UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 Washington,
D.C. 20549
 
 FORM
10-K
 
 ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934
 
 For the
fiscal year ended December 31, 2007
 
 Commission
File Number: 000-31929
 -------------------------SONOMA
      VALLEY BANCORP(Name
      of registrant at as specific in its charter)CALIFORNIA
              
              68-0454068(State
      of incorporation)
              
              (I.R.S.
      Employer Identification No.)202
      West Napa StreetSonoma,
      California 95476(707) 935-3200(Address,
      including zip code, and telephone number,including
      area code, of principal executive offices)------------------------
 Securities
to be registered under section 12(b) of the Exchange
Act:  None
 Securities
to be registered under section 12(g) of the Exchange Act:
 Name
      of each exchangeTitle of each class
              on which registeredCommon
      Stock, No Par Value
              None
 
 Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.
 o Yes x No
 
 Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Exchange Act.
 o Yes x No
 
 Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
 x Yes o No
 
 Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment of this
Form 10-K. x
 
 Indicate
by check mark whether the registrant is a large accelerated filed, an
accelerated filer or a non-accelerated filer.  See definition of
“accelerated filer and large accelerated filer” in Rule 12b-2 of the
Act.
 o Accerlerated Filer   o No
 Non-Accerlerated
Filer x YesSmaller Reporting Filer o No
  Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act.
 o Yes x No
  
  As of
June 30, 2007, the aggregate market value of the registrant’s common stock held
by non-affiliates of the registrant was $51,042,702based on the closing sale price as reported on the Over the
Counter Bulletin Board (“OTC Bulletin Board”).
 
 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 13,
    2008Common
      Stock, no par value per share
              2,288,709
 
 DOCUMENTS
INCORPORATE BY REFERENCE
 
 The
information required by Items 10,11,12,13 and 14 of Part III are incorporated by
reference to the registrant’s proxy statement, which will be filed within 120
days of the registrant’s year end.
  2
  With
the exception of historical facts stated herein, the matters discussed in this
Form 10-K are “forward looking” statements that involve risks and uncertainties
that could cause actual results to differ materially from projected results.
Such “forward looking” statements include, but are not necessarily limited to
statements regarding anticipated levels of future revenues and earnings from the
operation of Sonoma Valley Bancorp's  wholly owned subsidiary, Sonoma
Valley Bank (“the Bank”), projected costs and expenses related to operations of
the bank’s liquidity, capital resources, and the availability of future equity
capital on commercially reasonable terms. Factors that could cause actual
results to differ materially include, in addition to the other factors
identified in this Form 10-K, the following: (i) increased competition from
other banks, savings and loan associations, thrift and loan associations,
finance companies, credit unions, offerors of money market funds, and other
financial institutions; (ii) the risks and uncertainties relating to general
economic and political conditions, both domestically and internationally,
including, but not limited to, inflation, or natural disasters affecting the
primary service area of the Bank or its major industries; or (iii) changes in
the laws and regulations governing the Bank’s activities at either the state or
federal level. Readers of this Form 10-K are cautioned not to put undue reliance
on “forward looking” statements which, by their nature, are uncertain as
reliable indicators of future performance.  Sonoma Valley Bancorp
disclaims any obligation to publicly update these “forward looking” statements,
whether as a result of new information, future events, or
otherwise.
 
 PART
I
 ITEM
      1.
              BUSINESS
 
 General
 
 Sonoma
Valley Bancorp ("Company") was incorporated under California law on March 9,
2000 at the direction of Sonoma Valley Bank for the purpose of forming a
single-bank holding company structure pursuant to a plan of
reorganization.  The reorganization became effective November 1, 2000,
after obtaining all required regulatory approvals and permits, shares of the
Company's common stock were issued to shareholders of Sonoma Valley Bank in
exchange for their Sonoma Valley Bank stock.  Previously, Sonoma
Valley Bank filed its periodic reports and current reports under the Securities
Exchange Act of 1934 with the Federal Deposit Insurance Corporation
(“FDIC”).  Following the reorganization, periodic and current reports
are now filed with the Securities and Exchange Commission (“SEC”).
 
 The
business operations of the Company continue to be conducted through its
wholly-owned subsidiary, Sonoma Valley Bank ("Bank"), which began commercial
lending operations on June 3, 1988. In addition to its main branch located in
Sonoma, California, the Bank also operates two additional branch offices, one
branch office is located in Glen Ellen, California.  In March 2004,
the Bank opened another branch office, Banco de Sonoma, located in Boyes Hot
Springs, California.  The following discussion, although presented on
a consolidated basis, analyzes the financial condition and results of operations
of the Bank for the twelve month period ended December 31, 2007.
 
 Primary
Services
 
 The Bank
emphasizes the banking needs of small to medium-sized commercial businesses,
professionals and upper middle to high income individuals and families in its
primary service area of Sonoma, California and the immediate surrounding
area.  In recognition of CRA compliance, the Company offers products
to accommodate special needs of individuals regardless of their economic status
and more recently the Company has focused on the needs of the Latino
community.
  3
  The Bank
offers depository and lending services keyed to the needs of its business and
professional clientele.  These services include a variety of demand
deposit, savings and time deposit account alternatives, all insured by the FDIC
up to its applicable limits.  Special merchant and business services,
such as coin, night depository, courier, on line cash management and merchant
teller services are available.  The Bank offers Internet Banking for
both commercial and consumer customers, bank by mail service, drive-up ATM
service, extended hours including Saturday banking, drive-up windows and
telephone voice response.  The Bank's lending activities are directed
primarily towards granting short and medium-term commercial loans, augmented by
customized lines of credit, for such purposes as operating capital, business and
professional start-ups, inventory, equipment, accounts receivable, credit cards,
and interim construction financing, personal loans and loans secured by
residential real estate.
 
 With the
opening of our third branch office, Banco de Sonoma, in March 2004, the Bank is
offering additional services to the Latino community in our market
place.  The Banco de Sonoma Office is predominantly staffed by
bilingual officers, customer service employees and tellers.  The Bank
offers special money transfer services to facilitate the transfer of funds to
Mexico.
 
 The
business of the Bank is not seasonal.  The Bank intends to continue
with the same basic commercial banking activities it has operated with since
beginning operations June 3, 1988.  Retail deposit gathering
activities at the branches comprise the bulk of sources for
lending.  The Bank has approved borrowing levels at the Federal Home
Loan Bank for temporary funding needs.
 
 Competition
 
 In
general, the banking business in California and in the market areas which the
Bank serves, is highly competitive with respect to both loans and deposits, and
is dominated by a relatively small number of major banks, which have many
offices operating over a wide geographic area.  The Bank competes for
loans and deposits with these and other regional banks, including several which
are much larger than the Bank, as well as savings and loan associations, thrift
and loan associations, finance companies, credit unions, offerors of money
market funds and other financial institutions.
 
 The
Bank's primary service area is currently served by branches of eight other banks
(including three major banks:  Citigroup, Bank of America and Wells
Fargo Bank).  In order to compete with the major financial
institutions in its primary service area, the Bank uses its flexibility as an
independent bank.  This includes emphasis on specialized services and
personalized attention.
 
 In the
event there are customers whose loan demands exceed the Bank's lending limit,
the Bank seeks to arrange for such loans on a participation basis with other
financial institutions and intermediaries.  The Bank also is able to
assist those customers requiring other services not offered by the Bank by
obtaining those services through its correspondent banks.
 
 Concentration
of Credit Risk
 
 The
majority of the Bank's loan activity is with customers located within the county
of Sonoma.  While the Bank has a diversified loan portfolio,
approximately 91.3% of these loans are secured by real estate in its service
area.  This concentration for the year ending December 31, 2007 is
presented below:
 
 (in
      thousands of dollars)Secured
      by real estate:Construction/land
      development
              
              $
              44,106Farmland
              
              
              5,4721-4
      family residences
              
              
              52,460Commercial/multi-family
              
              
              126,729
  4
  Employees
 
 As of
December 31, 2007, the Company employed 51 full-time equivalent
employees.
 Website
Access
 
 We
maintain a website where certain information about the Bank is posted. Through
the website, our annual report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K, and amendment to those reports, as well as Section
16 reports and amendments, are available as soon as reasonably practicable after
such material is electronically filed with or furnished to the SEC. These
reports are free of charge and can be accessed through the web address www.SonomaValleyBank.comby
selecting the Financials
Tab- SECFilingslink. Further, certain corporate charters and policies are also posted on
this site, and are similarly available without
charge.
 Supervision
and Regulation
 
 The
Company is a registered bank holding company under the Bank Holding Company Act,
regulated, supervised and examined by the Federal Reserve Bank
(“FRB”).  As such, it must file with the FRB an annual report and
additional reports as the Federal Reserve Board may require.  The
Company is also subject to periodic examination by the Federal Reserve
Board.
 
 In
addition, both the Company and the Bank are extensively regulated under both
federal and state laws and regulations. These laws and regulations are primarily
intended to protect depositors, not shareholders. To the extent that the
following information describes statutory or regulatory provisions, it is
qualified in its entirety by reference to the particular statutory and
regulatory provisions at issue.
 
 As a
California state-licensed bank, the Bank is subject to regulation, supervision
and periodic examination by the California Department of Financial
Institutions.  The Bank is also subject to regulation, supervision,
and periodic examination by the FDIC.  The Bank is not a member of the
Federal Reserve System, but is nevertheless subject to certain regulations of
the Board of Governors of the Federal Reserve System.  As a state
bank, the Bank's deposits are insured by the FDIC to the maximum amount
permitted by law, which is currently $100,000 per depositor in most
cases.  For this protection, the Bank pays a semi-annual
assessment.
 
 The
regulations of these state and federal bank regulatory agencies govern most
aspects of the Company's and the Bank's business and operations, including but
not limited to, requiring the maintenance of non interest-bearing reserves on
deposits, limiting the nature and amount of investments and loans which may be
made, regulating the issuance of securities, restricting the payment of
dividends, regulating bank expansion and bank activities, including real estate
development activities.  The Federal Reserve Board, the FDIC, and the
California Department of Financial Institutions have broad enforcement powers
over depository institutions, including the power to prohibit a bank from
engaging in business practices which are considered to be unsafe or unsound, to
impose substantial fines and other civil and criminal penalties, to terminate
deposit insurance, and to appoint a conservator or receiver under a variety of
circumstances.  The Federal Reserve Board also has broad enforcement
powers over bank holding companies, including the power to impose substantial
fines and other civil and criminal penalties.
 
 Regulation
of Bank Holding Companies
 
 As a bank
holding company, the Company's activities are subject to extensive regulation by
the Federal Reserve Board.  The Bank Holding Company Act requires us
to obtain the prior approval of the Federal Reserve Board before (i) directly or
indirectly acquiring ownership or control of any voting shares of another bank
or bank holding company if, after such acquisition, we would own or control more
than 5% of the shares of the other bank or bank holding company (unless the
acquiring company already owns or controls a majority of such shares); (ii)
acquiring all or substantially all of the assets of another bank or bank holding
company; or (iii) merging or consolidating with another bank holding
company.  The Federal Reserve Board will not approve any acquisition,
merger or consolidation that would have a substantially anticompetitive result,
unless the anticompetitive effects of the proposed transaction are clearly
outweighed by a greater public interest in meeting the convenience and needs of
the community to be served.  The Federal Reserve Board also considers
capital adequacy and other financial and managerial factors in its review of
acquisitions and mergers.
  5
  With
certain exceptions, the Bank Holding Company Act also prohibits us from
acquiring or retaining direct or indirect ownership or control of more than 5%
of the voting shares of any company that is not a bank or bank holding company,
or from engaging directly or indirectly in activities other than those of
banking, managing or controlling banks, or providing services for its
subsidiaries.  The principal exceptions to these prohibitions involve
certain non-bank activities that, by statute or by Federal Reserve Board
regulation or order, have been determined to be activities closely related to
the business of banking or of managing or controlling banks.
 
 Federal
Deposit Insurance
 
 The FDIC
may terminate the deposit insurance of any insured depository institution if the
FDIC determines that the institution has engaged or is engaging in unsafe or
unsound practices, is in an unsafe or unsound condition to continue operations
or has violated any applicable law, regulation, order or any condition imposed
in writing by, or pursuant to written agreement with, the FDIC.  The
FDIC may also suspend deposit insurance temporarily during the hearing process
for a permanent termination of insurance if the institution has no tangible
capital.
 
 Impact
of Economic Conditions and Monetary Policies
 
 The
earnings and growth of the Bank are and will be affected by general economic
conditions, both domestic and international, and by the monetary and fiscal
policies of the United States Government and its agencies, particularly the
FRB.  One function of the FRB is to regulate the money supply and the
national supply of bank credit in order to mitigate recessionary and
inflationary pressures.  Among the instruments of monetary policy used
to implement these objects are open market transactions in United States
Government securities, changes in the discount rate on member bank borrowings,
and changes in reserve requirement held by depository
institutions.  The monetary policies of the FRB have had a significant
effect on the operating results of commercial banks in the past and are expected
to continue to do so in the future.  However, the effect of such
policies on the future business and earnings of the Bank cannot be accurately
predicted.
 
 Recent
and Proposed Legislation
 
 From time
to time, legislation is enacted which has the effect of increasing the cost of
doing business, limiting or expanding permissible activities, or affecting the
competitive balance between banks and other financial
institutions.  Proposals to change the laws and regulations governing
the operations and taxation of banks and other financial institutions are
frequently made in Congress, in the California legislature, and by various bank
regulatory agencies.  No prediction can be made as to the likelihood
of any major changes or the impact such changes might have on the
Bank.  Certain changes of potential significance to the Bank which
have been enacted recently or others which are currently under consideration by
Congress or various regulatory or professional agencies are discussed
below.
 
 Sarbanes-Oxley
Act of 2002.The Sarbanes-Oxley Act
of 2002 (“Sarbanes-Oxley”) intended to address corporate and accounting
fraud.  Sarbanes-Oxley applies to publicly reporting
companies.  In addition to the establishment of a new accounting
oversight board, which will enforce auditing, quality control and independence
standards and will be funded by fees from all publicly traded companies, the
bill restricts provision of both auditing and consulting services by accounting
firms.  To maintain auditor independence, any non-audit services being
provided to an audit client requires pre-approval by the Company’s audit
committee members. In addition, the audit partners must be
rotated.
  6
  Sarbanes-Oxley
also requires the chief executive officer and the chief financial officer to
certify to the accuracy of periodic reports filed with the SEC, subject to civil
and criminal penalties if they knowingly or willfully violate this certification
requirement.  In addition, under Sarbanes-Oxley, legal counsel will be
required to report evidence of a material violation of the securities laws or a
breach of fiduciary duty by a company to its chief executive officer or its
chief legal officer, and, if such officer does not appropriately respond, to
report such evidence to the audit committee or other similar committee of the
board of directors or the board itself.  Companies are required to
adopt a Code of Ethics for their Financial Managers and any violators are
subject to disciplinary action.
 
 Longer
prison terms and increased penalties will also be applied to corporate
executives who violate federal securities laws, the period during which certain
types of suits can be brought against a company or its officers has been
extended, and bonuses issued to top executives prior to restatement of a
company’s financial statements are now subject to disgorgement if such
restatement was due to corporate misconduct.  Executives are also
prohibited from insider trading during retirement plan “blackout” periods, and
loans to company executives are restricted.  Sarbanes-Oxley
accelerates the time frame for disclosures by public companies, as they must
immediately disclose any material changes in their financial condition or
operations.  Directors and executive officers must also provide
information for most changes in ownership in a company’s securities within two
business days of the change.
  Sarbanes-Oxley
also prohibits any officer or director of a company or any other person acting
under their direction from taking any action to fraudulently influence, coerce,
manipulate or mislead any independent public or certified accountant engaged in
the audit of the company’s financial statements for the purpose of rendering the
financial statements materially misleading.  In addition,
Sarbanes-Oxley requires that each financial report required to be prepared in
accordance with (or reconciled to) accounting principles generally accepted in
the United States of America and filed with the SEC reflect all material
correcting adjustments that are identified by a “registered public accounting
firm” in accordance with accounting principles generally accepted in the United
States of America and the rules and regulations of the SEC.
 
 Section
404 of Sarbanes-Oxley requires the SEC to prescribe rules requiring the
inclusion of an internal control report in each annual
report.  Accordingly, in the annual report for December 31, 2007,
management has included a report on the effectiveness of the Company’s
internal controls.  The Company retained the services of a
consulting firm to assist management and staff with this
process.  There can be no assurances that the evaluation required by
Sarbanes-Oxley will not result in the identification of significant control
deficiencies at some point or that the Company’s auditors will be able to
attest to the effectiveness of our internal controls over financial reporting.
The Company’s independent auditors are required to attest to and report on
management’s assessment of internal control beginning the year ending
December 31, 2008, which may be deferred to 2009.
  Regulation
W.  The FRB on
October 31, 2002 approved a final Regulation W that comprehensively implements
sections 23A and 23B of the Federal Reserve Act.  Sections 23A and 23B
and Regulation W restrict loans by a depository institution to its affiliates,
asset purchases by a depository institution from its affiliates, and other
transactions between a depository institution and its
affiliates.  Regulation W unifies in one public document the FRB ’s
interpretations of sections 23A and 23B.
  7
  Regulatory
Capital Treatment of Equity Investments.  In December of
2001 and January of 2002, the Office of the Comptroller of the Currency, the FRB
and the FDIC adopted final rules governing the regulatory capital treatment of
equity investments in non-financial companies held by banks, bank holding
companies and financial holding companies.  The new capital
requirements apply symmetrically to equity investments made by banks and their
holding companies in non-financial companies under the legal authorities
specified in the final rules.  Among others, these include the
merchant banking authority granted by the Gramm-Leach-Bliley Act and the
authority to invest in small business investment companies (“SBICs”) granted by
the Small Business Investment Act.  Covered equity investments will be
subject to a series of marginal Tier 1 capital charges, with the size of the
charge increasing as the organization’s level of concentration in equity
investments increases.  The highest marginal charge specified in the
final rules requires a 25 percent deduction from Tier 1 capital for covered
investments that aggregate more than 25 percent of an organization’s Tier 1
capital.  Equity investments through SBICs will be exempt from the new
charges to the extent such investments, in the aggregate, do not exceed 15
percent of the banking organization’s Tier 1 capital.  Grandfathered
investments made by state banks under section 24(f) of the Federal Deposit
Insurance Act also are exempted from coverage.
 
 USAPatriot Act.The terrorist
attacks in September, 2001, have impacted the financial services industry and
led to federal legislation that attempts to address certain issues involving
financial institutions.  On October 26, 2001, President Bush
signed into law the Uniting and Strengthening America by Providing Appropriate
Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA Patriot
Act”).
 
 Part of
the USA Patriot Act is the International Money Laundering Abatement and
Financial Anti-Terrorism Act of 2001 (“IMLA”).  IMLA authorizes the
Secretary of the Treasury, in consultation with the heads of other government
agencies, to adopt special measures applicable to banks, bank holding companies,
and/or other financial institutions.  These measures may include
enhanced recordkeeping and reporting requirements for certain financial
transactions that are of primary money laundering concern, due diligence
requirements concerning the beneficial ownership of certain types of accounts,
and restrictions or prohibitions on certain types of accounts with foreign
financial institutions.
 
 Among its
other provisions, IMLA requires each financial institution to: (i) establish an
anti-money laundering program; (ii) establish due diligence policies, procedures
and controls with respect to its private banking accounts and correspondent
banking accounts involving foreign individuals and certain foreign banks; and
(iii) avoid establishing, maintaining, administering, or managing correspondent
accounts in the United States for, or on behalf of, a foreign bank that does not
have a physical presence in any country.  In addition, IMLA contains a
provision encouraging cooperation among financial institutions, regulatory
authorities and law enforcement authorities with respect to individuals,
entities and organizations engaged in, or reasonably suspected of engaging in,
terrorist acts or money laundering activities.  IMLA expands the
circumstances under which funds in a bank account may be forfeited and requires
covered financial institutions to respond under certain circumstances to
requests for information from federal banking agencies within 120
hours.  IMLA also amends the Bank Holding Company Act and the Bank
Merger Act to require the federal banking agencies to consider the effectiveness
of a financial institution’s anti-money laundering activities when reviewing an
application under these acts.
 
 Merchant
Banking Investments.  The FRB and the
Secretary of the Treasury in January 2001 jointly adopted a final rule governing
merchant banking investments made by financial holding companies.  The
rule implements provisions of the Gramm-Leach-Bliley Act discussed below that
permit financial holding companies to make investments as part of a bona fide
securities underwriting or merchant or investment banking
activity.  The rule provides that a financial holding company may not,
without FRB approval, directly or indirectly acquire any additional shares,
assets or ownership interests or make any additional capital contribution to any
company the shares, assets or ownership interests of which are held by the
financial holding company subject to the rule if the aggregate carrying value of
all merchant banking investments held by the financial holding company
exceeds:
  8
  §
              30%
      of the Tier 1 capital of the financial holding company,
  or
 
 §
              after
      excluding interests in private equity funds, 20% of the Tier 1 capital of
      the financial holding company.
 
 A
separate final rule will establish the capital charge of merchant banking
investments for the financial holding company.
 
 Financial
Services Modernization Act of 1999.The Financial
Services Modernization Act of 1999 (also known as the “Gramm-Leach-Bliley Act”
after its Congressional sponsors) substantially eliminates most of the
separations between banks, brokerage firms, and insurers enacted by the
Glass-Steagall Act of 1933.  The reform legislation permits securities
firms and insurers to buy banks, and banks to underwrite insurance and
securities.  States retain regulatory authority over
insurers.  The Treasury Department’s Office of the Comptroller of the
Currency has authority to regulate bank subsidiaries that underwrite securities
and the Federal Reserve has authority over bank affiliates for activities such
as insurance underwriting and real-estate development.
 
 The U.S.
federal bank regulatory agencies’ risk-based capital guidelines are based upon
the 1988 capital accord of the Basel Committee on Banking Supervision (the
“Basel Committee”).  The Basel Committee is a committee of central
banks and bank supervisors from the major industrialized countries that develops
broad policy guidelines that each country’s supervisors can use to determine the
supervisory policies they apply.  In January 2001, the Basel Committee
on Banking Supervision issued a proposal for a "New Capital
Accord".  The New Capital Accord incorporates a three-part framework
of minimum capital requirements, supervisory review of an institution's capital
adequacy and internal assessment process, and market discipline through
effective disclosure to encourage safe and sound banking
practices.  To remain a financial holding company, a company must
remain “well capitalized” and “well managed”.  “Well managed” means
that at their most recent examination the bank received a satisfactory composite
rating and at least a satisfactory rating for management.  The federal
banking agencies are required to take "prompt corrective action" in respect of
depository institutions and their bank holding companies that do not meet
minimum capital requirements. FDIC established five capital tiers: "well
capitalized", "adequately capitalized", "undercapitalized", "significantly
undercapitalized" and "critically undercapitalized".  A depository
institution's capital tier, or that of its bank holding company, depends upon
where its capital levels are in relation to various relevant capital measures,
including a risk-based capital measure and a leverage ratio capital measure, and
certain other factors.  As of December 31, 2007, the Company and Bank
are “well capitalized” and “well managed”.
 
 Under the
regulations adopted by the federal banking agencies, a bank holding company is
"well capitalized" if it has (i) a total risk-based capital ratio of 10% or
greater, (ii) a Tier 1 risk-based capital ratio of 6% or greater, (iii) a
leverage ratio of 5% or greater and (iv) is not subject to any written
agreement, order or directive to meet and maintain a specific capital level for
any capital measure. An "adequately capitalized" depository institution is
defined as one that has (i) a total risk-based capital ratio of 8% or greater,
(ii) a Tier 1 risk-based capital ratio of 4% or greater and (iii) a leverage
ratio of 4% or greater (or 3% or greater in the case of a bank rated a composite
1 under the Uniform Financial Institution Rating System, “CAMELS rating”,
established by the Federal Financial Institution Examinations
Council).  A company is considered (i) "undercapitalized" if it has
(A) a total risk-based capital ratio of less than 8%, (B) a Tier 1 risk-based
capital ratio of less than 4% or (C) a leverage ratio of less than 4% (or 3% in
the case of an institution with a CAMELS rating of 1), (ii) "significantly
undercapitalized" if it has (A) a total risk-based capital ratio of less than
6%, or (B) a Tier 1 risk-based capital ratio of less than 3% or (C) a leverage
ratio of less than 3% and (iii) "critically undercapitalized" if it has a ratio
of tangible equity to total assets equal to or less than 2%. An institution may
be deemed by the regulators to be in a capitalization category that is lower
than is indicated by its actual capital position if, among other things, it
receives an unsatisfactory examination rating.
  9
  Accounting
Pronouncements
 
 Fair
Value Measurement
 
 In
September 2006 the FASB issued Statement of Financial Accounting Standards
Number 157(“FAS 157”), Fair
Value Measurements.FAS 157 establishes a formal framework for
measuring fair value under generally accepted accounting
principles.  It (1) codifies the many definitions of fair value
included among various other authoritative literature, (2) clarifies and, in
some instances, expands on the guidance for implementing fair value
measurements, and (3) increases the level of disclosure required for fair value
measurements.  FAS 157 does not, of itself, require any new fair value
measurements, nor does it establish valuation standards.  FAS 157 is
effective for the financial statements issued for fiscal years beginning after
November 15, 2007.
    In February 2007, the FASB issued
SFAS No. 159, The Fair Value
Option for Financial Assets and Financial Liabilities—Including an Amendment of
FASB Statement No. 115.  This Statement permits entities to
choose to measure many financial instruments and certain other items at fair
value at specified election dates.  Unrealized gains and losses on
items for which the fair value option has been elected are reported in earnings
at each subsequent reporting date.  This Statement is effective as of
the beginning of the entity’s first fiscal year that begins after November 15,
2007.
  Business
Combinations
 
 In
December 2007, the FASB issued SFAS No. 141, revised, Business
Combinations.  This Statement established principles and
requirements for how the acquirer recognizes and measures in its financial
statements the identifiable assets acquired, the liabilities assumed, and any
noncontrolling interest, recognizes and measures goodwill acquired in a business
combination, and discloses the nature and financial effects of the business
combination.  This Statement applies prospectively to business
combinations for which the acquisition date is on or after December 15,
2008.
 
 Noncontrolling
Interest in Consolidated Financial Statements
 
 In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements—an Amendment of ARB No.
51.  This Statement establishes accounting and reporting
standards for a minority interest in the parent company financial statements and
requires separate identification of equity and net income in the consolidated
financial statements.  This Statement is effective for fiscal years,
and interim periods within those fiscal years, beginning on or after December
15, 2008.
  10
  Statistical
Data
 
 The
following information is required by Industry Guide 3, "Statistical Disclosure
by Bank Holding Companies".  The averages shown have been calculated
using the average daily balance.
 
 Sequential
      PageNumberI.
              Distribution
      of Assets, Liabilities and Shareholders’Equity;
      Interest Rates and DifferentialA.
      Average balance sheets
              
              29B.
      Analysis of net interest
      earnings
              
              29C.
      Rate/volume analysis
              
              30II.
              Investment
      PortfolioA.
      Book value (Amortized Cost) of
      investments
              
              58B.
      Weighted average yield and
      maturity
              
              29,
      35, 41 and 59C.
      Securities of issuer exceeding ten percent of equity
              
              NoneIII.
              Loan
      PortfolioA.
      Types of loans
              
              29
      and 60B.
      Maturities and sensitivities of loans to
      change in interest rates
              
              41
      and 61C.
      Risk elements1.
      Non-accrual, past due, and restructured
      loans
              
              36
      and 612.
      Potential problem loans
              
              None3.
      Foreign outstandings
              
              None4.
      Loan concentrations
              
              35
      and 61D.
      Other Interest-Bearing Assets
              
              NoneIV.
              Summary of Loan Loss
    Experience
              
              36
      and 61V.
              DepositsA.
      Average balances and average rates
      paid
              
              29B.
      Other categories of deposits
              
              NoneC.
      Foreign outstandings
              
              NoneD.
      Maturity of time deposits greater than
      $100,000
              
              41E.
      Maturity of foreign time deposits greater than $100,000
              
              NoneVI.
              Return on Equity and
      Assets
              
              25VII.
              Short-term Borrowings:
              
              62
 
 
  11
  ITEM
1A.                                RISK
FACTORS.
 
 An
investment in the Company’s common stock is subject to risks inherent to the
Company’s business.  The material risks and uncertainties that
management believes affect the Company are described below.  Before
making an investment decision, you should carefully consider the risks and
uncertainties described below together with all of the other information
included or incorporated by reference in this report.  The risks and
uncertainties described below are not the only ones facing the
Company.  Additional risks and uncertainties that management is not
aware of or focused on or that management currently deems immaterial may also
impair the Company’s business operations.  This report is qualified in
its entirety by these risk factors.
 
