                                0.0
                                                %(3)
                                                
                                                
                                                0.1
                                                %Allowance
      for loan lossesto
      total loans
                                                
                                                
                                                1.41
                                                %
                                                
                                                
                                                0.87
                                                %
                                                
                                                
                                                0.95
                                                %
                                                
                                                
                                                1.16
                                                %
                                                
                                                
                                                1.20
                                                %Allowance
      for loan lossesto
      nonperforming loans
                                                
                                                
                                                65.7
                                                %
                                                
                                                
                                                ----
                                                (2)
                                                
                                                
                                                ----
                                                (2)
                                                
                                                
                                                8409.5
                                                %
                                                
                                                
                                                1729.6
                                                %Capital
      Ratios:BankLeverage
                                                
                                                
                                                10.8
                                                %
                                                
                                                
                                                11.4
                                                %
                                                
                                                
                                                11.0
                                                %
                                                
                                                
                                                11.3
                                                %
                                                
                                                
                                                8.4
                                                %Tier
      1 Risk-Based
                                                
                                                
                                                12.6
                                                %
                                                
                                                
                                                13.7
                                                %
                                                
                                                
                                                13.4
                                                %
                                                
                                                
                                                14.6
                                                %
                                                
                                                
                                                11.4
                                                %Total
      Risk-Based
                                                
                                                
                                                13.9
                                                %
                                                
                                                
                                                14.4
                                                %
                                                
                                                
                                                14.2
                                                %
                                                
                                                
                                                15.6
                                                %
                                                
                                                
                                                12.5
                                                %ConsolidatedLeverage
                                                
                                                
                                                10.9
                                                %
                                                
                                                
                                                11.5
                                                %
                                                
                                                
                                                11.1
                                                %
                                                
                                                
                                                11.5
                                                %
                                                
                                                
                                                10.8
                                                %Tier
      1 Risk-Based
                                                
                                                
                                                12.8
                                                %
                                                
                                                
                                                13.8
                                                %
                                                
                                                
                                                13.5
                                                %
                                                
                                                
                                                14.8
                                                %
                                                
                                                
                                                14.7
                                                %Total
      Risk-Based
                                                
                                                
                                                14.0
                                                %
                                                
                                                
                                                14.6
                                                %
                                                
                                                
                                                14.3
                                                %
                                                
                                                
                                                15.9
                                                %
                                                
                                                
                                                15.8
                                                %





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)
                                            (3)
                                            (4)
                                          There
      were no nonperforming assets or loans at December 31, 2007 and
      2006
                                            Less
      than .05%
                                            All share and per
      share data has been retroactively restatedto
      reflect the  September 2004 three-for-two stock split and
      the5% stock
      dividends issued in June 2008, June 2007, May 2006, May 2004 and May
      2003.





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





29
 Table of Contents





fair
value of available-for-sale securities impact the consolidated financial
statements by increasing or decreasing assets and shareholders’
equity.





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.





The
provisions of Financial Accounting Standards Board (FASB) Interpretation
No. 48, Accounting for
Uncertainty in Income Taxes (FIN 48) have been applied to all tax
positions of the Company since January 1, 2007.  FIN 48
prescribes a recognition threshold and measurement standard for the financial
statement recognition and measurement of an income tax position taken or
expected to be taken in a tax return.  Only tax positions that met the
more-likely-than-not recognition threshold on January 1, 2007 were
recognized or continue to be recognized.  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.  The Company accounts for share based
compensation Statement of Financial Accounting Standards No. 123 (R), Share-Based Payment (“SFAS
123 (R)”). Under SFAS 123(R), compensation cost is recognized for all awards
that vest subsequent to the date of adoption based on the grant-date fair value
estimated in accordance with SFAS No. 123, Accounting for Stock-Based
Compensation and SFAS 123(R). 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 earned net income of $1.85 million, or $0.74 per diluted share, for the
year ended December 31, 2008, compared to $2.66 million, or $1.03 per diluted
share, for the year ended December 31, 2007.  Net income was $2.96
million, or $1.16 per diluted share, for the year ended December 31,
2006.  The return on average assets was 0.62% for 2008, 0.99% for
2007, and 1.22% for 2006.  The return on average shareholders’ equity
for 2008, 2007, and 2006 was 6.29%, 9.83%, and 12.59%,
respectively.





The
decrease in earnings for 2008 resulted primarily from the $1.6 million loan loss
provision in 2008 compared with no provision for loan loss being recorded during
the years ended December 31, 2007 or 2006.  This was partially offset
by increases in both net interest income and non-interest income.  The
Company’s non-interest expense increased due to employee and occupancy costs
related to growth initiatives.  The ratio of non-interest expense to
net operating revenue (efficiency ratio) was 68.6% for 2008 compared to 69.6%
for 2007 and 62.8% for 2006.  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
2008 resulted from growth in net interest income and non-interest income
outpacing the growth in non-interest expense.





30
 Table of Contents





At
December 31, 2008, the Company’s total assets were $306.1 million, an increase
of $27.0 million or 10% compared to December 31, 2007.  Total loans,
net of the allowance for loan losses, were $226.7 million at December 31, 2008,
representing an increase of $27.2 million or 14% compared to December 31,
2007.  Total deposits were $257.3 million at December 31, 2008,
representing an increase of $41.9 million or 19% compared to December 31,
2007.





At
December 31, 2008, the Company’s leverage ratio was 10.9% while its tier 1
risk-based capital ratio and total risk-based capital ratios were 12.7% and
14.0%, respectively.  The leverage, tier 1 risk-based capital and
total risk-based capital ratios at December 31, 2007 were 11.5%, 13.8% and
14.6%, respectively. The decrease in the Company’s capital ratios in 2008
resulted from the Company’s 10% growth in risk based and total assets in 2008
outpacing the growth in risk based capital.





A
detailed presentation of the Company’s financial results as of, or for the
fiscal years ended December 31, 2008, 2007, and 2006 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




Fiscal
      year ended December 31,2008
                                                    
                                                    
                                                    2007
                                                    
                                                    
                                                    2006Interest
                                                    
                                                    
                                                    Average
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    Interest
                                                    
                                                    
                                                    Average
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    Interest
                                                    
                                                    
                                                    AverageAverage
                                                    
                                                    
                                                    Income/
                                                    
                                                    
                                                    Yield/
                                                    
                                                    
                                                    Average
                                                    
                                                    
                                                    Income/
                                                    
                                                    
                                                    Yield/
                                                    
                                                    
                                                    Average
                                                    
                                                    
                                                    Income/
                                                    
                                                    
                                                    Yield/(dollars
      in thousands)
                                                    
                                                    Balance
                                                    
                                                    
                                                    Expense
                                                    
                                                    
                                                    Cost
                                                    
                                                    
                                                    Balance
                                                    
                                                    
                                                    Expense
                                                    
                                                    
                                                    Cost
                                                    
                                                    
                                                    Balance
                                                    
                                                    
                                                    Expense
                                                    
                                                    
                                                    CostASSETSFederal
      funds sold
                                                    
                                                    $
                                                    10,921
                                                    
                                                    
                                                    $
                                                    170
                                                    
                                                    
                                                    
                                                    1.56
                                                    %
                                                    
                                                    $
                                                    78
                                                    
                                                    
                                                    $
                                                    4
                                                    
                                                    
                                                    
                                                    4.74
                                                    %
                                                    
                                                    $
                                                    3,019
                                                    
                                                    
                                                    $
                                                    138
                                                    
                                                    
                                                    
                                                    4.57
                                                    %Available-for-sale
      investment securities:Taxable
                                                    
                                                    
                                                    26,238
                                                    
                                                    
                                                    
                                                    1,305
                                                    
                                                    
                                                    
                                                    4.97
                                                    %
                                                    
                                                    
                                                    35,438
                                                    
                                                    
                                                    
                                                    1,582
                                                    
                                                    
                                                    
                                                    4.46
                                                    %
                                                    
                                                    
                                                    36,984
                                                    
                                                    
                                                    
                                                    1,445
                                                    
                                                    
                                                    
                                                    3.91
                                                    %Exempt
      from Federal income taxes
                                                    
                                                    
                                                    19,607
                                                    
                                                    
                                                    
                                                    799
                                                    
                                                    
                                                    
                                                    6.17
                                                    %
                                                    
                                                    
                                                    19,012
                                                    
                                                    
                                                    
                                                    771
                                                    
                                                    
                                                    
                                                    6.14
                                                    %
                                                    
                                                    
                                                    17,936
                                                    
                                                    
                                                    
                                                    719
                                                    
                                                    
                                                    
                                                    6.07
                                                    %Total
      securities (1)
                                                    
                                                    
                                                    45,845
                                                    
                                                    
                                                    
                                                    2,104
                                                    
                                                    
                                                    
                                                    5.49
                                                    %
                                                    
                                                    
                                                    54,450
                                                    
                                                    
                                                    
                                                    2,353
                                                    
                                                    
                                                    
                                                    5.05
                                                    %
                                                    
                                                    
                                                    54,920
                                                    
                                                    
                                                    
                                                    2,164
                                                    
                                                    
                                                    
                                                    4.61
                                                    %Loans
      (2) (3)
                                                    
                                                    
                                                    219,431
                                                    
                                                    
                                                    
                                                    15,510
                                                    
                                                    
                                                    
                                                    7.07
                                                    %
                                                    
                                                    
                                                    194,734
                                                    
                                                    
                                                    
                                                    16,113
                                                    
                                                    
                                                    
                                                    8.27
                                                    %
                                                    
                                                    
                                                    166,620
                                                    
                                                    
                                                    
                                                    14,448
                                                    
                                                    
                                                    
                                                    8.67
                                                    %Total
      interest-earning assets (1)
                                                    
                                                    
                                                    276,197
                                                    
                                                    
                                                    
                                                    17,784
                                                    
                                                    
                                                    
                                                    6.60
                                                    %
                                                    
                                                    
                                                    249,262
                                                    
                                                    
                                                    
                                                    18,470
                                                    
                                                    
                                                    
                                                    7.57
                                                    %
                                                    
                                                    
                                                    224,559
                                                    
                                                    
                                                    
                                                    16,750
                                                    
                                                    
                                                    
                                                    7.62
                                                    %Noninterest-earning
      assets,net
      of allowance for loan losses
                                                    
                                                    
                                                    19,906
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    18,363
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    17,244Total
      assets
                                                    
                                                    $
                                                    296,103
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    $
                                                    267,625
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    $
                                                    241,803LIABILITIES
      AND SHAREHOLDERS’ EQUITYDeposits:Interest
      bearing
                                                    
                                                    $
                                                    90,560
                                                    
                                                    
                                                    $
                                                    1,650
                                                    
                                                    
                                                    
                                                    1.82
                                                    %
                                                    
                                                    $
                                                    83,020
                                                    
                                                    
                                                    $
                                                    2,382
                                                    
                                                    
                                                    
                                                    2.87
                                                    %
                                                    
                                                    $
                                                    73,534
                                                    
                                                    
                                                    $
                                                    1,996
                                                    
                                                    
                                                    
                                                    2.71
                                                    %Time
      deposits less than $100,000
                                                    
                                                    
                                                    24,014
                                                    
                                                    
                                                    
                                                    836
                                                    
                                                    
                                                    
                                                    3.48
                                                    %
                                                    
                                                    
                                                    20,717
                                                    
                                                    
                                                    
                                                    968
                                                    
                                                    
                                                    
                                                    4.67
                                                    %
                                                    
                                                    
                                                    20,268
                                                    
                                                    
                                                    
                                                    820
                                                    
                                                    
                                                    
                                                    4.05
                                                    %Time
      deposits $100,000 or more
                                                    
                                                    
                                                    64,017
                                                    
                                                    
                                                    
                                                    2,415
                                                    
                                                    
                                                    
                                                    3.77
                                                    %
                                                    
                                                    
                                                    49,400
                                                    
                                                    
                                                    
                                                    2,453
                                                    
                                                    
                                                    
                                                    4.97
                                                    %
                                                    
                                                    
                                                    34,220
                                                    
                                                    
                                                    
                                                    1,491
                                                    
                                                    
                                                    
                                                    4.36
                                                    %Total
      interest-bearing deposits
                                                    
                                                    
                                                    178,591
                                                    
                                                    
                                                    
                                                    4,901
                                                    
                                                    
                                                    
                                                    2.74
                                                    %
                                                    
                                                    
                                                    153,137
                                                    
                                                    
                                                    
                                                    5,803
                                                    
                                                    
                                                    
                                                    3.79
                                                    %
                                                    
                                                    
                                                    128,022
                                                    
                                                    
                                                    
                                                    4,307
                                                    
                                                    
                                                    
                                                    3.36
                                                    %FHLB
      advances
                                                    
                                                    
                                                    10,915
                                                    
                                                    
                                                    
                                                    296
                                                    
                                                    
                                                    
                                                    2.71
                                                    %
                                                    
                                                    
                                                    13,608
                                                    
                                                    
                                                    
                                                    695
                                                    
                                                    
                                                    
                                                    5.11
                                                    %
                                                    
                                                    
                                                    11,488
                                                    
                                                    
                                                    
                                                    611
                                                    
                                                    
                                                    
                                                    5.32
                                                    %FHLB
      term borrowing
                                                    
                                                    
                                                    6,290
                                                    
                                                    
                                                    
                                                    303
                                                    
                                                    
                                                    
                                                    4.82
                                                    %
                                                    
                                                    
                                                    8,289
                                                    
                                                    
                                                    
                                                    362
                                                    
                                                    
                                                    
                                                    4.37
                                                    %
                                                    
                                                    
                                                    8,836
                                                    
                                                    
                                                    
                                                    380
                                                    
                                                    
                                                    
                                                    4.30
                                                    %Junior
      subordinated deferrable interest debentures
                                                    
                                                    
                                                    3,093
                                                    
                                                    
                                                    
                                                    219
                                                    
                                                    
                                                    
                                                    7.08
                                                    %
                                                    
                                                    
                                                    3,093
                                                    
                                                    
                                                    
                                                    271
                                                    
                                                    
                                                    
                                                    8.76
                                                    %
                                                    
                                                    
                                                    3,093
                                                    
                                                    
                                                    
                                                    263
                                                    
                                                    
                                                    
                                                    8.50
                                                    %Total
      interest-bearing liabilities
                                                    
                                                    
                                                    198,889
                                                    
                                                    
                                                    
                                                    5,719
                                                    
                                                    
                                                    
                                                    2.88
                                                    %
                                                    
                                                    
                                                    178,127
                                                    
                                                    
                                                    
                                                    7,131
                                                    
                                                    
                                                    
                                                    4.00
                                                    %
                                                    
                                                    
                                                    151,439
                                                    
                                                    
                                                    
                                                    5,561
                                                    
                                                    
                                                    
                                                    3.67
                                                    %Noninterest
      bearing deposits
                                                    
                                                    
                                                    66,106
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    60,465
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    65,440Other
      liabilities
                                                    
                                                    
                                                    1,821
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    1,964
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    1,438Total
      liabilities
                                                    
                                                    
                                                    266,816
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    240,556
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    218,317Shareholders’
      equity
                                                    
                                                    
                                                    29,287
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    27,069
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    23,486Total
      liabilities and shareholders’ equity
                                                    
                                                    $
                                                    296,103
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    $
                                                    267,625
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    $
                                                    241,803Net
      interest income and margin (1)
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    $
                                                    12,065
                                                    
                                                    
                                                    
                                                    4.52
                                                    %
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    $
                                                    11,339
                                                    
                                                    
                                                    
                                                    4.71
                                                    %
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    $
                                                    11,189
                                                    
                                                    
                                                    
                                                    5.15
                                                    %





(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 for 2008 was
      $52.  Non accrual interest received for 2008 was
      $38.  No interest was received on nonaccrual loans for 2007 or
      2006.(3)  Interest
      income includes net amortized loan fees of $185, $305 and
      $633 for 2008, 2007, and 2006,
  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
      rates2008
      vs 2007
                                    
                                    
                                    2007
      vs 2006Increase
      (decrease) due to change in:
                                    
                                    
                                    Increase
      (decrease) due to change in:Average
                                    
                                    
                                    Average
                                    
                                    
                                    
                                    
                                    
                                    Average
                                    
                                    
                                    AverageVolume
                                    
                                    
                                    Rate
      (1)
                                    
                                    
                                    Total
                                    
                                    
                                    Volume
                                    
                                    
                                    Rate
      (1)
                                    
                                    
                                    Total(In
      thousands)Increase
      (decrease) in interest income:Federal
      funds sold
                                    
                                    $
                                    514
                                    
                                    
                                    $
                                    (348
                                    )
                                    
                                    $
                                    166
                                    
                                    
                                    $
                                    (134
                                    )
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    (134
                                    )Investment
      securitiesTaxable
                                    
                                    
                                    (411
                                    )
                                    
                                    
                                    134
                                    
                                    
                                    
                                    (277
                                    )
                                    
                                    
                                    (60
                                    )
                                    
                                    
                                    197
                                    
                                    
                                    
                                    137Exempt
      from Federal Income taxes
                                    
                                    
                                    37
                                    
                                    
                                    
                                    (9
                                    )
                                    
                                    
                                    28
                                    
                                    
                                    
                                    65
                                    
                                    
                                    
                                    13
                                    
                                    
                                    
                                    78Total
      securities
                                    
                                    
                                    (374
                                    )
                                    
                                    
                                    125
                                    
                                    
                                    
                                    (249
                                    )
                                    
                                    
                                    5
                                    
                                    
                                    
                                    210
                                    
                                    
                                    
                                    215Loans
                                    
                                    
                                    2,044
                                    
                                    
                                    
                                    (2,647
                                    )
                                    