 If any of
the following risks actually occur, the Company’s financial condition and
results of operations could be materially and adversely affected. If this were
to happen, the value of the Company’s common stock could decline significantly,
and you could lose all or part of your investment.
 
 Risks Related to the Company’s
Business
 
 The
Company is Subject to Interest Rate Risk
 
 The
Company’s earnings and cash flows are largely dependent upon its net interest
income.  Net interest income is the difference between interest income
earned on interest-earning assets such as loans and securities and interest
expense paid on interest-bearing liabilities such as deposits and borrowed
funds.  Interest rates are highly sensitive to many factors that are
beyond the Company’s control, including general economic conditions and policies
of various governmental and regulatory agencies and, in particular, the Board of
Governors of the Federal Reserve System.  Changes in monetary policy,
including changes in interest rates, could influence not only the interest the
Company receives on loans and securities and the amount of interest it pays on
deposits and borrowings, but such changes could also affect (i) the
Company’s ability to originate loans and obtain deposits, (ii) the fair
value of the Company’s financial assets and liabilities, and (iii) the
average duration of the Company’s mortgage-backed securities
portfolio.  If the interest rates paid on deposits and other
borrowings increase at a faster rate than the interest rates received on loans
and other investments, the Company’s net interest income, and therefore
earnings, could be adversely affected.  Earnings could also be
adversely affected if the interest rates received on loans and other investments
fall more quickly than the interest rates paid on deposits and other
borrowings.
 
 Although
management believes it has implemented effective asset and liability management
strategies to reduce the potential effects of changes in interest rates on the
Company’s results of operations, any substantial, unexpected, prolonged change
in market interest rates could have a material adverse effect on the Company’s
financial condition and results of operations.  See Management’s
Discussion and Analysis of Financial Condition and Results of Operations located
elsewhere in this report for further discussion related to the Company’s
management of interest rate risk.
 
 The
Company is Subject to Lending Risk
 
 There are
inherent risks associated with the Company’s lending
activities.  These risks include, among other things, the impact of
changes in interest rates and changes in the economic conditions in the markets
where the Company operates as well as those across the State of California and
the United States. Increases in interest rates and/or weakening economic
conditions could adversely impact the ability of borrowers to repay outstanding
loans or the value of the collateral securing these loans.  The
Company is also subject to various laws and regulations that affect its lending
activities.  Failure to comply with applicable laws and regulations
could subject the Company to regulatory enforcement action that could result in
the assessment of significant civil money penalties against the
Company.
  12
  As of
December 31, 2007, approximately 91.3% of the Company’s loan portfolio is
directly or indirectly secured by real property.  Because the
Company’s loan portfolio contains a significant number of construction,
commercial and residential real estate loans, the deterioration of one or a few
of these loans could cause a significant increase in non-performing
loans.  An increase in non-performing loans could result in a net loss
of earnings from these loans, an increase in the provision for possible loan
losses and an increase in loan charge-offs, all of which could have a material
adverse effect on the Company’s financial condition and results of
operations.  See Management’s Discussion and Analysis of Financial
Condition and Results of Operations located elsewhere in this report for further
discussion related to commercial and industrial, construction and commercial
real estate loans.
 
 The
Company’s Allowance for Possible Loan Losses may be
Insufficient
 
 The
Company maintains an allowance for possible loan losses, which is a reserve
established through a provision for possible loan losses charged to expense,
that represents management’s best estimate of probable losses that have been
incurred within the existing portfolio of loans.  The allowance, in
the judgment of management, is necessary to reserve for estimated loan losses
and risks inherent in the loan portfolio.  The level of the allowance
reflects management’s continuing evaluation of industry concentrations; specific
credit risks; loan loss experience; current loan portfolio quality; present
economic, political and regulatory conditions and unidentified losses inherent
in the current loan portfolio.  The determination of the appropriate
level of the allowance for possible loan losses inherently involves a high
degree of subjectivity and requires the Company to make significant estimates of
current credit risks and future trends, all of which may undergo material
changes.  Changes in economic conditions affecting borrowers, new
information regarding existing loans, identification of additional problem loans
and other factors, both within and outside of the Company’s control, may require
an increase in the allowance for possible loan losses.  In addition,
bank regulatory agencies periodically review the Company’s allowance for loan
losses and may require an increase in the provision for possible loan losses or
the recognition of further loan charge-offs, based on judgments different than
those of management.  In addition, if charge-offs in future periods
exceed the allowance for possible loan losses; the Company will need additional
provisions to increase the allowance for possible loan losses.  Any
increases in the allowance for possible loan losses will result in a decrease in
net income and, possibly, capital, and may have a material adverse effect on the
Company’s financial condition and results of operations.  See
Management’s Discussion and Analysis of Financial Condition and Results of
Operations located elsewhere in this report for further discussion related to
the Company’s process for determining the appropriate level of the allowance for
possible loan losses.
 
 The
Company is Subject to Environmental Liability Risk Associated with Lending
Activities
 
 A
significant portion of the Company’s loan portfolio is secured by real
property.  During the ordinary course of business, the Company may
foreclose on and take title to properties securing certain loans.  In
doing so, there is a risk that hazardous or toxic substances could be found on
these properties.  If hazardous or toxic substances are found, the
Company may be liable for remediation costs, as well as for personal injury and
property damage.  Environmental laws may require the Company to incur
substantial expenses and may materially reduce the affected property’s value or
limit the Company’s ability to use or sell the affected property.  In
addition, future laws or more stringent interpretations or enforcement policies
with respect to existing laws may increase the Company’s exposure to
environmental liability. Although the Company has policies and procedures to
perform an environmental review before initiating any foreclosure action on real
property, these reviews may not be sufficient to detect all potential
environmental hazards.  The remediation costs and any other financial
liabilities associated with an environmental hazard could have a material
adverse effect on the Company’s financial condition and results of
operations.
  13
  The
Company’s Profitability Depends Significantly on Economic Conditions in the
State of California
 
 The
Company’s success depends primarily on the general economic conditions of the
State of California and the specific local markets in which the Company
operates.  Unlike larger national or other regional banks that are
more geographically diversified, the Company provides banking and financial
services to customers primarily in Sonoma and its immediate surrounding towns
(the “Sonoma Valley”).  The local economic conditions in these
areas have a significant impact on the demand for the Company’s products and
services as well as the ability of the Company’s customers to repay loans, the
value of the collateral securing loans and the stability of the Company’s
deposit funding sources.  A significant decline in general economic
conditions, caused by inflation, recession, acts of terrorism, outbreak of
hostilities or other international or domestic occurrences, unemployment,
changes in securities markets or other factors could impact these local economic
conditions and, in turn, have a material adverse effect on the Company’s
financial condition and results of operations.
 
 The
Company Operates in a Highly Competitive Industry and Market
Area
 
 The
Company faces substantial competition in all areas of its operations from a
variety of different competitors, many of which are larger and may have more
financial resources.  Such competitors primarily include national,
regional, and community banks within the various markets the Company
operates.  Additionally, various out-of-state banks have begun to
enter or have announced plans to enter the market areas in which the Company
currently operates.  The Company also faces competition from many
other types of financial institutions, including, without limitation, savings
and loans, credit unions, finance companies, brokerage firms, insurance
companies, factoring companies and other financial
intermediaries.  The financial services industry could become even
more competitive as a result of legislative, regulatory and technological
changes and continued consolidation.  Banks, securities firms and
insurance companies can merge under the umbrella of a financial holding company,
which can offer virtually any type of financial service, including banking,
securities underwriting, insurance (both agency and underwriting) and merchant
banking.  Also, technology has lowered barriers to entry and made it
possible for non-banks to offer products and services traditionally provided by
banks, such as automatic transfer and automatic payment systems.  Many
of the Company’s competitors have fewer regulatory constraints and may have
lower cost structures.  Additionally, due to their size, many
competitors may be able to achieve economies of scale and, as a result, may
offer a broader range of products and services as well as better pricing for
those products and services than the Company can.
 
 The
Company’s ability to compete successfully depends on a number of factors,
including, among other things:
 
 §
                The
      ability to develop, maintain and build upon long-term customer
      relationships based on top quality service, high ethical standards and
      safe, sound assets.
 §
                The
      ability to expand the Company’s market
position.
 §
                The
      scope, relevance and pricing of products and services offered to meet
      customer needs and demands.
 §
                The
      rate at which the Company introduces new products and services relative to
      its competitors.
 §
                Customer
      satisfaction with the Company’s level of
  service.
 §
                Industry
      and general economic trends.
 
 Failure
to perform in any of these areas could significantly weaken the Company’s
competitive position, which could adversely affect the Company’s growth and
profitability, which, in turn, could have a material adverse effect on the
Company’s financial condition and results of operations.
  14
  The
Company is Subject to Extensive Government Regulation and
Supervision
 
 The
Company, through its subsidiary Sonoma Valley Bank, is subject to extensive
federal and state regulation and supervision.  Banking regulations are
primarily intended to protect depositors’ funds, federal deposit insurance funds
and the banking system as a whole, not shareholders.  These
regulations affect the Company’s lending practices, capital structure,
investment practices, dividend policy and growth, among other
things.  Congress and federal regulatory agencies continually review
banking laws, regulations and policies for possible changes.  Changes
to statutes, regulations or regulatory policies, including changes in
interpretation or implementation of statutes, regulations or policies, could
affect the Company in substantial and unpredictable ways.  Such
changes could subject the Company to additional costs, limit the types of
financial services and products the Company may offer and/or increase the
ability of non-banks to offer competing financial services and products, among
other things.  Failure to comply with laws, regulations or policies
could result in sanctions by regulatory agencies, civil money penalties and/or
reputation damage, which could have a material adverse effect on the Company’s
business, financial condition and results of operations.  While the
Company has policies and procedures designed to prevent any such violations,
there can be no assurance that such violations will not occur.  See
the section captioned “Supervision and Regulation” in
Item 1.
 
 The
Company’s Controls and Procedures may Fail or be Circumvented
 
 Management
regularly reviews and updates the Company’s internal controls, disclosure
controls and procedures, and corporate governance policies and
procedures.  Any system of controls, however well designed and
operated, is based in part on certain assumptions and can provide only
reasonable, not absolute, assurances that the objectives of the system are
met.  Any failure or circumvention of the Company’s controls and
procedures or failure to comply with regulations related to controls and
procedures could have a material adverse effect on the Company’s business,
results of operations and financial condition.
 
 New
Lines of Business or new Products and Services may Subject the Company to
Additional Risks
 
 From time
to time, the Company may implement new lines of business or offer new products
and services within existing lines of business.  There are substantial
risks and uncertainties associated with these efforts, particularly in instances
where the markets are not fully developed.  In developing and
marketing new lines of business and/or new products and services the Company may
invest significant time and resources.  Initial timetables for the
introduction and development of new lines of business and/or new products or
services may not be achieved and price and profitability targets may not prove
feasible.  External factors, such as compliance with regulations,
competitive alternatives, and shifting market preferences, may also impact the
successful implementation of a new line of business or a new product or
service.  Furthermore, any new line of business and/or new product or
service could have a significant impact on the effectiveness of the Company’s
system of internal controls.  Failure to successfully manage these
risks in the development and implementation of new lines of business or new
products or services could have a material adverse effect on the Company’s
business, results of operations and financial condition.
 
 The Company may not be able to
Attract and Retain Skilled People
 
 The
Company’s success depends, in large part, on its ability to attract and retain
key people. Competition for the best people in most activities engaged in by the
Company can be intense and the Company may not be able to hire people or to
retain them.  The unexpected loss of services of one or more of the
Company’s key personnel could have a material adverse impact on the Company’s
business because of their skills, knowledge of the Company’s market, years of
industry experience and the difficulty of promptly finding qualified replacement
personnel.
  15
  The
Company’s Information Systems may Experience an Interruption or Breach in
Security
 
 The
Company relies heavily on communications and information systems to conduct its
business. Any failure, interruption or breach in security of these systems could
result in failures or disruptions in the Company’s customer relationship
management, general ledger, deposit, loan and other systems.  While
the Company has policies and procedures designed to prevent or limit the effect
of the failure, interruption or security breach of its information systems,
there can be no assurance that any such failures, interruptions or security
breaches will not occur or, if they do occur, that they will be adequately
addressed.  The occurrence of any failures, interruptions or security
breaches of the Company’s information systems could damage the Company’s
reputation, result in a loss of customer business, subject the Company to
additional regulatory scrutiny, or expose the Company to civil litigation and
possible financial liability, any of which could have a material adverse effect
on the Company’s financial condition and results of
operations.
 
 The
Company Continually Encounters Technological Change
 
 The
financial services industry is continually undergoing rapid technological change
with frequent introductions of new technology-driven products and
services.  The effective use of technology increases efficiency and
enables financial institutions to better serve customers and to reduce
costs.  The Company’s future success depends, in part, upon its
ability to address the needs of its customers by using technology to provide
products and services that will satisfy customer demands, as well as to create
additional efficiencies in the Company’s operations.  Many of the
Company’s competitors have substantially greater resources to invest in
technological improvements.  The Company may not be able to
effectively implement new technology-driven products and services or be
successful in marketing these products and services to its
customers.  Failure to successfully keep pace with technological
change affecting the financial services industry could have a material adverse
impact on the Company’s business and, in turn, the Company’s financial condition
and results of operations.
 
 The
Company is Subject to Claims and Litigation Pertaining to Fiduciary
Responsibility
 
 From time
to time, customers make claims and take legal action pertaining to the Company’s
performance of its fiduciary responsibilities.  Whether customer
claims and legal action related to the Company’s performance of its fiduciary
responsibilities are founded or unfounded, if such claims and legal actions are
not resolved in a manner favorable to the Company they may result in significant
financial liability and/or adversely affect the market perception of the Company
and its products and services as well as impact customer demand for those
products and services.  Any financial liability or reputation damage
could have a material adverse effect on the Company’s business, which, in turn,
could have a material adverse effect on the Company’s financial condition and
results of operations.
 
 Severe
Weather, Natural Disasters, Acts of War or Terrorism and Other External Events
Could Significantly Impact the Company’s Business
 
 Severe
weather, natural disasters, acts of war or terrorism and other adverse external
events could have a significant impact on the Company’s ability to conduct
business.  Such events could affect the stability of the Company’s
deposit base, impair the ability of borrowers to repay outstanding loans, impair
the value of collateral securing loans, cause significant property damage,
result in loss of revenue and/or cause the Company to incur additional
expenses.  Although management has established disaster recovery
policies and procedures, the occurrence of any such event could have a material
adverse effect on the Company’s business, which, in turn, could have a material
adverse effect on the Company’s financial condition and results of
operations.
  16
  Risks Associated with the Company’s
Common Stock
 
 The
Company’s Stock Price can be Volatile
 
 Stock
price volatility may make it more difficult for you to resell your common stock
when you want and at prices you find attractive. The Company’s stock price can
fluctuate significantly in response to a variety of factors including, among
other things:
 
 §
                Actual
      or anticipated variations in quarterly results of
    operations.
 §
                Recommendations
      by securities analysts.
 §
                Operating
      and stock price performance of other companies that investors deem
      comparable to the Company.
 §
                News
      reports relating to trends, concerns and other issues in the financial
      services industry.
 §
                Perceptions
      in the marketplace regarding the Company and/or its
      competitors.
 §
                New
      technology used, or services offered, by
  competitors.
 §
                Significant
      acquisitions or business combinations, strategic partnerships, joint
      ventures or capital commitments by or involving the Company or its
      competitors.
 §
                Failure
      to integrate acquisitions or realize anticipated benefits from
      acquisitions.
 §
                Changes
      in government regulations.
 §
                Geopolitical
      conditions such as acts or threats of terrorism or military
      conflicts.§
                Regional
      disasters, such as wild fires, earthquakes, and floods that may impact the
      Sonoma County region, and specifically our customers businesses, including
      agriculture and tourism.§
                Economic
      conditions in the financial industry, including further contractions on
      liquidity of financial institutions, Federal policies on interest rates
      and lending practices, and deterioration in other regional factors such as
      housing and commerical property
defaults.
 
 General
market fluctuations, industry factors and general economic and political
conditions and events, such as economic slowdowns or recessions, interest rate
changes or credit loss trends, could also cause the Company’s stock price to
decrease regardless of operating results.
 
 The
Trading Volume in the Company’s Common Stock is Less than that of Other Larger
Financial Services Companies
 
 Although
the Company’s common stock is listed for trading on the OTC Bulletin Board, the
trading volume in its common stock is less than that of other larger financial
services companies.  A public trading market having the desired
characteristics of depth, liquidity and orderliness depends on the presence in
the marketplace of willing buyers and sellers of the Company’s common stock at
any given time.  This presence depends on the individual decisions of
investors and general economic and market conditions over which the Company has
no control.  Given the lower trading volume of the Company’s common
stock, significant sales of the Company’s common stock, or the expectation of
these sales, could cause the Company’s stock price to fall.
 
 An
Investment in the Company’s Common Stock is not an Insured
Deposit
 
 The
Company’s common stock is not a bank deposit and, therefore, is not insured
against loss by the FDIC, any other deposit insurance fund or by any other
public or private entity.  Investment in the Company’s common stock is
inherently risky for the reasons described in this “Risk Factors” section and
elsewhere in this report and is subject to the same market forces that affect
the price of common stock in any company.  As a result, if you acquire
the Company’s common stock, you may lose some or all of your
investment.
  17
  Risks Associated with the Company’s
Industry
 
 The
Earnings of Financial Services Companies are Significantly Affected by General
Business and Economic Conditions
 
 The
Company’s operations and profitability are impacted by general business and
economic conditions in the United States and abroad.  These conditions
include short-term and long-term interest rates, inflation, money supply,
political issues, legislative and regulatory changes, fluctuations in both debt
and equity capital markets, broad trends in industry and finance, and the
strength of the U.S. economy and the local economies in which the Company
operates, all of which are beyond the Company’s control.  A
deterioration in economic conditions could result in an increase in loan
delinquencies and non-performing assets, decreases in loan collateral values and
a decrease in demand for the Company’s products and services, among other
things, any of which could have a material adverse impact on the Company’s
financial condition and results of operations.
 
 Financial
Services Companies Depend on the Accuracy and Completeness of Information About
Customers and Counterparties
 
 In
deciding whether to extend credit or enter into other transactions, the Company
may rely on information furnished by or on behalf of customers and
counterparties, including financial statements, credit reports and other
financial information.  The Company may also rely on representations
of those customers, counterparties or other third parties, such as independent
auditors, as to the accuracy and completeness of that
information.  Reliance on inaccurate or misleading financial
statements, credit reports or other financial information could have a material
adverse impact on the Company’s business and, in turn, the Company’s financial
condition and results of operations.
 
 Consumers
may Decide not to use Banks to Complete Their Financial
Transactions
 
 Technology
and other changes are allowing parties to complete financial transactions that
historically have involved banks through alternative methods.  For
example, consumers can now maintain funds that would have historically been held
as bank deposits in brokerage accounts or mutual funds. Consumers can also
complete transactions such as paying bills and/or transferring funds directly
without the assistance of banks.  The process of eliminating banks as
intermediaries, known as “disintermediation,” could result in the loss of fee
income, as well as the loss of customer deposits and the related income
generated from those deposits.  The loss of these revenue streams and
the lower cost deposits as a source of funds could have a material adverse
effect on the Company’s financial condition and results of
operations.
 
 ITEM
      1B.
              UNRESOLVED
      STAFF COMMENTS.
 
 None.
 
 ITEM   2.
              PROPERTIES
 
 The
Company is headquartered in Sonoma, California.  At the present time
the Company’s Bank has three branch offices.
 
 The
Sonoma Branch is located at 202 W. Napa Street, Sonoma.  The building
contains approximately 6800 square feet and has been subleased on a long-term
basis (the initial term expires in 2009, with option to extend for two
additional five-year terms).  The office is considered by management
to be well maintained and adequate for the purpose intended.  Lease
payments made in 2007 totaled $263,194 compared to the $253,071 paid in
2006.  The lease provides for future annual rents to be adjusted for
changes in the Consumer Price Index ("CPI"), with a minimum annual increase of
4%, effective each March 1st.
  18
  The Glen
Ellen Branch is located at 13751 Arnold Drive, Glen Ellen.  The
facility is 525 square feet.  The facility is leased for a five year
term expiring in 2008 with the option to extend for two additional five year
terms.  Lease payments made in 2007 totaled $15,294 compared to
$14,705 in 2006.  The lease provides for future annual rents to be
adjusted for changes in the CPI, with a minimum annual increase of 4% effective
April 1st of each year.
 
 The Banco
de Sonoma Branch, which opened in March 2004, is located at 18615 Sonoma Hwy,
Suite 108, Boyes Hot Springs, California.  The facility is 1200 square
feet.  The facility is leased for a five year term expiring in 2009
with options to extend for two additional five year terms.  Lease
payments in 2007 totaled $22,125 compared to $20,031 in 2006.  The
lease provides for future annual rents to be adjusted for changes in the CPI
effective February 1st of each year.
 
 In July
1995, the Bank entered into a lease for the building located at 463 Second
Street West (the “Operations Center”).  The building contains
approximately 2400 square feet and has been leased on a long term basis to
coincide with the Sonoma Branch lease.  The initial term and the first
option expired in 2000 and 2005, respectively.  The lease provides for
an additional option to extend for two additional five year terms and one
additional four year term.  Lease payments made in 2007 totaled
$44,578 compared with the $41,268 paid in 2006.  The lease provides
for future annual rents to be adjusted for changes in the CPI effective each
July 1st.
 
 In
September 1997, the Bank purchased the building and land at 472 Second St. West.
The building contains approximately 1013 square feet.  The Bank paid
$246,943 for the property.  At present the Bank is utilizing the
parking area for additional parking for Bank employees. In September 2007 the
Bank began renting out the building premises. Rental income for 2007 was
$5,000.
 
 In March
2005, the Bank entered into a lease for the building located at 453 Second
Street West (the “Finance Center”).  The building contains
approximately 1200 square feet.  The facility is leased for a five
year term expiring in February 2010 with the option to renew for two additional
five year terms.  Lease payments paid in 2007 totaled $21,451 compared
with the $20,972 paid in 2006.  The lease provides for future annual
rents to be adjusted for changes in the CPI effective March 15th of each
year.
 
 ITEM   3.
              LEGAL
      PROCEEDINGS
 
 In the
normal course of operations, the Company and/or its Bank may have disagreements
or disputes with vendors, borrowers, or employees, which may or may not result
in litigation.  These disputes are seen by the Company’s management as
a normal part of business.  There are no pending actions reported and
no threatened actions that management believes would have a significant material
impact on the Company’s financial position, results of operations or cash
flows.
 
 ITEM   4.
              SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY
HOLDERS
 
 The
Company did not submit any matters to security holders during the fourth quarter
of its last fiscal year ended December 31, 2007.
  19
  PART
II
 
 ITEM   5.                                MARKET
FOR THE COMPANY'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
 
 The
Company’s common stock is quoted on the OTC Bulletin Board under the symbol
"SBNK".  The Company is not listed on any exchange or on the National
Association of Securities Dealers Automated Quotation System
(“NASDAQ”).
 
 Several
brokers act as facilitators in the trades of the Company’s
stock.  They are:
 
 Wachovia
              Monroe
      Securities50
      Old Courthouse Square #110
              100
      N. Riverside Plaza, #1620Santa
      Rosa, CA 95409
              Chicago,
      IL 60606Jody
      Hampton
              Steven
      Schroeder(800)
      972-4800
              (312)
      506-8743Fax
      (707) 528-1117
              Fax
      (312) 506-8799sschroeder@monroesecurities.comHill,
      Thompson, Magid & Co., Inc.
              UBS
      Financial Services15
      Exchange Place, #800
              6570
      Oakmont DriveJersey
      City, NJ 07302
              Santa
      Rosa, CA 95409Tim
      Padala
              John
      Rector(866)
      291-6316 or (201) 369-2908
              (707)
      539-1500Fax
      (201) 395-0624
              Fax
      (707) 537-3553ht@hilltompson.comEdward
      Jones
              Howe
      Barnes Hoefer & Arnett515
      First Street East
              555
      Market Street, 18th FloorSonoma,
      CA 95476
              San
      Francisco, CA 94105Gary
      Scott
              John
      Cavender(707)
      935-1856
              (415)
      538-5723  Fax (415) 398-4875Fax
      (707) 935-1894
              Switchboard
      (800) 346-5544Wedbush
      Morgan Securities
              Stone
      & Youngberg LLC4949
      S.W. Meadow Rd. #100
              P.O.Box
      1688Lake
      Oswego, OR 97035
              42605
      Moonridge RoadLisa
      Gallo
              Big
      Bear, CA 92315(866)
      491-7828
              Troy
      NorlanderDirect
      Fax (866) 415-0756
              (800)
      288-2811Fax
      (503) 675-5037
              Fax
      (909) 585-7220lisa.gallo@wedbush.com
              tnorlander@syllc.com
 
  20
  The table
below summarizes those trades of the common stock as reported by OTC Bulletin
Board, setting forth the high and low prices for the periods
shown.  These over the counter quotations reflect inter-dealer prices,
without retail mark-up, mark-down or commission and may not necessarily
represent actual transactions.
 
 Quarter
      Ended:
              
              High
              
              
              LowDecember
      31, 2007
              
              $
              30.00
              
              
              $
              25.15September
      30, 2007
              
              
              30.95
              
              
              
              25.10June
      30, 2007
              
              
              29.50
              
              
              
              28.35March
      31, 2007
              
              
              29.50
              
              
              
              27.75December
      31, 2006
              
              $
              31.00
              
              
              $
              27.35September
      30, 2006
              
              
              28.00
              
              
              
              25.50June
      30, 2006
              
              
              30.00
              
              
              
              23.80March
      31, 2006
              
              
              24.95
              
              
              
              20.50
 
 
 As of
March 11, 2008 there were 1,040registered holders of the Company's common stock, in addition to
an unknown number of holders whose shares of common stock are held in street
name.
 
 Payment
of Dividends
 
 Under
state law, the Board of Directors of a California state-licensed bank may
declare a cash dividend, subject to the restriction that the amount available
for the payment of cash dividends shall be the lesser of retained earnings of
the bank or the bank's net income for its last three fiscal years (less the
amount of any distributions to shareholders made during such
period).
 
 However,
under the Financial Institutions Supervisory Act, the FDIC has broad authority
to prohibit a bank from engaging in banking practices which it considers to be
unsafe or unsound.  It is possible, depending upon the financial
condition of the bank in question and other factors, that the FDIC may assert
that the payment of dividends or other payments by a bank is considered an
unsafe and unsound banking practice and therefore, implement corrective action
to address such a practice.
 
 The
Company paid cash dividends of $0.25 per share to shareholders of record as of
March 1, 2005 with payment made on March 15, 2005, $.25 per share to
shareholders of record as of August 1, 2005 with payment made on August 15,
2005, $.25 per share to shareholders of record as of March 1, 2006 with payment
made on March 15, 2006, $.30 per share to shareholders of record as of September
1, 2006 with payment made on September 15, 2006 ,  $.30 per share to
shareholders of record as of March 15, 2007 with payment made on March 30, 2007
and $.30 per share to shareholders of record as of August 31, 2007 with payment
made on September 14, 2007 and $.30 per share to shareholders of record as of
March 14, 2008 with payment made on March 28, 2008.
 
 Historically,
the Company and the Bank (prior to the formation of the Holding Company) have
declared ten stock dividends of 5% each, two stock dividends of 10% in May 1996
and June 1997, a 2 for 1 stock split in March 1998, a 3 for 2 stock split in
July 2004 and nine cash dividends in February 2004, July 2004, February 2005,
July 2005, February 2006, August 2006, March 2007, August 2007 and March 2008 as
detailed as follows:
 21
   Dividends Paid by the
      BankDate
      Declared
              Record
      Date
              Date
      Paid
              Dividend
      PaidMay
      13, 1992
              May
      31, 1992
              June
      15, 1992
              5%
      Stock DividendJune
      26, 1993
              July
      15, 1993
              July
      31, 1993
              5%
      Stock DividendJuly
      20, 1994
              August
      1, 1994
              August
      15, 1994
              5%
      Stock DividendJanuary
      18, 1995
              February
      5, 1995
              February
      20, 1995
              5%
      Stock DividendAugust
      16, 1995
              September
      11, 1995
              September
      29, 1995
              5%
      Stock DividendMay
      22, 1996
              June
      14, 1996
              June
      28, 1996
              10%
      Stock DividendJune
      18, 1997
              July
      15, 1997
              August
      1, 1997
              10%
      Stock DividendMarch
      18, 1998
              April
      15, 1998
              April
      30, 1998
              2
      for 1 Stock SplitJuly
      21, 1999
              August
      16, 1999
              August
      31, 1999
              5%
      Stock DividendAugust
      16, 2000
              September
      8, 2000
              September
      25, 2000
              5%
      Stock DividendDividends Paid by the
      CompanyDate
      Declared
              Record
      Date
              Date
      Paid
              Dividend
      PaidJuly
      18, 2001
              August
      3, 2001
              August
      17, 2001
              5%
      Stock DividendJune
      17, 2002
              July
      2, 2002
              July
      16, 2002
              5%
      Stock DividendJune
      18, 2003
              July
      2, 2003
              July
      16, 2003
              5%
      Stock DividendFebruary
      18, 2004
              March
      1, 2004
              March
      15, 2004
              $.25
      Cash DividendJuly
      21, 2004
              August
      6, 2004
              August
      26, 2004
              3
      for 2 Stock Split & $.25 Cash DividendFebruary
      16, 2005
              March
      1, 2005
              March
      15, 2005
              $.25
      Cash DividendJuly
      20, 2005
              August
      1, 2005
              August
      15, 2005
              $.25
      Cash DividendFebruary
      15, 2006
              March
      1, 2006
              March
      15, 2006
              $.25
      Cash DividendAugust
      17, 2006
              September
      1, 2006
              September
      15, 2006
              $.30
      Cash DividendFebruary
      22, 2007
              March
      15, 2007
              March
      30, 2007
              $.30
      Cash DividendAugust
      15, 2007
              August
      31, 2007
              September
      14, 2007
              $.30
      Cash DividendFebruary
      20, 2008
              March
      14, 2008
              March
      28, 2008
              $.30
      Cash Dividend
  22
 Comparison
of Cumulative Total Return on Investment
 There can
be no assurance that our stock performance will continue into the future with
the same or similar trends depicted in the graph below.  The market
price of our common stock in recent years has fluctuated significantly and it is
likely that the price of the stock will fluctuate in the future.  We
do not endorse any predictions of future stock
performance.  Furthermore, the stock performance chart is not
considered by us to be (i) soliciting material, (ii) deemed filed with the
Securities and Exchange Commission, or (iii) to be incorporated by reference in
any filings by us under the Securities Act, or the Exchange Act.


Period
      EndingIndex
              12/31/00
              12/31/01
              12/31/02
              12/31/03
              12/31/04
              12/31/05
              12/31/06
              12/31/07Sonoma
      Valley Bancorp
              100.00
              121.03
              176.98
              180.65
              223.45
              203.83
              272.52
              249.86Russell
      2000
              100.00
              102.49
              81.49
              120.00
              142.00
              148.47
              175.73
              172.98SNL
      OTC & Pink Sheet Western Index
              100.00
              101.11
              120.72
              178.37
              223.14
              255.27
              281.51
              237.68
  Source:
SNL Financial LC, Charlottesville, VA,
 (434)
977-1600
 (c)
2008
 www.snl.com
  23
 The following chart summarizes
the Company repurchases of the Company’s common stock during the fourth quarter
of 2007.
   (a)
              (b)
              (c)
              (d)Period
              Total
      Number of
                Shares
      (or Units)
                Purchased
              Average
      Price paid
                per
      Share (or Unit)
              Total
      Number of
                Shares
      (or Units)
                Purchased
      as Part
                of
      Publicly
                Announced
      Plans or
                Programs
              Maximum
      Number (or Approximate Dollar Value) of Shares (or Units) that May Yet be
      Purchased Under the Plans or Programs10/1/07
      - 10/31/07
              2,000
              $30.00
              2,000
              41,81711/1/07
      - 11/30/07
              2,225
              $27.33
              2,225
              39,59212/1/07
      - 12/31/07
              0
              $ 
      0.00
              0
              39,592Total
              4,225
              $28.59
              4,225
  (1)
              On
      January 17, 2001 a repurchase program was approved up to
      $1,000,000.  On August 21, 2002 an additional $1,000,000 was
      approved.  No expiration.
 (2)
              On
      February 15, 2006, 60,000 shares were approved to repurchase, on October
      18, 2006, an additional 60,000 shares were approved for repurchase and on
      July 18, 2007, an additional 60,000 shares were approved for
      repurchase.  No
expiration.
 24
  ITEM
6.                      SELECTED FINANCIAL DATA
 
 SONOMA
VALLEY BANCORP
 Selected
Consolidated Financial Data
 dollars
in thousands, except share
 and
per share data
 
 For the
years ended:
 
 2007
              
              
              2006
              
              
              2005
              
              
              2004
              
              
              2003RESULTS
      OF OPERATIONS:Net
      interest income
              
              $
              14,367
              
              
              $
              12,922
              
              
              $
              11,300
              
              
              $
              10,004
              
              
              $
              8,906Provision
      for loan losses
              
              
              (680
              )
              
              
              (500
              )
              
              
              (360
              )
              
              
              (130
              )
              
              
              (20
              )Non-interest
      income
              
              
              2,279
              
              
              
              2,094
              
              
              
              1,968
              
              
              
              1,710
              
              
              
              1,715Non-interest
      expense
              
              
              (9,182
              )
              
              
              (8,306
              )
              
              
              (7,848
              )
              
              
              (7,225
              )
              
              
              (6,244
              )Provision
      for income tax
              
              
              (2,440
              )
              
              
              (2,218
              )
              
              
              (1,711
              )
              
              
              (1,451
              )
              
              
              (1,446
              )Net
      Income
              
              $
              4,344
              
              
              $
              3,992
              
              
              $
              3,349
              
              
              $
              2,908
              
              
              $
              2,911SELECTED
      AVERAGE BALANCES:Assets
              
              $
              286,692
              
              
              $
              262,090
              
              
              $
              232,543
              
              
              $
              210,883
              
              
              $
              195,177Loans,
      net of unearned
              
              
              237,338
              
              
              
              199,001
              
              
              
              160,655
              
              
              
              139,395
              
              
              
              123,044Deposits
              
              
              229,105
              
              
              
              23,560
              
              
              
              203,341
              
              
              
              186,496
              
              
              
              171,620FHLB
      borrowings
              
              
              9,192
              
              
              
              1,397
              
              
              
              0
              
              
              
              0
              
              
              
              0Shareholders'
      equity
              
              
              27,248
              
              
              
              25,111
              
              
              
              21,935
              
              
              
              20,799
              
              
              
              20,232PER
      SHARE DATA:Basic
      net income
              
              $
              1.94
              
              
              $
              1.78
              
              
              $
              1.54
              
              
              $
              1.35
              
              
              $
              1.34Fully
      diluted net income
              
              $
              1.88
              
              
              $
              1.68
              
              
              $
              1.45
              
              
              $
              1.25
              
              
              $
              1.23Period
      end book value
              
              $
              12.58
              
              
              $
              11.71
              
              
              $
              10.63
              
              
              $
              9.65
              
              
              $
              9.89Weighted
      average shares outstanding
              
              
              2,241,104
              
              
              
              2,247,231
              
              
              
              2,170,866
              
              
              
              2,148,558
              
              
              
              2,165,066Weighted
      average shares outstanding diluted
              
              
              2,313,588
              
              
              
              2,369,218
              
              
              
              2,303,639
              
              
              
              2,330,841
              
              
              
              2,364,433FINANCIAL
      RATIOS:Return
      on average assets
              
              
              1.52
              %
              
              
              1.52
              %
              
              
              1.44
              %
              
              
              1.38
              %
              
              
              1.49
              %Return
      on average shareholders' equity
              
              
              15.94
              %
              
              
              15.90
              %
              
              
              15.27
              %
              
              
              13.98
              %
              
              
              14.39
              %Net
      yield on earning assets
              
              
              5.51
              %
              
              
              5.46
              %
              
              
              5.46
              %
              
              
              5.48
              %
              
              
              5.24
              %Efficiency
      ratio
              
              
              53.88
              %
              
              
              53.95
              %
              
              
              57.44
              %
              
              
              59.52
              %
              
              
              56.95
              %Average
      shareholders' equity to average assets
              
              
              9.50
              %
              
              
              9.58
              %
              
              
              9.43
              %
              
              
              9.86
              %
              
              
              10.37
              %CAPITAL
      RATIOS:Risk-based
      capital:Tier
      I
              
              
              9.50
              %
              
              
              9.57
              %
              
              
              10.68
              %
              
              
              10.77
              %
              
              
              12.81
              %Total
              
              
              10.76
              %
              
              
              10.26
              %
              
              
              11.93
              %
              
              
              12.02
              %
              
              
              14.07
              %Leverage
      ratio
              
              
              9.21
              %
              
              
              11.51
              %
              
              
              9.61
              %
              
              
              9.51
              %
              
              
              10.50
              %CREDIT
      QUALITY:Net
      charge-offs to average loans
              
              
              0.10
              %
              
              
              0.00
              %
              
              
              0.01
              %
              
              
              0.24
              %
              
              
              0.14
              %Allowance
      for possible loan losses to period end loans
              
              
              1.49
              %
              
              
              1.49
              %
              
              
              1.62
              %
              
              
              1.59
              %
              
              
              2.15
              %
 
  25
  ITEM
7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
 
 The
Year Ended December 31, 2007 versus December 31, 2006
 
 The
business operations of the Company continue to be conducted through the Bank,
its wholly-owned subsidiary, which began commercial lending operations on June
3, 1988.  Accordingly, the following discussion and analysis of the
financial condition and the results of operations should be read in conjunction
with the financial statements and notes included elsewhere in this annual
report.  The continued growth and success of the company is dependent
upon a stable economy, an increasing deposit base in the Sonoma Valley and
economically viable technology to enhance customer service.  Expansion
of services in the Sonoma Valley such as the implementation of remote deposit
capture, Visa debit cards, internet/on line banking , bill pay and courier
banking service are some of the strategies contributing to successful
performance.  It is management’s opinion that community banking will
continue to prosper, by providing useful services in niche markets, in spite of
the consolidation taking place in the industry.
 
 Critical
Accounting Policies
 
 The
accounting and reporting policies of the Company conform to accounting
principles generally accepted in the United States and general practices within
the financial services industry.  The preparation of financial
statements in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes.  Actual results could
differ from those estimates.  A summary of the Company’s most
significant accounting policies is contained on pages 54 in Note A to the
consolidated financial statements.  The Company considers its most
critical accounting policies to consist of the allowance for loan and lease
losses and the estimation of fair value, which are separately discussed
below.
 
 Allowance
for Loan and Lease Losses.  The allowance for loan and lease
losses represents management’s best estimate of inherent losses in the existing
loan portfolio.  The allowance for loan and lease losses is increased
by the provision for losses on loans and leases charged to expense and reduced
by loans and leases charged off, net of recoveries.  The allowance for
loan and lease losses is determined based on management’s assessment of several
factors:  reviews and evaluations of specific loans and leases,
changes in the nature and volume of the loan portfolio, current economic
conditions and the related impact on specific borrowers and industry groups,
historical loan and lease loss experience, the level of classified and
nonperforming loans and the results of regulatory examinations.
 
 The
Company’s Audit Committee engages experienced independent loan portfolio review
professionals, many of whom are former bank examiners.  The Audit
Committee determines the scope of such reviews and provides the report of
findings to the Board of Directors after it has reviewed and accepted the
report.  These reviews are supplemented with periodic reviews
internally by the Company’s credit review function, as well as the periodic
examination of both selected credits and the credit review process by the
applicable regulatory agencies.  The information from these reviews
assists management in the timely identification of problems and potential
problems and provides a basis for deciding whether the credit represents a
probable loss or risk that should be recognized.
 
 Changes
in the financial condition of individual borrowers, in economic conditions, in
historical loss experience and in the conditions of the various markets in which
collateral may be sold may all affect the required level of the allowance for
loan and lease losses and the associated provision for loan and lease
losses.
  Estimation
of Fair Value.  Accounting principles generally accepted in the
United States require that certain assets and liabilities be carried on the
Consolidated Balance Sheet at fair value or at the lower of cost or fair value,
and that stock awards be recorded based on their estimated fair
value.  Furthermore, the fair value of financial instruments is
required to be disclosed as a part of the notes to the consolidated financial
statements for other assets and liabilities (see Note R, page 78). Fair values
are volatile and may be influenced by a number of factors, including market
interest rates, prepayment speeds, discount rates, the shape of yield curves and
the credit worthiness of counterparties.
  Fair
values for the majority of the Company’s available for sale investment
securities are based on quoted market prices.  In instances where
quoted market prices are not available, fair values are based on the quoted
prices of similar instruments with adjustment for relevant
distinctions.  For trading account assets, fair value is estimated
giving consideration to the contractual interest rates, weighted average
maturities and anticipated prepayment speeds of the underlying instruments and
market interest rates.
  26
 Overview
 
 We
reported net income of $4,343,538 for the year ending December 31, 2007, an
increase of $351,779 over $3,991,759 for the year ending December 31,
2006.   The strong earnings are a result of a 24.1% increase in
loan income of $3.8 million from $15.8 million in 2006 to $19.6 million in 2007.
Loan balances grew 14.0% over 2006.  Deposits showed growth of 1.4%
over 2006, from $232.8 million in 2006 to $236.0 million at year end
2007.    On a per share basis, net income equaled $1.94 in
2007 compared with $1.78 per share in 2006.
 
 Return on
average total assets for 2007, 2006 and 2005 was 1.52%, 1.52% and 1.44%,
respectively.  Return on average shareholders’ equity increased to
15.94% in 2007 compared to 15.90% in 2006. The stable return on assets is a
result of the growth rate of both average assets and net income of 9.4% and
8.8%, respectively. Return on equity also remained stable. Average equity showed
growth of $2.1 million or an 8.5% growth rate over 2006 and net income showed a
growth rate of 8.8% or $352,000.
  At
December 31, 2007, total assets were $297.9 million, a 7.3% increase over the
$277.7 million at December 31, 2006. We showed loans of $250.5 million at
year end 2007, compared with $219.6 million at year end 2006, an increase of
14.0%. The commercial side of the business continues to be strong in Sonoma and
the borrowers strong resulting in the strong loan growth. Deposits increased
$3.3 million, growing 1.4%, from $232.8 million at year end 2006 to $236.0
million at year end 2007. Deposit growth continues to be challenging due to
competition in the market from local banks, savings and loans and money market
accounts with brokers. The loan-to-deposit ratio increased to 106.1% in 2007
from 94.3% in 2006. In 2008 we anticipate slower growth in assets, loans and
deposits.
 
 Total
shareholders equity increased by $1.53 million or 5.8% during the twelve
months ended December 31, 2007.  At December 31, 2007, we reported net
income of $4,343,538.  In March, we paid out $695,888 for cash
dividends declared in February 2007 and in September 2007, we paid out $675,583
for cash dividends declared in August 2007.   In 2004, incentive
stock options were granted to senior employees with a fifth of the options
vesting each year over a five-year period.  In 2007, 12,450 options
vested which increased equity by $188,949 year to
date.    In July 2006, 26,000 restricted stock options were
granted to senior employees with a fifth of the options vesting each year over a
five-year period and 3,000 restricted stock options were granted to a senior
employee with a third of the options vesting over a three-year
period.  In 2007, 6,200 restricted stock options vested, which
resulted in a tax benefit of $7,935. In 2007, equity was increased by $162,750
to reflect the expense for these options. In July 2007, 10,000 unqualified stock
options were granted to a director with a fifth of the options vesting each year
over a five year period. In 2007, equity was increased by $10,760 to reflect the
expense for these options. In December 2007, 7,410 unqualified stock options
were granted to two directors with one-third vesting immediately and two-thirds
vesting over a two year period. In 2007, equity was increased by $16,764 to
reflect the expense for these options. The net income figure of $4,343,538
reflects an expense for the incentive stock options of $188,949, restricted
stock options of $162,750, and the unqualified stock options of $27,524;
therefore, the net effect of the stock option transactions relative to equity
was zero.  Directors exercised 46,330 options which added $373,175 to
the capital accounts.  The tax benefit of these options was $398,503,
which also increased equity.  Officers exercised 13,847 options which
added $203,308 to the capital accounts. The tax benefit was $9,386 which also
increased equity. During the twelve months ended December 31, 2007 we
repurchased 100,415 shares which lowered equity by $2,933,238.  The
net effect of this activity results in capital of $27,934,280 as of December 31,
2007, compared to capital of $26,404,071 as of December 31, 2006.  See
page 50 for detail of “Changes in Shareholders’ Equity”.
  Section
404 of Sarbanes-Oxley Act of 2002 (“Section 404”) requires the Securities and
Exchange Commission (“SEC”) to prescribe rules requiring the establishment,
maintenance and evaluation of an issuer’s internal control of financial
reporting.  Accordingly, in the annual report for December 31, 2006,
our management was going to be required to include an assessment on the
effectiveness of our internal controls over financial reporting in accordance
with standards set by the Public Company  Accounting  Oversight 
Board. On
September 21, 2005, the SEC extended for another year the deadline for
non-accelerated filers to first certify compliance with Section
404.  This means that we will have to certify compliance for this year
ended December 31, 2007.  Our external independent auditors are
required to attest to and report on management's assessment of internal control
over financial reporting beginning December 31, 2008, which may be deferred to
2009.  Our management and staff have worked diligently evaluating and
documenting the internal control systems in order to allow our management to
report on our internal control over financial reporting with this
filing.
 27
 RESULTS
OF OPERATIONS
 
 Net
Interest Income
 
 Net
interest income is the difference between total interest income and total
interest expense.  Net interest income, adjusted to a fully taxable
equivalent basis, increased $1.4 million to $14.7 million, up 11.0% from 2006
net interest income of $13.3 million.  Net interest income on a fully
taxable equivalent basis, as shown on the table - Average Balances, Yields and
Rates Paid on page 29,is higher than net interest income on the statements of operations
because it reflects adjustments applicable to tax-exempt income from certain
securities and loans ($397,000 in 2007 and $379,000 in 2006, based on a 34%
federal income tax rate).
 
 The
improvement in net interest income for the year ended December 31, 2007 (stated
on a fully taxable equivalent basis) is a result of the net effect of a $3.4
million increase in interest income offset by an increase in interest expense of
$2.0 million, the net effect being an increase of $1.4 million or
11.0%.  This increase in net interest income is a result of the growth
in the loan portfolio offset by pressure to increase rates on deposits due to
competitive factors. The fed funds and prime rates were stable for the first 8
months of the year at 5.25% and 8.25%, respectively. In September 2007, the
Federal Open Market Committee (FOMC), began lowering rates and at year end the
fed funds rate and prime rate were at 4.25% and 7.25% respectively. As we move
into 2008 the FOMC has continued lowering rates and the current fed funds and
prime rates are 3.00% and 6.00%, respectively.
 
 Net
interest income (stated on a fully taxable equivalent basis) expressed as a
percentage of average earning assets, is referred to as net interest
margin.  Our net interest margin increased to 5.51% in 2007 from 5.46%
in 2006.  The slight increase in the net interest margin is a result
of the growth in loan volume offset by an increase in deposit rates. We were
able to temper the increase in deposit rates by increasing borrowing at the
Federal Home Loan Bank (FHLB) which offers funding at lower rates.
 
 Interest
Income
 
 As
previously stated, interest income (stated on a fully taxable equivalent basis)
increased by $3.4 million to $21.2 million in 2007, a 19.4% increase over the
$17.8 million realized in 2006.
 
 The $3.4
million increase in interest income was the result of a $2.7 million increase
due to the growth in volume of average balances, together with a $781,000
increase in income related to higher interest rates paid.  The yield
on earning assets was 7.91% as of December 31, 2007 compared to 7.29% in 2006, a
62 basis point increase. The increase is primarily the result of the $24.6
million or 10.1% growth in average earning assets from $243.5 million as of
December 31, 2006 to $268.1 million in 2007.
 Interest
Expense
 
 Total
interest expense increased by $2.0 million to $6.4 million as of December 31,
2007 compared to $4.5 million in 2006.  The average rate paid on all
interest-bearing liabilities increased from 2.51% in 2006 to 3.22% in 2007, a 71
basis point increase.  Average balances on earning liabilities
increased from $177.5 million to $199.6 million, a 12.4% gain in earning
liabilities.  Of the increase in average interest-bearing liabilities,
$16.2 million was borrowings at the Federal Home Loan Bank.  We
continue to experience stronger loan growth than deposit growth, so determined
it is more cost effective to satisfy our liquidity needs by borrowing at the
Federal Home Loan Bank.
 
 The gain
in volume of average balances was responsible for a $1.1 million increase in
interest expense while higher rates paid were responsible for a $851,000
increase in interest expense resulting in an increase in interest expense of
$2.0 million.  The growth in volume of interest-bearing liability
balances is the primary cause for the increase in interest expense.
 
 Individual
components of interest income and interest expense are provided in the
table-Average Balances, Yields and Rates Paid on page 29.
  28
 SONOMA VALLEY BANCORP
 AVERAGE
BALANCES/YIELDS AND RATES PAID
 Rate/Volume
 2007
              2006
              2005ASSETS
              Average
      Balance
              Income/
                Expense
              Yield/
                Rate
              Average
      Balance
              Income/
                Expense
              Yield/
                Rate
              Average
      Balance
              Income/
                Expense
              Yield/
                RateInterest-earning
      assets:Loans(2):Commercial
              $158,772,063
              $12,943,010
              8.15%
              $136,909,555
              $10,895,909
              7.96%
              $109,030,041
              $8,186,579
              7.51%Consumer
              28,115,183
              2,504,305
              8.91%
              25,167,482
              2,065,754
              8.21%
              19,216,697
              1,367,094
              7.11%Real
      estate construction
              30,167,065
              2,640,403
              8.75%
              19,431,136
              1,593,551
              8.20%
              19,741,512
              1,494,312
              7.57%Real
      estate mortgage
              18,460,123
              1,378,532
              7.47%
              15,624,447
              1,088,846
              6.97%
              10,502,449
              729,886
              6.95%Tax
      exempt loans (1)
              2,278,470
              187,389
              8.22%
              2,379,741
              195,558
              8.22%
              2,604,858
              215,214
              8.26%Leases
              27,221
              2,928
              10.76%
              44,438
              5,185
              11.67%
              37,486
              3,677
              9.81%Tax
      exempt leases (1)
              0
              0
              0.00%
              0
              0
              0.00%
              0
              0
              0.00%Unearned
      loan fees
              (482,421)
              
              
              (555,992)
              
              
              (478,473)Total
      loans
              237,337,704
              19,656,567
              8.28%
              199,000,807
              15,844,803
              7.96%
              160,654,570
              11,996,762
              7.47%Investment
      securitiesAvailable
      for sale:Taxable
              12,659,444
              461,209
              3.64%
              25,545,606
              859,937
              3.37%
              33,559,732
              1,049,443
              3.13%Tax
      exempt (1)
              0
              0
              0.00%
              0
              0
              0.00%
              0
              0
              0.00%Hold
      to maturity:Taxable
              0
              0
              0.00%
              175,371
              5,128
              2.92%
              370,518
              10,149
              2.74%Tax
      exempt (1)
              15,689,127
              980,182
              6.25%
              15,897,167
              920,114
              5.79%
              16,604,344
              947,633
              5.71%Total
      investment securities
              28,348,571
              1,441,391
              5.08%
              41,618,144
              1,785,179
              4.29%
              50,534,594
              2,007,225
              3.97%Federal
      funds sold
              67,123
              3,506
              5.22%
              1,648,644
              74,102
              4.49%
              2,291,052
              59,256
              2.59%FHLB
      Stock
              1,466,403
              69,286
              4.72%
              1,045,871
              50,408
              4.82%
              814,701
              33,032
              4.05%Total
      Due from Banks/Interest
              834,271
              29,847
              3.58%
              157,468
              4,977
              3.16%
              61,200
              1,453
              2.37%Short
      term investments
              0
              0
              0.00%
              0
              0
              0.00%
              0
              0
              0.00%Total
      interest earning assets
              268,054,072
              $21,200,597
              7.91%
              243,470,934
              $17,759,469
              7.29%
              214,356,117
              $14,097,728
              6.58%Noninterest-bearing
      assets:Reserve
      for loan losses
              (3,620,160)
              
              
              (2,995,052)
              
              
              (2,668,551)Cash
      and due from banks
              5,676,187
              
              
              6,077,171
              
              
              6,732,111Premises
      and equipment
              861,563
              
              
              1,078,565
              
              
              1,282,313Other
      real estate owned
              0
              
              
              0
              
              
              0Other
      assets
              15,720,025
              
              
              14,458,246
              
              
              12,841,172Total
      assets
              $286,691,687
              
              
              $262,089,864
              
              
              $232,543,162LIABILITIES
      AND SHAREHOLDERS’ EQUITYInterest-bearing
      liabilities:Interest-bearing
      depositsInterest-bearing
      transaction
              $29,053,472
              $47,332
              0.16%
              $30,838,635
              $50,928
              0.17%
              34,027,331
              $57,905
              0.17%Savings
      deposits
              75,703,801
              1,887,350
              2.49%
              73,425,495
              1,363,563
              1.86%
              73,821,236
              826,657
              1.12%Time
      less than $100,000
              29,008,487
              1,300,629
              4.48%
              26,544,506
              1,015,391
              3.83%
              20,600,270
              568,772
              2.76%Time
      $100,000 and over
              41,397,521
              1,957,123
              4.73%
              38,501,063
              1,602,820
              4.16%
              27,300,405
              851,427
              3.12%Total
      interest-bearing deposits
              175,163,281
              5,192,434
              2.96%
              169,309,699
              4,032,702
              2.38%
              155,749,242
              2,304,761
              1.48%Federal
      funds purchased
              0
              0
              0.00%
              0
              0
              0.00%
              0
              0
              0.00%Long
      term debit & other borrowings
              24,441,329
              1,244,256
              5.09%
              8,225,343
              425,681
              5.18%
              2,990,049
              97,799
              3.27%Total
      interest-bearing liabilities
              199,604,610
              $6,436,690
              3.22%
              177,535,042
              $4,458,383
              2.51%
              158,739,291
              $2,402,560
              1.51%Non
      interest-bearing liabilities:Demand
      deposits
              53,941,828
              
              
              54,250,592
              
              
              47,591,444Other
      liabilities
              5,897,019
              
              
              5,193,491
              
              
              4,276,993Shareholders’
      equity
              27,248,230
              
              
              25,110,739
              
              
              21,935,434Total
      liabilities and shareholders' equity
              $286,691,687
              
              
              $262,089,864
              
              
              $232,543,162Interest
      rate spread
              
              
              4.68%
              
              
              4.78%
              
              
              5.06%Interest
      income
              
              $21,200,597
              7.91%
              
              $17,759,469
              7.29%
              
              $14,097,728
              6.58%Interest
      expense
              
              6,436,690
              2.40%
              
              4,458,383
              1.83%
              
              2,402,560
              1.12%Net
      interest income/margin
              
              $14,763,907
              5.51%
              
              $13,301,086
              5.46%
              
              $11,695,168
              5.46%
 
 (1)
              Fully
      tax equivalent adjustments are based on a federal income tax rate of 34%
      in 2007, 2006 and 2005
 (2)
              Non
      accrual loans have been included in loans for the purposes of the above
      presentation.  Loan fees of approximately $536,000, $471,000 and
      $367,000 for the twelve months ended December 31, 2007, 2006 and 2005,
      respectively, were amortized to the appropriate interest income
      categories.
  29
 SONOMA VALLEY
  BANCORP
 
 Rate/Volume
Analysis
 
 2007 over
    2006
              
              
              
              2006 over
    2005Volume
              Rate
              Vol/Rate
              Total
              
              Volume
              Rate
              Vol/Rate
              TotalASSETSInterest-earning
      assets:Loans:Commercial
              1,739,922
              264,882
              42,298
              2,047,102
              
              2,093,348
              490,547
              125,435
              2,709,330Consumer
              241,948
              175,990
              20,613
              438,551
              
              423,344
              210,218
              65,098
              698,660Real
      estate construction
              880,455
              107,179
              59,218
              1,046,852
              
              (23,494)
              124,693
              (1,960)
              99,239Real
      estate mortgage
              197,614
              77,928
              14,143
              289,685
              
              355,962
              2,015
              983
              358,960Tax
      exempt loans
              (8,322)
              160
              (7)
              (8,169)
              
              (18,599)
              (1,157)
              100
              (19,656)Leases
              (2,009)
              (405)
              157
              (2,257)
              
              682
              697
              129
              1,508Tax
      exempt leases
              0
              0
              0
              0
              
              0
              0
              0
              0Unearned
      fee income
              0
              0
              0
              0
              
              0
              0
              0
              0Total
      loans
              3,049,608
              625,734
              136,422
              3,811,764
              
              2,831,244
              827,013
              189,784
              3,848,041Investment
      securities:Available
      for sale:Taxable
              (433,784)
              70,741
              (35,684)
              (398,728)
              
              (250,609)
              80,272
              (19,169)
              (189,506)Tax-exempt
              0
              0
              0
              0
              
              0
              0
              0
              0Held
      to maturity:Taxable
              (5,128)
              
              
              (5,128)
              
              (5,345)
              685
              (361)
              (5,021)Tax-exempt
              (12,041))
              73,065
              (956)
              60,068
              
              (40,360))
              13,412
              (571)
              (27,519)Total
      investment Securities
              (450,953)
              143,806
              (36,640)
              (343,787)
              
              (296,314)
              94,369
              (20,101)
              (222,046)Federal
      funds sold
              (71,085)
              12,011
              (11,522)
              (70,596)
              
              (16,615)
              43,720
              (12,259)
              (14,846)FHLB
      Stock
              20,268
              (992)
              (399)
              18,878
              
              9,373
              6,234
              1,769
              17,376Due
      from banks-int bearing
              21,391
              657
              2,822
              24,870
              
              2,286
              481
              757
              3,524Short
      term investments
              0
              0
              0
              0
              
              0
              0
              0
              0Total
      interest-earning Assets
              2,569,229
              781,216
              90,683
              3,441,128
              
              2,529,973
              971,818
              159,950
              3,661,741LIABILITIESInterest-bearing
      liabilities:Interest-bearing
      deposits:Savings
      deposits
              (2,948)
              (688)
              40
              (3,596)
              
              (5,426)
              (1,711)
              160
              (6,977)Interest-bearing
      demand Deposits
              42,310
              466,987
              14,490
              523,787
              
              (4,432)
              544,255
              (2,918)
              536,906Time
      less than $100,000
              94,253
              174,763
              16,222
              285,238
              
              164,120
              219,238
              63,261
              446,619Time
      $100,000 and over
              120,581
              217,369
              16,353
              354,303
              
              349,319
              285,104
              116,971
              751,393Total
      interest-bearing Deposits
              254,196
              858,431
              47,105
              1,159,732
              
              503,581
              1,046,885
              177,475
              1,727,941Federal
      funds purchased
              0
              0
              0
              0
              
              0
              0
              0
              0Long
      term debit & other borrowing
              839,216
              (6,946)
              (13,694)
              818,575
              
              171,237
              56,943
              99,702
              327,882Total
      interest-bearing Liabilities
              1,093,412
              851,485
              33,411
              1,978,307
              
              674,818
              1,103,829
              277,177
              2,055,823Interest
      differential
              1,475,817
              (70,269)
              57,272
              1,462,821
              
              1,855,156
              (132,011)
              (117,227)
              1,605,918
 
 Volume/Rate
      variances were allocated in the following
  manner:
 a.  Changes
      affected by volume (change in volume times old
  rate)
 b.  Changes
      affected by rates (change in rates times old
  volume)
 c.  Changes
      affected by rate/volume (change in volume times change in
      rates)
 The
      total for each category was arrived at by totaling the individual items in
      their respective categories.
 