                                    
                                    (603
                                    )
                                    
                                    
                                    2,438
                                    
                                    
                                    
                                    (773
                                    )
                                    
                                    
                                    1,665Total
      interest income
                                    
                                    
                                    2,184
                                    
                                    
                                    
                                    (2,870
                                    )
                                    
                                    
                                    (686
                                    )
                                    
                                    
                                    2,309
                                    
                                    
                                    
                                    (563
                                    )
                                    
                                    
                                    1,746(Decrease)
      increase  in interest expense:Interest-bearing
      deposits
                                    
                                    
                                    216
                                    
                                    
                                    
                                    (948
                                    )
                                    
                                    
                                    (732
                                    )
                                    
                                    
                                    257
                                    
                                    
                                    
                                    129
                                    
                                    
                                    
                                    386Time
      deposits less than $100,000
                                    
                                    
                                    154
                                    
                                    
                                    
                                    (286
                                    )
                                    
                                    
                                    (132
                                    )
                                    
                                    
                                    18
                                    
                                    
                                    
                                    130
                                    
                                    
                                    
                                    148Time
      certificates $100,000 or more
                                    
                                    
                                    726
                                    
                                    
                                    
                                    (764
                                    )
                                    
                                    
                                    (38
                                    )
                                    
                                    
                                    661
                                    
                                    
                                    
                                    301
                                    
                                    
                                    
                                    962Total
      interest-bearing deposits
                                    
                                    
                                    1,096
                                    
                                    
                                    
                                    (1,998
                                    )
                                    
                                    
                                    (902
                                    )
                                    
                                    
                                    936
                                    
                                    
                                    
                                    560
                                    
                                    
                                    
                                    1,496FHLB
      advances
                                    
                                    
                                    (138
                                    )
                                    
                                    
                                    (261
                                    )
                                    
                                    
                                    (399
                                    )
                                    
                                    
                                    113
                                    
                                    
                                    
                                    (29
                                    )
                                    
                                    
                                    84FHLB
      term borrowing
                                    
                                    
                                    (87
                                    )
                                    
                                    
                                    28
                                    
                                    
                                    
                                    (59
                                    )
                                    
                                    
                                    (24
                                    )
                                    
                                    
                                    6
                                    
                                    
                                    
                                    (18
                                    )Junior
      subordinated deferrable interest debentures
                                    
                                    
                                    -
                                    
                                    
                                    
                                    (52
                                    )
                                    
                                    
                                    (52
                                    )
                                    
                                    
                                    -
                                    
                                    
                                    
                                    8
                                    
                                    
                                    
                                    8Total
      interest expense
                                    
                                    
                                    871
                                    
                                    
                                    
                                    (2,283
                                    )
                                    
                                    
                                    (1,412
                                    )
                                    
                                    
                                    1,025
                                    
                                    
                                    
                                    545
                                    
                                    
                                    
                                    1,570Increase
      (decrease) in net interest income
                                    
                                    $
                                    1,313
                                    
                                    
                                    $
                                    (587
                                    )
                                    
                                    $
                                    726
                                    
                                    
                                    $
                                    1,284
                                    
                                    
                                    $
                                    (1,108
                                    )
                                    
                                    $
                                    176(1)
      Factors contributing to both changes in rate and volume have been
      attributed to changes in
rates.




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.





32
 Table of Contents





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.





Net
interest income before provision for loan losses increased to $12.1 million for
2008 from $11.3 million for 2007, an increase of $726,100 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, a decrease of 19 basis points.





2007 compared to 2006.Total
interest income increased from $16.7 million in 2006 to $18.5 million in 2007
due to higher average interest earning assets partially offset by a slight
decline in the yield earned on average interest-earning
assets.  Average earning assets in 2007 were $24.7 million or 11%
greater than in 2006 due to an increase of $28.1 million or 17% in average loans
outstanding.  The average yield on loans was 8.27% and 8.67% for 2007
and 2006, respectively, while the average tax equivalent yield on investment
securities was 5.05% and 4.61%, respectively.  The increase in average
loans was due to the Company’s continued marketing efforts which resulted in
growth in real estate mortgage and construction segments of the loan
portfolio.  The majority of the loan portfolio is priced with floating
interest rates. Therefore, the decrease in weighted average yield on loans
resulted primarily from the Federal funds rate decreases that occurred in the
latter part of 2007.  In addition, competitive pressures for high
quality credits and consumer demand for fixed interest rate loans, and reduced
loan fees during the 2007 period caused the yields to decline
slightly.  The increase in weighted average tax equivalent yield on
investment securities resulted primarily from the higher yields earned on
taxable investment securities.





Total
interest expense increased $1.5 million or 35% from $5.6 million in 2006 to $7.1
million in 2007.  Average interest-bearing deposits increased by $25.1
million or 20% in 2007 while average noninterest-bearing deposits decreased by
$5.0 million or 8% in 2007.  During 2007, market interest rate
pressure on deposit accounts and increased competition for deposits caused the
Company to increase the interest rates paid on its interest-bearing deposits
compared with rates paid in 2006.  Although the Federal Reserve
decreased interest rates in October of 2007, the movement of deposit volume to
higher interest rate categories was evident through the end of
2007.





Interest
expense on short-term borrowings from the Federal Home Loan Bank of San
Francisco (FHLB) increased from $0.6 million in 2006 to $0.7 million in
2007.  This was due primarily to average volume of this debt
increasing from $11.5 million in 2006 to $13.6 million in 2007 as the Company
relied more heavily on this source to fund asset growth.





As noted
above, non-interest bearing deposits decreased with average balances of $60.5
million and $65.4 million in 2007 and 2006, respectively.  These
deposits represented 28% of average total deposits during 2007, compared with
34% of average total deposits during 2006.  This further highlights
the Company’s reliance on interest-bearing deposits and short-term borrowings to
fund asset growth in 2007.





Net
interest income before provision for loan losses increased to $11.3 million for
2007 from $11.2 million for 2006, an increase of $150,000 or 1%.  The
increase generally resulted from growth of earning assets offset in part by
rising costs of funds.  The increase in net interest income
attributable to higher volume of average interest-earning assets in 2007 was
$2.3 million while the increase attributable to higher volume of average
interest-bearing liabilities was $1.0 million, a net increase of $1.3
million.  The decrease in net interest income attributable to lower
interest rates on average interest-earning assets was $0.6 million and was
compounded by a $0.5 million decrease in net interest income resulting from
higher interest rates on average interest-bearing liabilities.





The
Company’s net interest margin on a tax equivalent basis for 2007 was 4.71%
compared to 5.15% in 2006, a decrease of 44 basis points.




33
 Table of Contents





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 $1.6 million in
2008.  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 or 2006 based on management’s assessment of
the loan portfolio and related credit quality.





Non-Interest
Income





Non-interest
income for 2008 totaled $1.3 million compared with $1.2 million in 2007 and
$996,000 in 2006.  The components of non-interest income during each
year were as follows:




Non-interest
      incomeYears
      Ended December 31,
                            
                            
                            Change
      during year(in
      thousands)
                            
                            2008
                            
                            
                            2007
                            
                            
                            2006
                            
                            
                            2008
                            
                            
                            2007Service
      charges
                            
                            $
                            716
                            
                            
                            $
                            591
                            
                            
                            $
                            547
                            
                            
                            $
                            125
                            
                            
                            $
                            44Gain
      (loss) on sale of available-for-sale investmentsecurities
                            
                            
                            46
                            
                            
                            
                            (1
                            )
                            
                            
                            (53
                            )
                            
                            
                            47
                            
                            
                            
                            52Mortgage
      loan brokerage fees
                            
                            
                            53
                            
                            
                            
                            77
                            
                            
                            
                            125
                            
                            
                            
                            (24
                            )
                            
                            
                            (48
                            )Earnings
      on cash surrender value of life insurancepolicies
                            
                            
                            253
                            
                            
                            
                            258
                            
                            
                            
                            153
                            
                            
                            
                            (5
                            )
                            
                            
                            105Other
                            
                            
                            215
                            
                            
                            
                            230
                            
                            
                            
                            224
                            
                            
                            
                            (15
                            )
                            
                            
                            6Total
      non-interest income
                            
                            $
                            1,283
                            
                            
                            $
                            1,155
                            
                            
                            $
                            996
                            
                            
                            $
                            128
                            
                            
                            $
                            159





2008 Compared to
2007.Non-interest income increased by $125,000 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.





2007 Compared to
2006.Non-interest income increased during 2007 due primarily
to increased earnings on bank-owned life insurance policies purchased in
2006.  Income from service charges on deposit accounts increased by
$44,000 in 2007 due mainly to a $27,000 increase in account analysis charges,
and a $14,000 increase in NSF and overdraft charges.  Other
non-interest income includes FHLB dividend income which was $79,000 in 2007 and
$55,000 in 2006.  FHLB dividend income increased in 2007 due to
mandatory additional investments in FHLB stock resulting from higher short term
borrowings.  A slowing residential real estate market caused a $48,000
decrease in mortgage loan brokerage fees.





34
 Table of Contents





Non-Interest
Expense





Total non-interest expense was $9.2
million in 2008, up $455,000 or 5%, from the $8.70 million in non-interest
expense in 2007.  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)
                                                            
                                                            2008
                                                            
                                                            
                                                            2007
                                                            
                                                            
                                                            2006
                                                            
                                                            
                                                            2007
                                                            
                                                            
                                                            2007Salaries
      and employee benefits
                                                            
                                                            $
                                                            5,128
                                                            
                                                            
                                                            $
                                                            4,770
                                                            
                                                            
                                                            $
                                                            4,261
                                                            
                                                            
                                                            $
                                                            358
                                                            
                                                            
                                                            $
                                                            509Occupancy
      and equipment
                                                            
                                                            
                                                            1,259
                                                            
                                                            
                                                            
                                                            1,073
                                                            
                                                            
                                                            
                                                            890
                                                            
                                                            
                                                            
                                                            186
                                                            
                                                            
                                                            
                                                            183Data
      processing
                                                            
                                                            
                                                            524
                                                            
                                                            
                                                            
                                                            495
                                                            
                                                            
                                                            
                                                            460
                                                            
                                                            
                                                            
                                                            29
                                                            
                                                            
                                                            
                                                            35Operations
                                                            
                                                            
                                                            509
                                                            
                                                            
                                                            
                                                            480
                                                            
                                                            
                                                            
                                                            454
                                                            
                                                            
                                                            
                                                            29
                                                            
                                                            
                                                            
                                                            26Professional
      and legal
                                                            
                                                            
                                                            394
                                                            
                                                            
                                                            
                                                            508
                                                            
                                                            
                                                            
                                                            330
                                                            
                                                            
                                                            
                                                            (114
                                                            )
                                                            
                                                            
                                                            178Advertising
      and business development
                                                            
                                                            
                                                            273
                                                            
                                                            
                                                            
                                                            305
                                                            
                                                            
                                                            
                                                            268
                                                            
                                                            
                                                            
                                                            (32
                                                            )
                                                            
                                                            
                                                            37Telephone
      and postal
                                                            
                                                            
                                                            216
                                                            
                                                            
                                                            
                                                            213
                                                            
                                                            
                                                            
                                                            206
                                                            
                                                            
                                                            
                                                            3
                                                            
                                                            
                                                            
                                                            7Supplies
                                                            
                                                            
                                                            181
                                                            
                                                            
                                                            
                                                            188
                                                            
                                                            
                                                            
                                                            180
                                                            
                                                            
                                                            
                                                            (7
                                                            )
                                                            
                                                            
                                                            8Assessment
      and insurance
                                                            
                                                            
                                                            259
                                                            
                                                            
                                                            
                                                            197
                                                            
                                                            
                                                            
                                                            114
                                                            
                                                            
                                                            
                                                            62
                                                            
                                                            
                                                            
                                                            83Amortization
      expense
                                                            
                                                            
                                                            8
                                                            
                                                            
                                                            
                                                            63
                                                            
                                                            
                                                            
                                                            63
                                                            
                                                            
                                                            
                                                            (55
                                                            )
                                                            
                                                            
                                                            -Other
      expenses
                                                            
                                                            
                                                            403
                                                            
                                                            
                                                            
                                                            407
                                                            
                                                            
                                                            
                                                            427
                                                            
                                                            
                                                            
                                                            (4
                                                            )
                                                            
                                                            
                                                            (20
                                                            )Total
      non-interest expense
                                                            
                                                            $
                                                            9,154
                                                            
                                                            
                                                            $
                                                            8,699
                                                            
                                                            
                                                            $
                                                            7,653
                                                            
                                                            
                                                            $
                                                            455
                                                            
                                                            
                                                            $
                                                            1,046





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.





2007 Compared to
2006.The increase in non-interest expense resulted primarily
from increased employee costs associated with the Company’s growth and the
highly competitive environment for qualified bank personnel.  Salary
and employee benefits increased by $509,000 including $445,000 for promotional
and merit pay raises and the increase in full time equivalents from 77 to 79
employees, and a $205,000 increase in health and post retirement
benefits.  These increases were partially offset by an increase in
deferred salary costs of $136,000 associated with loan originations which are
amortized over the estimated life of the loan.





Occupancy
and equipment costs increased $183,000 in 2007 due to increased maintenance and
repairs, depreciation on leasehold improvements, increased computer system
maintenance and upgrades, and rent increases.  Operations costs
increased $26,000 due to significantly higher correspondent bank charges which
is reflective of the Company’s growth.  Professional and legal costs
increased $178,000 in 2007 primarily due to the incurred professional fees
related to the implementation of requirements under Section 404 of the
Sarbanes-Oxley Act.  Assessment and insurance costs increased $83,000
due to an increase in FDIC assessment rate for deposit
insurance.  Other expenses decreased $20,000 due to a $53,000 decrease
in employee recruitment and hiring costs.





35
 Table of Contents





Provision
for Income Taxes





The
provision for income taxes for 2008 decreased to $746,000 compared to $1.13
million in 2007 and $1.58 million in 2006.  The decrease in the
provision for income taxes was mainly due to a decrease in pre-tax net income.
The Company’s effective tax rate was 28.8% for 2008 compared to 29.9% and 34.8%
in 2007 and 2006, respectively.  The decrease in provision as a
percentage of pre-tax income relates 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.





Financial
Condition





Investment
Securities





The
decrease in the outstanding balance and the change in the composition of the
portfolio as of the end of 2008 reflected the sale and maturation of government
agency and corporate debt securities.  The percentage of investment
portfolio balances in U.S. Treasury and government agencies, mortgage-backed
securities, municipal securities, and corporate debt to total investment
securities were 17%, 37%, 46%, and none, respectively, at December 31, 2008
versus 31%, 30%, 34% and 5%, respectively, at December 31, 2007.  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 of U.S. government sponsored
enterprises typically provide both an increase in yields over U.S. Treasury and
agency securities and cash flows for liquidity and reinvestment
opportunities.  At December 31, 2008, total balances in these
mortgage-backed securities amounted to $15.7 million down from $17.0 million at
December 31, 2007.  Although these securities typically have final
maturities of between ten and twenty years, the pass-through nature of the
monthly principal payments is expected to significantly reduce the average life
of these securities.





Obligations
of states and political subdivisions (municipal securities) typically provide
attractive tax equivalent yields for the Company.  Since the majority
of the interest earnings on these securities are 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, 2008 and 2007, 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 gain or loss within shareholders’ equity.





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





December
      31, 2008(in
      thousands)
                                                          
                                                          Amortized
      Cost
                                                          
                                                          
                                                          Unrealized
      Gains
                                                          
                                                          
                                                          Unrealized
      Losses
                                                          
                                                          
                                                          Fair
                                                            ValueU.S.
      Treasury security
                                                          
                                                          $
                                                          247
                                                          
                                                          
                                                          $
                                                          33
                                                          
                                                          
                                                          $
                                                          -
                                                          
                                                          
                                                          $
                                                          280U.S.
      government  agencies
                                                          
                                                          
                                                          6,753
                                                          
                                                          
                                                          
                                                          225
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          6,978Mortgage-backed
      securities
                                                          
                                                          
                                                          15,102
                                                          
                                                          
                                                          
                                                          554
                                                          
                                                          
                                                          
                                                          (2
                                                          )
                                                          
                                                          
                                                          15,654Municipal
      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 security
                                                                      
                                                                      $
                                                                      246
                                                                      
                                                                      
                                                                      $
                                                                      18
                                                                      
                                                                      
                                                                      $
                                                                      -
                                                                      
                                                                      
                                                                      $
                                                                      264U.S.
      government agencies
                                                                      
                                                                      
                                                                      17,298
                                                                      
                                                                      
                                                                      
                                                                      62
                                                                      
                                                                      
                                                                      
                                                                      (70
                                                                      )
                                                                      
                                                                      
                                                                      17,290Mortgage-backed
      securities
                                                                      
                                                                      
                                                                      16,853
                                                                      
                                                                      
                                                                      
                                                                      192
                                                                      
                                                                      
                                                                      
                                                                      (85
                                                                      )
                                                                      
                                                                      
                                                                      16,960Municipal
      securities
                                                                      
                                                                      
                                                                      19,304
                                                                      
                                                                      
                                                                      
                                                                      42
                                                                      
                                                                      
                                                                      
                                                                      (227
                                                                      )
                                                                      
                                                                      
                                                                      19,119Corporate
      debt securities
                                                                      
                                                                      
                                                                      3,005
                                                                      
                                                                      
                                                                      
                                                                      1
                                                                      
                                                                      
                                                                      
                                                                      (24
                                                                      )
                                                                      
                                                                      
                                                                      2,982Total
                                                                      
                                                                      $
                                                                      56,706
                                                                      
                                                                      
                                                                      $
                                                                      315
                                                                      
                                                                      
                                                                      $
                                                                      (406
                                                                      )
                                                                      
                                                                      $
                                                                      56,615





December
      31, 2006Amortized
                                                                            Cost
                                                                          
                                                                          
                                                                          Unrealized
                                                                            Gains
                                                                          
                                                                          
                                                                          Unrealized
                                                                            Losses
                                                                          
                                                                          
                                                                          Fair
                                                                            ValueU.S.
      government  agencies
                                                                          
                                                                          $
                                                                          20,325
                                                                          
                                                                          
                                                                          $
                                                                          6
                                                                          
                                                                          
                                                                          $
                                                                          (282
                                                                          )
                                                                          
                                                                          $
                                                                          20,049Mortgage-backed
      securities
                                                                          
                                                                          
                                                                          12,422
                                                                          
                                                                          
                                                                          
                                                                          65
                                                                          
                                                                          
                                                                          
                                                                          (250
                                                                          )
                                                                          
                                                                          
                                                                          12,237Municipal
      securities
                                                                          
                                                                          
                                                                          18,950
                                                                          
                                                                          
                                                                          
                                                                          142
                                                                          
                                                                          
                                                                          
                                                                          (36
                                                                          )
                                                                          
                                                                          
                                                                          19,056Corporate
      debt securities
                                                                          
                                                                          
                                                                          4,033
                                                                          
                                                                          
                                                                          
                                                                          -
                                                                          
                                                                          
                                                                          
                                                                          (77
                                                                          )
                                                                          
                                                                          
                                                                          3,956Total
                                                                          
                                                                          $
                                                                          55,730
                                                                          
                                                                          
                                                                          $
                                                                          213
                                                                          
                                                                          
                                                                          $
                                                                          (645
                                                                          )
                                                                          
                                                                          $
                                                                          55,298





Management
periodically evaluates each investment security for other than temporary
impairment, relying primarily on industry analyst reports, observation of market
conditions and interest rate fluctuations.  Management believes it
will be able to collect all amounts due according to the contractual terms of
the underlying investment securities and that changes in fair value are
temporary and due to interest rate fluctuations and other temporary market
conditions.