 30
  Provision
for Loan Losses
 
 The
provision for loan losses charged to operations as of December 31, 2007 was
$680,000 compared to $500,000 in 2006.  The provision for loan losses
is based on our monthly evaluation of the loan portfolio and the adequacy of the
allowance for loan losses in relation to total loans outstanding.  We
experienced strong loan growth in 2007 and we anticipate loan growth will
continue, although significantly slower, which could require additional
provisions for loan losses.  Additionally, there are regulatory
concerns about concentrations of commercial real estate loans among many
financial institutions.  We have a concentration of commercial real
estate loans and although the loans are adequately collateralized, we determined
that it is prudent to continue making a provision for loan losses. In addition
to the above, in recent months the economy has demonstrated weakness and real
estate values have declined. We are monitoring our loan portfolio in order to be
aware of any concerns which may develop.
 
 At year
end the non-performing assets to total loans ratio continued to be below 1% at
0.45% as of December 31, 2007 compared to 0.42% in 2006. A non-performing
asset ratio below 1% is considered very strong by industry standards. Non
accrual loans were $800,000 as of December 31, 2007 compared to $820,000 as of
December 31, 2006, a decline of 2.39%.  Loans charged-off were
$250,976 and recoveries were $17,221 for 2007 compared with $18,855 in
charge-offs and $19,320 in recoveries for the same period in
2006.  The increase in charge offs in 2007 is a result of management’s
conservative approach and analysis regarding collectability of loans and the
desire to reflect conditions appropriately.  Of the $250,976 in charge
offs, 64.3% or $161,318 involved one customer relating to a bankruptcy.
 Refer to page 61,Note D for an analysis in the changes in allowance for loan losses
including charge offs and recoveries.
 
 Non-interest
Income
 
 Non-interest
income of $2.3 million for 2007 increased 8.8% or $185,000 compared to the $2.1
million recorded in 2006.  Of the increase 43.5% or $81,000 was due to
an increase in all other non-interest income, 31.6% was a result of increases in
service charges on deposit account of $58,000 and the remainder of the increase
was in the area of other fee income, an increase of $46,000 or
24.9%.  All other non-interest income showed a 22.3% increase or
$81,000 from $361,000 in 2006 to $442,000 in 2007.  This is largely a
result of an increase in the income generated by bank owned life insurance
policies in 2007.  Income on the policies was $417,000 in 2007
compared to $348,000 in 2006 or yields of 4.14% and 3.73%, respectively. The
earnings on these policies will increase as the balances increase and if market
rates increase, the income produced by these policies should also increase.
Additionally, there was an $11,600 increase in check printing income due to a
change in vendors.
 
 Other fee
income showed an increase in 2007 of 12.4% or $46,000 from $380,000 in 2006 to
$426,000 in 2007.  The higher income is a result of an increase of
$24,000 in income we earned from loan referrals, which increased from $56,000 in
2006 to $80,000 in 2007.  Also contributing to the increase was an
increase of $11,000 in credit card merchant fee income from $162,000 in 2006 to
$173,000 in 2007.
 
 
 Non-interest
Expense
 
 Total
non-interest expense increased 10.6% to $9.2 million in 2007 from $8.3 million
in 2006.  Non-interest expense represented 3.20% of average total
assets in 2007 and 3.17% in 2006. The expense/asset ratio is a standard industry
measurement of a bank's ability to control its overhead or non-interest costs.
During 2008, we will continue to emphasize cost controls, although certain
costs, such as costs of company insurance and certain salary and benefit
expenses such as workers compensation insurance and medical benefits are not
controllable by management.  We monitor our efficiency ratio relative
to peers as a means of evaluating out control over expenses. The efficiency
ratio is operating expenses divided by revenues (net interest income plus
non-interest income). This ratio has become an industry “benchmark” and is used
as a means of measuring overall expense management. For example, an efficiency
ratio of 60% indicates that a bank spends $0.60 to generate $1.00 of revenues.
As of December 31, 2007 and December 31, 2006 our efficiency ratios were 53.88%
and 53.95%, respectively. Refer to Note I, page 65 for a detailed
description of Non-Interest Income and Other Non-Interest Expense.
 
 
 31
 Salaries
and Benefits
 
 The most
significant dollar increase was in the salaries and benefits
category.  Salary and benefits increased 13.1% from $4.9 million in
2006 to $5.5 million in 2007. The increase is a result of an increase of
$357,000 in salary expense which grew from $2.9 million in 2006 to $3.3 million
in 2007. At December 31, 2007 and December 31, 2006 total full time equivalent
employees were 51 and 49, respectively an increase of two full time equivalent
employees. Also contributing to the increase is normal merit increases. Year-end
assets per employee were $5.8 million in 2007 compared with $5.7 million in
2006.  Additionally, accrual adjustments were necessary to the
Supplemental Executive retirement plan.   An additional increase
in expense of $81,000 over prior year was taken for restricted stock that was
granted to bank officers.
 
 Premises
and Equipment
 
 Expense
relative to premises and equipment decreased 5.7% to $959,000 in 2007 from
$1.016 million  in 2006.  Most areas of premises and
equipment showed declines except for lease expense.  Lease expense
increased from $364,000 in 2006 to $381,000 in 2007, a $17,000 (4.64%)
increase.  The Bank continues to emphasize security in its computer
operations.  Equipment and software are monitored and upgraded as
appropriate to ensure confidentiality of customer and Company data contributing
to additional increases in expense.  We continue to emphasize the
utilization of technology to accommodate customer and market
demands.
 
 Other
Non-interest Expense
 
 Other
non-interest expense showed an increase of 12.2% or $286,000 to $2.6 million in
2007 from $2.3 million in 2006.  The largest piece of this increase
was due to increases in professional fees.  Professional fees were
$702,000 in 2006 and increased to $1.0 million in 2007, an increase of
$316,000.  The categories of professional fees which showed the most
significant increases were in the areas of accounting and taxes, legal
fees-corporate matters, other professional fees, other exam fees and director
fees.  Other professional grew significantly due to the involvement of
an outside technology company to assist with network security and disaster
planning.
 
 Expense
for advertising and marketing increased $10,000 from $276,000 in 2006 to
$286,000 in 2007.  The increases in this category are a result of our
involvement in the community, both through donations as well as participation in
civic organizations.  Additionally, shareholder relations showed an
increase in 2007 over 2006.
 
 
 Provision
for Income Taxes
 
 The
provision for income taxes increased to an effective tax rate of 36% in 2007
compared with 35.7% in 2006.  The higher effective tax rate is a
reflection of the increase in taxable income when compared with income derived
from tax exempt investments.  Income taxes reported in the financial
statements include deferred taxes resulting from timing differences in the
recognition of items for tax and financial reporting purposes.
 
 
 32
   Unaudited
Quarterly Statement of Operations Data
 
 (Dollars in thousands, except per share
data)
 
 Q4
              
              
              
              Q3
              
              
              
              Q2
              
              
              
              Q1
              
              
              
              Q4
              
              
              
              Q3
              
              
              
              Q2
              
              
              
              Q12007
              
              
              2007
              
              
              2007
              
              
              2007
              
              
              2006
              
              
              2006
              
              
              2006
              
              
              2006Net
      interest income
              
              $
              3,681
              
              
              $
              3,571
              
              
              $
              3,640
              
              
              $
              3,475
              
              
              $
              3,440
              
              
              $
              3,298
              
              
              $
              3,204
              
              
              $
              2,978Provision
      for loan and lease losses
              
              
              (115
              )
              
              
              (140
              )
              
              
              (290
              )
              
              
              (135
              )
              
              
              (180
              )
              
              
              (30
              )
              
              
              (240
              )
              
              
              (50
              )Other
      operating income
              
              
              568
              
              
              
              582
              
              
              
              579
              
              
              
              550
              
              
              
              536
              
              
              
              534
              
              
              
              520
              
              
              
              505Other
      operating expenses
              
              
              (2,379
              )
              
              
              (2,331
              )
              
              
              (2,274
              )
              
              
              (2198
              )
              
              
              (2,098
              )
              
              
              (2,230
              )
              
              
              (1,973
              )
              
              
              (2,004
              )Income
      before income taxes
              
              
              1,755
              
              
              
              1,682
              
              
              
              1,655
              
              
              
              1,692
              
              
              
              1,698
              
              
              
              1,572
              
              
              
              1,511
              
              
              
              1,429Provision
      for income taxes
              
              
              (593
              )
              
              
              (589
              )
              
              
              (582
              )
              
              
              (676
              )
              
              
              (609
              )
              
              
              (560
              )
              
              
              (542
              )
              
              
              (507
              )Net
      Income
              
              
              1,162
              
              
              
              1,093
              
              
              
              1,073
              
              
              
              1,016
              
              
              
              1,089
              
              
              
              1,012
              
              
              
              969
              
              
              
              922Per
      share:Basic
      earnings per share
              
              $
              .52
              
              
              $
              .49
              
              
              $
              .48
              
              
              $
              .45
              
              
              $
              .48
              
              
              $
              .45
              
              
              $
              .43
              
              
              $
              .41Diluted
      earnings per share
              
              $
              .50
              
              
              $
              .47
              
              
              $
              .46
              
              
              $
              .43
              
              
              $
              .46
              
              
              $
              .43
              
              
              $
              .41
              
              
              $
              .40
 
  33
  BALANCE
SHEET ANALYSIS
 
 Investment
Securities
 
 Investment
securities were $22.8 million at December 31, 2007, a 38.2% decline from the
$36.8 million at December 31, 2006.  At year end 2007, the overall
portfolio had a market value of $23.0 million compared with an amortized cost of
$22.8 million.  We purchase securities rated A or higher by Standard
and Poor’s and/or Moody’s Investors Service.  In the event a security
is downgraded, we will monitor the investment more closely or sell if
appropriate.  Local tax-exempt bonds are occasionally purchased
without an A rating.
 
 Securities
are classified as held to maturity (HTM) if we have both the intent and the
ability to hold these securities to maturity.  As of December 31,
2007, we had securities totaling $14.6 million with a market value of $14.8
million categorized as held to maturity.  Decisions to acquire
municipal securities, which are generally placed in this category, are based on
tax planning needs and pledge requirements.
 
 Securities
are classified as available for sale (AFS) if we intend to hold these debt
securities for an indefinite period of time, but not necessarily to
maturity.  Investment securities which are categorized as available
for sale are acquired as part of the overall asset and liability management
function and serve as a primary source of liquidity.  Decisions to
acquire or dispose of different investments are based on an assessment of
various economic and financial factors, including, but not limited to, interest
rate risk, liquidity and capital adequacy.  Securities held in the
available for sale category are recorded at market value, which is $8.2 million
compared to an amortized cost of $8.3 million as of December 31,
2007.
 
 There
were seven Federal Farm Credit Bank and Federal Home Loan Bank securities of
$7.2 million and fifteen equity securities of $32,000 in the AFS portfolio and
fourteen securities of $3.7 million in the HTM portfolio that are temporarily
impaired as of December 31, 2007.  Of the above, there were seven
Federal Farm Credit Bank and Federal Home Loan Bank securities of $7.2 million
and eight equity securities of $20,200 in the AFS portfolio and thirteen
municipal securities of $3.6 million in the HTM portfolio that have been in a
continuous loss position for 12 months or more as of December 31,
2007.    The primary cause of the impairment of these
securities is interest rate volatility inherent in a rising rate environment
which causes the market value of the security to decline.  We
understood the potential market risks at the time of acquisition and determined
the benefit to us of the higher interest rates received more than offset the
potential deterioration in value.  It is our intention to carry the
securities to maturity date, at which time we will receive face value for the
securities at no loss. The equity securities are minimal shares of local and
peer group banks so that we may better review their financial and compensation
information.
 
 Although
the quoted market values fluctuate, investment securities are generally held to
maturity, and accordingly, gains and losses to the income statement are
recognized upon sale, or at such time as management determines that a permanent
decline in value exists.  In our opinion, there was no investment in
securities at December 31, 2007 that constituted a material credit risk to the
Company.  The lower market value to amortized costs was a result of
the increase in market interest rates and not an indication of lower credit
quality. There is some uncertainty in the market relative to the companies
insuring the municipal securities that we hold. We are monitoring this situation
very closely and believe that the municipalities will be able to fulfill their
obligations and there will be no need to rely on the insurance companies for
payment. If the insurance companies are down graded it could lower the rating on
the securities and therefore effect the fair value.
 
 The table
on the following page shows the components of the investment portfolio and
average yields.  For further information concerning our total
securities portfolio, including market values and unrealized gains and losses,
refer to Note C of the Notes to Consolidated Financial Statements on page
59.
  34
  
 Twelve Months Ended
      12/31/07
              
              
              Twelve
      Months Ended 12/31/06Average
              
              
              Income/
              
              
              Yield/
              
              
              Average
              
              
              Income/
              
              
              Yield/Balance
              
              
              Expense
              
              
              Rate
              
              
              Balance
              
              
              Expense
              
              
              RateInvestment
      securities:U.S.
      Treasury securities
              
              $
              2,953,303
              
              
              $
              99,747
              
              
              
              3.38
              %
              
              $
              5,319,515
              
              
              $
              177,501
              
              
              
              3.34
              %U.S.
      federal agency issues
              
              
              9,668,731
              
              
              
              360,231
              
              
              
              3.73
              %
              
              
              20,201,000
              
              
              
              681,782
              
              
              
              3.37
              %State,
      county & munis
              
              
              15,689,127
              
              
              
              980,182
              
              
              
              6.25
              %
              
              
              16,072,538
              
              
              
              925,242
              
              
              
              5.76
              %Other
      securities
              
              
              37,410
              
              
              
              1,231
              
              
              
              3.29
              %
              
              
              25,091
              
              
              
              654
              
              
              
              2.61
              %Total
      investment securities
              
              $
              28,348,571
              
              
              $
              1,441,391
              
              
              
              5.08
              %
              
              $
              41,618,144
              
              
              $
              1,785,179
              
              
              
              4.29
              %
 
 Loans
 
 A
comparative schedule of average loan balances is presented in the table on page
29; year-end balances are presented in Note D to the Consolidated Financial
Statements on page 60.
 
 Loan
balances, net of deferred loan fees at December 31, 2007, were $250.5 million,
an increase of 14.0% over 2006.  Commercial loans, comprising 70.9% of
the portfolio, increased $31.4 million, or 21.4% over 2006 showing the greatest
change in volume of all categories.  Included in Commercial loans are
loans made for commercial purposes and secured by real estate.
 
 Consumer
loans and Real Estate Mortgage loans both showed growth over 2006 of 4.9% and
4.6% or $1.4 million and $791,000, respectively.  Growth in home
equity loans has contributed to the increase in Consumer loans in 2007 from
$27.8 million in 2006 to $29.2 million at year end 2007.  During 2007
we were able to continue to expand the conventional real estate mortgage loan
portfolio, as Real Estate Mortgage loans grew from $17.2 million in 2006 to
$17.9 million in 2007.  It is anticipated that the growth rate will be
more modest in 2008 due to tightened lending standards.
 
 Real
Estate Construction loans and Lease Financing Receivables showed declines over
2006.  Real Estate Construction loans show a decline of 9.9% or $2.8
million from $28.6 million in 2006 to $25.8 million in 2007.  This
decrease is a result of seasonality in construction loans and as projects are
funded construction loans could show an increase.  Lease Financing
Receivables decreased by 39.9% or $14,000 from $36,000 in 2006 to $22,000 in
2007.  Customer interest in lease financing receivables has declined
in our market and we do not see this changing in the foreseeable
future.
 
 Risk
Elements
 
 The
majority of our loan activity is with customers located within Sonoma
County.  Approximately 91.3% of the total loan portfolio is secured by
real estate located in our service area.  Significant concentrations
of credit risk may exist if a number of loan customers are engaged in similar
activities and have similar economic characteristics.  We believe the
Company has policies in place to identify problem loans and to monitor
concentrations of credit (see Note O, on page 73 of the Consolidated
Financial Statements, Concentration of Credit Risk).
 
 Based on
its risk management review and a review of its loan portfolio, management
believes that its allowance for loan losses as of December 31, 2007, is
sufficient to absorb losses inherent in the loan portfolio.  This
assessment is based upon the best available information and does involve
uncertainty and matters of judgment.  Accordingly, the adequacy of the
loan loss reserve cannot be determined with precision, but is subject to
periodic review, and could be susceptible to significant change in future
periods.
  35
  Loan
Commitments and Letters of Credit
 
 Loan
commitments are written agreements to lend to customers at agreed upon terms,
provided there are no violations of any condition established in the
contract.  Commitments generally have fixed expiration dates or other
termination clauses.  Loan commitments may have variable interest
rates and terms that reflect current market conditions at the date of
commitment.  Because many of the commitments are expected to expire
without being drawn upon, the amount of total commitments does not necessarily
represent our anticipated future funding requirements.  Unfunded loan
commitments were $51.5 million at December 31, 2007 and $54.5 million at
December 31, 2006.
 
 Standby
letters of credit commit us to make payments on behalf of customers when certain
specified events occur.  Standby letters of credit are primarily
issued to support customers' financing requirements of twelve months or less and
must meet our normal policies and collateral requirements.  Standby
letters of credit outstanding were $158,000 at December 31, 2007 and $348,000 at
December 31, 2006.
 
 Nonperforming Assets
 
 Management
classifies all loans as non-accrual loans when they become more than 90 days
past due as to principal or interest, or when the timely collection of interest
or principal becomes uncertain, if earlier, unless they are adequately secured
and in the process of collection.
 
 A loan
remains in a non-accrual status until both principal and interest have been
current for six months and meets cash flow or collateral criteria, or when the
loan is determined to be uncollectible and is charged off against the allowance
for loan losses, or in the case of real estate loans, is transferred to other
real estate owned.  A loan is classified as a restructured loan when
the interest rate is reduced, when the term is extended beyond the original
maturity date, or other concessions are made by us, because of the inability of
the borrower to repay the loan under the original terms.
 
 We had
loans of $800,029 in non-accrual status at December 31, 2007 and $819,637 at
December 31, 2006.  There were $601,238 in loans 90 days or more past
due at December 31, 2007 and $157,678 in loans 90 days or more past due at
December 31, 2006.  Occasionally, we will have more loans in
non-accrual status than are 90 days past due following the guidelines in the
above paragraph or if management determines the collection of principal or
interest is unlikely.
 
 Allowance
for Loan Losses
 
 The
allowance for loan losses is maintained at a level considered adequate to
provide for losses that can be reasonably anticipated.  The allowance
is increased by provisions charged to operating expense and reduced by
charge-offs, net of recoveries.  The allowance is based on estimates,
and ultimate losses may vary from the current estimates.  These
estimates are reviewed monthly and, as adjustments become necessary, they are
reported in earnings in the periods in which they become known.
 
 The
review process is intended to identify loan customers who may be experiencing
financial difficulties.  In these circumstances, a specific reserve
allocation or charge-off may be recommended.  Other factors considered
by management in evaluating the adequacy of the allowance
include:  loan volume, historical net loan loss experience, the
condition of industries and geographic areas experiencing or expected to
experience economic adversities, credit evaluations, and current economic
conditions.  The allowance for loan losses is not a precise amount,
but based on the factors above, represents management's best estimate of losses
that may be ultimately realized from the current loan
portfolio.
  36
  Worsening
conditions in certain economic sectors and geographic areas could adversely
affect the loan portfolio, necessitating larger provisions for loan losses than
currently estimated.  However, as of December 31, 2007, we believe the
overall allowance for loan losses is adequate based on our analysis of
conditions at that time.
 
 At
December 31, 2007, the allowance for loan losses was $3.7 million, or 1.49% of
year end loans, compared with $3.3 million or 1.49% of year end loans at
December 31, 2006.  The increase in the allowance is a result of the
loan growth and our review and analysis of the portfolio.
 
 Net
charge-offs to average loans increased when compared with the prior
year.  We recorded net losses of $234,000 or .10% of average loans in
2007 compared to 2006 which showed more recoveries than charge offs for a net
recoveries of $465.  The increase, although still low by industry
standards, reflects our attention and effort in managing and collecting past due
loans by encouraging the customer to bring them to a current status or to pay
them off and management’s desire to quickly charge off a loan when it is
determined to be uncollectible.  The prompt charge-off of loans
improves the quality of the loan portfolio.
 
 Deposits
 
 A
comparative schedule of average deposit balances is presented in the table on
page 29;year-end
deposit balances are presented in the table below.
 
 Total
deposits increased $3.3 million or 1.4% in 2007, to $236.0 million compared to
$232.8 million in 2006.  Other time deposits, savings, interest
bearing checking and time deposits greater than $100,000 showed increases over
2006. The deposits showing the strongest growth were other time deposits, which
increased $2.0 million or 7.3% from $27.6 million in 2006 to $29.6 million in
2007. This increase can be attributed to special rate promotions on time deposit
accounts. Savings increased $1.2 million or 1.69% from $72.3 million to $73.5
million. Showing smaller increases were interest bearing checking and time
deposits greater than $100,000, which increased $151,000 and $93,000, to $30.1
million and $44.2 million, respectively.
 
 Non-interest
bearing demand showed a slight decline in 2007 of $151,000 or .26% from $58.7
million in 2006 to $58.6 million at year end. Non-interest bearing demand is
24.8% of total deposits.
 
 The
composition of deposits for the years ending December 31, 2007 and 2006 are as
follows:
 
 December
      31,
              
              
              Percentage
              
              
              December
      31,
              
              
              Percentage2007
              
              
              of
      Total
              
              
              2006
              
              
              of
      TotalInterest-bearing
      Transaction Deposits
              
              $
              30,135,049
              
              
              
              12.8
              %
              
              $
              29,983,572
              
              
              
              12.9
              %Savings
      deposits
              
              
              73,528,081
              
              
              
              31.1
              %
              
              
              72,346,136
              
              
              
              31.1
              %Time
      deposits, over $100,000
              
              
              44,160,741
              
              
              
              18.7
              %
              
              
              44,067,435
              
              
              
              18.9
              %Other
      time deposits
              
              
              29,634,626
              
              
              
              12.6
              %
              
              
              27,629,801
              
              
              
              11.9
              %Total
      interest-bearing deposits
              
              
              177,458,497
              
              
              
              75.2
              %
              
              
              174,026,944
              
              
              
              74.8
              %Noninterest-bearing
      demand
              
              
              58,589,202
              
              
              
              24.8
              %
              
              
              58,740,471
              
              
              
              25.2
              %Total
      deposits
              
              $
              236,047,699
              
              
              
              100.0
              %
              
              $
              232,767,415
              
              
              
              100.0
              %
 
  37
  Capital
 
 The Bank
is subject to FDIC regulations governing capital adequacy.  The FDIC
has adopted risk-based capital guidelines which establish a risk-adjusted ratio
relating capital to different categories of assets and off-balance sheet
exposures.  Under the current guidelines, as of December 31, 2007, the
Bank was required to have minimum Tier I and total risk-based capital ratios of
4% and 8%, respectively. To be well capitalized under Prompt Corrective Action
Provisions requires minimum Tier I and total risk-based capital ratios to be 6%
and 10%, respectively.
 
 The FDIC
has also adopted minimum leverage ratio guidelines for compliance by banking
organizations.  The guidelines require a minimum leverage ratio of 4%
of Tier 1 capital to total average assets.  Banks experiencing high
growth rates are expected to maintain capital positions well above the minimum
levels.  The leverage ratio, in conjunction with the risk-based
capital ratio, constitutes the basis for determining the capital adequacy of
banking organizations.
 
 Based on
the FDIC's guidelines, the Bank's total risk-based capital ratio at December 31,
2007 was 10.76% and its Tier 1 risk-based capital ratio was
9.50%.  The Bank's leverage ratio was 9.01%.  All the ratios
exceed the minimum guidelines of 8.00%, 4.00% and 4.00%,
respectively.  The total risk based capital, Tier 1 risk based capital
and leverage ratios for the Company at December 31, 2006, were 11.51%, 10.26%
and 9.57%, respectively.  The capital ratios for the Company at
December 31, 2007, were 10.98%, 9.73% and 9.21%, respectively.
 
 In
February 2001, we approved a program to repurchase Sonoma Valley Bancorp stock
up to $1.0 million and in August 2002 we approved the repurchase of an
additional $1.0 million of Sonoma Valley Bancorp stock.  As of
December 31, 2005, $1,580,162 had been repurchased and retired, net of options
which were exercised and then subsequently repurchased and
retired.  In February 2006 we approved the repurchase of 60,000 shares
of Sonoma Valley Bancorp stock, in October 2006 we approved an additional 60,000
shares of Sonoma Valley Bancorp stock and in July, 2007 we approved an
additional 60,000 shares of Sonoma Valley Bancorp stock.  During the
twelve months ended December 31, 2006, 55,028 shares were repurchased and
retired of which 15,035 shares or $364,729 were a part of the amount approved
August 2002.   During the twelve months ended December 31, 2007,
100,415 shares have been repurchased and retired.  Refer to page 27,
for a discussion of the changes in capital and pages 50 and 51 for the
table of “Changes in Shareholders’ Equity.”
  We
believe that the Bank's current capital position, which exceeds guidelines
established by industry regulators, is adequate to support our
business.
 