The
following table summarizes the amounts and distribution of investment securities
and their weighted average yields as of December 31, 2008.  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
      saleAfter
      one
                                                                    
                                                                    
                                                                    After
      fiveWithin
                                                                    
                                                                    
                                                                    but
      within
                                                                    
                                                                    
                                                                    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.
      Treasury andgovernment
      agencies
                                                                    
                                                                    $
                                                                    1,000
                                                                    
                                                                    
                                                                    
                                                                    4.34
                                                                    %
                                                                    
                                                                    $
                                                                    534
                                                                    
                                                                    
                                                                    
                                                                    5.13
                                                                    %
                                                                    
                                                                    $
                                                                    4,501
                                                                    
                                                                    
                                                                    
                                                                    5.38
                                                                    %
                                                                    
                                                                    $
                                                                    965
                                                                    
                                                                    
                                                                    
                                                                    5.69
                                                                    %
                                                                    
                                                                    $
                                                                    7,000
                                                                    
                                                                    
                                                                    
                                                                    5.26
                                                                    %Mortgage-backedsecurities
                                                                    
                                                                    
                                                                    205
                                                                    
                                                                    
                                                                    
                                                                    4.00
                                                                    %
                                                                    
                                                                    
                                                                    3,037
                                                                    
                                                                    
                                                                    
                                                                    4.52
                                                                    %
                                                                    
                                                                    
                                                                    2,596
                                                                    
                                                                    
                                                                    
                                                                    4.64
                                                                    %
                                                                    
                                                                    
                                                                    9,264
                                                                    
                                                                    
                                                                    
                                                                    5.65
                                                                    %
                                                                    
                                                                    
                                                                    15,102
                                                                    
                                                                    
                                                                    
                                                                    5.22
                                                                    %Municipal
      securities (1)
                                                                    
                                                                    
                                                                    -
                                                                    
                                                                    
                                                                    
                                                                    -
                                                                    
                                                                    
                                                                    
                                                                    20
                                                                    
                                                                    
                                                                    
                                                                    7.23
                                                                    %
                                                                    
                                                                    
                                                                    2,406
                                                                    
                                                                    
                                                                    
                                                                    5.49
                                                                    %
                                                                    
                                                                    
                                                                    17,327
                                                                    
                                                                    
                                                                    
                                                                    5.82
                                                                    %
                                                                    
                                                                    
                                                                    19,753
                                                                    
                                                                    
                                                                    
                                                                    5.78
                                                                    %Total
                                                                    
                                                                    $
                                                                    1,205
                                                                    
                                                                    
                                                                    
                                                                    4.28
                                                                    %
                                                                    
                                                                    $
                                                                    3,591
                                                                    
                                                                    
                                                                    
                                                                    4.63
                                                                    %
                                                                    
                                                                    $
                                                                    9,503
                                                                    
                                                                    
                                                                    
                                                                    5.21
                                                                    %
                                                                    
                                                                    $
                                                                    27,556
                                                                    
                                                                    
                                                                    
                                                                    5.76
                                                                    %
                                                                    
                                                                    $
                                                                    41,855
                                                                    
                                                                    
                                                                    
                                                                    5.49
                                                                    %


(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, 2008
                                    
                                    
                                    December
      31, 2007
                                    
                                    
                                    December
      31, 2006
                                    
                                    
                                    December
      31, 2005
                                    
                                    
                                    December
      31, 2004Commercial
                                    
                                    $
                                    58,325
                                    
                                    
                                    
                                    25
                                    %
                                    
                                    $
                                    41,824
                                    
                                    
                                    
                                    21
                                    %
                                    
                                    $
                                    41,104
                                    
                                    
                                    
                                    22
                                    %
                                    
                                    $
                                    40,271
                                    
                                    
                                    
                                    26
                                    %
                                    
                                    $
                                    34,389
                                    
                                    
                                    
                                    29
                                    %Real
      estate –mortgage
      (1)
                                    
                                    
                                    129,267
                                    
                                    
                                    
                                    56
                                    %
                                    
                                    
                                    106,873
                                    
                                    
                                    
                                    53
                                    %
                                    
                                    
                                    92,639
                                    
                                    
                                    
                                    50
                                    %
                                    
                                    
                                    72,753
                                    
                                    
                                    
                                    48
                                    %
                                    
                                    
                                    60,688
                                    
                                    
                                    
                                    52
                                    %Real
      estate –construction
                                    
                                    
                                    35,113
                                    
                                    
                                    
                                    15
                                    %
                                    
                                    
                                    44,896
                                    
                                    
                                    
                                    22
                                    %
                                    
                                    
                                    44,273
                                    
                                    
                                    
                                    24
                                    %
                                    
                                    
                                    32,560
                                    
                                    
                                    
                                    21
                                    %
                                    
                                    
                                    14,694
                                    
                                    
                                    
                                    13
                                    %Agricultural
                                    
                                    
                                    4,011
                                    
                                    
                                    
                                    2
                                    %
                                    
                                    
                                    4,988
                                    
                                    
                                    
                                    3
                                    %
                                    
                                    
                                    4,693
                                    
                                    
                                    
                                    3
                                    %
                                    
                                    
                                    4,432
                                    
                                    
                                    
                                    3
                                    %
                                    
                                    
                                    4,535
                                    
                                    
                                    
                                    4
                                    %Consumer
      andOther
                                    
                                    
                                    3,566
                                    
                                    
                                    
                                    2
                                    %
                                    
                                    
                                    2,995
                                    
                                    
                                    
                                    1
                                    %
                                    
                                    
                                    1,805
                                    
                                    
                                    
                                    1
                                    %
                                    
                                    
                                    2,376
                                    
                                    
                                    
                                    2
                                    %
                                    
                                    
                                    2,388
                                    
                                    
                                    
                                    2
                                    %Subtotal
                                    
                                    
                                    230,282
                                    
                                    
                                    
                                    100
                                    %
                                    
                                    
                                    201,576
                                    
                                    
                                    
                                    100
                                    %
                                    
                                    
                                    184,514
                                    
                                    
                                    
                                    100
                                    %
                                    
                                    
                                    152,392
                                    
                                    
                                    
                                    100
                                    %
                                    
                                    
                                    116,694
                                    
                                    
                                    
                                    100
                                    %Deferred
      loanfees,
      net
                                    
                                    
                                    (341
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    (304
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    (436
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    (635
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    (459
                                    )Allowance
      forloan
      losses
                                    
                                    
                                    (3,244
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    (1,758
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    (1,746
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    (1,766
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    (1,401
                                    )Total
      loans, net
                                    
                                    $
                                    226,697
                                    
                                    
                                    
                                    
                                    
                                    
                                    $
                                    199,514
                                    
                                    
                                    
                                    
                                    
                                    
                                    $
                                    182,332
                                    
                                    
                                    
                                    
                                    
                                    
                                    $
                                    149,991
                                    
                                    
                                    
                                    
                                    
                                    
                                    $
                                    114,834








(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,
2008 increased by $27.2 million or 14% compared to December 31,
2007.  While the Company’s marketing efforts are focused primarily on
commercial loans, the strongest growth for 2008 occurred in the commercial and
real estate mortgage segments of the portfolio, which was indicative of
continued economic growth in the Company’s lending territory despite a slow down
that commenced in the latter part of 2007.  Tulare and Fresno counties
are two of the top counties in the United States for agricultural production,
but are growing in population more rapidly than many other areas of California
due to the low cost of real estate relative to California’s urban
areas.





The
following table presents the maturity distribution of the loan portfolio as of
December 31, 2008.  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.  During 2008, the Company’s volume of loans with fixed
interest rates increased due to customer demand.  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
                                    
                                    $
                                    33,510
                                    
                                    
                                    $
                                    15,796
                                    
                                    
                                    $
                                    9,019
                                    
                                    
                                    $
                                    58,325Real
      estate – mortgage (1)
                                    
                                    
                                    1,725
                                    
                                    
                                    
                                    35,465
                                    
                                    
                                    
                                    92,077
                                    
                                    
                                    
                                    129,267Real
      estate – construction
                                    
                                    
                                    14,563
                                    
                                    
                                    
                                    11,728
                                    
                                    
                                    
                                    8,822
                                    
                                    
                                    
                                    35,113Agriculture
                                    
                                    
                                    2,422
                                    
                                    
                                    
                                    236
                                    
                                    
                                    
                                    1,353
                                    
                                    
                                    
                                    4,011Consumer
      and other
                                    
                                    
                                    2,560
                                    
                                    
                                    
                                    915
                                    
                                    
                                    
                                    91
                                    
                                    
                                    
                                    3,566Total
                                    
                                    $
                                    54,780
                                    
                                    
                                    $
                                    64,140
                                    
                                    
                                    $
                                    111,362
                                    
                                    
                                    $
                                    230,282Loans
      with fixed interest rates
                                    
                                    
                                    2,395
                                    
                                    
                                    
                                    44,855
                                    
                                    
                                    
                                    84,095
                                    
                                    
                                    
                                    131,345Loans
      with floating interest rates
                                    
                                    
                                    52,385
                                    
                                    
                                    
                                    19,285
                                    
                                    
                                    
                                    27,267
                                    
                                    
                                    
                                    98,937Total
                                    
                                    $
                                    54,780
                                    
                                    
                                    $
                                    64,140
                                    
                                    
                                    $
                                    111,362
                                    
                                    
                                    $
                                    230,282





(1)
Consists primarily of commercial mortgage loans.





Nonperforming
Assets.There were $4.9 million in nonaccrual loans at
December 31, 2008, which comprised the Company’s total nonperforming
assets.  As of December 31, 2007 there were no nonaccrual
loans.  As of December 31, 2008 and 2007 there were no loans past due
90 days and still accruing interest, restructured loans or other real estate
owned.  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).  From the time a loan is placed on nonaccrual
status, interest previously accrued but not collected is reversed from interest
income.  There was $27,252 in foregone interest on nonaccrual loans
during the year ended December 31, 2008.  There was no interest
foregone on nonaccrual loans for the years ended December 31, 2007 and
2006.  Any interest or principal payments received on a nonaccrual
loan are normally applied as a principal reduction.   Interest
income recognized on a cash basis for impaired loans totaled $52,494 during the
year ended December 31, 2008.  There was no interest income recognized
on a cash basis for impaired loans during the years ended December 31, 2007, and
2006.  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.  We are actively pursuing collection of all the contractual
amounts due under the loan agreements for these nonperforming assets and
impaired loans.  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, 2007 and 2006.  At December 31, 2008, the recorded
investment in loans that were considered to be impaired totaled $4.9
million.  The specific allowance for loan losses for impaired loans at
December 31, 2008 totaled $425,000.  There were no impaired loans at
December 31, 2007 or 2006.  The average recorded investment in
impaired loans for the year ended December 31, 2008 totaled $1.5 million. The
average recorded investment in impaired loans for the years ended December 31,
2007, and 2006 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.





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





39
 Table of Contents





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 (“classified
      loans”),


§
            general
      or formula allocation,


§
            and
      discretionary allocation based on loan portfolio
    segmentation.





The
Company’s methodology incorporates the following accounting pronouncements, as
amended, in determining the adequacy of the allowance for loan
losses:





§
            SFAS
      No. 5 - “Accounting for
Contingencies”,


§
            SFAS
      No.114 - “Accounting by Creditors for Impairment of a Loan”
      and


§
            SFAS
      No. 118 - “Accounting by Creditors for Impairment of a Loan - Income
      Recognition and Disclosures.”





Specific
allocations are established based on management’s periodic evaluation of loss
exposure inherent in classified, 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,
classified 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





40
 Table of Contents





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 seven 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.





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 $3.2 million or 1.41% of total loans at
December 31, 2008 compared to $1.76 million or 0.87% at December 31, 2007, and
$1.75 million or 0.95% at December 31, 2006.  The Company’s loan loss
provisions recorded during 2008 totaled $1.6 million.  No provision
for loan losses were recorded in 2007 or 2006. The provision recorded during
2008 included approximately $0.4 million related to specific reserves for
impaired loans and $1.2 million in general reserves related to the overall
trends in credit quality of our loan portfolio including an increase in the
number and amount of classified and past due loans, and deterioration in the
general economic environment in our primary market area.  Management
believes that the allowance for loan losses was adequate at December 31,
2008.  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)
                            
                            2008
                            
                            
                            2007
                            
                            
                            2006
                            
                            
                            2005
                            
                            
                            2004Balance,
      beginning
                            
                            $
                            1,758
                            
                            
                            $
                            1,746
                            
                            
                            $
                            1,766
                            
                            
                            $
                            1,401
                            
                            
                            $
                            1,393Provision
      for  loan losses
                            
                            
                            1,600
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            369
                            
                            
                            
                            138Charge-offs(1)
                            
                            
                            (142
                            )
                            
                            
                            -
                            
                            
                            
                            (21
                            )
                            
                            
                            (4
                            )
                            
                            
                            (148
                            )Recoveries
                            
                            
                            28
                            
                            
                            
                            12
                            
                            
                            
                            1
                            
                            
                            
                            -
                            
                            
                            
                            18Balance,
      ending
                            
                            $
                            3,244
                            
                            
                            $
                            1,758
                            
                            
                            $
                            1,746
                            
                            
                            $
                            1,766
                            
                            
                            $
                            1,401Net
      charge-offs to average loans outstanding
                            
                            
                            .05
                            %
                            
                            
                            (.01
                            )%
                            
                            
                            .01
                            %
                            
                            
                            --
                            (2)
                            
                            
                            .12
                            %Average
      loans outstanding
                            
                            $
                            219,431
                            
                            
                            $
                            194,734
                            
                            
                            $
                            166,620
                            
                            
                            $
                            134,008
                            
                            
                            $
                            107,262Ending
      allowance to total loans outstanding
                            
                            
                            1.41
                            %
                            
                            
                            0.87
                            %
                            
                            
                            0.95
                            %
                            
                            
                            1.16
                            %
                            
                            
                            1.20
                            %





(1)
            Charge-off
      recorded in the years ended 2008 and 2004 related primarily to real estate
      mortgage loans while all other charge-offs relate 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 2008, 2007, and 2006 are
presented in the “Results of Operations” section under the heading “Net Interest
Income.”  Average total deposits for 2008 were $244.7 million compared
to $213.6 million for 2007, an increase of $31.1 million or 15%.  The
Company has utilized brokered deposits since December 2006 as a way of
diversifying its funding sources.  Total brokered deposits at December
31, 2008, 2007 and 2006 were $15.9 million, $2.9 million and $9.9 million,
respectively.  Average brokered deposits were $15.5 million in 2008,
$8.8 million in 2007 and $109,000 in 2006.





In 2008,
the Company continued its strong marketing effort to attract local
deposits.  Total deposits at December 31, 2008 were $257.3 million
compared to $215.4 million at December 31, 2007, an increase of $41.9 million or
19%.  If the brokered time deposits are excluded, total deposits at
December 31, 2008 increased by $28.9 million or 14% from December 21,
2007.