 Off
Balance Sheet Commitments and Contractual Obligations
 
 Our off
balance sheet commitments consist of commitments to extend credit and standby
letters of credit.  These commitments are extended to customers in the
normal course of business and are described on page 36, Loan Commitments and
Letters of Credit and in Note N to the Consolidated Financial Statements on
page 74. We also has contractual obligations consisting of operating
leases for various facilities and payments to participants under our
supplemental executive retirement plan, director retirement plan and deferred
compensation plan, which are described in Note H on page63.  38
 The
following table summarizes our contractual obligations as of December 31,
2007.
  Payments
      due by periodContractual
      Obligations
              
              Total
              
              
              Less
      than 1 year
              
              
              1-3
      years
              
              
              3-5 Years
              
              
              More
      than 5 yearsOperating
      Lease Obligations
              
              $
              607,379
              
              
              $
              367,482
              
              
              $
              239,897
              
              
              
              --
              
              
              
              --Executive
      Officer Supplemental Retirement
              
              $
              11,138,025
              
              
              $
              27,592
              
              
              $
              273,933
              
              
              $
              752,844
              
              
              $
              10,083,656Federal
      Home Loan Bank - Long Term Borrowings
              
              $
              10,000,000
              
              
              $
              5,000,000
              
              
              $
              5,000,000
              
              
              
              --
              
              
              
              --Director
      Retirement Plan
              
              $
              1,027,237
              
              
              $
              9,500
              
              
              $
              22,407
              
              
              $
              62,315
              
              
              $
              933,015Deferred
      Compensation
              
              $
              3,463,935
              
              
              $
              91,683
              
              
              $
              536,092
              
              
              $
              357,793
              
              
              $
              2,478,367
 
 Liquidity
Management and Capital Resources
 
 Our
liquidity is determined by the level of assets (such as cash, federal funds sold
and available-for-sale securities) that are readily convertible to cash to meet
customer withdrawal and borrowing needs.  Deposit growth also
contributes to our liquidity.  We review our liquidity position on a
regular basis to verify that it is adequate to meet projected loan funding and
potential withdrawal of deposits.  We have a comprehensive Asset and
Liability Policy which we use to monitor and determine adequate levels of
liquidity.  At year end 2007, our primary liquidity ratio (adjusted
liquid assets to deposits and short term liabilities) was 5.9% compared to 11.4%
and 20.1% at year end 2006 and 2005, respectively.  Available
liquidity which includes the ability to borrow at the Federal Home Loan Bank was
40.0% in December 31, 2007 and 27.1% and 33.8% in 2006 and 2005,
respectively.  Management expects that liquidity will remain adequate
throughout 2008, as loan growth slows. Any excess funds will be invested in
quality liquid assets, such as U.S. Treasury and Agency
securities.  Management believes that the Company has adequate
liquidity and capital resources to meet its short term and long term
commitments.
 
 Market
Risk Management
 
 Overview.  Market
risk is the risk of loss from adverse changes in market prices and
rates.  Our market risk arises primarily from interest rate risk
inherent in our loan, investment and deposit functions.  The goal for
managing our assets and liabilities is to maximize shareholder value and
earnings while maintaining a high quality balance sheet without exposing us to
undue interest rate risk.  Our Board of Directors has overall
responsibility for the interest rate risk management policies.  Sonoma
Valley Bank has an Asset and Liability Management Committee (ALCO) that
establishes and monitors guidelines to control the sensitivity of earnings to
changes in interest rates.
 
 Asset/Liability
Management.  Activities involved in asset/liability management
include but are not limited to lending, accepting and placing deposits and
investing in securities.  Interest rate risk is the primary market
risk associated with asset/liability management.  Sensitivity of
earnings to interest rate changes arises when yields on assets change in a
different time period or in a different amount from that of interest costs on
liabilities.  To mitigate interest rate risk, the structure of the
balance sheet is managed with the goal that movements of interest rates on
assets and liabilities are correlated and contribute to earnings even in periods
of volatile interest rates.  When interest rates increase, the market
value of securities held in the investment portfolio
declines.  Generally, this decline is offset by an increase in
earnings.  When interest rates decline, the market value of securities
increases while earnings decrease due to our asset sensitivity caused by the
variable rate loans.  Usually we are able to mitigate the risk from
changes in interest rates with this balance sheet
structure.   The asset/liability management policy sets limits on
the acceptable amount of variance in net interest margin and market value of
equity under changing interest environments.  We use simulation models
to forecast earnings, net interest margin and market value of
equity.
 
 Simulation
of earnings is the primary tool used to measure the sensitivity of earnings to
interest rate changes.  Using computer-modeling techniques, we are
able to estimate the potential impact of changing interest rates on
earnings.  A balance sheet forecast is prepared quarterly using inputs
of actual loans, securities and interest bearing liabilities (i.e.
deposits/borrowings) positions as the beginning base.  The forecast
balance sheet is processed against five interest rate scenarios.  The
scenarios include 100 and 200 basis point rising rate forecasts, a flat rate
forecast and 100 and 200 basis point falling rate forecasts which take place
within a one year time frame.  The net interest income is measured
during the year assuming a gradual change in rates over the twelve-month
horizon.  Our 2008 net income, as forecast below, was modeled
utilizing a forecast balance sheet projected from year end 2007
balances.  The following table summarizes the effect on net income of
±100 and ±200 basis point changes in interest rates as measured against a
constant rate (no change) scenario.
 
 39
 Interest
Rate Risk Simulation of Net Income as of December 31, 2007
 (In
thousands)
 
 Variation
      from a constant rate scenario
              $
      Change in Net Income+200bp
              
              (80)+100bp
              
              (64)-100bp
              
              (193)-200bp
              
              (337)
 
 The
simulations of earnings do not incorporate any management actions, which might
moderate the negative consequences of interest rate
deviations.  Therefore, they do not reflect likely actual results, but
serve as conservative estimates of interest rate risk.  Since the
primary tool used by management to measure and manage interest rate exposure is
a simulation model, use of the model to perform simulations reflecting changes
in interest rates over a twelve month horizon enables management to develop and
initiate strategies for managing exposure to interest rate risks.  Our
management believes that both individually and in the aggregate its modeling
assumptions are reasonable, but the complexity of the simulation modeling
process results in a sophisticated estimate, not an absolutely precise
calculation of exposure.
 
 Interest Rate Sensitivity
Analysis.  Interest rate sensitivity is a function of the
repricing characteristics of the portfolio of assets and
liabilities.  These repricing characteristics are the time frames
within which the interest-bearing assets and liabilities are subject to change
in interest rates either at replacement, repricing or
maturity.  Interest rate sensitivity management focuses on the
maturity of assets and liabilities and their  repricing during periods
of changes in market interest rates.  Interest rate sensitivity is
measured as the difference between the volumes of assets and liabilities in the
current portfolio that are subject to repricing at various time
horizons.  The differences are known as interest sensitivity
gaps.
 
 A
positive cumulative gap may be equated to an asset sensitive
position.  An asset sensitive position in a rising interest rate
environment will cause a bank’s interest rate margin to expand.  This
results as floating or variable rate loans reprice more rapidly than fixed rate
certificates of deposit that reprice as they mature over
time.  Conversely, a declining interest rate environment will cause
the opposite effect.  A negative cumulative gap may be equated to a
liability sensitive position.  A liability sensitive position in a
rising interest rate environment will cause a bank’s interest rate margin to
contract, while a declining interest rate environment will have the opposite
effect.  The table above shows net interest income declining both when
rates increase and when rates decline.  Although we are usually asset
sensitive, which would cause the Bank’s net interest margin to expand when rates
increase, the simulation is showing a negative change in net interest income
both in a rising and declining rate environment due to the need to rapidly
increase deposit rates.  The decline in net income in the rising rate
environment is a result of our conservative evaluation of the market pressure to
increase rates on deposits, which causes a decline in the net interest
margin.
  40
  The
following table sets forth the dollar amounts of maturing and/or repricing
assets and liabilities for various periods. This does not include the impact of
prepayments or other forms of convexity caused by changing interest rates.
Historically, this has been immaterial and estimates for them are not
included.
 
 We have
more liabilities than assets repricing during the next year. Usually because our
asset rates change more than deposit rates, our interest income will change more
than the cost of funds when rates change.  For the current quarter, we
are making a more conservative assumption.  Historically, we have been
able to raise deposit rates with a lag to loan rate increases, however loan
rates have remained flat and market demands are creating pressure to raise
interest rates on deposits.  Therefore for a period of time we have
chosen to use the simulation to forecast deposits rates rising quite
rapidly.  This causes the net interest margin to shrink and net
interest income to decline in both a rising and falling rate
environment.  The table below indicates that we are liability
sensitive throughout the next year.  At the end of the twelve month
cycle, the rate sensitive gap shows $54.9 million more in liabilities than
assets with a repricing opportunity.
 
 We
control long-term interest rate risk by keeping long term fixed rate assets
(longer than 5 years) less than its long term fixed rate funding, primarily
demand deposit accounts and capital. The following table sets forth cumulative
maturity distributions as of December 31, 2007 for our interest-bearing assets
and interest-bearing liabilities, and our interest rate sensitivity gap as a
percentage of total interest-earning assets.  Of the $131.1 million in
fixed rate assets repricing in the over 12 months category, shown in the table
below, $23.9million are long term
assets with a maturity over five years.  This $23.9 million compares
favorably to our long term funding of $85.9 million which includes demand and
core deposits and equity.
  (dollars in thousands)
 
 December
      31, 2007
              
              Immediate
                Reprice
              
              
              Up
      to 3
                Months
              
              
              4
      to 6
                Months
              
              
              7
      to 12
                Months
              
              
              Over
                12 Months
              
              
              TotalASSETS:Securities
      + Other Interest-Bearing Balances
              
              $
              0
              
              
              $
              3,306
              
              
              $
              482
              
              
              $
              965
              
              
              $
              18,004
              
              
              $
              22,757Loans
              
              
              60,209
              
              
              
              12,148
              
              
              
              21,447
              
              
              
              39,830
              
              
              
              113,104
              
              
              
              246,738Fed
      Funds Sold + OvernightInterest-Bearing
      Balances
              
              
              3,066
              
              
              
              0
              
              
              
              0
              
              
              
              0
              
              
              
              0
              
              
              
              3,066Total
      Rate Sensitive Assets
              
              $
              63,275
              
              
              $
              15,454
              
              
              $
              21,929
              
              
              $
              40,795
              
              
              $
              131,108
              
              
              $
              272,561LIABILITIES:MMDA/NOW/SAV
              
              $
              103,663
              
              
              $
              0
              
              
              $
              0
              
              
              $
              0
              
              
              $
              0
              
              
              $
              103,663CD’s<$100
              
              
              0
              
              
              
              8,427
              
              
              
              9,840
              
              
              
              9,840
              
              
              
              1,528
              
              
              
              29,635CD’s>$100
              
              
              0
              
              
              
              11,066
              
              
              
              24,793
              
              
              
              6,198
              
              
              
              2,104
              
              
              
              44,161Borrowings
              
              
              17,500
              
              
              
              0
              
              
              
              0
              
              
              
              5,000
              
              
              
              5,000
              
              
              
              27,500Total
      Rate Sensitive Liabilities
              
              $
              121,163
              
              
              $
              19,493
              
              
              $
              34,633
              
              
              $
              21,038
              
              
              $
              8,632
              
              
              $
              204,959Rate
      Sensitivity Gap
              
              $
              (57,888
              )
              
              $
              (4,039
              )
              
              $
              (12,704
              )
              
              $
              19,757
              
              
              $
              122,476
              
              
              $
              67,602Cumulative
      Rate Sensitivity Gap
              
              $
              (57,888
              )
              
              $
              (61,927
              )
              
              $
              (74,631
              )
              
              $
              (54,874
              
              
              $
              67,602Cumulative
      Position to Total Assets
              
              
              (19.4
              %)
              
              
              (20.8
              %)
              
              
              (25.1
              %)
              
              
              (18.4
              %)
              
              
              22.7
              %
 
 
 41
 Market risk in
securities.Market risk in securities shows the amount of gain
or loss (before tax) in the securities portfolio.  Portfolio volume,
sector distribution, duration, and quality all affect market
valuation.  The adjusted equity ratio is Tier 1 capital adjusted for
the market gain or loss less any applicable tax effect divided by average total
assets for leverage capital purposes for the most recent quarter.  The
ratio is designed to show Tier 1 capital if the securities portfolio had to be
liquidated and all gains and losses recognized.  If the ratio remains
strong after a +2% or +3% rate shock, market risk is reasonable in relation to
the level of capital.  A bank has flexibility and strength when the
securities portfolio can be liquidated for liquidity purposes without affecting
capital adequacy.
 
 We have
only moderate market risk in investments because the average maturity in the
portfolio is not very long, except for municipals, which are held to maturity
(see page 34for a discussion of
investments).  The portfolio should decline in value only about 1.5%
or $474,000 for a 1% increase in rates.  The gain in value if rates
fall would be somewhat less, because there are some callable
bonds.  Marking-to-market available for sale securities when rates
change would add only modest volatility to a strong level of
equity.  This market risk acts to offset the interest rate risk (i.e.
if rates decline and NIM is squeezed, there would be a concurrent gain in the
value of securities).
 
 Inflation
 
 Assets
and liabilities of a financial institution are principally monetary in
nature.  Accordingly, interest rates, which generally move with the
rate of inflation, have potentially the most significant effect on our net
interest income.  We attempt to limit inflation's impact on rates and
net income margins by minimizing its effect on these margins through continuing
asset/liability management programs.
  42
  Management's
Discussion and Analysis
 The
Year Ended December 31, 2006 versus December 31, 2005
 
 Summary
 
 Net
income for 2006 was $3,991,759 compared with $3,348,529 million in
2005.  Basic earnings per share for 2006 were $1.78 compared with
$1.54 in 2005.  Return on average assets was 1.52% in 2006 compared
with 1.44% the previous year, while return on average equity was 15.90% in 2006
and 15.27% for the previous year.
 
 Total
assets reached $277.7 million in 2006, a 13.8% increase over the $244.1 million
at December 31, 2005.  We showed loans of $219.6 million in 2006,
compared with $171.2 million at year-end 2005, an increase of
28.3%.  Deposits increased, growing 7.9%, from $215.8 million at
year-end 2005 to $232.8 million at year-end 2006.  The loan-to-deposit
ratio increased to 94.3% in 2006 from 79.3% in 2005.
 
 Net
Interest Income
 
 Net
interest income, adjusted to a fully taxable equivalent basis, increased $1.6
million to $13.3 million, up 13.7% from 2005 net interest income of $11.7
million.  Our net interest margin remained the same
at  5.46% in 2005 and 2006.
 
 Individual
components of interest income and interest expense are provided in the table -
Average Balances, Yields and Rates Paid on page 29.
 
 Interest
Income
 
 Interest
income increased by $3.7 million, or 26.2%, to $17.8 million over the $14.1
million realized in 2005.  The gain in volume of average earning
assets was responsible for a $2.7 million increase in interest income, while the
increase in yield contributed $1.0 million for a total increase of $3.7
million.
 
 Interest
Expense
 
 Total
interest expense increased $2.1 million to $4.5 million.  The average
rate paid on all interest-bearing liabilities was 2.51% in 2006, compared to
1.51% in 2005.  Average balances increased from $158.7 million to
$177.5 million, an 11.8% gain.
 
 The gain
in volume of average balances was responsible for a $1.0 million increase in
interest expense in conjunction with a $1.1 million increase related to higher
interest rates paid for a net increase of $2.1 million.  The higher
rates paid on interest-bearing liabilities is a result of market pressures
driving interest rates paid on deposit accounts higher.
 
 Individual
components of interest income and interest expense are provided in the table –
Average Balances, Yields and Rates Paid on page 29.
 
 Provision
for Loan Losses
 
 The
provisions to the allowance for loan losses amounted to $500,000 in 2006 and
$360,000 in 2005. The increase in the provision is the result of management’s
evaluation and assessment of the loan portfolio and the growth in the loan
portfolio.  We anticipate some loan growth will continue in 2007,
which could necessitate a further increase in the provision to the allowance for
loan losses.
  43
  The
non-performing assets ratio at December 31, 2006 was .41% compared to .63% as of
year end 2005.  Non accrual loans were $820,000 as of December 31,
2006 compared to $994,000 as of December 31, 2005, a decline of
17.5%.   Loans charged-off, net of recoveries, resulted in
recoveries totaling $465 in 2006 compared with net losses of $12,000 in 2005.
Refer to page 61, Note D for an analysis of the changes in the allowance for
loan and lease losses.
 
 Non-interest
Income
 
 Non-interest
income of $2.1 million for 2006 increased 6.4% or $125,000 in comparison with
the $2.0 million recorded in 2005.  Of the increase 74.6% was due to
increases in service charges on deposit accounts.  In 2006 income from
service charges on deposit accounts increased 7.4% or $94,000 from $1.3 million
in 2005 to $1.4 million in 2006.  This increase was a result of both
increases in service charges and growth of new accounts.
 
 Other fee
income showed an increase in 2006 of 4.4% or $16,000 from $364,000 in 2005 to
$380,000 in 2006 and comprised 12.7% of the 2006 increase of
$125,000.  The higher income is a result of $18,000 in income we
earned from loan referrals, which increased from $38,000 in 2005 to $56,000 in
2006. Also contributing to the increase was an increase of $8,000 or 40.9% in
wire transfer fee income from $28,000 in 2005 to $36,000 in 2006.
 
 Other
non-interest income showed a 4.6% increase or $15,000 from $346,000 in 2005 to
$361,000 in 2006.  This is largely a result of an increase in the
income generated by bank owned life insurance policies in
2006.  Income on the policies was $326,000 in 2005 compared to
$348,000 in 2006 or yields of 3.60% and 3.63%, respectively. The earnings on
these policies will increase as the balances increase and if market rates
increase, the income produced by these policies should also
increase.
 
 Non-interest
Expense
 
 Total
non-interest expense increased 5.8% to $8.3 million in 2006 from $7.8 million in
2005.  Non-interest expense represented 3.17% of average total assets
in 2006 and 3.38% in 2005. The expense/asset ratio is a standard industry
measurement of a bank's ability to control its overhead or non-interest costs.
During 2007, we will continue to emphasize cost controls, although certain
costs, such as professional fees associated with the implementation and
compliance with Sarbanes-Oxley, costs of company insurance and salary and
benefit expense including workers compensation insurance and medical benefits
are not controllable by management.  Refer to Note I, page 65 for
a detailed description of Non-Interest Income and Other Non-Interest
Expense.
 
 Salaries
and Benefits
 
 The most
significant dollar increase was in the salaries and benefits
category.  Salary and benefits increased 12.0% from $4.4 million in
2005 to $4.9 million in 2006. The increase is a result of increases in employee
incentives paid as a result of the strong earnings in 2006, an increase of
$148,000 from $490,000 in 2005 to $638,000 in 2006.  Additionally,
accrual adjustments were necessary to the Supplemental Executive retirement plan
due to additional accruals in 2006 for 2005. There was a $21,000 increase in
employee group insurance from $218,000 in 2005 to $239,000 in 2006. An
additional expense of $81,000 was taken for restricted stock that was granted to
bank officers.  At December 31, 2006 and 2005 total full-time
equivalent employees were 49 and 50, respectively, a decrease of one full time
equivalent employee.  Year-end assets per employee were $5.7 million
in 2006 compared with $4.9 million in 2005.
  44
  Premises
and Equipment
 
 Expense
relative to premises and equipment increased 1.7% to $1.016 million in 2006 from
$999,000 in 2005.  The increase in 2006 is a result of normal
increases in lease expense from $347,000 in 2005 to $364,000 in 2006, a $17,000
(4.88%) increase. There were also increases in janitorial service, real property
tax, additional costs for equipment maintenance, and an increase in software
expense of $9,000, $10,000, $10,000 and $17,000 respectively. These increases
were offset by declines in building maintenance and repair of $11,000 and
depreciation of equipment as more equipment was fully depreciated of $27,000.
The Bank  continues to emphasize security in our computer
operations.  Equipment and software are monitored and upgraded as
appropriate to ensure confidentiality of customer and Company data contributing
to additional increases in expense.  We continue to emphasize the
utilization of technology to accommodate customer and market
demands.
 
 Other
Non-interest Expense
 
 Other
non-interest expense declined by 3.7% to $2.3 million in 2006 from $2.4 million
in 2005.  The decrease in other non-interest expense was due to
decreases in professional fees, FDIC and other insurance and loan expense which
declined by 26.3%, 5.1% and 66.6%, respectively.  Professional fees
were $953,000 in 2005 and declined to $702,000 in 2006, a decline of
$251,000.  The categories of professional fees which showed the most
significant decreases were in the areas of accounting and taxes, accruals for
Sarbanes Oxley professional assistance, other professional fees, other exam fees
and transfer agent fees.  The delay in the implementation of Sarbanes
Oxley, Rule 404, regarding internal controls of financial statement reporting
has been delayed to December 31, 2007.  We anticipate an increase in
2007 to cover fees associated with the implementation.
 
 Advertising
and marketing expense increased $51,000 from $225,000 in 2005 to $276,000 in
2006.  The increases in this category are a result of our involvement
in the community, both through donations as well as participation in civic
organizations.  Additionally, shareholder relations showed an increase
in 2006 over 2005.
 
 Staff
related expenses grew $5,000 from $202,000 in 2005 to $207,000 in
2006.  These increases were a result of director and employee
involvement in attending meetings and seminars and related costs.  It
is important that directors and employee keep up with the many regulatory
changes in recent years and the regulators have increased their attention
relative to the involvement of employees and directors in training.
 
 Provision
for Income Taxes
 
 The
provision for income taxes increased to an effective tax rate of 35.7% in 2006
compared with 33.8% in 2005.
 
 
 ITEM
      7A.
              QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
 
 Information
regarding Quantitative and Qualitative Disclosures about Market Risk appears on
pages 39through 42
under the caption “Management’s Discussion and Analysis of Consolidated
Financial Condition and Results of Operations – Market Risk Management” and is
incorporated herein by reference.
  45
  
                 SONOMA VALLEY BANCORP AND
SUBSIDIARY
 
 Audited
Consolidated Financial Statements
 
 December
31, 2007
                             
  46
  
 Richardson &
      Company
              550
      Howe Avenue, Suite 210Sacramento,
      California 95825Telephone:
      (916) 564-8727FAX:
      (916) 564-8728
 
 REPORT OF
RICHARDSON & COMPANY
 INDEPENDENT
REGISTERED PUBLIC
 ACCOUNTING
FIRM
 
 
 Board of
Directors and Shareholders
 Sonoma
Valley Bancorp and Subsidiary
 Sonoma,
California
 
 
 We have
audited the accompanying consolidated balance sheets of Sonoma Valley Bancorp
and Subsidiary as of December 31, 2007 and 2006, and the related consolidated
statements of operations, changes in shareholders' equity and cash flows for
each of the three years in the period ended December 31, 2007.  These
financial statements are the responsibility of the Company’s
management.  Our responsibility is to express an opinion on these
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 audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  The
Company is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting.  Our audit included
consideration of internal control over financial reporting as a basis of
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Company’s
internal control over financial reporting.  Accordingly, we express no
such opinion.  An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, 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 financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Sonoma Valley Bancorp
and Subsidiary as of December 31, 2007 and 2006, and the consolidated results of
their operations and their consolidated cash flows for each of the three years
in the period ended December 31, 2007, in conformity with accounting principles
generally accepted in the United States of America.
 
 March 4,
2008
  47
  SONOMA VALLEY BANCORP AND
SUBSIDIARY
 
 CONSOLIDATED
BALANCE SHEETS
 December
31, 2007 and 2006
 ASSETS
              
              2007
              
              
              2006Cash
      and due from banks
              
              $
              6,268,091
              
              
              $
              6,159,931Interest-bearing
      due from banks
              
              
              3,065,543
              
              
              
              1,292,325Total
      cash and cash equivalents
              
              
              9,333,634
              
              
              
              7,452,256Investment
      securities available-for-sale, at fair value
              
              
              8,203,190
              
              
              
              20,991,232Investment securities held-to-maturity (fair value of $14,754,249 and
      $15,951,553, respectively)
              
              
              14,554,224
              
              
              
              15,804,421Loans
      and lease financing receivables, net
              
              
              246,738,218
              
              
              
              216,330,690Premises
      and equipment, net
              
              
              792,455
              
              
              
              949,224Accrued
      interest receivable
              
              
              1,682,209
              
              
              
              1,671,618Cash
      surrender value of life insurance
              
              
              10,354,153
              
              
              
              9,587,306Other
      assets
              
              
              6,201,195
              
              
              
              4,867,187Total
      assets
              
              $
              297,859,278
              
              
              $
              277,653,934LIABILITIESNoninterest-bearing
      demand deposits
              
              $
              58,589,202
              
              
              $
              58,740,471Interest-bearing
      transaction deposits
              
              
              30,135,049
              
              
              
              29,983,572Savings
      and money market deposits
              
              
              73,528,081
              
              
              
              72,346,136Time
      deposits, $100,000 and over
              
              
              44,160,741
              
              
              
              44,067,435Other
      time deposits
              
              
              29,634,626
              
              
              
              27,629,801Total
      deposits
              
              
              236,047,699
              
              
              
              232,767,415Federal
      Home Loan Bank borrowings
              
              
              27,500,000
              
              
              
              12,600,000Accrued
      interest payable  and other liabilities
              
              
              6,377,299
              
              
              
              5,882,448Total
      liabilities
              
              
              269,924,998
              
              
              
              251,249,863Commitments
      and contingencies ( see accompanying notes )SHAREHOLDERS’
      EQUITYCommon
      stock, no par value; 10,000,000 shares authorized; 2,242,809 shares
      in 2007
                and 2,283,047 in 2006 issued and outstanding
              
              
              15,578,903
              
              
              
              15,479,556Additional paid-in-capital
              
              
              2,455,409
              
              
              
              1,872,648Retained earnings
              
              
              9,934,967
              
              
              
              9,206,716Accumulated other comprehensive loss
              
              
              (34,999
              )
              
              
              (154,849
              )Total
      shareholders’ equity
              
              
              27,934,280
              
              
              
              26,404,071Total
      liabilities and shareholders’ equity
              
              $
              297,859,278
              
              
              $
              277,653,934
 
 The
accompanying notes are an integral part of these financial
statements.
  48
  SONOMA VALLEY BANCORP AND
SUBSIDIARY
 
 CONSOLIDATED
STATEMENTS OF OPERATIONS
 
 For the
years ended December 31, 2007, 2006 and 2005
 
 
 2007
              
              
              2006
              
              
              2005INTEREST
      INCOMELoans
      and leases
              
              $
              19,592,855
              
              
              $
              15,778,313
              
              
              $
              11,923,589Taxable
      securities
              
              
              459,978
              
              
              
              864,410
              
              
              
              1,059,592Tax-exempt
      securities
              
              
              646,920
              
              
              
              607,276
              
              
              
              625,438Federal
      funds sold and other
              
              
              33,352
              
              
              
              79,079
              
              
              
              60,710Dividends
              
              
              70,517
              
              
              
              51,062
              
              
              
              33,031Total
      interest income
              
              
              20,803,622
              
              
              
              17,380,140
              
              
              
              13,702,360INTEREST
      EXPENSEInterest-bearing
      transaction deposits
              
              
              47,332
              
              
              
              50,928
              
              
              
              57,905Savings
      and money market deposits
              
              
              1,887,350
              
              
              
              1,363,563
              
              
              
              826,657Time
      deposits, $100,000 and over
              
              
              1,957,123
              
              
              
              1,602,820
              
              
              
              851,427Other
      time deposits
              
              
              1,300,629
              
              
              
              1,015,391
              
              
              
              568,772Interest
      on borrowings
              
              
              1,244,256
              
              
              
              425,681
              
              
              
              97,799Total
      interest expense
              
              
              6,436,690
              
              
              
              4,458,383
              
              
              
              2,402,560NET
      INTEREST INCOME
              
              
              14,366,932
              
              
              
              12,921,757
              
              
              
              11,299,800Provision
      for loan and lease losses
              
              
              680,000
              
              
              
              500,000
              
              
              
              360,000NET
      INTEREST INCOME AFTER PROVISION
                FOR
      LOAN AND LEASE LOSSES
              
              
              13,686,932
              
              
              
              12,421,757
              
              
              
              10,939,800NON-INTEREST
      INCOME
              
              
              2,278,810
              
              
              
              2,093,738
              
              
              
              1,968,394NON-INTEREST
      EXPENSESalaries
      and employee benefits
              
              
              5,587,176
              
              
              
              4,940,130
              
              
              
              4,410,604Premises
      and equipment
              
              
              959,021
              
              
              
              1,016,200
              
              
              
              999,019Other
              
              
              2,635,845
              
              
              
              2,349,639
              
              
              
              2,438,886Total
      non-interest expense
              
              
              9,182,042
              
              
              
              8,305,969
              
              
              
              7,848,509Income
      before provision for income taxes
              
              
              6,783,700
              
              
              
              6,209,526
              
              
              
              5,059,685Provision
      for income taxes
              
              
              2,440,162
              
              
              
              2,217,767
              
              
              