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 31,2008
                      
                      
                      2007
                      
                      
                      2006Average
                      
                      
                      
                      
                      
                      Average
                      
                      
                      
                      
                      
                      AverageAverage
                      
                      
                      Yield/
                      
                      
                      Average
                      
                      
                      Yield/
                      
                      
                      Average
                      
                      
                      Yield/(dollars
      in thousands)
                      
                      Balance
                      
                      
                      Rate
                      
                      
                      Balance
                      
                      
                      Rate
                      
                      
                      Balance
                      
                      
                      RateDeposits:Non-interest
      bearing deposits
                      
                      $
                      66,106
                      
                      
                      
                      
                      
                      $
                      60,465
                      
                      
                      
                      
                      
                      $
                      65,440Interest-bearing
      deposits:Interest
      bearing demand deposits
                      
                      
                      29,324
                      
                      
                      
                      1.74
                      %
                      
                      
                      27,052
                      
                      
                      
                      2.84
                      %
                      
                      
                      21,530
                      
                      
                      
                      2.81
                      %Money
      market accounts
                      
                      
                      52,349
                      
                      
                      
                      2.12
                      %
                      
                      
                      47,308
                      
                      
                      
                      3.27
                      %
                      
                      
                      42,047
                      
                      
                      
                      3.08
                      %Savings
                      
                      
                      8,887
                      
                      
                      
                      0.37
                      %
                      
                      
                      8,660
                      
                      
                      
                      0.80
                      %
                      
                      
                      9,957
                      
                      
                      
                      0.96
                      %Time
      deposits
                      
                      
                      88,031
                      
                      
                      
                      3.69
                      %
                      
                      
                      70,117
                      
                      
                      
                      4.88
                      %
                      
                      
                      54,488
                      
                      
                      
                      4.24
                      %Total
      interest-bearing deposits
                      
                      
                      178,591
                      
                      
                      
                      2.74
                      %
                      
                      
                      153,137
                      
                      
                      
                      3.79
                      %
                      
                      
                      128,022
                      
                      
                      
                      3.36
                      %Total
      deposits
                      
                      $
                      244,697
                      
                      
                      
                      
                      
                      
                      $
                      213,602
                      
                      
                      
                      
                      
                      
                      $
                      193,462





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,
2008.








Maturities of certificates of deposit of $100,000
      or more(dollars
      in thousands)
                                    
                                    Balance
                                    
                                    
                                    Percent
      of  totalThree
      months or less
                                    
                                    $
                                    22,695
                                    
                                    
                                    
                                    34
                                    %Over
      three months through nine months
                                    
                                    
                                    34,703
                                    
                                    
                                    
                                    52
                                    %Over
      nine months through twelve months
                                    
                                    
                                    8,062
                                    
                                    
                                    
                                    12
                                    %Over
      twelve months
                                    
                                    
                                    1,322
                                    
                                    
                                    
                                    2
                                    %Total
      certificates of deposit of $100,000 and more
                                    
                                    $
                                    66,782
                                    
                                    
                                    
                                    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, 2008, term borrowing outstanding from the FHLB totaled $5.2 million
compared to $8.1 million at December 31, 2007.  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 incurred during 2008 and the reduction from the prior year was
attributable to scheduled principal repayments and
maturities.  Average total term borrowings from FHLB totaled $6.3
million for 2008 at an average cost of 4.82% compared to average term borrowings
of $8.3 million at an average cost of 4.37% for 2007.





There
were $8.0 million in short-term borrowings from FHLB at December 31, 2008
compared to $21.8 million at December 31, 2007.  The Company utilized
short-term borrowings from FHLB to fund a portion of its asset growth in 2007
due to competitive market conditions for deposits, but scaled back these
borrowings in 2008 due to increased local and brokered deposit
growth.  Average total short-term borrowings from FHLB totaled $10.9
million for 2008 at an average cost of 2.71% compared to average short-term
borrowings of $13.6 million in 2007 at an average cost of 5.11%.  The
decrease in interest rates on short-term borrowings was reflective of the
decrease in short-term market rates that occurred in 2008.








42
 Table of Contents





Federal Reserve Discount
Window.At December 31, 2008, the Bank could borrow
approximately 75% of pledged loans from the Federal Reserve Bank of San
Francisco.  The Bank’s discount window borrowing line was
approximately $59 million at December 31, 2008 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 December 31, 2008 and $10.0 million at December 31,
2007.  The borrowing line is utilized infrequently and there was no
balance outstanding at December 31, 2008 and 2007.





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, 2008 and December
31, 2007 was 8.05% and 8.54%, 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, 2008 and December 31, 2007, commitments to extend credit and
letters of credit were the only financial instruments with off-balance sheet
risk.  As of December 31, 2008 and December 31, 2007, commitments to
extend credit totaled $47.4 million and $53.5 million, respectively, and letters
of credit totaled $337,000 and $209,000, 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 branch, administrative and
other office space in Visalia, Fresno, and Tulare which expire at various dates
through 2009, and salary continuation plans





Capital
Resources





Federal
regulations establish guidelines for calculating “risk-adjusted” capital
ratios.  These guidelines, 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.  “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, 2008 and December 31,
2007:





Capital and capital adequacy
      ratiosYear ended December
31,2008
                                          
                                          
                                          2007(dollars
      in thousands)
                                          
                                          Amount
                                          
                                          
                                          Ratio
                                          
                                          
                                          Amount
                                          
                                          
                                          RatioLeverage RatioValley
      Commerce Bancorpand
      Subsidiary
                                          
                                          $
                                          33,044
                                          
                                          
                                          
                                          10.9
                                          %
                                          
                                          $
                                          31,927
                                          
                                          
                                          
                                          11.5
                                          %Minimum
      regulatory requirement
                                          
                                          $
                                          12,150
                                          
                                          
                                          
                                          4.0
                                          %
                                          
                                          $
                                          11,101
                                          
                                          
                                          
                                          4.0
                                          %Valley
      Business Bank
                                          
                                          $
                                          32,751
                                          
                                          
                                          
                                          10.8
                                          %
                                          
                                          $
                                          31,538
                                          
                                          
                                          
                                          11.4
                                          %Minimum
      requirement for “Well-Capitalized”
      institution
                                          
                                          $
                                          15,181
                                          
                                          
                                          
                                          5.0
                                          %
                                          
                                          $
                                          13,871
                                          
                                          
                                          
                                          5.0
                                          %Minimum
      regulatory requirement
                                          
                                          $
                                          12,145
                                          
                                          
                                          
                                          4.0
                                          %
                                          
                                          $
                                          11,097
                                          
                                          
                                          
                                          4.0
                                          %Tier 1 Risk-Based Capital
    RatioValley
      Commerce Bancorpand
      Subsidiary
                                          
                                          $
                                          33,044
                                          
                                          
                                          
                                          12.7
                                          %
                                          
                                          $
                                          31,927
                                          
                                          
                                          
                                          13.8
                                          %Minimum
      regulatory requirement
                                          
                                          $
                                          10,367
                                          
                                          
                                          
                                          4.0
                                          %
                                          
                                          $
                                          9,233
                                          
                                          
                                          
                                          4.0
                                          %Valley
      Business Bank
                                          
                                          $
                                          32,751
                                          
                                          
                                          
                                          12.6
                                          %
                                          
                                          $
                                          31,538
                                          
                                          
                                          
                                          13.7
                                          %Minimum
      requirement for “Well-Capitalized”
      institution
                                          
                                          $
                                          15,548
                                          
                                          
                                          
                                          6.0
                                          %
                                          
                                          $
                                          13,844
                                          
                                          
                                          
                                          6.0
                                          %Minimum
      regulatory requirement
                                          
                                          $
                                          10,363
                                          
                                          
                                          
                                          4.0
                                          %
                                          
                                          $
                                          9,230
                                          
                                          
                                          
                                          4.0
                                          %Total Risk-Based Capital
    RatioValley
      Commerce Bancorpand
      Subsidiary
                                          
                                          $
                                          35,284
                                          
                                          
                                          
                                          14.0
                                          %
                                          
                                          $
                                          33,684
                                          
                                          
                                          
                                          14.6
                                          %Minimum
      regulatory requirement
                                          
                                          $
                                          20,734
                                          
                                          
                                          
                                          8.0
                                          %
                                          
                                          $
                                          18,465
                                          
                                          
                                          
                                          8.0
                                          %Valley
      Business Bank
                                          
                                          $
                                          35,990
                                          
                                          
                                          
                                          13.9
                                          %
                                          
                                          $
                                          33,296
                                          
                                          
                                          
                                          14.4
                                          %Minimum
      requirement for “Well-Capitalized”
      institution
                                          
                                          $
                                          25,909
                                          
                                          
                                          
                                          10.0
                                          %
                                          
                                          $
                                          23,074
                                          
                                          
                                          
                                          10.0
                                          %Minimum
      regulatory requirement
                                          
                                          $
                                          20,728
                                          
                                          
                                          
                                          8.0
                                          %
                                          
                                          $
                                          18,459
                                          
                                          
                                          
                                          8.0
                                          %








At
December 31, 2008 and December 31, 2007, 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,
2008, and December 31, 2007, the entire $3.0 million was included in Tier 1
capital.





The
Company’s average equity as a percentage of average assets was 9.89% for 2008
and 10.11% for 2007.  Year-end shareholders’ equity as a percentage of
year-end assets was 9.85% and 10.35% at December 31, 2008 and 2007,
respectively.  The decrease in these ratios reflects 2008 earnings and
capital received from the exercise of stock options offset by stock
repurchased.





The
Company issued a 5% stock dividend in 2008 and 2007.  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





As
discussed above, 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 business customers and 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, 2008, the Company had available credit of $34.1 million from the
FHLB, $59.1 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 $47.4
million and $337,000, respectively, at December 31, 2008.  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 on or 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.





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, 2008 and 2007
                                48III.
                                Consolidated
      Statement of Income for the years ended December 31, 2008, 2007 and
      2006
                                49IV.
                                Consolidated
      Statement of Changes in Shareholders’ Equity for the years ended December
      31, 2008, 2007 and 2006
                                50V.
                                Consolidated
      Statement of Cash Flows for the years ended December 31, 2008, 2007 and
      2006
                                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, 2008 and 2007, and the
related consolidated statements of income, changes in shareholders' equity and
cash flows for each of the years in the three-year period ended December 31,
2008.  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, 2008 and 2007, and the consolidated
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2008, in conformity with accounting
principles generally accepted in the United States of America.








/s/
      Perry-Smith LLP








Sacramento,
California


March 30,
2009




47
 Table of Contents





VALLEY
COMMERCE BANCORP AND SUBSIDIARY


CONSOLIDATED BALANCE SHEET





December
31, 2008 and 2007








2008
                                        
                                        
                                        2007ASSETSCash
      and due from banks
                                        
                                        $
                                        8,755,867
                                        
                                        
                                        $
                                        9,297,346Federal
      funds sold
                                        
                                        
                                        13,390,000
                                        
                                        
                                        
                                        -Cash
      and cash equivalents
                                        
                                        
                                        22,145,867
                                        
                                        
                                        
                                        9,297,346Available-for-sale
      investment securities, at fair value (Note 4 and 8)
                                        
                                        
                                        42,018,000
                                        
                                        
                                        
                                        56,615,000Loans,
      less allowance for loan losses of $3,244,454in
      2008 and $1,757,591 in 2007 (Notes 5, 8, 10 and 14)
                                        
                                        
                                        226,696,838
                                        
                                        
                                        
                                        199,514,271Bank
      premises and equipment, net (Notes 6 and 10)
                                        
                                        
                                        3,974,845
                                        
                                        
                                        
                                        3,037,063Cash
      surrender value of bank-owned life insurance(Note
      15)
                                        
                                        
                                        6,421,863
                                        
                                        
                                        
                                        6,184,531Accrued
      interest receivable and other assets (Note 13)
                                        
                                        
                                        4,841,565
                                        
                                        
                                        
                                        4,432,665Total
      assets
                                        
                                        $
                                        306,098,978
                                        
                                        
                                        $
                                        279,080,876LIABILITIES
      AND SHAREHOLDERS' EQUITYDeposits:Non-interest
      bearing
                                        
                                        $
                                        77,405,517
                                        
                                        
                                        $
                                        66,992,568Interest
      bearing (Note 7)
                                        
                                        
                                        179,917,916
                                        
                                        
                                        
                                        148,393,500Total
      deposits
                                        
                                        
                                        257,323,433
                                        
                                        
                                        
                                        215,386,068Accrued
      interest payable and other liabilities
                                        
                                        
                                        2,357,915
                                        
                                        
                                        
                                        1,778,548FHLB
      advances (Note 8)
                                        
                                        
                                        8,000,000
                                        
                                        
                                        
                                        21,804,000FHLB
      term borrowing (Note 8)
                                        
                                        
                                        5,184,346
                                        
                                        
                                        
                                        8,146,049Junior
      subordinated deferrable interest debentures (Note 9)
                                        
                                        
                                        3,093,000
                                        
                                        
                                        
                                        3,093,000Total
      liabilities
                                        
                                        
                                        275,958,694
                                        
                                        
                                        
                                        250,207,665Commitments
      and contingencies (Note 10)Shareholders'
      equity (Note 11):Serial
      preferred stock - no par value; 10,000,000shares
      authorized; none issued
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -Common
      stock - no par value; 30,000,000 sharesauthorized;
      issued and outstanding – 2,473,739shares
      in 2008 and 2,396,435 shares in 2007
                                        
                                        
                                        24,684,529
                                        
                                        
                                        
                                        23,511,066Retained
      earnings
                                        
                                        
                                        5,359,535
                                        
                                        
                                        
                                        5,423,324Accumulated other comprehensive
      gain (loss), net of taxes(Notes
      4 and 16)
                                        
                                        
                                        96,220
                                        
                                        
                                        
                                        (61,179
                                        )Total
      shareholders' equity
                                        
                                        
                                        30,140,284
                                        
                                        
                                        
                                        28,873,211Total
      liabilities and shareholders’ equity
                                        
                                        $
                                        306,098,978
                                        
                                        
                                        $
                                        279,080,876








The
accompanying notes are an integral


part of
these consolidated financial statements





48
 Table of Contents




VALLEY
COMMERCE BANCORP AND SUBSIDIARY


CONSOLIDATED STATEMENT OF INCOME





For
the Years Ended December 31, 2008, 2007 and 2006





2008
                  
                  
                  2007
                  
                  
                  2006Interest
      income:Interest
      and fees on loans
                  
                  $
                  15,509,954
                  
                  
                  $
                  16,113,423
                  
                  
                  $
                  14,448,209Interest
      on investment securities:Taxable
                  
                  
                  1,304,535
                  
                  
                  
                  1,581,892
                  
                  
                  
                  1,444,707Exempt
      from Federal income taxes
                  
                  
                  798,960
                  
                  
                  
                  771,368
                  
                  
                  
                  719,117Interest
      on Federal funds sold
                  
                  
                  170,389
                  
                  
                  
                  3,658
                  
                  
                  
                  137,749Total
      interest income
                  
                  
                  17,783,838
                  
                  
                  
                  18,470,341
                  
                  
                  
                  16,749,782Interest
      expense:Interest
      on deposits (Note 7)
                  
                  
                  4,900,988
                  
                  
                  
                  5,802,852
                  
                  
                  
                  4,306,344Interest
      on FHLB advances (Note 8)
                  
                  
                  296,170
                  
                  
                  
                  695,062
                  
                  
                  
                  610,911Interest
      on FHLB term borrowings (Note 8)
                  
                  
                  302,670
                  
                  
                  
                  362,665
                  
                  
                  
                  380,212Interest
      on junior subordinated deferrable interest debentures (Note
    9)
                  
                  
                  218,672
                  
                  
                  
                  270,690
                  
                  
                  
                  263,310Total
      interest expense
                  
                  
                  5,718,500
                  
                  
                  
                  7,131,269
                  
                  
                  
                  5,560,777Net
      interest income before provision for loan losses
                  
                  
                  12,065,338
                  
                  
                  
                  11,339,072
                  
                  
                  
                  11,189,005Provision
      for loan losses (Note 5)
                  
                  
                  1,600,000
                  
                  
                  
                  -
                  
                  
                  
                  -Net
      interest income after provision for loan losses
                  
                  
                  10,465,338
                  
                  
                  
                  11,339,072
                  
                  
                  
                  11,189,005Non-interest
      income:Service
      charges
                  
                  
                  715,651
                  
                  
                  
                  590,900
                  
                  
                  
                  546,514Gain
      (loss) on sale of available-for-sale investment securities, net (Note
      4)
                  
                  
                  46,412
                  
                  
                  
                  (1,145
                  )
                  
                  
                  (52,737
                  )Mortgage
      loan brokerage fees
                  
                  
                  52,535
                  
                  
                  
                  76,636
                  
                  
                  
                  125,085Earnings
      on cash surrender value of life insurance policies (Note
    15)
                  
                  
                  252,796
                  
                  
                  
                  258,134
                  
                  
                  
                  153,394Other
                  
                  
                  215,386
                  
                  
                  
                  230,140
                  
                  
                  
                  223,693Total
      non-interest income
                  
                  
                  1,282,780
                  
                  
                  
                  1,154,665
                  
                  
                  
                  995,949Non-interest
      expense:Salaries
      and employee benefits (Notes 5 and 15)
                  
                  
                  5,127,725
                  
                  
                  
                  4,770,498
                  
                  
                  
                  4,260,909Occupancy
      and equipment (Notes 6 and 10)
                  
                  
                  1,259,491
                  
                  
                  
                  1,073,196
                  
                  
                  
                  890,337Other
      (Note 12)
                  
                  
                  2,766,313
                  
                  
                  
                  2,855,193
                  
                  
                  
                  2,501,930Total
      non-interest expense
                  
                  
                  9,153,529
                  
                  
                  
                  8,698,887
                  
                  
                  
                  7,653,176Income
      before provision for income taxes
                  
                  
                  2,594,589
                  
                  
                  
                  3,794,850
                  
                  
                  
                  4,531,778Provision
      for income taxes (Note 13)
                  
                  
                  746,000
                  
                  
                  
                  1,134,000
                  
                  
                  
                  1,576,000Net
      income
                  
                  $
                  1,848,589
                  
                  
                  $
                  2,660,850
                  
                  
                  $
                  2,955,778Basic
      earnings per share (Note 11)
                  
                  $
                  0.75
                  
                  
                  $
                  1.07
                  
                  
                  $
                  1.22Diluted
      earnings per share (Note 11)
                  
                  $
                  0.74
                  
                  
                  $
                  1.03
                  
                  
                  $
                  1.16





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, 2008, 2007 and 2006





AccumulatedOtherCompre-
                                            
                                            
                                            Total
                                            
                                            
                                            TotalCommon Stock
                                            
                                            
                                            
                                            
                                            
                                            hensive
                                            
                                            
                                            Share-
                                            
                                            
                                            Compre-Retained
                                            
                                            
                                            Income(Loss)
                                            
                                            
                                            holders’
                                            
                                            
                                            hensiveShares
                                            
                                            
                                            Amount
                                            
                                            
                                            Earnings
                                            
                                            
                                            (Net of Taxes)
                                            
                                            
                                            Equity
                                            
                                            
                                            IncomeBalance,
      January 1, 2006
                                            
                                            
                                            2,087,508
                                            
                                            
                                            $
                                            18,332,290
                                            
                                            
                                            $
                                            4,122,088
                                            
                                            
                                            $
                                            (545,121
                                            )
                                            
                                            $
                                            21,909,257Comprehensive
      income (Note 16):Net
      income
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            2,955,778
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            2,955,778
                                            
                                            
                                            $
                                            2,955,778Other
      comprehensive income, net of tax:Net
      change in unrealized losses on available-for-sale investment
      securities
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            269,119
                                            
                                            
                                            
                                            269,119
                                            
                                            
                                            
                                            269,119Total
      comprehensive income
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            $
                                            3,224,897Stock
      dividend
                                            
                                            
                                            104,123
                                            
                                            
                                            
                                            2,032,481
                                            
                                            
                                            
                                            (2,032,481
                                            )Cash
      paid for fractional shares
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (5,004
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            (5,004
                                            )Stock
      options exercised and  related tax benefit
                                            
                                            
                                            24,134
                                            
                                            
                                            
                                            280,230
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            280,230Stock-based
      compensation expense
                                            
                                            
                                            
                                            
                                            
                                            
                                            38,719
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            38,719Balance,
      December 31, 2006
                                            
                                            
                                            2,215,765
                                            
                                            
                                            
                                            20,683,720
                                            
                                            
                                            
                                            5,040,381
                                            
                                            
                                            
                                            (276,002
                                            )
                                            
                                            
                                            25,448,099Comprehensive
      income (Note 16):Net
      income
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            2,660,850
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            2,660,850
                                            
                                            
                                            $
                                            2,660,850Other
      comprehensive income, net of tax:Net
      change in unrealized losses on available-for-sale investment
      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 related tax 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
                                            )
                                            
                                            
                                            28,873,211




(continued)





50
 Table of Contents





VALLEY
COMMERCE BANCORP AND SUBSIDIARY


CONSOLIDATED
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY


(Continued)




For
the Years Ended December 31, 2008, 2007 and 2006




AccumulatedOtherCompre-
                          
                          
                          Total
                          
                          
                          TotalCommon Stock
                          
                          
                          
                          
                          
                          hensive
                          
                          
                          Share-
                          
                          
                          Compre-Retained
                          
                          
                          Income(Loss)
                          
                          
                          holders’
                          
                          
                          hensiveShares
                          
                          
                          Amount
                          
                          
                          Earnings
                          
                          
                          (Net of Taxes)
                          
                          
                          Equity
                          
                          
                          IncomeBalance,
      December 31, 2007
                          
                          
                          2,396,435
                          
                          
                          $
                          23,511,066
                          
                          
                          $
                          5,423,324
                          
                          
                          $
                          (61,179
                          )
                          
                          $
                          28,873,211Cumulative
      effect of change in accounting principle, adoption of EITF 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-sale investment
      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 related tax 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
  
 2008
                  
                  
                  2007
                  
                  
                  2006Disclosure
      of reclassification amount, net of taxes (Note 16):Unrealized
      holding gains arising during the year
                  
                  $
                  184,713
                  
                  
                  $
                  214,054
                  
                  
                  $
                  235,394Less:
      reclassification adjustment for gains (losses) included in net
      income
                  
                  
                  27,314
                  
                  
                  
                  (769
                  )
                  
                  
                  (33,725
                  )Net
      change in unrealized gains on available-for-sale investment
      securities
                  
                  $
                  157,399
                  
                  
                  $
                  214,823
                  
                  
                  $
                  269,119





The
accompanying notes are an integral


part of
these consolidated financial statements.





51
 Table of Contents




VALLEY COMMERCE BANCORP AND SUBSIDIARY


CONSILIDATED
STATEMENT OF CASH FLOWS




For
the Years Ended December 31, 2008, 2007 and 2006





2008
                      
                      
                      2007
                      
                      
                      2006Cash
      flows from operating activities:Net
      income
                      
                      $
                      1,848,589
                      
                      
                      $
                      2,660,850
                      
                      
                      $
                      2,955,778Adjustments
      to reconcile net income to net cash provided by operating
      activities:Provision
      for loan losses
                      
                      
                      1,600,000
                      
                      
                      
                      -
                      
                      
                      
                      -Increase
      (decrease) in deferred loan origination fees, net
                      
                      
                      36,969
                      
                      
                      
                      (131,895
                      )
                      
                      
                      (199,771
                      )Depreciation
                      
                      
                      466,069
                      
                      
                      
                      315,365
                      
                      
                      
                      242,116Amortization
      of intangibles
                      
                      
                      7,718
                      
                      
                      
                      62,538
                      
                      
                      
                      62,538(Gain)
      loss on sale of available-for-sale investment securities,
    net
                      
                      
                      (46,412
                      )
                      
                      
                      1,145
                      
                      
                      
                      52,737Dividends
      on Federal Home Loan Bank stock
                      
                      
                      (82,100
                      )
                      
                      
                      (79,100
                      )
                      
                      
                      (54,900
                      )(Amortization)
      accretion of investment securities, net
                      
                      
                      (31,620
                      )
                      
                      
                      (23,459
                      )
                      
                      
                      38,099Loss
      on disposition of premises and equipment
                      
                      
                      1,198
                      
                      
                      
                      16,470
                      
                      
                      
                      -Provision
      for deferred income taxes
                      
                      
                      (935,000
                      )
                      
                      
                      (77,000
                      )
                      
                      
                      2,000Tax
      benefits on stock-based compensation
                      
                      
                      (30,338
                      )
                      
                      
                      (335,893
                      )
                      
                      
                      (125,828
                      )Increase
      in cash surrender value of bank owned life insurance
                      
                      
                      (237,332
                      )
                      
                      
                      (249,968
                      )
                      
                      
                      (153,394
                      )Stock-based
      compensation expense
                      
                      
                      59,883
                      
                      
                      
                      44,410
                      
                      
                      
                      38,719(Increase)
      decrease in accrued interest receivable and other assets
                      
                      
                      (35,637
                      )
                      
                      
                      627,659
                      
                      
                      
                      (354,558
                      )Increase
      in accrued interest payable and other liabilities
                      
                      
                      409,971
                      
                      
                      
                      378,761
                      
                      
                      
                      111,387Net
      cash provided by operating activities
                      
                      
                      3,031,958
                      
                      
                      
                      3,209,883
                      
                      
                      
                      2,614,923Cash
      flows from investing activities:Proceeds
      from matured and called available-for-sale investment
      securities
                      
                      
                      10,000,000
                      
                      
                      
                      7,615,000
                      
                      
                      
                      1,658,100Proceeds
      from sales of available-for-sale investment securities
                      
                      
                      4,537,315
                      
                      
                      
                      1,533,619
                      
                      
                      
                      2,731,795Purchases
      of available-for-sale investment securities
                      
                      
                      (2,949,149
                      )
                      
                      
                      (12,530,396
                      )
                      
                      
                      (11,082,486
                      )Proceeds
      from principal repayments from available-for-sale mortgage-backed
      securities
                      
                      
                      3,341,502
                      
                      
                      
                      2,427,545
                      
                      
                      
                      2,152,829Net
      increase in loans
                      
                      
                      (28,819,536
                      )
                      
                      
                      (17,050,870
                      )
                      
                      
                      (32,141,121
                      )Redemption
      (purchase) of Federal Home Loan Bank stock, net
                      
                      
                      636,500
                      
                      
                      
                      246,400
                      
                      
                      
                      (714,100
                      )Purchase
      of premises and equipment
                      
                      
                      (1,407,299
                      )
                      
                      
                      (1,544,749
                      )
                      
                      
                      (850,977
                      )Proceeds
      from sale of premises and equipment
                      
                      
                      2,250
                      
                      
                      
                      8,028
                      
                      
                      
                      -Premiums
      paid for life insurance policies
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (3,000,000
                      )Net
      cash used in investing activities
                      
                      
                      (14,658,417
                      )
                      
                      
                      (19,295,423
                      )
                      
                      
                      (41,245,960
                      )








(Continued)





52
 Table of Contents




VALLEY COMMERCE
BANCORP AND SUBSIDIARY
 CONSILIDATED
STATEMENT OF CASH FLOWS
 (Continued)


For
the Years Ended December 31, 2008, 2007 and 2006





2008
                        
                        
                        2007
                        
                        
                        2006Cash
      flows from financing activities:Net
      increase (decrease) in noninterest bearing and interest-bearing
      deposits
                        
                        $
                        11,873,611
                        
                        
                        $
                        14,956,957
                        
                        
                        $
                        (655,498
                        )Net
      increase (decrease) in time deposits
                        
                        
                        30,063,754
                        
                        
                        
                        (7,147,058
                        )
                        
                        
                        15,650,553Proceeds
      from exercised stock options
                        
                        
                        97,506
                        
                        
                        
                        556,336
                        
                        
                        
                        154,402Cash
      paid to repurchase common stock
                        
                        
                        (821,037
                        )
                        
                        
                        (381,808
                        )
                        
                        
                        -Tax
      benefits from stock-based compensation
                        
                        
                        30,338
                        
                        
                        
                        335,893
                        
                        
                        
                        125,828Proceeds
      from FHLB advances
                        
                        
                        8,000,000
                        
                        
                        
                        4,204,000
                        
                        
                        
                        17,600,000Payments
      on FHLB advances
                        
                        
                        (21,804,000
                        )
                        
                        
                        -
                        
                        
                        
                        -Payments
      on FHLB term borrowings
                        
                        
                        (2,961,703
                        )
                        
                        
                        (401,589
                        )
                        
                        
                        (591,982
                        )Cash
      paid to repurchase fractional shares
                        
                        
                        (3,489
                        )
                        
                        
                        (5,392
                        )
                        
                        
                        (5,004
                        )Net
      cash provided by financing activities
                        
                        
                        24,474,980
                        
                        
                        
                        12,117,339
                        
                        
                        
                        32,278,299(Increase)
      decrease in cash and cash equivalents
                        
                        
                        12,848,521
                        
                        
                        
                        (3,968,201
                        )
                        
                        
                        (6,352,738
                        )Cash
      and cash equivalents at beginning of year
                        
                        
                        9,297,346
                        
                        
                        
                        13,265,547
                        
                        
                        
                        19,618,285Cash
      and cash equivalents at end of year
                        
                        $
                        22,145,867
                        
                        
                        $
                        9,297,346
                        
                        
                        $
                        13,265,547Supplemental
      disclosure of cash flow information:Cash
      paid during the year for:Interest
      expense
                        
                        $
                        5,653,063
                        
                        
                        $
                        7,184,869
                        
                        
                        $
                        5,472,442Income
      taxes
                        
                        $
                        1,727,000
                        
                        
                        $
                        740,000
                        
                        
                        $
                        1,750,000Non-cash
      investing activities:Net
      change in unrealized gain/loss on available-for-sale investment
      securities
                        
                        $
                        254,636
                        
                        
                        $
                        340,454
                        
                        
                        $
                        458,074







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 December 31, 2009, 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 2008.





Stock
Dividends





On May
20, 2008 and May 15, 2007 the Board of Directors declared a 5% stock dividend
payable on June 25, 2008 and June 20, 2007, respectively, to shareholders of
record on June 11, 2008 and June 6, 2007, 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, 2008.





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. Once a decline in value is determined to be
other than temporary, the value of the security is reduced and a corresponding
charge to earnings is recognized.




55
 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, 2008, 2007, and 2006,
Federal Home Loan Bank stock totaled $1,104,200, $1,658,600, and $1,825,900
respectively.  On the consolidated balance sheet, Federal Home Loan
Bank stock is included in accrued interest receivable and other
assets.





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, 2008 and 2007, there were no loans
being accounted for under this policy.




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, 2008 and 2007,
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, 2008 and 2007.





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)





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 and
$62,538 for each of the years in the two-year period ended December 31,
2007.  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.





Accounting for Uncertainty
in Income Taxes





Since
January 1, 2007, the Company has accounted for uncertainty in income taxes under
Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income
Taxes (“FIN 48”). Under the provisions of FIN 48 only tax
positions that met the more-likely-than-not recognition threshold on
January 1, 2007 were recognized or continue to be recognized upon
adoption.  The Company previously recognized income tax positions
based on management's estimate of whether it was reasonably possible that a
liability had been incurred for unrecognized income tax benefits by applying
FASB Statement No. 5, Accounting for
Contingencies.





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.





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





58
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VALLEY COMMERCE
BANCORP AND SUBSIDIARY
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 (Continued)


2.         SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (Continued)





Earnings Per
Share





Basic
earnings per share (EPS), which excludes dilution, is computed by dividing
income 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.





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, 2008, 2007 and 2006, the Company recorded
compensation expense of $59,883, $44,410 and $38,719,
respectively.  As a result of recognizing the compensation expense,
the Company’s net income was reduced by $52,971, $31,402 and $31,510, for years
ended December 31, 2008, 2007 and 2006, respectively.  For the years
ended December 31, 2008, 2007 and 2006 basic and diluted earnings per were not
impacted as a result of recognizing the compensation expense.





As of
December 31, 2008, there was $191,886 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 1.84 years.





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 2008. There were 40,425 stock options granted
in 2007 and 11,025 in 2006.  The fair value of each option granted in
2007 and 2006 was estimated on the date of grant using an option-pricing model
with the following assumptions:





2007
                    
                    
                    2006Weighted
      average fair value of options granted
                    
                    $
                    7.07
                    
                    
                    $
                    7.61Dividend
      yield
                    
                    
                    N/A
                    
                    
                    
                    N/AExpected
      volatility
                    
                    
                    28.22
                    %
                    
                    
                    11.27
                    %Risk-free
      interest rate
                    
                    
                    3.49
                    %
                    
                    
                    5.11
                    %Expected
      option life
                    
                    7.5
      years
                    
                    
                    7.5
      years





59
 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





The Fair
Value Option for Financial Assets and Financial Liabilities




In
February 2007, the FASB issued Statement of Financial Accounting Standards No.
159, The Fair Value Option for
Financial Assets and Financial Liabilities (“SFAS No. 159”), which
permits fair value accounting to be irrevocably elected for certain financial
assets and liabilities at certain measurement dates.  For those
instruments for which fair value accounting is elected, changes in fair value
will be recognized in earnings and fees and costs associated with origination or
acquisition will be recognized as incurred rather than deferred.  The
Bank adopted SFAS No. 159 on January 1, 2008, but did not elect the fair value
option for any assets or liabilities during the year ended December 31,
2008.





Business
Combinations




In
December 2007, the FASB issued Statement of Financial Accounting Standards No.
141 (revised 2007), Business
Combinations(“SFAS No. 141R”).  SFAS No. 141(R), among other
things, establishes principles and requirements for how the acquirer in a
business combination (i) recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed, and any non-controlling
interest in the acquired business, (ii) recognizes and measures the goodwill
acquired in the business combination or a gain from a bargain purchase, and
(iii) determines what information to disclose to enable users of the financial
statements to evaluate the nature and financial effects of the business
combination.  The Bank is required to adopt SFAS No. 141(R) for all
business combinations for which the acquisition date is on or after January 1,
2009.  This standard will change the Bank’s accounting treatment for
business combinations on a prospective basis.





The
Hierarchy of Generally Accepted Accounting Principles




In May
2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles (SFAS No. 162). This standard identifies the
sources of accounting principles and the framework for selecting the principles
to be used in the preparation of financial statements of nongovernmental
entities that are presented in conformity with GAAP. It establishes that the
GAAP hierarchy should be directed to entities because it is the entity (not the
auditor) that is responsible for selecting accounting principles for financial
statements that are presented in conformity with GAAP. SFAS 162 became effective
onNovember
15, 2008. The implementation of SFAS No. 162 did not have any effect on the
Company’s consolidated financial statements.





Employers’
Disclosures about Postretirement Benefit Plan Assets




In
December 2008, the FASB issued FASB Staff Position (“FSP”) SFAS No. 132(R)-1,
Employers’ Disclosures about
Postretirement Benefit Plan Assets(FSP 132(R)-1). This standard provides
guidance on an employer’s disclosures about plan assets of a defined benefit
pension or other postretirement plan.  The objectives of the
disclosures about plan assets in an employer’s defined benefit pension or other
postretirement plan are to provide users of financial statements with an
understanding of how investment allocation decisions are made, including the
factors that are pertinent to an understanding of investment policies and
strategies, the major categories of plan assets, the inputs and valuation
techniques used to measure the fair value of plan assets, the effect of fair
value measurements using significant unobservable inputs (Level 3) on changes in
plan assets for the period, and significant concentrations of risk within plan
assets.  The disclosures about plan assets required by the FSP are
effective for fiscal years ending after December 15, 2009. Early adoption is
permitted.  The adoption of FSP 132(R)-1 is not expected to have a
material impact on the Company’s financial position, results of operations or
cash flows.