              1,711,156NET
      INCOME
              
              $
              4,343,538
              
              
              $
              3,991,759
              
              
              $
              3,348,529BASIC
      EARNINGS PER SHARE
              
              $
              1.94
              
              
              $
              1.78
              
              
              $
              1.54DILUTED
      EARNINGS PER SHARE
              
              $
              1.88
              
              
              $
              1.68
              
              
              $
              1.45
 
 The
accompanying notes are an integral part of these financial
statements.
  49
 SONOMA VALLEY BANCORP AND
SUBSIDIARY
  CONSOLIDATED
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
  For the
years ended December 31, 2007, 2006 and 2005
  AccumulatedAdditional
                    
                    
                    
                    
                    
                    OtherComprehensive
                    
                    
                    Common
      Stock
                    
                    
                    Paid-in
                    
                    
                    Retained
                    
                    
                    ComprehensiveIncome
                    
                    
                    Shares
                    
                    
                    Amount
                    
                    
                    Capital
                    
                    
                    Earnings
                    
                    
                    Income
      (Loss)
                    
                    
                    TotalBALANCE
      AT JANUARY 1, 2005
                    
                    
                    
                    
                    2,142,104
                    
                    
                    $
                    14,512,665
                    
                    
                    $
                    1,016,275
                    
                    
                    $
                    5,295,732
                    
                    
                    $
                    (143,512
                    )
                    
                    $
                    20,681,160Redemption
      and retirement of stock
                    
                    
                    
                    
                    (5,616
                    )
                    
                    
                    (41,165
                    )
                    
                    
                    
                    
                    
                    
                    (72,503
                    )
                    
                    
                    
                    
                    
                    
                    (113,668
                    )Stock
      options exercised and related tax benefits
                    
                    
                    
                    
                    68,461
                    
                    
                    
                    532,635
                    
                    
                    
                    132,337
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    664,972Cash
      dividends of $.50 per share
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (1,078,001
                    )
                    
                    
                    
                    
                    
                    
                    (1,078,001
                    )Stock
      options granted
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    103,680
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    103,680Net
      income for the year
                    $
                    3,348,529
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3,348,529
                    
                    
                    
                    
                    
                    
                    
                    3,348,529Other
      comprehensive income net of tax:Unrealized
      holding losses on securities available-for-sale arising during the year,
      net of taxes of $116,709
                    
                    (166,879
                    )Other
      comprehensive income, net of taxes
                    
                    (166,879
                    )
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (166,879
                    )
                    
                    
                    (166,879
                    )Total
      comprehensive income
                    $
                    3,181,650BALANCE
      AT DECEMBER 31, 2005
                    
                    
                    
                    
                    
                    2,204,949
                    
                    
                    
                    15,004,135
                    
                    
                    
                    1,252,292
                    
                    
                    
                    7,493,757
                    
                    
                    
                    (310,391
                    )
                    
                    
                    23,439,793Redemption
      and retirement of stock
                    
                    
                    
                    
                    
                    (55,028
                    )
                    
                    
                    (410,308
                    )
                    
                    
                    
                    
                    
                    
                    (1,025,843
                    )
                    
                    
                    
                    
                    
                    
                    (1,436,151
                    )Stock
      options exercised and related tax benefits
                    
                    
                    
                    
                    
                    104,126
                    
                    
                    
                    885,729
                    
                    
                    
                    438,757
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    1,324,486Cash
      dividends of $.55 per share
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (1,252,957
                    )
                    
                    
                    
                    
                    
                    
                    (1,252,957
                    )Stock
      options granted
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    100,224
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    100,224Restricted
      stock granted
                    
                    
                    
                    
                    
                    29,000
                    
                    
                    
                    
                    
                    
                    
                    81,375
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    81,375Net
      income for the year
                    $
                    3,991,759
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3,991,759
                    
                    
                    
                    
                    
                    
                    
                    3,991,759Other
      comprehensive income, net of tax: Unrealized holding gains on securities
      available-for-sale arising during the year, net of taxes of
      $108,781
                    
                    155,542Other
      comprehensive income, net of taxes
                    
                    155,542
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    155,542
                    
                    
                    
                    155,542Total
      comprehensive income
                    $
                    4,147,301BALANCE
      AT DECEMBER 31, 2006
                    
                    
                    
                    
                    
                    2,283,047
                    
                    
                    $
                    15,479,556
                    
                    
                    $
                    1,872,648
                    
                    
                    $
                    9,206,716
                    
                    
                    $
                    (154,849
                    )
                    
                    $
                    26,404,071
 50
  SONOMA
VALLEY BANCORP AND SUBSIDIARY
  CONSOLIDATED
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
  For the
years ended December 31, 2007, 2006 and 2005
 
 AccumulatedAdditional
              
              
              
              
              
              OtherComprehensive
              
              
              Common
      Stock
              
              
              Paid-in
              
              
              Retained
              
              
              ComprehensiveIncome
              
              
              Shares
              
              
              Amount
              
              
              Capital
              
              
              Earnings
              
              
              Income
      (Loss)
              
              
              TotalRedemption
      and retirement of stock
              
              
              
              
              
              (100,415
              )
              
              $
              (689,422
              )
              
              
              
              
              $
              (2,243,816
              )
              
              
              
              
              $
              (2,933,238
              )Stock
      options exercised and related tax benefits
              
              
              
              
              
              60,177
              
              
              
              626,019
              
              
              
              358,353
              
              
              
              
              
              
              
              
              
              
              984,372Cash
      dividends of $.60 per share
              
              
              
              
              
              
              
              
              
              
              
              
              
              (1,371,471
              )
              
              
              
              
              
              
              
              
              
              (1,371,471
              )Stock
      options granted
              
              
              
              
              
              
              
              
              
              
              
              
              
              216,473
              
              
              
              
              
              
              
              
              
              
              216,473Restricted
      stock granted
              
              
              
              
              
              
              
              
              
              
              
              
              
              162,750
              
              
              
              
              
              
              
              
              
              
              162,750Restricted
      stock vested and related tax benefits
              
              
              
              
              
              
              
              
              
              162,750
              
              
              
              (154,815
              )
              
              
              
              
              
              
              
              
              
              7,935Net
      income for the year
              
              $
              4,343,538
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              4,343,538
              
              
              
              
              
              
              4,343,538Other
      comprehensive Income, net of tax:Unrealized
      holding gains on securities available-for-sale arising during the year,
      net of taxes of $108,781
              
              
              119,850Other
      comprehensive income,net of taxes
              
              
              119,850
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              119,850
              
              
              
              119,850Total
      comprehensive income
              
              $
              4,463,388BALANCE
      AT DECEMBER 31, 2007
              
              
              
              
              
              
              2,242,809
              
              
              $
              15,578,903
              
              
              $
              2,455,409
              
              
              $
              9,934,967
              
              
              $
              (34,999
              )
              
              $
              27,934,280


The
accompanying notes are an integral part of these financial
statements.




51
   SONOMA VALLEY BANCORP AND SUBSIDIARY
 
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 
 For the
years ended December 31, 2007, 2006 and 2005
 
 
 2007
              
              
              2006
              
              
              2005OPERATING
      ACTIVITIESNet
      income
              
              $
              4,343,538
              
              
              $
              3,991,859
              
              
              $
              3,348,529Adjustments
      to reconcile net income to net cash provided by operating
      activities:Provision
      for loan and lease losses
              
              
              680,000
              
              
              
              500,000
              
              
              
              360,000Depreciation
              
              
              239,374
              
              
              
              284,357
              
              
              
              307,202Loss
      on sale of equipment
              
              
              
              
              
              
              
              
              
              
              306Amortization
      and other
              
              
              40,254
              
              
              
              116,041
              
              
              
              166,269Stock
      options and restricted stock granted
              
              
              379,223
              
              
              
              181,599
              
              
              
              103,680Net
      change in interest receivable
              
              
              (10,591
              )
              
              
              (271,363
              )
              
              
              (261,648
              )Net
      change in cash surrender value of life insurance
              
              
              (416,847
              )
              
              
              (347,867
              )
              
              
              (326,303
              )Net
      change in other assets
              
              
              (1,002,003
              )
              
              
              (185,303
              )
              
              
              (
      1,002,386
              )Net
      change in interest payable and other liabilities
              
              
              494,851
              
              
              
              1,018,091
              
              
              
              961,070NET
      CASH PROVIDED BY OPERATING ACTIVITIES
              
              
              4,747,799
              
              
              
              5,287,414
              
              
              
              3,656,719INVESTING
      ACTIVITIESPurchases
      of securities held-to-maturity
              
              
              (101,751
              )
              
              
              (438,272
              )
              
              
              (399,570
              )Purchases
      of securities available-for-sale
              
              
              (4,195
              )
              
              
              (42,140
              )
              
              
              (15,014,859
              )Proceeds
      from maturing securities held-to-maturity
              
              
              1,307,600
              
              
              
              1,055,000
              
              
              
              1,219,406Proceeds
      from maturing securities available-for-sale
              
              
              13,000,000
              
              
              
              13,195,000
              
              
              
              1,000,000Net
      increase in loans and leases
              
              
              (31,087,528
              )
              
              
              (48,412,605
              )
              
              
              (18,045,998
              )Purchases
      of premises and equipment
              
              
              (82,605
              )
              
              
              (54,915
              )
              
              
              (122,095
              )Purchases
      of life insurance
              
              
              (350,000
              )
              
              
              0
              
              
              
              0Proceeds
      from disposal of equipment
              
              
              0
              
              
              
              0
              
              
              
              800NET
      CASH USED FOR INVESTING ACTIVITIES
              
              
              (17,318,479
              )
              
              
              (34,697,932
              )
              
              
              (31,362,316
              )
 
 (Continued)
 
  52
  SONOMA
VALLEY BANCORP AND SUBSIDIARY
 
 CONSOLIDATED
STATEMENTS OF CASH FLOWS (Continued)
 
 For the
years ended December 31, 2007, 2006 and 2005
 
 
 2007
              
              
              2006
              
              
              2005FINANCING
      ACTIVITIESNet
      change in demand, interest-bearing transaction and savings
      deposits
              
              $
              1,182,153
              
              
              $
              1,805,126
              
              
              $
              9,540,545Net
      change in time deposits
              
              
              2,098,131
              
              
              
              15,203,522
              
              
              
              12,555,207Stock
      repurchases
              
              
              (2,933,237
              )
              
              
              (1,436,151
              )
              
              
              (113,668
              )Stock
      options exercised
              
              
              576,482
              
              
              
              864,993
              
              
              
              532,635Proceeds
      from FHLB borrowings
              
              
              14,900,000
              
              
              
              12,600,000Cash
      dividends paid
              
              
              (1,371,471
              )
              
              
              (1,252,957
              )
              
              
              (1,078,001
              )NET
      CASH PROVIDED BYFINANCING ACTIVITIES
              
              
              14,452,058
              
              
              
              27,784,533
              
              
              
              21,436,718NET
      CHANGE IN CASH AND CASH EQUIVALENTS
              
              
              1,881,378
              
              
              
              (1,626,085
              )
              
              
              (6,268,879
              )Cash
      and cash equivalents at beginning of year
              
              
              7,452,256
              
              
              
              9,078,341
              
              
              
              15,347,220CASH
      AND CASH EQUIVALENTSAT END OF YEAR
              
              $
              9,333,634
              
              
              $
              7,452,256
              
              
              $
              9,078,341SUPPLEMENTAL
      DISCLOSURES OF CASH FLOW INFORMATIONInterest
      expense
              
              $
              6,431,217
              
              
              $
              4,404,411
              
              
              $
              2,367,482Income
      taxes
              
              $
              2,265,000
              
              
              $
              2,195,000
              
              
              $
              2,340,000SUPPLEMENTAL
      DISCLOSURES OF NONCASH ACTIVITIES:Net
      change in unrealized gains and losses on securities
              
              $
              203,669
              
              
              $
              264,323
              
              
              $
              (283,588
              )Net
      change in deferred income taxes on unrealized gains and losses on
      securities
              
              $
              83,819
              
              
              $
              108,781
              
              
              $
              116,709
 
 The
accompanying notes are an integral part of these financial
statements.
 
  53
  NOTE A—SIGNIFICANT ACCOUNTING
POLICIES
 
 Business:  Sonoma
Valley Bancorp (the Company), formed in 2000, is a bank holding company whose
principal activity is the ownership and management of its wholly-owned
subsidiary, Sonoma Valley Bank.  Sonoma Valley Bank was organized in
1987 and commenced operations on June 3, 1988 as a California state-chartered
bank.  The Bank is subject to regulation, supervision and regular
examination by the State Department of Financial Institutions and Federal
Deposit Insurance Corporation.  The regulations of these agencies
govern most aspects of the Bank's business.
 
 Principles of
Consolidation: The consolidated financial statements include the accounts
of the Company and the Bank.  All material inter-company accounts and
transactions have been eliminated.
 
 Nature of
Operations:  The Bank provides a variety of banking services to
individuals and businesses in its primary service area of Sonoma, California and
the immediate surrounding area.  The Bank offers depository and
lending services primarily to meet the needs of its business and professional
clientele.  These services include a variety of demand deposit,
savings and time deposit account alternatives and special merchant and business
services.  The Bank's lending activities are directed primarily
towards granting short and medium-term commercial loans, customized lines of
credit, for such purposes as operating capital, business and professional
start-ups, inventory, equipment and accounts receivable and interim construction
financing.
 
 Use of
Estimates:  The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent 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 those
estimates.
   
 Cash and Cash
Equivalents:  For the purposes of reporting cash flows, cash
and cash equivalents are defined as those amounts included in the balance sheet
captions "Cash and due from banks" and "Federal funds sold." Generally, federal
funds are sold or purchased for one-day periods.
 
 Investment
Securities:  Securities are classified as held-to-maturity if
the Company has both the intent and ability to hold those debt securities to
maturity regardless of changes in market conditions, liquidity needs or changes
in general economic conditions.  These securities are carried at cost
adjusted for amortization of premium and accretion of discount, computed by the
interest method over their contractual lives.
 
 Securities
are classified as available-for-sale if the Company intends to hold those debt
securities for an indefinite period of time, but not necessarily to
maturity.  Any decision to sell a security classified as
available-for-sale would be based on various factors, including significant
movements in interest rates, changes in the maturity mix of the Company's assets
and liabilities, liquidity needs, regulatory capital considerations and other
similar factors.  Securities available-for-sale are carried at fair
value.  Unrealized holding gains or losses are reported as increases
or decreases in shareholders' equity, net of the related deferred tax
effect.  Realized gains or losses, determined on the basis of the cost
of specific securities sold, are included in earnings.
  54
  NOTE
A—SIGNIFICANT ACCOUNTING POLICIES (Continued)
 
 Loans and Lease Financing
Receivables:  Loans are stated at the amount of unpaid
principal, less the allowance for loan losses and net deferred loan
fees.  Interest on loans is accrued and credited to income based on
the principal amount outstanding.  Loan origination fees and certain
direct loan origination costs are capitalized and recognized as an adjustment of
the yield on the related loan.  However, loan origination costs in
excess of fees collected are not deferred but this treatment has an immaterial
impact on the financial statements.  Amortization of net deferred loan
fees is discontinued when the loan is placed on nonaccrual status.
 
 All of
the Company’s leases are classified and accounted for as direct financing
leases.  Under the direct financing method of accounting for leases,
the total net rentals receivable under the lease contracts, net of unearned
income, are recorded as a net investment in direct financing leases, and the
unearned income is recognized each month as it is earned so as to produce a
constant periodic rate of return on the unrecovered investment.
 
 Allowance for Loan and Lease
Losses:  The allowance is maintained at a level which, in the
opinion of management, is adequate to absorb probable losses inherent in the
loan and lease portfolio.  Credit losses related to off-balance-sheet
instruments are included in the allowance for loan and lease losses except if
the loss meets the criteria for accrual under Statement of Financial Accounting
Standards (SFAS) No. 5, in which case the amount is accrued and reported
separately as a liability.  Management determines the adequacy of the
allowance based upon reviews of individual loans and leases, recent loss
experience, current economic conditions, the risk characteristics of the various
categories of loans and leases and other pertinent factors.  The
allowance is based on estimates, and ultimate losses may vary from the current
estimates.  These estimates are reviewed monthly and, as adjustments
become necessary, they are reported in earnings in the periods in which they
become known. Loans and leases deemed uncollectible are charged to the
allowance.  Provisions for loan and lease losses and recoveries on
loans previously charged off are added to the allowance.
 
 Commercial
loans are considered impaired, based on current information and events, if it is
probable that the Company will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement.  Allowances on impaired loans are established based on the
present value of expected future cash flows discounted at the loan’s historical
effective interest rate or, for collateral-dependent loans, on the fair value of
the collateral.  Cash receipts on impaired loans are used to reduce
principal.
 
 Income Recognition on
Impaired and Nonaccrual Loans and Leases:  Loans and leases,
including impaired loans, are generally classified as nonaccrual if they are
past due as to maturity or payment of principal or interest for a period of more
than 90 days, unless such loans are well-secured and in the process of
collection.  If a loan or lease or a portion of a loan or lease is
classified as doubtful or is partially charged off, the loan or lease is
classified as nonaccrual.  Loans and leases that are on a current
payment status or past due less than 90 days may also be classified as
nonaccrual if repayment in full of principal and/or interest is in
doubt.
  55
  NOTE
A—SIGNIFICANT ACCOUNTING POLICIES (Continued)
 
 Loans and
leases may be returned to accrual status when all principal and interest amounts
contractually due (including arrearages) are reasonably assured of repayment
within an acceptable period of time, and there is a sustained period of
repayment performance by the borrower, in accordance with the contractual terms
of interest and principal.
 
 While a
loan or lease is classified as nonaccrual and the future collectibility of the
recorded balance is doubtful, collections of interest and principal are
generally applied as a reduction to principal outstanding.  When the
future collectibility of the recorded balance is expected, interest income may
be recognized on a cash basis.  In the case where a nonaccrual loan or
lease had been partially charged off, recognition of interest on a cash basis is
limited to that which would have been recognized on the recorded balance at the
contractual interest rate.  Cash interest receipts in excess of that
amount are recorded as recoveries to the allowance for loan losses until prior
charge-offs have been fully recovered.
 
 Premises and
Equipment:  Premises and equipment are stated at cost, less
accumulated depreciation.  The provision for depreciation is computed
principally by the straight-line method over the estimated useful lives of the
related assets.  Leasehold improvements are amortized over the shorter
of their useful life or the lease term.
 
 Investments in Limited
Partnerships:  The Company owns a 3.06% interest in a limited
partnership that owns and operates affordable housing projects.  The
investment in this project serves as an element of the Company’s compliance with
the Community Reinvestment Act and the Company receives tax benefits in the form
of deductions for operating losses and tax credits.  The tax credits
may be used to reduce taxes currently payable or may be carried back one year or
forward ten years to recapture or reduce taxes.  The Company uses the
cost  method of accounting for the investment whereby the excess of the
carrying amount of the investment over its estimated residual value is amortized
based on the proportion of the credits received and tax credits are recorded in
the years they become available to reduce income taxes.
  Investment in Federal
Home Loan Bank Stock
 
 Income
Taxes:  Provisions for income taxes are based on amounts
reported in the statements of operations (after exclusion of non-taxable income
such as interest on state and municipal securities) and include deferred taxes
on temporary differences in the recognition of income and expense for tax and
financial statement purposes.  Deferred taxes are computed using the
asset and liability method.  Deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of assets and liabilities and their
respective tax bases.  Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled.   The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.  Deferred tax assets are recognized for deductible
temporary differences and tax credit carryforwards, and  then a
valuation allowance is established to reduce that deferred tax asset if it is
"more likely than not" that the related tax benefits will not be
realized.
 
 Advertising:  Advertising
costs are charged to operations in the year incurred.
 
 Net Income Per Share of
Common Stock:  Net income per share of common stock is computed
by dividing net income by the weighted average number of shares of common stock
outstanding during the year, after giving retroactive effect to stock dividends
and splits.  Net income per share—assuming dilution is computed
similar to net income per share except that the denominator is increased to
include the number of additional common shares that would have been outstanding
if the dilutive potential common shares had been issued.  Included in
the denominator is the dilutive effect of stock options and unvested restricted
stock computed under the treasury method.
  56
  NOTE
A—SIGNIFICANT ACCOUNTING POLICIES (Continued)
 
 Share-Based Payment
Accounting:  At December 31, 2007, the Company has a
stock-based employee and director compensation plan, which is described more
fully in Note L.  The Company adopted the fair value recognition
provisions of Statement of financial Accounting Standard (SFAS) No. 123, Accounting for Stock-Based
Compensation, prospectively to all employee awards granted, modified, or
settled after January 1, 2003.  Options were granted in 2004 and 2007
under the fair value method.  Awards under the plan vest over two to
five years.  Restricted stock was granted in July 2006 that vests over
three to five years beginning July 2007.  The cost related to
share-based employee compensation is included in the determination of net income
for the years ended December 31, 2007, 2006 and 2005.
 
 Off-Balance-Sheet Financial
Instruments:  In the ordinary course of business the Company
has entered into off-balance-sheet financial instruments consisting of
commitments to extend credit and standby letters of credit.  Such
financial instruments are recorded in the financial statements when they become
payable.
 
 Operating
Segments:  Reportable segments are based on products and
services, geography, legal structure, management structure and any other manner
in which management desegregates a company for making operating decisions and
assessing performance.  The Company has determined that its business
is comprised of a single operating segment.
 
 New Accounting
Pronouncements:  In September 2006 the Financial Accounting
Standards Board (FASB) issued Statement Number 157(SFAS No. 157), Fair Value
Measurements.  SFAS 157 changes the definition of fair value,
the methods used to measure fair value and also expands disclosures about fair
value measurement.  SFAS No. 157 is effective for the financial
statements issued for fiscal years beginning after November 15,
2007.
  In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities—Including an Amendment of FASB Statement No.
115.  This Statement permits entities to choose to measure many
financial instruments and certain other items at fair value at specified
election dates.  Unrealized gains and losses on items for which the
fair value option has been elected are reported in earnings at each subsequent
reporting date.  This Statement is effective as of the beginning of
the entity’s first fiscal year that begins after November 15, 2007.
 
 In
December 2007, the FASB issued SFAS No. 141, revised, Business
Combinations.  This Statement established principles and
requirements for how the acquirer recognizes and measures in its financial
statements the identifiable assets acquired, the liabilities assumed, and any
noncontrolling interest, recognizes and measures goodwill acquired in a business
combination, and discloses the nature and financial effects of the business
combination.  This Statement applies prospectively to business
combinations for which the acquisition date is on or after December 15,
2008.
 
 In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements—an Amendment of ARB No.
51.  This Statement establishes accounting and reporting
standards for a minority interest in the parent company financial statements and
requires separate identification of equity and net income in the consolidated
financial statements.  This Statement is effective for fiscal years,
and interim periods within those fiscal years, beginning on or after December
15, 2008.
  57
  NOTE
B—RESTRICTIONS ON CASH AND DUE FROM BANKS
 
 Cash and
due from banks include amounts the Bank is required to maintain to meet certain
average reserve and compensating balance requirements of the Federal
Reserve.  The total requirement at December 31, 2007 and 2006 was
$721,000 and $680,000, respectively.
 
  NOTE C—INVESTMENT SECURITIES
  The amortized cost and approximate fair
value of investment securities are summarized as follows:
 
 Amortized
      Cost
              
              
              Unrealized
                Gain
              
              
              Unrealized
      Losses
              
              
              Fair
      ValueDecember
      31, 2007:Securities
      Available-For-SaleU.S.
      Treasury securities
              
              $
              999,495
              
              
              $
              349
              
              
              
              
              
              $
              999,844U.S.
      Government agency securities
              
              
              7,216,834
              
              
              
              
              
              
              
              (45,481
              )
              
              
              7,171,353Equity
      securities
              
              
              46,335
              
              
              
              
              
              
              
              (14,342
              )
              
              
              31,993$
              8,262,664
              
              
              $
              349
              
              
              $
              (59,823
              )
              
              $
              8,203,190Securities
      Held-to-MaturityMunicipal
      securities
              
              $
              14,554,224
              
              
              $
              226,356
              
              
              $
              (26,331
              )
              
              $
              14,754,249
 
 
 Amortized
      Cost
              
              
              Unrealized
                Gain
              
              
              Unrealized
      Losses
              
              
              Fair ValueDecember
      31, 2006:Securities
      Available-For-SaleU.S.
      Treasury securities
              
              $
              4,987,285
              
              
              
              
              
              $
              (51,816
              )
              
              $
              4,935,469U.S.
      Government agency securities
              
              
              16,224,950
              
              
              
              
              
              
              (207,344
              )
              
              
              16,017,606Equity
      securities
              
              
              42,140
              
              
              
              1,163
              
              
              
              (5,146
              )
              
              
              38, 157Securities
      Held-to-Maturity
              
              $
              21,254,375
              
              
              $
              1,163
              
              
              $
              (264,306
              )
              
              $
              20,991,232Municipal
      securities
              
              $
              15,804,421
              
              
              $
              262,609
              
              
              $
              (115,477
              )
              
              $
              15,951,553
 
 Contractual
maturities of investment securities at December 31, 2007 were as
follows:
 
 Securities
      Available-For-Sale
              
              
              Securities
      Held-To-MaturityAmortized
      Cost
              
              
              Fair
      Value
              
              
              Amortized
      Cost
              
              
              Fair
      ValueDue
      in one year or less
              
              
              3,999,495
              
              
              
              3,989,147
              
              
              
              606,902
              
              
              
              607,029Due
      after one year through five years
              
              
              4,216,834
              
              
              
              4,182,049
              
              
              
              6,226,081
              
              
              
              6,277,419Due
      after five years through ten years
              
              
              
              
              
              
              
              
              
              
              6,039,921
              
              
              
              6,160,623Due
      after ten years
              
              
              
              
              
              
              
              
              
              
              1,681,320
              
              
              
              1,709,178Equity
      securities
              
              
              46,335
              
              
              
              31,9938,262,664
              
              
              
              8,203,189
              
              
              $
              14,554,224
              
              
              
              14,754,249
 
 58
 NOTE
C—INVESTMENT SECURITIES (Continued)
  During
2007, 2006 and 2005, the Company did not sell any securities
available-for-sale.
 
 As of
December 31, 2007, investment securities with a carrying amount of $6,131,085
and an approximate fair value of $6,247,992 were pledged, in accordance with
federal and state requirements, as collateral for public
deposits.  Investment securities with a carrying amount and fair value
of $3,991,635 at December 31, 2007 were pledged to meet the requirements of the
Federal Reserve and the U.S. Department of Justice.  As of December
31, 2006, investment securities with a carrying amount of $7,298,481 and an
approximate fair value of $7,438,150 were pledged, in accordance with federal
and state requirements, as collateral for public deposits.  Investment
securities with a carrying amount and fair value of $5,318,743 at December 31,
2006 were pledged to meet the requirements of the Federal Reserve and the U.S.
Department of Justice.
 The
following table shows the investments’ gross unrealized losses and fair value,
aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position, at December 31.
  2007Less
      Than 12 Months
              
              
              12
      Months or GreaterFair
              
              
              Unrealized
              
              
              Fair
              
              
              UnrealizedDescription
      of Securities
              
              Value
              
              
              Losses
              
              
              Value
              
              
              LossesU.S.
      Treasury securitiesU.S.
      Government agency securities
              
              
              
              
              
              
              
              
              7,171,353
              
              
              
              45,481Municipal
      securities
              
              $
              101,564
              
              
              $
              63
              
              
              
              3,608,462
              
              
              
              26,268Equity
      securities
              
              
              11,778
              
              
              
              4,216
              
              
              
              20,215
              
              
              
              10,126Total
      temporarily impaired securities
              
              $
              113,342
              
              
              $
              4,279
              
              
              $
              10,800,030
              
              
              $
              81,875
 
 
 2006Less
      Than 12 Months
              
              
              12
      Months or GreaterFair
              
              
              Unrealized
              
              
              Fair
              
              
              UnrealizedDescription
      of Securities
              
              Value
              
              
              Losses
              
              
              Value
              
              
              LossesU.S.
      Treasury securities
              
              
              
              
              
              
              
              $
              4,935,469
              
              
              $
              51,816U.S.
      Government agency securities
              
              
              
              
              
              
              
              
              16,017,606
              
              
              
              207,344Municipal
      securities
              
              $
              1,582,429
              
              
              $
              8,141
              
              
              
              4,888,575
              
              
              
              107,336Equity
      securities
              
              
              28,198
              
              
              
              5,146Total
      temporarily impaired securities
              
              $
              1,610,627
              
              
              $
              13,287
              
              
              $
              25,841,650
              
              
              $
              366,496
 
 There
were 7 U.S. government agency securities, 14 municipal securities and 15
equity securities in an unrealized loss position at December 31,
2007.  There were 16 U.S. government agency securities, 5 U.S.
Treasury Notes and 21 municipal securities and 9 equity securities in an
unrealized loss position at December 31, 2006.  The unrealized losses
on these securities were caused by interest  rate increases or, in the
case of the equity securities, market disfavor with financial institutions
stock.  The Company purchased small amounts of various bank equity
securities in order to track and analyze peer group banks and the potential loss
is relatively small. In the case of the U.S. government securities and the
municipal securities, the contractual terms of these investments do not permit
the issuer to settle the securities at a price less that the par value of the
investment. Because the Company has the ability and intent to hold these
investments until a recovery of fair value, which may be maturity, the Company
does not consider these investments to be other-than-temporarily impaired at
December 31, 2007 and 2006.
  59
  NOTE D—LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE
LOSSES
 
 The
composition of the loan and lease portfolio was as follows at December
31:
 
 2007
              
              
              2006Commercial
              
              $
              177,989,391
              
              
              
              70.9
              %
              
              $
              146,573,119
              
              
              
              66.6
              %Consumer
              
              
              29,163,877
              
              
              
              11.6
              %
              
              
              27,797,562
              
              
              
              12.6
              %Real
      estate mortgage
              
              
              17,946,113
              
              
              
              7.2
              %
              
              
              17,154,768
              
              
              
              7.8
              %Real
      estate construction
              
              
              25,772,958
              
              
              
              10.3
              %
              
              
              28,590,367
              
              
              
              13.0
              %Lease
      financing receivables, net of unearned income of $6,290 in 2007 and $9,513
      in 2006
              
              
              21,665
              
              
              
              0.0
              %
              
              
              36,030
              
              
              
              0.0
              %250,894,004
              
              
              
              100.0
              %
              
              
              220,151,846
              
              
              
              100.0
              %Deferred
      loan fees and costs,  net
              
              
              (432,569
              )
              
              
              
              
              
              
              (544,184
              )Allowance
      for loan and lease losses
              
              
              (3,723,217
              )
              
              
              
              
              
              
              (3,276,972
              )$
              246,738,218
              
              
              
              
              
              
              $
              216,330,690
 
 At
December 31, 2007, the recorded investment in loans for which impairment has
been recognized in accordance with SFAS No. 114 totaled $2,097,000 with a
corresponding valuation allowance of $283,000. At December 31, 2006, the
recorded investment in loans for which impairment has been recognized in
accordance with Statement No. 114 totaled $939,000, with a corresponding
valuation allowance of $124,000.  For the years ended December 31,
2007, 2006 and 2005, the average recorded investment in impaired loans was
approximately $332,000, $1,035,000 and $1,060,000,
respectively.  During 2007, 2006 and 2005, $162,944, $8,000 and $8,000
of interest was received and recognized on impaired loans,
respectively.
 