60
 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, 2008
                          
                          
                          December
      31, 2007Carrying
                          
                          
                          Fair
                          
                          
                          Carrying
                          
                          
                          FairAmount
                          
                          
                          Value
                          
                          
                          Amount
                          
                          
                          ValueFinancial
      assets:Cash
      and cash equivalents
                          
                          $
                          22,145,867
                          
                          
                          $
                          22,145,867
                          
                          
                          $
                          9,297,346
                          
                          
                          $
                          9,297,346Investment
      securities
                          
                          
                          42,018,000
                          
                          
                          
                          42,018,000
                          
                          
                          
                          56,615,000
                          
                          
                          
                          56,615,000Loans,
      net
                          
                          
                          226,696,838
                          
                          
                          
                          220,628,940
                          
                          
                          
                          199,514,271
                          
                          
                          
                          192,838,151Cash
      surrender value of lifeinsurance policies
                          
                          
                          6,421,863
                          
                          
                          
                          6,421,863
                          
                          
                          
                          6,184,531
                          
                          
                          
                          6,184,531Accrued
      interest receivable
                          
                          
                          1,351,939
                          
                          
                          
                          1,351,939
                          
                          
                          
                          2,774,065
                          
                          
                          
                          2,774,065FHLB
      stock
                          
                          
                          1,104,200
                          
                          
                          
                          1,104,200
                          
                          
                          
                          1,658,600
                          
                          
                          
                          1,658,600Financial
      liabilities:Deposits
                          
                          $
                          257,323,433
                          
                          
                          $
                          256,576,304
                          
                          
                          $
                          215,386,068
                          
                          
                          $
                          214,836,974FHLB
      advances
                          
                          
                          8,000,000
                          
                          
                          
                          8,000,000
                          
                          
                          
                          21,804,000
                          
                          
                          
                          21,804,000FHLB
      term borrowing
                          
                          
                          5,184,246
                          
                          
                          
                          4,976,558
                          
                          
                          
                          8,146,049
                          
                          
                          
                          7,977,153Junior
      subordinated deferrableinterest debentures
                          
                          
                          3,093,000
                          
                          
                          
                          866,000
                          
                          
                          
                          3,093,000
                          
                          
                          
                          3,093,000Accrued
      interest payable
                          
                          
                          296,779
                          
                          
                          
                          296,779
                          
                          
                          
                          231,342
                          
                          
                          
                          231,342





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, 2008 and 2007:





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.





61
 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.





On
January 1, 2008, the Bank adopted Financial Accounting Standards Board (FASB)
Statement No. 157 (SFAS 157),Fair Value
Measurements.  SFAS No. 157 defines fair value,
establishes a framework for measuring fair value under GAAP, and expands
disclosures about fair value measurement.  There was no cumulative
effect adjustment to beginning retained earnings recorded upon adoption and no
impact on the financial statements during 2008.





On
October 10, 2008, the FASB issued FSP FAS 157-3, Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active. The FSP is
effective immediately, clarifies the application of FASB Statement No. 157, Fair
Value Measurements, in a market that is not active and provides an example to
illustrate key considerations in determining the fair value of a financial asset
when the market for that financial asset is not active.





The
following tables present information about the Company’s assets and liabilities
measured at fair value on a recurring and non recurring basis as of December 31,
2008, and indicates the fair value hierarchy of the valuation techniques
utilized by the Company to determine such fair value based on the
hierarchy:





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.





62
 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)





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.





There
were no changes in the valuation techniques used during 2008.  Assets
and liabilities measured at fair value on a recurring basis are summarized
below:





Fair
      Value Measurementsat December 31, 2008, UsingQuoted
      Pricesin
      ActiveMarkets
      for
                        
                        
                        Other
                        
                        
                        Significantfor
      Identical
                        
                        
                        Observable
                        
                        
                        UnobservableDecember
      31,
                        
                        
                        Assets
                        
                        
                        Inputs
                        
                        
                        InputsDescription
                        
                        2008
                        
                        
                        (Level 1)
                        
                        
                        (Level 2)
                        
                        
                        (Level 3)Assets:Available-for-sale
      securities
                        
                        $
                        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 2008. Changes in fair market
value are recorded in other comprehensive income.





63
 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)




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





Fair
      Value Measurementsat December 31, 2008, UsingQuoted
      Pricesin
      ActiveMarkets
      for
                    
                    
                    Other
                    
                    
                    Significantfor
      Identical
                    
                    
                    Observable
                    
                    
                    UnobservableDecember
      31,
                    
                    
                    Assets
                    
                    
                    Inputs
                    
                    
                    InputsDescription
                    
                    2008
                    
                    
                    (Level 1)
                    
                    
                    (Level 2)
                    
                    
                    (Level 3)Assets:Impaired
      loans
                    
                    $
                    2,420,903
                    
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    2,420,903




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
balance of $2,845,903 with a related valuation allowance of $425,000 at December
31, 2008.





4.         AVAILABLE-FOR-SALE
INVESTMENT SECURITIES





The
amortized cost and estimated fair value of available-for-sale investment
securities at December 31, 2008 and 2007 consisted of the
following:





2008Gross
                              
                              
                              Gross
                              
                              
                              EstimatedAmortized
                              
                              
                              Unrealized
                              
                              
                              Unrealized
                              
                              
                              FairCost
                              
                              
                              Gains
                              
                              
                              Losses
                              
                              
                              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
                              
                              
                              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





64
 Table of Contents




VALLEY COMMERCE
BANCORP AND SUBSIDIARY
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 (Continued)


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 loss 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 $46,412, respectively.





2007Gross
                        
                        
                        Gross
                        
                        
                        EstimatedAmortized
                        
                        
                        Unrealized
                        
                        
                        Unrealized
                        
                        
                        FairCost
                        
                        
                        Gains
                        
                        
                        Losses
                        
                        
                        ValueDebt
      securities:U.S.
      Treasury securities
                        
                        $
                        246,466
                        
                        
                        $
                        17,401
                        
                        
                        $
                        -
                        
                        
                        $
                        263,867U.S.
      Government agencies
                        
                        
                        17,297,622
                        
                        
                        
                        62,845
                        
                        
                        
                        (70,334
                        )
                        
                        $
                        17,290,133Mortgage-backed
      securities
                        
                        
                        16,853,448
                        
                        
                        
                        191,633
                        
                        
                        
                        (85,081
                        )
                        
                        
                        16,960,000Municipal
      securities
                        
                        
                        19,303,490
                        
                        
                        
                        41,984
                        
                        
                        
                        (226,474
                        )
                        
                        
                        19,119,000Corporate
      debt securities
                        
                        
                        3,005,110
                        
                        
                        
                        651
                        
                        
                        
                        (23,761
                        )
                        
                        
                        2,982,000$
                        56,706,136
                        
                        
                        $
                        314.514
                        
                        
                        $
                        (405,650
                        )
                        
                        $
                        56,615,000





Net
unrealized losses on available-for-sale investment securities totaling $91,136
were recorded, net of $29,957 in tax benefits, as accumulated other
comprehensive loss within shareholders' equity at December 31,
2007.  Proceeds and realized losses from the sale of
available-for-sale investment securities for the year ended December 31,
2007 totaled $1,508,855 and $1,145, respectively. Proceeds and realized losses
from the sale of available-for-sale investment securities for the year ended
December 31, 2006 totaled $3,907,737 and $52,737, respectively.





65
 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, 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
                        
                        $
                        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
                        )







Investment
securities with unrealized losses at December 31, 2007 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:U.S.
      Governmentagencies
                              
                              $
                              1,489,000
                              
                              
                              $
                              (3,028
                              )
                              
                              $
                              8,741,000
                              
                              
                              $
                              (67,306
                              )
                              
                              $
                              10,230,000
                              
                              
                              $
                              (70,334
                              )Mortgage-backedsecurities
                              
                              
                              992,000
                              
                              
                              
                              (632
                              )
                              
                              
                              5,687,000
                              
                              
                              
                              (84,449
                              )
                              
                              
                              6,679,000
                              
                              
                              
                              (85,081
                              )Municipal
      securities 12,384,000
                              
                              
                              (213,024
                              )
                              
                              
                              1,035,000
                              
                              
                              
                              (13,450
                              )
                              
                              
                              13,419,000
                              
                              
                              
                              (226,474
                              )Corporate
      debtsecurities
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              2,478,000
                              
                              
                              
                              (23,761
                              )
                              
                              
                              2,478,000
                              
                              
                              
                              (23,761
                              )$
                              14,865,000
                              
                              
                              $
                              (216,684
                              )
                              
                              $
                              17,941,000
                              
                              
                              $
                              (188,966
                              )
                              
                              $
                              32,806,000
                              
                              
                              $
                              (405,650
                              )





Mortgage-backed
Obligations





At
December 31, 2008, the Company held 46 mortgage-backed obligations of which 4
were in a loss position for less than twelve months and none were in a loss
position for twelve months or more.  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, 2008.





Municipal
Securities





At
December 31, 2008, the Company held 62 obligations of states and political
subdivision securities of which 41 were in a loss position for less than twelve
months and 5 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, 2008.





66
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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, 2008 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.





EstimatedAmortized
                            
                            
                            FairCost
                            
                            
                            ValueWithin
      one year
                            
                            $
                            999,716
                            
                            
                            $
                            1,026,000After
      one year through five years
                            
                            
                            3,555,306
                            
                            
                            
                            3,699,000After
      five years through ten years
                            
                            
                            5,549,324
                            
                            
                            
                            5,638,000After
      ten years
                            
                            
                            16,648,415
                            
                            
                            
                            16,001,00026,752,761
                            
                            
                            
                            26,364,000Investment
      securities not due at a single maturity
      date:Mortgage-backed
      securities
                            
                            
                            15,101,739
                            
                            
                            
                            15,654,000$
                            41,854,500
                            
                            
                            $
                            42,018,000





At
December 31, 2008 and 2007, 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
      31,2008
                        
                        
                        2007Commercial
                        
                        $
                        58,324,986
                        
                        
                        $
                        41,823,876Real
      estate - mortgage
                        
                        
                        129,267,195
                        
                        
                        
                        106,872,707Real
      estate – construction
                        
                        
                        35,113,099
                        
                        
                        
                        44,896,223Agricultural
                        
                        
                        4,010,551
                        
                        
                        
                        4,987,839Consumer
      and other
                        
                        
                        3,566,210
                        
                        
                        
                        2,994,997230,282,041
                        
                        
                        
                        201,575,642Deferred
      loan fees, net
                        
                        
                        (340,749
                        )
                        
                        
                        (303,780
                        )Allowance
      for loan losses
                        
                        
                        (3,244,454
                        )
                        
                        
                        (1,757,591
                        )$
                        226,696,838
                        
                        
                        $
                        199,514,271





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





67
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VALLEY COMMERCE
BANCORP AND SUBSIDIARY
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 (Continued)


5.         LOANS
AND THE ALLOWANCE FOR LOAN LOSSES





Changes
in the allowance for loan losses were as follows:





Year Ended December 31,2008
                        
                        
                        2007
                        
                        
                        2006Balance,
      beginning of year
                        
                        $
                        1,757,591
                        
                        
                        $
                        1,745,582
                        
                        
                        $
                        1,766,115Provision
      charged to operations
                        
                        
                        1,600,000
                        
                        
                        
                        -
                        
                        
                        
                        -Losses
      charged to allowance
                        
                        
                        (141,456
                        )
                        
                        
                        -
                        
                        
                        
                        (20,833
                        )Recoveries
                        
                        
                        28,319
                        
                        
                        
                        12,009
                        
                        
                        
                        300Balance,
      end of year
                        
                        $
                        3,244,454
                        
                        
                        $
                        1,757,591
                        
                        
                        $
                        1,745,582





The
recorded investment in loans that were considered to be impaired totaled
$4,932,424 of which $2,845,903 had a related allowance for loan losses
of $425,000 at December 31, 2008.  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, 2008 was $1,453,620. The average
recorded investment in impaired loans for the year ended December 31, 2007 was
$8,680.  The Company recognized $52,494 in interest income on a cash
basis for impaired loans during the year ended December 31,
2008.  There was no interest income recognized on a cash basis for
impaired loans during the years ended December 31, 2007, and 2006.





There was
$4,932,424 in nonaccrual loans at December 31, 2008.  There were no
nonaccrual loans at December 31, 2007.  There was $27,252 interest
foregone on nonaccrual loans for the year ended December 31,
2008.  There was no interest foregone on nonaccrual loans for the
years ended December 31, 2007 and 2006.





Salaries
and employee benefits totaling $691,755, $687,155 and $551,154 have been
deferred as loan origination costs during the years ended December 31, 2008,
2007 and 2006, respectively.





6.         PREMISES
AND EQUIPMENT





Premises
and equipment consisted of the following:





December 31,2008
                          
                          
                          2007Furniture
      and equipment
                          
                          $
                          2,805,728
                          
                          
                          $
                          2,334,786Construction
      in progress
                          
                          
                          5,957
                          
                          
                          
                          756,617Premises
                          
                          
                          2,094,517
                          
                          
                          
                          614,477Leasehold
      improvements
                          
                          
                          550,548
                          
                          
                          
                          522,057Land
                          
                          
                          601,530
                          
                          
                          
                          452,3206,058,280
                          
                          
                          
                          4,680,257Less
      accumulated depreciationand
      amortization
                          
                          
                          (2,083,435
                          )
                          
                          
                          (1,643,194
                          )$
                          3,974,845
                          
                          
                          $
                          3,037,063





68
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VALLEY COMMERCE
BANCORP AND SUBSIDIARY
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 (Continued)


Depreciation
and amortization included in occupancy and equipment expense totaled $466,069,
$315,365 and $242,116 for the years ended December 31, 2008, 2007 and 2006,
respectively.





7.         INTEREST-BEARING
DEPOSITS





Interest-bearing
deposits consisted of the following:





December
      31,2008
                      
                      
                      2007Savings
                      
                      $
                      8,617,400
                      
                      
                      $
                      8,355,350Money
      market
                      
                      
                      46,369,197
                      
                      
                      
                      48,844,837NOW
      accounts
                      
                      
                      32,751,133
                      
                      
                      
                      29,076,881Time,
      $100,000 or more
                      
                      
                      66,781,933
                      
                      
                      
                      44,013,799Other
      time
                      
                      
                      25,398,253
                      
                      
                      
                      18,102,633$
                      179,917,916
                      
                      
                      $
                      148,393,500





Aggregate
annual maturities of time deposits are as follows:





Year
      EndingDecember 31,2009
                      
                      $
                      89,582,7672010
                      
                      
                      2,099,5382011
                      
                      
                      1,8282012
                      
                      
                      369,1702013
                      
                      
                      126,883$
                      92,180,186





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





Year Ended December 31,2008
                                
                                
                                2007
                                
                                
                                2006Savings
                                
                                $
                                32,431
                                
                                
                                $
                                68,879
                                
                                
                                $
                                95,780Money
      market
                                
                                
                                1,108,286
                                
                                
                                
                                1,545,160
                                
                                
                                
                                1,175,225NOW
      accounts
                                
                                
                                510,100
                                
                                
                                
                                767,979
                                
                                
                                
                                723,834Time,
      $100,000 or more
                                
                                
                                2,414,599
                                
                                
                                
                                2,453,317
                                
                                
                                
                                1,491,363Other
      time
                                
                                
                                835,572
                                
                                
                                
                                967,517
                                
                                
                                
                                820,142$
                                4,900,988
                                
                                
                                $
                                5,802,852
                                
                                
                                $
                                4,306,344








At
December 31, 2008, the contractual maturities of time deposits with a
denomination of $100,000 and over were as follows: $22,695,000 in 3 months or
less, $34,703,000 over 3 months through 6 months, $8,062,000 over 6 months
through 12 months, and $1,332,000 over 12 months.





69
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VALLEY COMMERCE
BANCORP AND SUBSIDIARY
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 (Continued)


Deposit
overdrafts reclassified as loan balances were $1,243,000 and $8,300 at
December 31, 2008 and 2007, 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, 2008 and at December 31, 2007. The Bank also had an
unsecured line of credit of $3,000,000 with a second correspondent bank at
December 31, 2007.  This bank withdrew its correspondent line during
2008. There were no borrowings outstanding under either of these borrowing
arrangements as of December 31, 2008 and 2007.





Federal Home Loan Bank
Advances and Term Borrowings





At
December 31, 2008 and 2007 the Bank could borrow up to 49% of pledged real
estate mortgage loans from the Federal Home Loan Bank of San Francisco
(FHLB).  As of December 31, 2008 and 2007, the Bank had pledged
investment securities with total carrying market values of $9,150,000 and
$30,048,000 respectively.  As of December 31, 2008 and 2007, the Bank
had pledged loans with total carrying values of $61,189,000 and $56,102,000,
respectively.  At December 31, 2008 borrowings were comprised of
$8,000,000 in advances (less than twelve months) with fixed rate debt with
a weighted average interest rate of 2.71%, and $5,184,346 of term borrowing
fixed rate debt with a weighted average interest rate and maturity of 5.16% and
1.93 years, respectively. At December 31, 2007, the Company had $21,804,000 in
advances (one day) adjustable rate debt with an interest rate of 3.25% and term
borrowings totaling $8,146,049 with a weighted average interest rate and
maturity of 4.38% and 2.2 years, respectively.





As of
December 31, 2008 and 2007, outstanding term borrowings from the Federal Home
Loan Bank (FHLB) consisted of the following:





2008
                                
                                2007Amount
                                
                                
                                Rate
                                
                                Maturity Date
                                
                                Amount
                                
                                
                                Rate
                                
                                Maturity Date$
                                900,000
                                
                                
                                
                                3.08
                                %
                                March
      6, 20081,600,000
                                
                                
                                
                                2.67
                                %
                                May
      27, 2008250,000
                                
                                
                                
                                3.71
                                %
                                October
      22, 2008$
                                900,000
                                
                                
                                
                                3.94
                                %
                                April
      27, 2009
                                
                                
                                900,000
                                
                                
                                
                                3.94
                                %
                                April
      27, 2009400,000
                                
                                
                                
                                4.51
                                %
                                May
      12, 2009
                                
                                
                                400,000
                                
                                
                                
                                4.51
                                %
                                May
      12, 2009926,878
                                
                                
                                
                                7.41
                                %
                                June
      22, 2010
                                
                                
                                953,614
                                
                                
                                
                                7.41
                                %
                                June
      22, 2010100,000
                                
                                
                                
                                5.09
                                %
                                May
      12, 2011
                                
                                
                                100,000
                                
                                
                                
                                5.09
                                %
                                May
      12, 2011607,468
                                
                                
                                
                                4.01
                                %
                                December
      6, 2011
                                
                                
                                792,435
                                
                                
                                
                                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$
                                5,184,346
                                
                                
                                
                                
                                
                                
                                
                                $
                                8,146,049




70
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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 31,2009
                    
                    $
                    1,522,3472010
                    
                    
                    1,100,3512011
                    
                    
                    1,561,6482012
                    
                    
                    1,000,000$
                    5,184,346





Federal Reserve Discount
Window Borrowing Arrangement





At
December 31, 2008 the Bank could borrow up to 75% of pledged commercial loans
from the Federal Reserve Bank of San Francisco under the discount window
borrowing program.  As of December 31, 2008, the Bank had pledged
loans with total carrying values of $78,828,000.  There are no
borrowings with the Federal Reserve Bank of San Francisco at December 31,
2008.





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 8.05% (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, 2008, the rate was
8.05%.  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





71
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VALLEY COMMERCE
BANCORP AND SUBSIDIARY
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 (Continued)


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.














10.         COMMITMENTS
AND CONTINGENCIES





Leases





The
Company leases its Fresno and Visalia branch offices under noncancelable
operating leases which expire in September 2017 and November 2009,
respectively.  The Company’s administrative office is leased on a
month to month basis.  Future minimum lease payments, including lease
payments for the Visalia Branch office and Administrative office for 2009 only,
are as follows:





Year
      EndingDecember 31,2009
                    
                    $
                    302,9182010
                    
                    
                    94,9422011
                    
                    
                    94,9422012
                    
                    
                    99,8282013
                    
                    
                    114,488Thereafter
                    
                    
                    429,332$
                    1,136,450





Rental
expense included in occupancy and equipment expense totaled $328,344, $309,657,
and $293,504 for the years ended December 31, 2008, 2007 and 2006,
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.





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.




72
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VALLEY COMMERCE
BANCORP AND SUBSIDIARY
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 (Continued)


10.         COMMITMENTS AND CONTINGENCIES(Continued)




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





December
      31,2008
                      
                      
                      2007Commitments
      to extend credit
                      
                      $
                      47,408,977
                      
                      
                      $
                      53,452,752Standby
      letters of credit
                      
                      $
                      337,330
                      
                      
                      $
                      209,463




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, 2008 or
2007.  The Company recognizes these fees as revenue over the term of
the commitment or when the commitment is used.





At
December 31, 2008, consumer loan commitments represent approximately 5% of total
commitments and are generally unsecured.  Commercial loan commitments
represent approximately 64% of total commitments and are generally secured by
various assets of the borrower.  Real estate loan commitments
represent the remaining 31% 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.





73
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VALLEY COMMERCE
BANCORP AND SUBSIDIARY
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 (Continued)


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.





74
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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, 2008, the maximum amount available for dividend distribution
under this restriction was approximately $7,728,00.  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 8).





As
discussed more fully in Note 18, beginning in 2009 the Company will be
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.





Earnings Per
Share





A
reconciliation of the numerators and denominators of the basic and diluted
earnings per share computations is as follows:




WeightedNet
                          
                          
                          AverageShares
                          
                          
                          Number
      of
                          
                          
                          Per
      ShareFor the Year Ended
                          
                          Income
                          
                          
                          Outstanding
                          
                          
                          AmountDecember 31, 2008Basic
      earnings per share
                          
                          $
                          1,848,589
                          
                          
                          
                          2,471,550
                          
                          
                          $
                          0.75Effect
      of dilutive stock options
                          
                          
                          
                          
                          
                          
                          26,831Diluted
      earnings per share
                          
                          $
                          1,848,589
                          
                          
                          
                          2,498,381
                          
                          
                          $
                          0.74




75
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VALLEY COMMERCE
BANCORP AND SUBSIDIARY
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 (Continued)


11.         SHAREHOLDERS' EQUITY(Continued)





Earnings Per Share
(Continued)





December
      31, 2007Basic
      earnings per share
                              
                              $
                              2,660,850
                              
                              
                              
                              2,476,271
                              
                              
                              $
                              1.07Effect
      of dilutive stock options
                              
                              
                              
                              
                              
                              
                              95,063Diluted
      earnings per share
                              
                              $
                              2,660,850
                              
                              
                              
                              2,571,334
                              
                              
                              $
                              1.03December
      31, 2006Basic
      earnings per share
                              
                              $
                              2,955,778
                              
                              
                              
                              2,427,747
                              
                              
                              $
                              1.22Effect
      of dilutive stock options
                              
                              
                              
                              
                              
                              
                              122,787Diluted
      earnings per share
                              
                              $
                              2,955,778
                              
                              
                              
                              2,550,534
                              
                              
                              $
                              1.16





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 antidilutive 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.  There were no options excluded from the computation of
diluted earnings per share for the years ended December 31,
2006.





Stock-Based
Compensation





The
Company has two active share based compensation plans.  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, 91,357
shares of common stock are reserved for issuance to employees and directors
under incentive and nonstatutory agreements.  There were no options
granted during the year ended December 31, 2008.  During the year
ended December 31, 2007 a total of 40,425 options were granted under the
Incentive Plan.  On February 17, 2007 the Valley Commerce Bancorp
Amended and Restated 1997 Stock Option Plan (‘Prior Plan”)
expired.  Under the Prior Plan, 144,227 shares of common stock are
reserved for issuance.  Subsequent to the 11,025 options granted
during the year ended December 31, 2006, there were no additional options
granted under the Prior Plan and no further grants may be made under this
plan.  The purpose of the plans is to align the interests of
management and the shareholders 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.





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.





76
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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 Year Ended December 31,
      2008Weighted
                                                        
                                                        
                                                        Weighted
      AverageAverage
                                                        
                                                        
                                                        Remaining
                                                        
                                                        
                                                        AggregateShares
                                                        
                                                        
                                                        Exercise
      Price
                                                        
                                                        
                                                        Contractual
      Term
                                                        
                                                        
                                                        IntrinsicValueIncentive:Options
      outstanding at January 1, 2006
                                                        
                                                        
                                                        39,378
                                                        
                                                        
                                                        $
                                                        7.81Options
      granted
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -Options
      exercised
                                                        
                                                        
                                                        (1,700
                                                        )
                                                        
                                                        
                                                        6.70Options
      cancelled
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -Options
      outstanding at December 31, 2006
                                                        
                                                        
                                                        37,678
                                                        
                                                        
                                                        $
                                                        7.81Options
      granted
                                                        
                                                        
                                                        40,425
                                                        
                                                        
                                                        
                                                        13.81Options
      exercised
                                                        
                                                        
                                                        (2,009
                                                        )
                                                        
                                                        
                                                        6.47Options
      cancelled
                                                        
                                                        
                                                        (638
                                                        )
                                                        
                                                        
                                                        10.97Options
      outstanding at December 31, 2007
                                                        
                                                        
                                                        75,456
                                                        
                                                        
                                                        
                                                        11.03Options
      granted
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -Options
      exercised
                                                        
                                                        
                                                        (362
                                                        )
                                                        
                                                        
                                                        10.97Options
      cancelled
                                                        
                                                        
                                                        (3,768
                                                        )
                                                        
                                                        
                                                        13.74Options
      outstanding at December 31, 2008
                                                        
                                                        
                                                        71,326
                                                        
                                                        
                                                        
                                                        10.88
                                                        
                                                        
                                                        6.35
      years
                                                        
                                                        
                                                        $
                                                        82,368
                                                        (1)Options
      vested or expected to vest atDecember 31,
    2008
                                                        
                                                        
                                                        67,845
                                                        
                                                        
                                                        
                                                        10.76
                                                        
                                                        
                                                        6.20
      years
                                                        
                                                        
                                                        $
                                                        76,043
                                                        (2)Options
      exercisable atDecember
      31, 2008
                                                        
                                                        
                                                        40,051
                                                        
                                                        
                                                        
                                                        8.73
                                                        
                                                        
                                                        4.49
      years
                                                        
                                                        
                                                        $
                                                        82,368
                                                        (2)Nonstatutory:Options
      outstanding at January 1, 2006
                                                        
                                                        
                                                        224,629
                                                        
                                                        
                                                        $
                                                        7.47Options
      granted
                                                        
                                                        
                                                        11,025
                                                        
                                                        
                                                        
                                                        17.69Options
      exercised
                                                        
                                                        
                                                        (24,912
                                                        )
                                                        
                                                        
                                                        5.74Options
      cancelled
                                                        
                                                        
                                                        (1,093
                                                        )
                                                        
                                                        
                                                        6.73Options
      outstanding at December 31, 2006
                                                        
                                                        
                                                        209,649
                                                        
                                                        
                                                        $
                                                        7.47Options
      granted
                                                        
                                                        
                                                        -Options
      exercised
                                                        
                                                        
                                                        (100,468
                                                        )
                                                        
                                                        
                                                        6.03Options
      cancelled
                                                        
                                                        
                                                        -Options
      outstanding at December 31, 2007
                                                        
                                                        
                                                        109,181
                                                        
                                                        
                                                        
                                                        8.67Options
      granted
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -Options
      exercised
                                                        
                                                        
                                                        (14,774
                                                        )
                                                        
                                                        
                                                        5.87Options
      cancelled
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -Options
      outstanding at December 31, 2008
                                                        
                                                        
                                                        94,407
                                                        
                                                        
                                                        
                                                        9.10
                                                        
                                                        
                                                        3.68
      years
                                                        
                                                        
                                                        $
                                                        189,989
                                                        (3)Options
      vested or expected to vest atDecember 31,
    2008
                                                        
                                                        
                                                        93,834
                                                        
                                                        
                                                        
                                                        9.25
                                                        
                                                        
                                                        4.75
      years
                                                        
                                                        
                                                        $
                                                        56,487
                                                        (3)Options
      exercisable at December 31, 2008
                                                        
                                                        
                                                        89,997
                                                        
                                                        
                                                        
                                                        8.69
                                                        
                                                        
                                                        3.50
      years
                                                        
                                                        
                                                        $
                                                        180,764
                                                        (4)




(1)
       46,042 options are excluded from
intrinsic value because they are not in the money.
 (2)        14,768
options are excluded from intrinsic value because they are not in the
money.
 (3)   
    32,905 options are excluded from intrinsic value because
they are not in the money.
 (4)    
   28,495 options are excluded from intrinsic value because they
are not in the money.


77
 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, 2008.  There
were 15,136, 102,477 and 26,612 options exercised during the years ended
December 31, 2008, 2007 and 2006, respectively.  The total intrinsic
value of options exercised during the years ended December 31, 2008, 2007, and
2006 was $18,151, $1,152,962, and $331,737, respectively.  The total
fair value of shares vested during the years ended December 31, 2008, 2007, and
2006 was $155,492, $219,283, and $295,328, respectively.




Cash
received from option exercise for the years ended December 31, 2008, 2007, and
2006 was $90,644, $556,335, and $154,402, respectively.  The total tax
benefit of the non-qualified options exercised in 2008 and 2007, and 2006 was
$30,338, $335,894 and $125,828, respectively.





The
Company bases the fair value of the options granted on the date of grant using a
Black-Scholes-Merton option pricing model that uses assumptions based on
expected option life and the level of estimated forfeitures, expected stock
volatility, risk free interest rate, and dividend yield.  The Company
uses historical data to estimate expected option life.  Stock
volatility is based on the historical volatility of the Company’s
stock.  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 grant.





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, 2008 and
2007.





78
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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
      31,2008
                                                
                                                
                                                2007Amount
                                                
                                                
                                                Ratio
                                                
                                                
                                                Amount
                                                
                                                
                                                RatioLeverage RatioValley
      Commerce Bancorp and
    Subsidiary
                                                
                                                $
                                                33,044,000
                                                
                                                
                                                
                                                10.9
                                                %
                                                
                                                $
                                                31,927,000
                                                
                                                
                                                
                                                11.5
                                                %Minimum
      regulatory requirement
                                                
                                                $
                                                12,150,000
                                                
                                                
                                                
                                                4.0
                                                %
                                                
                                                $
                                                11,101,000
                                                
                                                
                                                
                                                4.0
                                                %Valley
      Business Bank
                                                
                                                $
                                                32,751,000
                                                
                                                
                                                
                                                10.8
                                                %
                                                
                                                $
                                                31,538,000
                                                
                                                
                                                
                                                11.4
                                                %Minimum
      requirement for "Well-Capitalized"institution
                                                
                                                $
                                                15,181,000
                                                
                                                
                                                
                                                5.0
                                                %
                                                
                                                $
                                                13,871,000
                                                
                                                
                                                
                                                5.0
                                                %Minimum
      regulatory requirement
                                                
                                                $
                                                12,145,000
                                                
                                                
                                                
                                                4.0
                                                %
                                                
                                                $
                                                11,097,000
                                                
                                                
                                                
                                                4.0
                                                %Tier 1 Risk-Based Capital
      RatioValley
      Commerce Bancorp and Subsidiary
                                                
                                                $
                                                33,044,000
                                                
                                                
                                                
                                                12.7
                                                %
                                                
                                                $
                                                31,927,000
                                                
                                                
                                                
                                                13.8
                                                %Minimum
      regulatory requirement
                                                
                                                $
                                                10,367,000
                                                
                                                
                                                
                                                4.0
                                                %
                                                
                                                $
                                                9,233,000
                                                
                                                
                                                
                                                4.0
                                                %Valley
      Business Bank
                                                
                                                $
                                                32,751,000
                                                
                                                
                                                
                                                12.6
                                                %
                                                
                                                $
                                                31,538,000
                                                
                                                
                                                
                                                13.7
                                                %Minimum
      requirement for "Well-Capitalized"institution
                                                
                                                $
                                                15,545,000
                                                
                                                
                                                
                                                6.0
                                                %
                                                
                                                $
                                                13,844,000
                                                
                                                
                                                
                                                6.0
                                                %Minimum
      regulatory requirement
                                                
                                                $
                                                10,363,000
                                                
                                                
                                                
                                                4.0
                                                %
                                                
                                                $
                                                9,230,000
                                                
                                                
                                                
                                                4.0
                                                %Total Risk-Based Capital
      RatioValley
      Commerce Bancorp and Subsidiary
                                                
                                                $
                                                36,284,000
                                                
                                                
                                                
                                                14.0
                                                %
                                                
                                                $
                                                33,684,000
                                                
                                                
                                                
                                                14.6
                                                %Minimum
      regulatory requirement
                                                
                                                $
                                                20,734,000
                                                
                                                
                                                
                                                8.0
                                                %
                                                
                                                $
                                                18,465,000
                                                
                                                
                                                
                                                8.0
                                                %Valley
      Business Bank
                                                
                                                $
                                                35,990,000
                                                
                                                
                                                
                                                13.9
                                                %
                                                
                                                $
                                                33,296,000
                                                
                                                
                                                
                                                14.4
                                                %Minimum
      requirement for "Well-Capitalized"institution
                                                
                                                $
                                                25,909,000
                                                
                                                
                                                
                                                10.0
                                                %
                                                
                                                $
                                                23,074,000
                                                
                                                
                                                
                                                10.0
                                                %Minimum
      regulatory requirement
                                                
                                                $
                                                20,728,000
                                                
                                                
                                                
                                                8.0
                                                %
                                                
                                                $
                                                18,459,000
                                                
                                                
                                                
                                                8.0
                                                %





79
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VALLEY COMMERCE
BANCORP AND SUBSIDIARY
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 (Continued)


11.         SHAREHOLDERS' EQUITY(Continued)





Stock
Repurchase





On
November 13, 2007 the Company announced that its Board of Directors authorized a
common stock repurchase plan.  The plan calls for the repurchase up to
an aggregate of $3,000,000 of the Company’s common stock.  The
repurchases will be made from time to time by the Company in the open market or
privately negotiated transactions as conditions allow and all shares repurchased
under this plan will be returned to authorized but unissued
shares.  The number, price and timing of the repurchases 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.  During 2008 the Company repurchased 57,385
shares at an average cost of $14.31 for a total cost of
$821,037.  During 2007 the Company repurchased 28,811 shares at an
average price of $13.25 for a total cost of $381,808.





As
discussed more fully in Note 18, beginning in 2009, the Company will be
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.