 At
December 31, 2007, the Company had other nonaccrual loans totaling $89,409 for
which impairment has not been recognized.
 
 The
Company has no commitments to loan additional funds to the borrowers of impaired
or nonaccrual loans.
  60
  NOTE D—LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE
LOSSES  (Continued)
 
 The
maturity and repricing distribution of the loan and lease portfolio at December
31:
 
 2007
              
              
              2006Fixed
      rate loan maturitiesThree
      months or less
              
              $
              32,464,840
              
              
              $
              10,269,932Over
      three months to twelve months
              
              
              60,965,840
              
              
              
              40,265,531Over
      one year to five years
              
              
              93,613,696
              
              
              
              97,220,910Over
      five years
              
              
              16,817,804
              
              
              
              20,611,428Floating
      rate loans repricingQuarterly
      or more frequently
              
              
              39,892,211
              
              
              
              46,890,506Quarterly
      to annual frequency
              
              
              311,741
              
              
              
              1,456,216One
      to five years frequency
              
              
              6,027,843
              
              
              
              2,617,687250,093,975
              
              
              
              219,332,210Nonaccrual
      loans
              
              
              800,029
              
              
              
              819,637$
              250,894,004
              
              
              $
              220,151,847
 
 An analysis of the changes in the allowance for loan and
lease losses is as follows for the years ended December 31:
 
 2007
              
              
              2006
              
              
              2005Beginning
      balance
              
              $
              3,276,972
              
              
              $
              2,776,507
              
              
              $
              2,428,572Provision
      for loan and lease losses
              
              
              680,000
              
              
              
              500,000
              
              
              
              360,000Loans
      charged off:Commercial
              
              
              (187,075
              )
              
              
              (6,593
              )
              
              
              (53,337
              )Consumer
              
              
              (63,901
              )
              
              
              (12,262
              )
              
              
              (16,976
              )(250,976
              )
              
              
              (18,855
              )
              
              
              (70,313
              )Recoveries:Commercial
              
              
              16,315
              
              
              
              17,668
              
              
              
              55,055Consumer
              
              
              906
              
              
              
              1,652
              
              
              
              3,19317,221
              
              
              
              19,320
              
              
              
              58,248Ending
      balance
              
              $
              3,723,217
              
              
              $
              3,276,972
              
              
              $
              2,776,507
 
  61
  NOTE
E—PREMISES AND EQUIPMENT
 
 Premises
and equipment consisted of the following at December 31:
 
 2007
              
              
              2006Land
              
              $
              175,000
              
              
              $
              175,000Building
              
              
              71,943
              
              
              
              71,943Building
      improvements
              
              
              25,432
              
              
              
              0Leasehold
      improvements
              
              
              797,191
              
              
              
              797,191Furniture,
      fixtures and equipment
              
              
              2,073,218
              
              
              
              2,016,0453,142,784
              
              
              
              3,060,179Less:
      Accumulated depreciation
              
              
              (2,350,329
              )
              
              
              (2,110,955
              )$
              792,455
              
              
              $
              949,224
 
 NOTE
F—TIME DEPOSITS
 
 The
maturities of time deposits at December 31, 2007 are as follows:
 
 Maturing
      within one year
              
              $
              70,163,000Maturing
      in one year to two years
              
              
              1,901,000Maturing
      two years through five years
              
              
              1,731,000$
              73,795,000
 
 
 NOTE G—FEDERAL FUNDS CREDIT LINES AND
BORROWINGS
 
 The
Company has uncommitted federal funds lines of credit agreements with other
banks.  The maximum borrowings available under these lines totaled
$27,000,000 at December 31, 2007.  There were no borrowings
outstanding under these agreements at December 31, 2007 or 2006.
 
 The
Company pledged loans totaling $165,379,970 as collateral to secure advances
from the Federal Home Loan Bank of up to $74,760,016.  At December 31,
2007, the Company borrowed $17,500,000 over-night with the Federal Home Loan
Bank and also has a long-term borrowing of $10,000,000.  The
over-night borrowing expires two days from the date of purchase and carries an
interest on the outstanding principal balance of 3.30%.  The long-term
borrowings carry a fixed interest rate on outstanding principal of 5.03% for the
$5,000,000 borrowed September 2006 and 4.92% for the $5,000,000 borrowed March
2007.  Interest is due monthly and the principal is due on September
22, 2008 and March 2, 2009.
  62
  NOTE
H—EMPLOYEE BENEFIT PLANS
 
 The
Company has a 401(k) Employee Savings Plan (the Plan) in which the Company
matches a portion of the employee's contribution each payday.  All
employees are eligible for participation following three months of
employment.  Bancorp contributions are 100% vested at all
times.  The Company made contributions totaling $147,994 in 2007,
$148,691 in 2006 and $131,548 in 2005.
 
 The
Company purchased single premium life insurance policies in connection with the
implementation of retirement plans for four key officers and for the Board of
Directors.  The policies provide protection against the adverse
financial effects from the death of a key officer and provide income to offset
expenses associated with the plans.  The officers are insured under
the policies, but the Company is the owner and beneficiary.  At
December 31, 2007 and 2006, the cash surrender value of these policies totaled
$10,354,153 and $9,587,306 respectively.
 
 The
retirement plans are unfunded and provide for the Company to pay the officers
and directors specified amounts for specified periods after retirement and allow
them to defer a portion of current compensation in exchange for the Company's
commitment to pay a deferred benefit at retirement.  If death occurs
prior to or during retirement, the Company will pay the officer's beneficiary or
estate the benefits set forth in the plans.  Deferred compensation is
vested as to the amounts deferred.  Liabilities are recorded for the
estimated present value of future salary continuation benefits and for the
amounts deferred by the officers and directors.  At December 31, 2007
and 2006, the liability recorded for the executive officer supplemental
retirement plan totaled $2,665,602 and $2,123,778 respectively.  The
amount of pension expense related to this plan for 2007 and 2006 was $541,824
and $421,967, respectively.  At December 31, 2007 and 2006, the
liability recorded for the director supplemental retirement plan totaled
$444,580 and $573,647, respectively.  The amount of pension expense
related to this plan for 2007 and 2006 was ($129,067) and $97,646,
respectively.  At December 31, 2007 and 2006, the liability recorded
for the deferred compensation plans totaled $1,583,308 and $1,448,181,
respectively.  The amount of expense related to these plans for 2007
and 2006 was $109,768 and $96,677, respectively.  The following are
the components of the accumulated benefit obligation related to the executive
officer and director supplemental retirement plans as of December
31:
 
 Directors
              
              
              Officers2007
              
              
              2006
              
              
              2007
              
              
              2006Projected
      benefit obligation
              
              $
              411,282
              
              
              $
              524,469
              
              
              $
              2,933,784
              
              
              $
              2,311,592Accrued
      prior service costs
              
              
              33,298
              
              
              
              49,178
              
              
              
              (268,814
              )
              
              
              (187,814
              )Benefit
      obligation included in other liabilities
              
              $
              444,580
              
              
              $
              573,647
              
              
              $
              2,665,602
              
              
              $
              2,123,778
 
 The
weighted-average discount rate used in determining the actuarial present value
of the projected benefit obligation was 6.75% for both 2007 and
2006.  Inflationary increases of 4% for 2007 and 4.5% for 2006 were
assumed.  The Directors projected benefit calculation includes a 2%
cost of living adjustment.  The entire accumulated benefit obligation
was not fully vested at December 31, 2007 and 2006.  Full vesting for
the Officers does not occur until the participant has been in the plan for 15
years.  The Directors only receive the benefit if they are on the
Board upon reaching age 70.
  63
  NOTE
H—EMPLOYEE BENEFIT PLANS (Continued)
 
 SFAS No.
158 applies to this Plan and requires unamortized prior service costs be
recognized as a component of other comprehensive income.  The Plan has
a net after tax unrecognized prior service cost of $138,229 at December 31, 2007
and $81,587 at December 31, 2006.  The amounts are not deemed to be
material and are not included in other comprehensive income.
 
 The
following is a reconciliation of the beginning and ending balances of the
benefit obligation for the years ended December 31:
 
 Directors
              
              
              Officers2007
              
              
              2006
              
              
              2005
              
              
              2007
              
              
              2006
              
              
              2005Benefit
      obligation at beginning of year
              
              $
              573,647
              
              
              $
              476,001
              
              
              $
              396,696
              
              
              $
              2,123,778
              
              
              $
              1,701,811
              
              
              $
              1,494,540Net
      periodic pension cost:Service
      cost
              
              
              54,277
              
              
              
              110,027
              
              
              
              30,469
              
              
              
              218,799
              
              
              
              195,710
              
              
              
              134,943Interest
      cost on projected benefit Obligation
              
              
              23,987
              
              
              
              26,275
              
              
              
              35,679
              
              
              
              190,652
              
              
              
              159,440
              
              
              
              90,054Amortization
      of prior service costs
              
              
              (51,638
              )
              
              
              (38,656
              )
              
              
              7,990
              
              
              
              132,373
              
              
              
              66,817
              
              
              
              (17,726
              )Amendments
              
              
              
              
              
              
              
              
              
              
              5,167Terminations
              
              
              (155,693
              )Net
      periodic pension cost recognized
              
              
              (129,067
              )
              
              
              97,646
              
              
              
              79,305
              
              
              
              421,967
              
              
              
              421,967
              
              
              
              207,271Benefit
      obligation at end of year
              
              $
              444,580
              
              
              $
              573,647
              
              
              $
              476,001
              
              
              $
              2,123,778
              
              
              $
              2,123,778
              
              
              $
              1,701,811
 
 The
following benefit payments, which reflect expected future service, as
appropriate, are expected to be paid:
 
 Directors
              
              
              Officers2008
              
              $
              9,500
              
              
              $
              27,5922009
              
              
              9,690
              
              
              
              246,3412010
              
              
              12,717
              
              
              
              246,3412011
              
              
              25,459
              
              
              
              376,4222012
              
              
              36,856
              
              
              
              376,4222013
      to 2017
              
              
              320,263
              
              
              
              1,882,110
 
  64
  NOTE
I—NON-INTEREST INCOME AND OTHER NON-INTEREST EXPENSE
 
 Non-interest
income is comprised of the following for the years ended December
31:
 
 2007
              
              
              2006
              
              
              2005Service
      charges on deposit accounts
              
              $
              1,410,637
              
              
              $
              1,352,251
              
              
              $
              1,258,728Other
      fee income
              
              
              426,220
              
              
              
              380,070
              
              
              
              364,157Life
      insurance earnings
              
              
              416,847
              
              
              
              347,867
              
              
              
              326,303Investment
      securities gains
              
              
              
              
              
              
              
              
              
              
              5,094Other
              
              
              25,106
              
              
              
              13,550
              
              
              
              14,112$
              2,278,810
              
              
              $
              2,093,738
              
              
              $
              1,968,394
 
 Other
non-interest expense is comprised of the following for the years ended December
31:
 
 2007
              
              
              2006
              
              
              2005Professional
      and consulting fees
              
              $
              1,018,088
              
              
              $
              702,221
              
              
              $
              952,681Data
      processing
              
              
              546,924
              
              
              
              501,873
              
              
              
              478,991Stationary
      and supplies
              
              
              132,410
              
              
              
              160,468
              
              
              
              143,129Staff
      related
              
              
              155,430
              
              
              
              164,271
              
              
              
              173,727Advertising
      and business development
              
              
              286,074
              
              
              
              276,232
              
              
              
              224,512Postage
      and telephone
              
              
              133,808
              
              
              
              120,096
              
              
              
              111,429Assessments
      and insurance
              
              
              133,154
              
              
              
              142,378
              
              
              
              150,049Other
              
              
              229,957
              
              
              
              282,100
              
              
              
              204,368$
              2,635,845
              
              
              $
              2,349,639
              
              
              $
              2,438,886
 
  65
  NOTE
J—INCOME TAXES
 
 The
provision for income taxes is comprised of the following:
 
 2007
              
              
              2006
              
              
              2005CurrentFederal
              
              $
              2,062,700
              
              
              $
              2,077,673
              
              
              $
              1,648,074State
              
              
              782,799
              
              
              
              755,982
              
              
              
              605,0032,845,499
              
              
              
              2,833,655
              
              
              
              2,253,077DeferredFederal
              
              
              (331,115
              )
              
              
              (507,264
              )
              
              
              (441,020
              )State
              
              
              (74,222
              )
              
              
              (108,624
              )
              
              
              (100,901
              )(405,337
              )
              
              
              (615,888
              )
              
              
              (541,921
              )Provision
      for income taxes
              
              $
              2,440,162
              
              
              $
              2,217,767
              
              
              $
              1,711,156
 
 The
following is a reconciliation of income taxes computed at the Federal statutory
income tax rate of 34% to the effective income tax rate used for the provision
for income taxes:
 
 2007
              
              
              2006
              
              
              2005Income
      tax at Federal statutory rate
              
              $
              2,306,458
              
              
              $
              2,111,239
              
              
              $
              1,720,293State
      franchise tax, less Federal income tax benefit
              
              
              485,333
              
              
              
              444,254
              
              
              
              361,990Interest
      on municipal obligations exempt from Federal tax
              
              
              (235,525
              )
              
              
              (229,226
              )
              
              
              (247,467
              )Life
      insurance earnings
              
              
              (171,551
              )
              
              
              (143,163
              )
              
              
              (134,288
              )Incentive
      stock option expense
              
              
              57,616
              
              
              
              41,247
              
              
              
              42,669Meals
      and entertainment
              
              
              6,654
              
              
              
              6,888
              
              
              
              5,452Tax
      credits
              
              
              (7,922
              )
              
              
              -
              
              
              
              -Other
      differences
              
              
              (901
              )
              
              
              (13,472
              )
              
              
              (37,493
              )Provision
      for income taxes
              
              $
              2,440,162
              
              
              $
              2,217,767
              
              
              $
              1,711,156
 
  66
  NOTE
J—INCOME TAXES (Continued)
 
 The tax
effects of temporary differences that give rise to the components of the net
deferred tax asset recorded as an other asset as of December 31 were as
follows:
 
 2007
              
              
              2006
              
              
              2005Deferred
      tax assets:Nonqualified
      benefit plans
              
              $
              1,931,578
              
              
              $
              1,706,099
              
              
              $
              1,427,237Allowance
      for loan losses
              
              
              1,305,486
              
              
              
              1,153,381
              
              
              
              979,526Unrealized
      securities holding losses
              
              
              24,477
              
              
              
              108,295
              
              
              
              217,076Accrued
      liabilities
              
              
              290,976
              
              
              
              240,490
              
              
              
              210,374State
      franchise taxes
              
              
              228,912
              
              
              
              215,884
              
              
              
              201,710Restricted
      stock
              
              
              50,499
              
              
              
              63,956Other
              
              
              74,978
              
              
              
              102,850
              
              
              
              60,983Total
      deferred tax assets
              
              
              3,906,906
              
              
              
              3,590,955
              
              
              
              3,096,906Deferred
      tax liabilities:Depreciation
              
              
              85,556
              
              
              
              120,217
              
              
              
              153,976Other
              
              
              112,602
              
              
              
              83,510
              
              
              
              62,809Total
      deferred tax liabilities
              
              
              198,158
              
              
              
              203,727
              
              
              
              216,785Net
      deferred tax assets
              
              $
              3,708,748
              
              
              $
              3,387,228
              
              
              $
              2,880,121
 
 The
amounts presented for the tax effects of temporary differences are based upon
estimates and assumptions and could vary from amounts ultimately reflected on
the Company's tax returns.
 
 Income
tax payable was $99,212 at December 31, 2007. Income tax receivable was $66,784
at December 31, 2006.
 
 The
Company or one of its subsidiaries files income tax returns in the U.S. Federal
jurisdiction and the state of California jurisdiction.  The Company is
no longer subject to U.S. federal income tax examinations by tax authorities for
years before 2004.
 
 The
Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income
Taxes,on January 1, 2007.  No adjustments were identified for
unrecognized tax benefits which would require an adjustment to the January 1,
2007 beginning balance of retained earnings.  There were also no
adjustments identified for unrecognized tax benefits which would require an
adjustment to the income statement for the year ended December 31,
2007.
 
 The
Company recognizes interest accrued and penalties related to unrecognized tax
benefits in tax expense.  During the years ended December 31, 2007 and
2006 the Company recognized no interest and penalties.
  67
  NOTE
K—EARNINGS PER SHARE
 
 The
following is the computation of basic and diluted earnings per share for the
years ended December 31:
 
 2007
              
              
              2006
              
              
              2005Basic:Net
      income
              
              $
              4,343,538
              
              
              $
              3,991,759
              
              
              $
              3,348,529Weighted-average
      common shares outstanding
              
              
              2,241,104
              
              
              
              2,247,231
              
              
              
              2,170,866Earnings
      per share
              
              $
              1.94
              
              
              $
              1.78
              
              
              $
              1.54Diluted:Net
      income
              
              $
              4,343,538
              
              
              $
              3,991,759
              
              
              $
              3,348,529Weighted-average
      common shares outstanding
              
              
              2,241,104
              
              
              
              2,247,231
              
              
              
              2,170,866Net
      effect of dilutive share-based awards – based on the treasury stock method
      using average market price
              
              
              72,484
              
              
              
              121,987
              
              
              
              132,773Weighted-average
      common shares outstanding and common stock equivalents
              
              
              2,313,588
              
              
              
              2,369,218
              
              
              
              2,303,639Earnings
      per share - assuming dilution
              
              $
              1.88
              
              
              $
              1.68
              
              
              $
              1.45
 
 Nonvested
restricted shares are included in the computation of diluted earnings per share
using the treasury stock method.  Vested restricted shares are
outstanding for both basic and diluted earnings per share.
 
 NOTE
L—EQUITY INCENTIVE PLAN
 
 The
Company has a stock option plan (the Plan), effective March 31, 1996 and
terminated on May 14, 2002 under which incentive and nonstatutory stock options,
as defined under the Internal Revenue Code, were granted.  The Plan
was administered by a Committee appointed by the Board.  No additional
options are available for granting under this plan; however, there are
unexercised options currently outstanding under this plan.  The
options granted under this plan have an exercise period of 10 years, a portion
of which were subject to a graded vesting schedule of 20% per year.
 
 The
Company approved an equity incentive plan (the Plan), effective May 14, 2002 and
terminating May 14, 2012, under which stock options, restricted stock, stock
appreciation rights and stock bonuses may be granted. The Plan is administered
by a Committee appointed by the Board. Options representing 123,555 shares of
the Company’s authorized and unissued common stock may be granted under the Plan
by the Committee to directors and employees of the Company at a price to be
determined by the Committee but shall not be less than 100% of the fair market
value of the shares on the date the incentive stock option is granted. The
options generally vest based on 5 years of continuous service and have 10-year
contractual terms. No options were granted in 2005 and 2006. There were 10,000
options granted in June 2007 and 7,410 options granted in December 2007. The
Company has 12,195 options available to grant under this plan at December 31,
2007.
  68
  NOTE
L—EQUITY INCENTIVE PLAN (Continued)
 
 The fair
value of options granted is estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions
used:
 
 June
    2007
              December
      2007Expected
      Life in Years
              
              
              7.00
              
              
              
              4.00Risk
      Free Interest Rate
              
              
              5.09
              %
              
              
              3.30
              %Expected
      Stock Price Volatility
              
              
              35.00
              %
              
              
              35.00
              %Expected
      Cash Dividend Yield
              
              
              2.40
              %
              
              
              2.40
              %Expected
      Annual Forfeiture Rate
              
              
              0.00
              %
              
              
              0.00
              %
 
 The
Company uses historical data to estimate expected cash dividend yield, expected
life in years, expected stock price volatility and expected annual forfeiture
rate within the valuation model. Expected volatilities are based on the
historical volatility of the Company’s stock.  The expected life of
options represents the period of time that options granted are expected to be
outstanding.  The risk-free rate for periods within the contractual
life of the option is based on the U.S. Treasury yield curve in effect at the
time of grant.
 
 The
Company granted a stock bonus under the 2002 plan in July of 2006, consisting of
29,000 shares of restricted stock, with a fair value at grant date of
$26.25.  The employees have dividend and voting rights at the time of
grant, regardless of whether they are vested in these shares.  This
restricted stock vests over three to five years.
 
 The
Company approved an equity incentive plan (the Plan), effective February 21,
2007 and terminating February 20, 2017, under which stock options, restricted
stock, stock appreciation rights and stock bonuses may be granted. The Plan is
administered by a Committee appointed by the Board. Options representing 231,963
shares of the
Company’s  authorized  and  unissued  common  stock  may  be  granted  under  the  Plan  by  the
Committee to directors and employees of the Company at a price to be determined
by the Committee but shall not be less than 100% of the fair market value of the
shares on the date the incentive stock option is granted.  The options
generally vest based on 5 years of continuous service and have 10-year
contractual terms. There have been no shares issued under the 2007
Plan.
  69
  
 NOTE
L—EQUITY INCENTIVE PLAN (Continued)
 
 A summary
of stock option activity follows for the years ended December 31:
 
 Incentive
      Stock Options2007
              
              2006
              
              2005Weighted-
                Average
                Exercise
      Price
              
              Shares
              
              Weighted-
                Average
                Exercise
      Price
              
              Shares
              
              Weighted-
                Average
                Exercise
      Price
              
              SharesShares
      under option at beginning of year
              $
              17.00
              
              
              92,621
              
              $
              14.64
              
              
              133,085
              
              $
              12.94
              
              
              179,730Options
      exercised
              
              14.69
              
              
              (13,848
              )
              
              8.90
              
              
              (39,264
              )
              
              7.70
              
              
              (45,295
              )Options
      forfeited or expired
              
              0.00
              
              
              0
              
              
              20.71
              
              
              (1,200
              )
              
              20.71
              
              
              (1,350
              )Shares
      under option at end of year
              
              17.40
              
              
              78,773
              
              
              17.00
              
              
              92,621
              
              
              14.64
              
              
              133,085Options
      exercisable at end of year
              
              16.78
              
              
              66,323
              
              
              15.63
              
              
              67,721
              
              
              12.11
              
              
              93,935
 
 
 Nonstatutory
      Stock Options2007
              
              2006
              
              2005Weighted-
                Average
                Exercise
      Price
              
              Shares
              
              Weighted-
                Average
                Exercise
      Price
              
              Shares
              
              Weighted-
                Average
                Exercise
      Price
              
              SharesShares
      under option at Beginning of year
              $
              8.12
              
              
              120,438
              
              $
              8.07
              
              
              185,300
              
              $
              8.05
              
              
              208,465Options
      granted
              
              27.48
              
              
              17,410Options
      exercised
              
              8.06
              
              
              (46,316
              )
              
              7.95
              
              
              (64,862
              )
              
              7.94
              
              
              (23,165
              )Shares
      under option at end of year
              
              11.85
              
              
              91,532
              
              
              8.12
              
              
              120,438
              
              
              8.07
              
              
              185,300Options
      exercisable at end of year
              
              8.75
              
              
              76,592
              
              
              8.12
              
              
              120,438
              
              
              8.07
              
              
              185,300Weighted-average
      fair value of options granted during the year
              
              8.68
 
  70
  NOTE
L—EQUITY INCENTIVE PLAN (Continued)
 
 Following
is the intrinsic value and weighted average contractual term of stock options
outstanding for the years ended December 31:
 
 Incentive
      Stock Options2007
              
              
              2006
              
              
              2005Intrinsic
      value:Outstanding
      shares
              
              $
              610,396
              
              
              $
              1,019,333
              
              
              $
              899,589Exercisable
      shares
              
              
              555,081
              
              
              
              837,751
              
              
              
              872,458Weighted
      averageremaining
      contractual term:Outstanding
      shares
              
              5.21
      years
              
              
              6.15
      years
              
              
              6.58
      yearsExercisable
      shares
              
              5.01
      years
              
              
              5.71
      years
              
              
              5.54
      years
 
 Nonstatutory
      Stock Options2007
              
              
              2006
              
              
              2005Intrinsic
      value:Outstanding
      shares
              
              $
              1,217,399
              
              
              $
              2,392,987
              
              
              $
              2,470,660Exercisable
      shares
              
              
              1,255,745
              
              
              
              2,392,987
              
              
              
              2,470,660Weighted
      averageremaining
      contractual term:Outstanding
      shares
              
              4.02
      years
              
              
              2.02
      years
              
              
              3.11
      yearsExercisable
      shares
              
              1.49
      years
              
              
              2.02
      years
              
              
              3.11
      years
 
 Upon the
exercise of stock options, new shares are issued.  The total amount of
cash received from the exercise of stock options during 2007, 2006 and 2005 was
$576,483, $864,993 and $532,635, respectively.  The tax benefits
realized for the tax deductions from stock options exercised during 2007, 2006
and 2005 was $407,889, $459,493 and $132,337, respectively.
 
 A summary
of the status of the Company’s nonvested shares and changes during the years
ended December 31 are presented below:
 
 Incentive
      Stock Options2007
              
              
              2006
              
              
              2005Weighted-Average
              
              
              
              
              
              Weighted-Average
              
              
              
              
              
              Weighted-AverageGrant-Date
              
              
              
              
              
              Grant-Date
              
              
              
              
              
              Grant-DateNonvested
      Shares
              
              Shares
              
              
              Fair
      Value
              
              
              Shares
              
              
              Fair
      Value
              
              
              Shares
              
              
              Fair
      ValueNonvested
      at beginning of year
              
              
              24,900
              
              
              $
              7.68
              
              
              
              39,150
              
              
              $
              7.68
              
              
              
              54,000
              
              
              $
              7.68Vested
              
              
              (12,450
              )
              
              
              7.68
              
              
              
              (13,050
              )
              
              
              7.68
              
              
              
              (13,500
              )
              
              
              7.68Forfeited
              
              
              
              
              
              
              
              
              
              
              (1,200
              )
              
              
              7.68
              
              
              
              (1,350
              )
              
              
              7.68Nonvested
      at end of year
              
              
              12,450
              
              
              
              7.68
              
              
              
              24,900
              
              
              
              7.68
              
              
              
              39,150
              
              
              
              7.68
 
  71
  NOTE
L—EQUITY INCENTIVE PLAN (Continued)
 
 Nonstatutory
      Stock Options2007Weighted-AverageGrant-DateNonvested
      Shares
              
              Shares
              
              
              Fair
      ValueNonvested
      at beginning of year
              
              
              0Granted
              
              
              17,410
              
              
              $
              8.68Vested
              
              
              (2,470
              )
              
              $
              6.79Nonvested
      at end of year
              
              
              14,940
              
              
              $
              9.00
 
 As of
December 30, 2007 and 2006 there was $125,918 and $191,232, respectively, of
total unrecognized compensation cost related to nonvested stock options granted
under the Plan.  That cost is expected to be recognized over a
weighted-average period of two years.  The total fair value of shares
vested during the years ended December 31, 2007, 2006 and 2005, was $112,379,
$100,224 and $103,680, respectively.
 