12.         OTHER
EXPENSES





Other
expenses consisted of the following:


Year Ended December 31,2008
                        
                        
                        2007
                        
                        
                        2006Data
      processing
                        
                        $
                        523,943
                        
                        
                        $
                        494,863
                        
                        
                        $
                        459,981Operations
                        
                        
                        508,533
                        
                        
                        
                        479,803
                        
                        
                        
                        454,229Professional
      and legal
                        
                        
                        393,924
                        
                        
                        
                        507,920
                        
                        
                        
                        330,101Promotional
                        
                        
                        273,259
                        
                        
                        
                        304,774
                        
                        
                        
                        268,374Supplies
                        
                        
                        258,843
                        
                        
                        
                        187,834
                        
                        
                        
                        180,384Telephone
      and postal
                        
                        
                        215,689
                        
                        
                        
                        213,401
                        
                        
                        
                        205,804Assessment
      and insurance
                        
                        
                        180,925
                        
                        
                        
                        197,225
                        
                        
                        
                        114,270Amortization
      expense
                        
                        
                        7,718
                        
                        
                        
                        62,538
                        
                        
                        
                        62,538Other
      expenses
                        
                        
                        403,479
                        
                        
                        
                        406,835
                        
                        
                        
                        426,249$
                        2,766,313
                        
                        
                        $
                        2,855,193
                        
                        
                        $
                        2,501,930





80
 Table of Contents




VALLEY COMMERCE
BANCORP AND SUBSIDIARY
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 (Continued)


13.         INCOME
TAXES





The
provision for income taxes for the years ended December 31, 2008, 2007 and 2006
consisted of the following:





Federal
                              
                              
                              State
                              
                              
                              Total2008Current
                              
                              $
                              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
                              
                              
                              $
                              1,134,0002006Current
                              
                              $
                              1,107,000
                              
                              
                              $
                              467,000
                              
                              
                              $
                              1,574,000Deferred
                              
                              
                              (6,000
                              )
                              
                              
                              8,000
                              
                              
                              
                              2,000Provision
      for income taxes
                              
                              $
                              1.101,000
                              
                              
                              $
                              475,000
                              
                              
                              $
                              1,576,000




81
 Table of Contents




VALLEY COMMERCE
BANCORP AND SUBSIDIARY
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 (Continued)
  13. INCOME TAXES  (C





Deferred
tax assets (liabilities) consisted of the following:





December 31,2008
                          
                          
                          2007Deferred
      tax assets:Allowance
      for loan losses
                          
                          $
                          1,454,000
                          
                          
                          $
                          740,000Unrealized
      loss on available-for-sale investment
      securities
                          
                          
                          
                          
                          
                          
                          30,000Deferred
      compensation
                          
                          
                          721,000
                          
                          
                          
                          499,000Intangible
      assets
                          
                          
                          76,000
                          
                          
                          
                          92,000Future
      benefit of state income tax deduction
                          
                          
                          
                          
                          
                          
                          20,000Total
      deferred tax assets
                          
                          
                          2,251,000
                          
                          
                          
                          1,381,000Deferred
      tax liabilities:Bank
      premises and equipment
                          
                          
                          
                          
                          
                          
                          (34,000
                          )Loan
      costs
                          
                          
                          (293,000
                          )
                          
                          
                          (261,000
                          )Unrealized
      gain on available-for-sale investment
      securities
                          
                          
                          (67,000
                          )Other
                          
                          
                          (2,000
                          )
                          
                          
                          (35,000
                          )Total
      deferred tax liabilities
                          
                          
                          (362,000
                          )
                          
                          
                          (330,000
                          )Net
      deferred tax assets
                          
                          $
                          1,889,000
                          
                          
                          $
                          1,051,000




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 income before income
taxes.  The items comprising these differences consisted of the
following:





Year Ended December 31,2008
                            
                            
                            2007
                            
                            
                            2006Rate
                            
                            
                            Rate
                            
                            
                            RateFederal
      income tax expense, at statutory
      rate
                            
                            
                            34.0
                            %
                            
                            
                            34.0
                            %
                            
                            
                            34.0
                            %State
      franchise tax, net of Federal tax effect
                            
                            
                            6.4
                            %
                            
                            
                            7.2
                            %
                            
                            
                            7.2
                            %Interest
      on obligations of states and political
      Subdivisions
                            
                            
                            (8.6
                            )%
                            
                            
                            (6.0
                            )%
                            
                            
                            (4.8
                            )%Net
      increase in cash surrender value of bank-owned life
      insurance
                            
                            
                            (3.1
                            )%
                            
                            
                            (2.2
                            )%
                            
                            
                            (1.2
                            )%Other
                            
                            
                            0.1
                            %
                            
                            
                            (0.4
                            )%
                            
                            
                            (3.1
                            )%Total
      income tax expense
                            
                            
                            
                            
                            
                            
                            28.8% 29.9
                            %
                            
                            
                            34.8
                            %
  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, 2005, and by state and
local taxing authorities for years ended before December 31, 2004.
  The
unrecognized tax benefits and the interest and penalties accrued by the Company
as of December 31, 2008 were not
significant.





82
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VALLEY COMMERCE
BANCORP AND SUBSIDIARY
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 (Continued)





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 2008:





Balance,
      January 1, 2008
                        
                        $
                        8,456,436Disbursements
                        
                        
                        2,514,090Amounts
      repaid
                        
                        
                        (2,819,898
                        )Balance,
      December 31, 2008
                        
                        $
                        8,150,628Undisbursed
      commitments to related parties, December 31,
      2008
                        
                        $
                        3,533,226








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.  The Company
matched 70% of the employees’ contributions, applicable to contributions of up
to 6% of the employees’ annual salary beginning in April 2006.  Prior
to that the Company had 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, 2008, 2007, and 2006 totaled $117,036, $112,583,
and $89,493 respectively.





83
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VALLEY COMMERCE
BANCORP AND SUBSIDIARY
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 (Continued)





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, 2008, 2007,
and 2006 totaled $273,442, $229,774, and $184,807, respectively. Income earned
on these policies, net of expenses, totaled $97,228, $111,813, and $108,034 for
the years ended December 31, 2008, 2007 and 2006, respectively. Accrued
compensation payable under the salary continuation plan totaled $1,528,921 and
$1,081,498 at December 31, 2008 and 2007, respectively.  On January 1,
2008 the Company adopted EITF 06-4, Accounting for Deferred Compensation
and Postretirement Benefit Aspects of Endorsed Split-Dollar Life Insurance
Arrangements and recorded a liability of $102,116 for the future benefits
or premiums to be provided to the participants with a corresponding reduction as
a cumulative-effect adjustment to retained earnings.





In
connection with these agreements, the Bank purchased single premium life
insurance policies with cash surrender values totaling $6,421,863 and $6,184,531
at December 31, 2008 and 2007, respectively.  Income earned on
these policies, net of expenses, totaled $237,332, $249,968 and $153,394 for the
years ended December 31, 2008, 2007 and 2006, respectively.  Income
earned on these policies is not subject to Federal and state income
tax.





16.         COMPREHENSIVE
INCOME





Comprehensive
income is reported in addition to net income for all periods
presented.  Comprehensive income 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 and the components of
accumulated other comprehensive income (loss) are presented in the consolidated
statement of changes in shareholders’ equity.







84
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VALLEY COMMERCE
BANCORP AND SUBSIDIARY
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 (Continued)


16.         COMPREHENSIVE
INCOME (Continued)
 At
December 31, 2008, 2007 and 2006, the Company held securities classified as
available-for-sale which had unrealized gains as follows:
 
 TaxBefore
                                
                                
                                Benefit
                                
                                
                                AfterTax
                                
                                
                                (Expense)
                                
                                
                                TaxFor the Year Ended December 31,
      2008Other
      comprehensive income:Unrealized
      holding gains
                                
                                $
                                301,049
                                
                                
                                $
                                (116,337
                                )
                                
                                $
                                184,712Reclassification
      adjustment for gains  included in net
    income
                                
                                
                                46,412
                                
                                
                                
                                (19,099
                                )
                                
                                
                                27,313Total
      other comprehensiveIncome
                                
                                $
                                254,637
                                
                                
                                $
                                (97,238
                                )
                                
                                $
                                157,399


For 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
                                      
                                      $
                                      340,454
                                      
                                      
                                      $
                                      (125,631
                                      )
                                      
                                      $
                                      214,823For the Year Ended December 31,
      2006Other
      comprehensive income:Unrealized
      holding gains
                                      
                                      $
                                      405,337
                                      
                                      
                                      $
                                      (169,943
                                      )
                                      
                                      $
                                      235,394Reclassification
      adjustment for losses included in net income
                                      
                                      
                                      (52,737
                                      )
                                      
                                      
                                      19,012
                                      
                                      
                                      
                                      (33,725
                                      )Total
      other comprehensive Income
                                      
                                      $
                                      458,074
                                      
                                      
                                      $
                                      (188,955
                                      )
                                      
                                      $
                                      269,119





85
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VALLEY COMMERCE
BANCORP AND SUBSIDIARY
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 (Continued)


17.         PARENT
ONLY FINANCIAL STATEMENTS








CONDENSED
BALANCE SHEET


December
31, 2008 and 2007





2008
                      
                      
                      2007ASSETSCash
      and due from banks
                      
                      $
                      207,831
                      
                      
                      $
                      378,772Investment
      in bank subsidiary
                      
                      
                      32,847,042
                      
                      
                      
                      31,484,801Other
      assets
                      
                      
                      287,430
                      
                      
                      
                      214,957$
                      33,342,303
                      
                      
                      $
                      32,078,530LIABILITIES
      ANDSHAREHOLDERS'
      EQUITYOther
      liabilities
                      
                      $
                      109,019
                      
                      
                      $
                      112,319Junior
      subordinated debentures due to subsidiary grantor trust
                      
                      
                      3,093,000
                      
                      
                      
                      3,093,000Total
      liabilities
                      
                      
                      3,202,019
                      
                      
                      
                      3,205,319Shareholders'
      equity:Common
      stock
                      
                      
                      24,684,529
                      
                      
                      
                      23,511,066Retained
      earnings
                      
                      
                      5,359,535
                      
                      
                      
                      5,423,324Accumulated
      other comprehensive loss,net of taxes
                      
                      
                      96,220
                      
                      
                      
                      (61,179
                      )Total
      shareholders' equity
                      
                      
                      30,140,284
                      
                      
                      
                      28,873,211$
                      33,342,303
                      
                      
                      $
                      32,078,530





86
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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, 2008, 2007 and 2006





2008
                              
                              
                              2007
                              
                              
                              2006Income:Dividends declared
      by bank subsidiary
                              
                              $
                              1,000,000
                              
                              
                              $
                              -
                              
                              
                              $
                              -Earnings
      from investment in Valley Commerce Trust I
                              
                              
                              6,575
                              
                              
                              
                              8,139
                              
                              
                              
                              7,917Miscellaneous
      other income
                              
                              
                              96
                              
                              
                              
                              -
                              
                              
                              
                              -Total
      Income
                              
                              
                              1,006,671
                              
                              
                              
                              8,139
                              
                              
                              
                              7,917Expenses:Interest
      on junior subordinated deferrable interest Debentures
                              
                              
                              218,672
                              
                              
                              
                              270,690
                              
                              
                              
                              263,310Other
      expenses
                              
                              
                              483,637
                              
                              
                              
                              531,689
                              
                              
                              
                              390,647Total
      expenses
                              
                              
                              702,309
                              
                              
                              
                              802,379
                              
                              
                              
                              653,957Income
      (loss) before equity in undistributed income of subsidiary
                              
                              
                              304,362
                              
                              
                              
                              (794,240
                              )
                              
                              
                              (646,040
                              )Equity
      in undistributed income of subsidiary
                              
                              
                              1,264,227
                              
                              
                              
                              3,128,090
                              
                              
                              
                              3,335,818Income
      before income taxes
                              
                              
                              1,568,589
                              
                              
                              
                              2,333,850
                              
                              
                              
                              2,689,778Income
      tax benefit
                              
                              
                              280,000
                              
                              
                              
                              327,000
                              
                              
                              
                              266,000Net
      income
                              
                              $
                              1,848,589
                              
                              
                              $
                              2,660,850
                              
                              
                              $
                              2,955,778




87
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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, 2008, 2007 and 2006





2008
                              
                              
                              2007
                              
                              
                              2006Cash
      flows from operating activities:Net
      income
                              
                              $
                              1,848,589
                              
                              
                              $
                              2,660,850
                              
                              
                              $
                              2,955,778Adjustments
      to reconcile net income to net cash provided by (used in) operating
      activities:Undistributed
      net income of subsidiary
                              
                              
                              (1,264,227
                              )
                              
                              
                              (3,128,090
                              )
                              
                              
                              (3,335,818
                              )Stock-based
      compensation expense
                              
                              
                              17,152
                              
                              
                              
                              32,519
                              
                              
                              
                              18,847Tax
      benefits on stock-based compensation
                              
                              
                              (30,338
                              )
                              
                              
                              (335,893
                              )
                              
                              
                              (125,828
                              )(Increase)
      decrease in other assets
                              
                              
                              (42,135
                              )
                              
                              
                              523,238
                              
                              
                              
                              77,182Decrease
      (increase) in other liabilities
                              
                              
                              (3,300
                              )
                              
                              
                              8,041
                              
                              
                              
                              (4,007
                              )Net
      cash provided by (used in) operating activities
                              
                              
                              525,741
                              
                              
                              
                              (239,335
                              )
                              
                              
                              (413,846
                              )Cash
      flows from financing activities:Cash
      paid for fractional shares
                              
                              
                              (3,489
                              )
                              
                              
                              (5,392
                              )
                              
                              
                              (5,004
                              )Proceeds
      from the exercise of stock options
                              
                              
                              97,506
                              
                              
                              
                              556,336
                              
                              
                              
                              154,402Tax
      benefits from stock-based compensation
                              
                              
                              30,338
                              
                              
                              
                              335,893
                              
                              
                              
                              125,828Cash
      paid to repurchase common stock
                              
                              
                              (821,037
                              )
                              
                              
                              (381,808
                              )
                              
                              
                              -Net
      cash (used in) provided by financing activities
                              
                              
                              (696,682
                              )
                              
                              
                              505,029
                              
                              
                              
                              275,226Increase
      (decrease) in cash and cash equivalents
                              
                              
                              (170,941
                              )
                              
                              
                              265,694
                              
                              
                              
                              (138,620
                              )Cash
      and cash equivalents at beginning of year
                              
                              
                              378,772
                              
                              
                              
                              113,078
                              
                              
                              
                              251,698Cash
      and cash equivalents at end of year
                              
                              $
                              207,831
                              
                              
                              $
                              378,772
                              
                              
                              $
                              113,078




88
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VALLEY COMMERCE
BANCORP AND SUBSIDIARY
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 (Continued)




18.         SUBSEQUENT
EVENTS





Issuance of Preferred Stock
to United States Department of the Treasury





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 Perpetual 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.  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. The Company has agreed to register the
Series B Preferred Stock and the Warrant Preferred as soon as practicable
(but not later than 30 days) after demand by the United States Department of the
Treasury.  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 greater than
3% per annum; 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.





89
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VALLEY COMMERCE
BANCORP AND SUBSIDIARY
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 (Continued)





18.         SUBSEQUENT EVENTS(Continued)





Purchase of Office Building
/ Relocation of Headquarters





On
February 20, 2009, the Company completed the purchase of an 18,700 square foot
office building in Visalia, California.  The Company plans to relocate
its administrative office and Visalia branch to the new facility in the latter
part of 2009.





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,
2008, 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, 2008, 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, 2008, 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, 2008, 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, 2008 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 2009 Annual Meeting of Shareholders to be filed pursuant to Regulation
14A (the “2009 Proxy Statement”), which section of the Proxy Statement is
incorporated herein by reference.







ITEM 11 - EXECUTIVE COMPENSATION





The
information required by Items 11 will be included in the 2009 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 2009 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 2009 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 2009 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 BANCORP/s/
      Donald A. GillesBy:
                        
                        Donald
      A. Gilles
                          President
      and Chief Executive Officer/s/
      Roy O. EstridgeBy:
                        
                        Roy
      O. Estridge
                          Executive
      Vice President and Chief Financial OfficerDate:
                        
                        March
      30, 2009

















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
                  March
      30, 2009Donald
      A. Gilles
                  
                  Officer
      (Principal ExecutiveOfficer)/s/ Roy O.
      Estridge
                  
                  Chief
      Financial Officer
                  March
      30, 2009Roy
      O. Estridge
                  
                  (Principal
      Financial Officer and Principal Accounting Officer)/s/ David B.
      Day
                  
                  Director
                  March
      30, 2009David
      B. Day/s/ Walter A.
      Dwelle
                  
                  Chairman
      and Director
                  March
      30, 2009Walter
      A. Dwelle/s/ Thomas A.
      Gaebe
                  
                  Director
                  March
      30, 2009Thomas
      A. Gaebe/s/ Philip R. Hammond,
      Jr.
                  
                  Director
                  March
      30, 2009Philip
      R. Hammond, Jr./s/ Russell F.
      Hurley
                  
                  Vice
      Chairman and Director
                  March
      30, 2009Russell
      F. Hurley/s/ Fred P. LoBue,
      Jr.
                  
                  Secretary
      and Director
                  March
      30, 2009Fred
      P. LoBue, Jr./s/ Kenneth H.
      Macklin
                  
                  Director
                  March
      30, 2009Kenneth
      H. Macklin/s/ Barry R.
      Smith
                  
                  Director
                  March
      30, 2009Barry
      R. Smith





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)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)10.6
                        Valley
      Commerce Bancorp Amended and Restated 1997 Stock Option Plan
      (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)21
                        Subsidiaries
      of the Company (1)23.2
                        Consent of
      Independant Registered Public Accounting Firm date March 27, 2009
      (5)24
                        Powers
      of Attorney (included on signature pages)31
                        Rule
      13a-14(a)/15d-14(a) Certifications32
                        Section
      1350
Certifications


_______________________________________


(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.




(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.




95