 A summary
of restricted stock activity follows for the years ended December 31, 2007 and
2006:
 
 2007
              
              2006Weighted-Average
              
              Aggregate
              
              
              
              
              Weighted-Average
              
              AggregateGrant-Date
              
              Intrinsic
              
              
              
              
              Grant-Date
              
              IntrinsicRestricted Stock
              
              Shares
              
              
              Fair Value
              
              Value
              
              Shares
              
              
              Fair Value
              
              ValueNonvested
      at beginning of year
              
              
              29,000
              
              
              $
              26.25Granted
              
              
              
              
              
              
              
              
              
              
              
              29,000
              
              
              $
              26.25Shares
      Vested and Issued
              
              
              (6,200
              )
              
              $
              26.25Nonvested
      at end of year
              
              
              22,800
              
              
              $
              26.25
              
              $   (25,080)
              
              
              29,000
              
              
              $
              26.25
              
              $    50,750
 
 As of
December 31, 2007 and 2006, there was $517,125 and $679,875 of total
unrecognized compensation cost related to nonvested restricted
stock.  That cost is expected to be recognized over a weighted-average
period of 3.5 years and 4.5 years, respectively.
 
 Total
compensation cost for all share-based payments recognized in net income for
2007, 2006 and 2005 totaled $223,172, $106,871 and $61,011, respectively, which
is net of the related tax benefits for 2007, 2006 and 2005 of $156,050, $74,728
and $42,669, respectively
  72
  NOTE
M—RELATED PARTY TRANSACTIONS
 
 The
Company has entered into transactions with its directors, executive officers and
their affiliates (related parties).  Such transactions were made in
the ordinary course of business on substantially the same terms and conditions,
including interest rates and collateral, as those prevailing at the same time
for comparable transactions with other customers, and did not, in the opinion of
management, involve more than normal credit risk or present other unfavorable
features.  The following is a summary of the aggregate activity
involving related party borrowers at December 31, 2007 and 2006:
 
 2007
              
              
              2006Loans
      outstanding at beginning of year
              
              $
              2,657,000
              
              
              $
              2,657,000Loans
      disbursements
              
              
              703,000
              
              
              
              415,000Loan
      repayments
              
              
              (899,000
              )
              
              
              (415,000
              )Loans
      outstanding at end of year
              
              $
              2,461,000
              
              
              $
              2,657,000
 
 At
December 31, 2007, commitments to related parties of approximately $1,744,000
were undisbursed.  Deposits received from directors and officers
totaled $4,621,000 and $3,567,000 at December 31, 2007 and 2006,
respectively.
 
 The
Company leases its Glen Ellen office from a director of the Company under a
noncancellable operating lease.  Lease expense for the years ended
December 31, 2007 and 2006 was $15,294 and $14,705, respectively. The remaining
lease commitment is approximately $3,861 expiring March 2008.  When
the current term expires the Company has the option to extend the lease for two
additional 5 year terms.  The lease expense increases annually based
upon the Consumer Price Index, but not less than 4% annually.
 
 NOTE
N—COMMITMENTS AND CONTINGENT LIABILITIES
 
 Lease Commitments:
The Company leases its three Sonoma offices, the Glen Ellen office and the Banco
de Sonoma office under noncancelable operating leases with remaining terms of
approximately two years, three years, three years, one year and one year,
respectively. All of the leases require adjustments to the base rent for
changing price indices and two have a minimum annual increase of four percent.
The Sonoma main office lease and the
Sonoma Finance Center lease have the option to renew for two consecutive
five-year terms and the Sonoma annex office has an option to renew for one
five-year period and one four-year period. The Glen Ellen office and the Banco
de Sonoma office lease each have an option to renew for two additional five-year
terms. The following table summarizes future minimum commitments under the
noncancelable operating leases.
 
 Year
      ended December 312008
              
              $
              367,4822009
              
              
              212,6422010
              
              
              27,255$
              607,379
 
 Rental
expense was $381,000 in 2007, $364,000 in 2006 and $347,000 in
2005.
  73
  NOTE
N—COMMITMENTS AND CONTINGENT LIABILITIES (Continued)
 
 Financial Instruments with
Off-Balance-Sheet Risk:  The Company's financial statements do
not reflect various commitments and contingent liabilities which arise in the
normal course of business and which involve elements of credit risk, interest
rate risk and liquidity risk.  These commitments and contingent
liabilities are commitments to extend credit and standby letters of
credit.  A summary of the Company's commitments and contingent
liabilities at December 31 is as follows:
 
 Contractual
      Amounts2007
              
              
              2006Commitments
      to extend credit
              
              $
              51,458,000
              
              
              $
              54,526,000Standby
      letters of credit
              
              
              158,000
              
              
              
              348,000
 
 Commitments
to extend credit and standby letters of credit include exposure to some credit
loss in the event of nonperformance of the customer.  The Company's
credit policies and procedures for credit commitments and financial guarantees
are the same as those for extensions of credit that are recorded on the balance
sheet.  Because these instruments have fixed maturity dates, and
because many of them expire without being drawn upon, they do not generally
present any significant liquidity risk to the Company.
 
 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. The Company evaluates each customer’s credit worthiness 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 customer. Collateral held varies but may include accounts receivable,
inventory, property, plant, and equipment, certificates of deposits and
income-producing commercial properties.
 
 Standby
letters of credit are conditional commitments issued by the Company to guarantee
the performance of a customer to a third party.  Those guarantees are
primarily issued to support public and private borrowing
arrangements.  The credit risk involved in issuing letters of credit
is essentially the same as that involved in extending facilities to
customers.
 
 The
Company has not incurred any losses on its commitments in 2007, 2006 or
2005.
 
 As a
guarantor of its customer’s credit card accounts, the Company is contingently
liable for credit card receivable balances held by another financial institution
should the customers default.  The total amount guaranteed as of
December 31, 2007 and 2006 was $655,000 and $313,000, respectively.
 
 
 NOTE
O—CONCENTRATIONS OF CREDIT RISK
 
 Most of
the Company's business activity is with customers located within the State of
California, primarily in Sonoma County.  The economy of the Company's
primary service area is heavily dependent on the area's major industries which
are tourism and agriculture, especially wineries, dairies and cheese
producers.  General economic conditions or natural disasters affecting
the primary service area or its major industries could affect the ability of
customers to repay loans and the value of real property used as
collateral.
  74
  NOTE
O—CONCENTRATIONS OF CREDIT RISK (Continued)
 
 The
composition of the loan portfolio by credit type is set forth in Note
D.  Note D does not include unfunded loan commitments, which represent
18.0% of loans outstanding.  While the Company has approximately 91%
of its loan portfolio centered in real estate secured loans within its service
area, the loans in this category are diversified.  Based on
outstanding loan commitments (“total loans”), the Company has the following loan
concentrations:  Non-owner occupied land and construction (18.17%),
owner-occupied land and construction (6.0%), mixed-use commercial real estate
(13.55%), industrial and warehouse commercial real estate (13.31%), retail
commercial real estate (11.97%), office commercial real estate (7.01%) and loans
to the wine and tourism industries (9.58%).  Standby letters of credit
were granted primarily to commercial borrowers.  The Company, as a
matter of policy, does not extend credit to any single borrower or group of
related borrowers on a secured basis in excess of 25% of its unimpaired capital
(shareholders' equity plus the allowance for credit losses) and on an unsecured
basis in excess of 15% of its unimpaired capital.
 
 The
concentrations of investments are set forth in Note C.  The Company
places its investments primarily in financial instruments backed by the U.S.
Government and its agencies or by high quality financial institutions,
municipalities or corporations.  The Company has significant funds
deposited with four correspondent banks.  In addition, deposits with
two correspondent banks were in excess of the federally insured limit by
$449,055 at December 31, 2007.  While management recognizes the
inherent risks involved in such concentrations, this concentration provides the
Company with an effective and cost efficient means of managing its liquidity
position and item processing needs.  Management closely monitors the
financial condition of their correspondent banks on a continuous
basis.  The Company also maintains additional deposit accounts with
other correspondent banks should management determine that a change in its
correspondent banking relationship would be appropriate.
 
 At
December 31, 2007, the Company had life insurance policies with cash surrender
values of $2,603,914, $1,945,487, $1,944,232 and $1,923,559 with four insurance
companies, which represented 9.3%, 7.0%, 7.0% and 6.9%, respectively, of the
Company's net worth.  Management closely monitors the financial
condition and rating of these insurance companies on a regular
basis.
 
 NOTE
P—REGULATORY MATTERS
 
 Banking
regulations limit the amount of cash dividends that may be paid without prior
approval of the Bank's regulatory agency.  Cash dividends are limited
to the lesser of retained earnings, if any, or net income for the last three
years, net of the amount of any other distributions made to shareholders during
such periods.  As of December 31, 2007, $7,736,503 was available for
cash dividend distribution without prior approval.
 
 The Bank
is subject to various regulatory capital requirements administered by its
primary federal regulator, the Federal Deposit Insurance Corporation
(FDIC).  Failure to meet 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 Bank’s 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 Bank’s capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
  75
  NOTE
P—REGULATORY MATTERS (Continued)
 
 Quantitative
measures established by regulation to ensure capital adequacy require the Bank
to maintain minimum amounts and ratios (set forth in the table below) of total
and Tier I capital (as defined in the regulations) to risk-weighted assets (as
defined), and of Tier I capital (as defined) to average assets (as
defined).  Management believes, as of December 31, 2007, that the Bank
meets all capital adequacy requirements to which it is subject.
 
 As of
December 31, 2007, 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 I risk-based and Tier I leverage ratios as set
forth in the table. There are no conditions or events since that notification
that management believes have changed the institution’s category.  The
Bank’s actual capital amounts and ratios are also presented in the
table.
 
 To
      Be WellCapitalized
      UnderFor
      Capital
              Prompt
      CorrectiveActual
              Adequacy Purposes
              Action ProvisionsAmount
              
              
              Ratio
              
              Amount
              Ratio
              Amount
              Ratio(in
      thousands)As
      of December 31, 2007:Total
      Capital(to
      Risk Weighted Assets)
              
              $
              29,996
              
              
              
              10.8
              %
              >$ 22,310
              >8.0%
              >$27,887
              >10.0%Tier
      I Capital(to
      Risk Weighted Assets)
              
              $
              26,507
              
              
              
              9.5
              %
              >$ 11,155
              >4.0%
              >$16,732
              >6.0%Tier
      I Capital(to
      Average Assets)
              
              $
              26,507
              
              
              
              9.0
              %
              >$ 11,761
              >4.0%
              >$14,701
              > 5.0%As
      of December 31, 2006:Total
      Capital(to
      Risk Weighted Assets)
              
              $
              28,223
              
              
              
              11.0
              %
              >$ 20,466
              >8.0%
              >$25,583
              >10.0%Tier
      I Capital(to
      Risk Weighted Assets)
              
              $
              25,024
              
              
              
              9.8
              %
              >$ 10,233
              >4.0%
              >$15,350
              > 6.0%Tier
      I Capital(to
      Average Assets)
              
              $
              25,024
              
              
              
              9.1
              %
              >$ 10,960
              >4.0%
              >$13,700
              >
5.0%
 
  76
  NOTE
Q—CONDENSED FINANCIAL INFORMATION OF THE PARENT COMPANY
 
 A
condensed balance sheet as of December 31, 2007 and 2006 and the related
condensed statement of operations and cash flows for the years ended December
31, 2007, 2006 and 2005 for Sonoma Valley Bancorp (parent company only) are
presented as follows:
 
 Condensed
Balance Sheets
 December
31, 2007 and 2006
 2007
              
              
              2006AssetsCash
              
              $
              55,380
              
              
              $
              682,798Other
      assets
              
              
              947,911
              
              
              
              764,470Investment
      in common stock of subsidiary
              
              
              27,218,520
              
              
              
              25,236,403Total
      assets
              
              $
              28,221,811
              
              
              $
              26,683,671
 
 2007
              
              
              2006LiabilitiesAccrued
      expenses
              
              $
              287,531
              
              
              $
              279,600Shareholders’
      equityCommon
      stock
              
              
              15,578,903
              
              
              
              15,479,556Additional
      paid-in-capital
              
              
              2,455,409
              
              
              
              1,872,648Retained
      earnings and other equity
              
              
              9,899,968
              
              
              
              9,051,867Total
      liabilities and shareholders’ equity
              
              $
              28,221,811
              
              
              $
              26,683,671
 
 Condensed
Statements of Operations
 For the
years ended December 31, 2007, 2006 and 2005
 
 2007
              
              
              2006
              
              
              2005Dividend
      from subsidiary
              
              $
              3,000,000
              
              
              $
              1,750,000
              
              
              $
              500,000Expenses
              
              
              892,962
              
              
              
              583,724
              
              
              
              601,886Income
      (loss) before income taxes and equity in undistributed income of
      subsidiary
              
              
              2,107,038
              
              
              
              1,166,276
              
              
              
              (101,886
              )Equity
      in undistributed net income of subsidiary
              
              
              1,862,267
              
              
              
              2,621,241
              
              
              
              3,252,996Income
      tax benefit
              
              
              374,233
              
              
              
              204,242
              
              
              
              197,419Net
      income
              
              $
              4,343,538
              
              
              $
              3,991,759
              
              
              $
              3,348,529
 
  77
  NOTE
Q—CONDENSED FINANCIAL INFORMATION OF THE PARENT COMPANY (Continued)
 
 Condensed
Statements of Cash Flows
 For the
years ended December 31, 2007, 2006 and 2005
 
 2007
              
              
              2006
              
              
              2005Operating
      activities:Net
      income
              
              $
              4,343,538
              
              
              $
              3,991,759
              
              
              $
              3,348,529Adjustments
      to reconcile net income to net cashprovided
      by operating activities:Equity
      in undistributed net income of subsidiary
              
              
              (1,862,267
              )
              
              
              (2,621,241
              )
              
              
              (3,252,996
              )Restricted
      stock granted
              
              
              162,750
              
              
              
              81,375Stock
      options granted
              
              
              216,473
              
              
              
              100,224
              
              
              
              103,680Net
      change in other assets
              
              
              232,383
              
              
              
              (15,100
              )
              
              
              549,057Net
      change in accrued expenses
              
              
              7,931
              
              
              
              58,457
              
              
              
              159,893Net
      cash provided by operating activities
              
              
              3,100,808
              
              
              
              1,595,474
              
              
              
              908,163
 
 Financing
      activities:Stock
      repurchases
              
              
              (2,933,237
              )
              
              
              (1,436,151
              )
              
              
              (113,668
              )Stock
      options exercised
              
              
              576,482
              
              
              
              864,993
              
              
              
              532,635Cash
      dividends paid
              
              
              (1,371,471
              )
              
              
              (1,252,957
              )
              
              
              (1,078,001
              )Net
      cash used by financing activities
              
              
              (3,728,226
              )
              
              
              (1,824,115
              )
              
              
              (659,034
              )Net
      change in cash and cash equivalents
              
              
              (627,418
              )
              
              
              (228,641
              )
              
              
              249,129Cash
      and cash equivalents at beginning of year
              
              
              682,798
              
              
              
              911,439
              
              
              
              662,310Cash
      and cash equivalents at end of year
              
              $
              55,380
              
              
              $
              682,798
              
              
              $
              911,439
 
 NOTE
R—FAIR VALUES OF FINANCIAL INSTRUMENTS
 
 Statement
of Financial Accounting Standards No. 107, Disclosures about Fair Value of
Financial Instruments, requires disclosure of fair value information
about financial instruments, whether or not recognized in the balance
sheet.  In cases where quoted market prices are not available, fair
values are based on estimates using present value or other valuation
techniques.  Those techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash
flows.  In that regard, the derived fair value estimates cannot be
substantiated by comparison to independent markets and, in many cases could not
be realized in immediate settlement of the instruments.  Statement No.
107 excludes certain financial instruments and all nonfinancial instruments from
its disclosure requirements.  Accordingly, the aggregate fair value
amounts presented do not represent the underlying value of the Company as a
whole.
  78
  NOTE
R—FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)
 
 The
estimated fair values of the Company and Subsidiary's financial instruments are
as follows at December 31:
 
 2007
              
              
              2006Carrying
      Amount
              
              
              Estimated
      Fair Value
              
              
              Carrying
      Amount
              
              
              Estimated
      Fair ValueFinancial
      assets:Cash
      and due from banks
              
              $
              6,268,091
              
              
              $
              6,268,091
              
              
              $
              6,159,931
              
              
              $
              6,159,931Federal
      funds soldInterest-bearing
      due from banks
              
              
              3,065,543
              
              
              
              3,065,543
              
              
              
              1,292,325
              
              
              
              1,292,325Investment
      securities available-for-sale
              
              
              8,203,190
              
              
              
              8,203,190
              
              
              
              20,991,232
              
              
              
              20,991,232Investment
      securities held-to-maturity
              
              
              14,554,224
              
              
              
              14,754,249
              
              
              
              15,804,421
              
              
              
              15,951,553Loans
      and lease financing receivable, net
              
              
              246,738,218
              
              
              
              245,521,222
              
              
              
              216,330,690
              
              
              
              214,690,033Accrued
      interest receivable
              
              
              1,682,209
              
              
              
              1,682,209
              
              
              
              1,671,618
              
              
              
              1,671,618Cash
      surrender value of life insurance
              
              
              10,354,153
              
              
              
              10,354,153
              
              
              
              9,587,306
              
              
              
              9,587,306Financial
      liabilities:Deposits
              
              
              236,047,699
              
              
              
              236,347,423
              
              
              
              232,767,415
              
              
              
              233,038,180Accrued
      interest payable
              
              
              150,109
              
              
              
              150,109
              
              
              
              144,636
              
              
              
              144,636Federal
      Home Loan Bank
                Borrowings
              
              
              27,500,000
              
              
              
              27,638,811
              
              
              
              12,600,000
              
              
              
              12,600,000
 
 The
carrying amounts in the preceding table are included in the balance sheet under
the applicable captions.
 
 The
following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments:
 
 Cash, due
from banks and federal funds sold:  The carrying amount is a
reasonable estimate of fair value.
 
 Investment
securities:  Fair values for investment securities are based on quoted
market prices, where available.  If quoted market prices are not
available, fair values are based on quoted market prices of comparable
instruments.  The carrying amount of accrued interest receivable
approximates its fair value.
  79
  NOTE
R—FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)
 
 Loans and
lease financing receivables, net:  For variable-rate loans and leases
that reprice frequently and fixed rate loans and leases that mature in the near
future, with no significant change in credit risk, fair values are based on
carrying amounts.  The fair values for other fixed rate loans and
leases are estimated using discounted cash flow analysis, based on interest
rates currently being offered for loans or leases with similar terms to
borrowers of similar credit quality.  Loan and lease fair value
estimates include judgments regarding future expected loss experience and risk
characteristics and are adjusted for the allowance for loan and lease
losses.  The carrying amount of accrued interest receivable
approximates its fair value.
 
 Cash
surrender value of life insurance:  The carrying amount approximates
its fair value.
 
 Deposits:  The
fair values disclosed for demand deposits (for example, interest-bearing
checking accounts and passbook accounts) are, by definition, equal to the amount
payable on demand at the reporting date (that is, their carrying
amounts).  The fair values for certificates of deposit are estimated
using a discounted cash flow calculation that applies interest rates currently
being offered on certificates to a schedule of aggregated contractual maturities
on such time deposits.  The carrying amount of accrued interest
payable approximates fair value.
 
 Federal
Home Loan Bank borrowings:  The carrying amount of overnight
borrowings approximates fair value.  The fair value of the long-term
borrowings is estimated using a discounted cash flow calculation that applies
current interest rates on similar borrowings with similar terms.
 
 Off-balance
sheet instruments:  Off-balance sheet commitments consist of
commitments to extend credit and standby letters of credit.  The
contract or notional amounts of the Company’s financial instruments with
off-balance-sheet risk are disclosed in Note N.  Estimating the fair
value of these financial instruments is not considered practicable due to the
immateriality of the amounts of fees collected, which are used as a basis for
calculating the fair value, on such instruments.
 
 NOTE
S—SUBSEQUENT EVENTS
 
 On
February 20, 2008, the Board of Directors declared a cash dividend of $.30 per
share to shareholders of record on March 14, 2008 and payable on March 28,
2008.
  80
  ITEM
      9.
              CHANGES
      IN AND DISAGREEMENTS WITH A ACCOUNTANTS ON ACCOUNTING AND FINANACIAL
      DISCLOSURE
 None
 
 ITEM
      9A.
              CONTROLS
      AND PROCEDURES.
  Disclosure Controls and
Procedures
  Disclosure controls
and procedures are designed with the objective of ensuring that information
required to be disclosed in reports filed by the Company under the Exchange Act,
such as this Annual Report, is recorded, processed, summarized and reported
within the time periods specified in the
rules and forms of the Securities and Exchange Commission. Disclosure controls
and procedures are also designed with the objective of ensuring that such
information is accumulated and communicated to management, including the Chief
Executive Officer and the Chief Financial Officer, as appropriate to allow
timely decisions regarding required disclosure.
  Evaluation of Disclosure
Controls and Procedures and Internal Control over Financial
Reporting
 The
Company carried out an evaluation, under the supervision and with the
participation of management, including the Chief Executive Officer and the Chief
Financial Officer, about the effectiveness of disclosure controls and procedures
pursuant to Exchange Act Rule 13a-15(e). Based upon that evaluation, the Chief
Executive Officer and the Chief Financial Officer concluded that the disclosure
controls and procedures, as of the end of the period covered by this Form 10-K,
are effective in alerting them to material information required to be included
in this Form 10-K.
  Management's Report on
Internal Control over Financial Reporting
 Management of the
Company is responsible for establishing and maintaining adequate internal
control over financial reporting. As defined in Rule 13a-15(f) under the
Exchange Act, internal control over financial reporting is a process designed
by, or under the supervision of, a company's principal executive and principal
financial officers and effected by a company's board of directors, management
and other personnel, to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. It includes those
policies and procedures that:
  a) Pertain to the
maintenance of records that in reasonable detail accurately and fairly
reflect the transactions and dispositions of the assets of a company;
  b) Provide reasonable
assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of a company are
being made only in accordance with authorizations of management and the board of directors
of the company; and
  c) Provide reasonable
assurance regarding prevention or timely detection of unauthorized
acquisition, use or disposition of a company's assets that could have a material effect on
its financial statements.
  Because of the
inherent limitations, internal control over financial reporting may not prevent
or detect misstatements. Also, projections of any evaluation of effectiveness to
future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
  81
 The Company's
management has used the criteria established in "Internal Control-Integrated
Framework" issued by the Committee of Sponsoring Organizations of the Treadway
Commission ("COSO") to evaluate the effectiveness of the Company's internal
control over financial reporting. Management has selected the COSO framework for
its evaluation as it is a control framework recognized by the SEC and the Public
Company Accounting Oversight Board, that is free from bias, permits reasonably
consistent qualitative and quantitative measurement of the Company's internal
controls, is sufficiently complete so that relevant controls are not omitted,
and is relevant to an evaluation of internal controls over financial
reporting.
  Based on our
assessment, management has concluded that our internal control over financial
reporting, based on criteria established in "Internal Control-Integrated
Framework" issued by COSO was effective as of December 31, 2007.
  
  Date: March 4,
2008
   /s/Mel Switzer,
Jr.                                
/s/Mary Dieter
Smith
 Mel
Switzer, Jr.  Mary Dieter Smith
 Chief Executive
Officer   Chief Financial
Officer
 ITEM
      9B.
              OTHER
      INFORMATION.
 
 None
 PART
III
 
 ITEM
      10.
              DIRECTORS
      AND EXECUTIVE OFFICERS OF THE
REGISTRANT.
 
 The
information called for in Item 10 of Part III is incorporated by reference from
the definitive proxy statement of the Company to be filed with the Securities
and Exchange Commission within 120 days from fiscal year end.
 
 ITEM.
      11.
              EXECUTIVE
      COMPENSATION.
 
 The
information called for in Item 11 of Part III is incorporated by reference from
the definitive proxy statement of the Company to be filed with the Securities
and Exchange Commission within 120 days from fiscal year end.
 
 ITEM
      12.
              SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS.
 
 The
information called for in Item 12 of Part III is incorporated by reference from
the definitive proxy statement of the Company to be filed with the Securities
and Exchange Commission within 120 days from fiscal year end.
 
 ITEM
      13.
              CERTAIN
      RELATIONSHIPS AND RELATED
TRANSACTIONS.
 
 The
information called for in Item 13 of Part III is incorporated by reference from
the definitive proxy statement of the Company to be filed with the Securities
and Exchange Commission within 120 days from fiscal year
end.
   ITEM
      14.
              PRINCIPAL
      ACCOUNTING FEES AND SERVICES.
 
 The
information called for in Item 14 of Part III is incorporated by reference from
the definitive proxy statement of the Company to be filed with the Securities
and Exchange Commission within 120 days from fiscal year end.
 
 82
 PART
IV
 
 ITEM
      15.
              EXHIBITS,
      FINANCIAL STATEMENT SCHEDULES.
 
 Financial
Statements
 
 The
following financial statements of the Company are filed as part of this Annual
Report:
 
 
 PageNumber1.
              Independent Auditor's
      Report
              472.
              Consolidated Balance Sheets as of
      December 31, 2007 and 2006
              483.
              Consolidated Statements of Operations
      for the three years ended December 31, 2007, 2006 and
    2005
              494.
              Consolidated Statements of Changes in
      Shareholders' Equity for the three years ended December 31, 2007, 2006 and
      2005
              50 and
      515.
              Consolidated Statements of Cash Flows for the
      three years ended December 31, 2007, 2006 and 2005
              52
      and 536.
              Notes to Consolidated Financial
      Statements
              54
 
 Financial
Statement Schedules
 
 All other
schedules have been omitted since the required information is not present or is
not present in sufficient amounts to require submission of the schedules or
because the information is included in the financial statements or the notes
thereto.
  83
  Exhibits
 
 The
following Exhibits are attached or incorporated herein by
reference:
 
 3.1
              Sonoma
      Valley Bancorp Articles of Incorporation, filed as Exhibit 3.1 to the
      Registrant's Registration Statement on Form S-8 filed on June 5,
      2001.
 
 3.3
              Sonoma
      Valley Bancorp By-laws, filed as Exhibit 3.2 to the Registrant's
      Registration Statement on Form S-8 filed on June 5,
  2001.
 
 4.2
              Agreement
      for the sale of Sonoma Valley Bank Stock dated September 23, 1992, filed
      as Exhibit 4.2 (formerly A-1) to the Form F-2 for the year ended December
      31, 1992.
 
 10.1
              Lease
      for Sonoma branch office, filed as Exhibit 10.1 (formerly 7.1) to the
      Registrant's Registration Statement on Form F-1 filed on May 1,
      1989.
 
 10.2
              Sonoma
      Valley Bank Chief Executive Officer Severance Agreement dated January 4,
      1995, filed as Exhibit 10.2 to the Form 10-KSB for the year ended December
      31, 1997.
 
 10.3
              Sonoma
      Valley Bank Supplemental Executive Retirement Plan, as amended on March
      20, 1996, filed as Exhibit 10.3 to the Form 10-KSB for the year ended
      December 31, 1997.
 
 10.4
              Sonoma
      Valley Bank Deferred Compensation Plan, filed as Exhibit 10.4 to the Form
      10-KSB for the year ended December 31,
1997.
 
 10.5
              Sonoma
      Valley Bank Master Trust Agreement for Executive Deferral Plans, filed as
      Exhibit 10.5 to the Form 10-KSB for the year ended December 31,
      1997.
 
 10.6
              Sonoma
      Valley Bank 1996 Stock Option Plan, filed as Exhibit 10.6 to the Form
      10-KSB for the year ended December 31,
1997.
 
 10.7
              Sonoma
      Valley Bank Severance Agreement with Mel Switzer, Jr. dated October 21,
      1998, filed as Exhibit 10.7 to the From 10-KSB for the year ended December
      31, 1998.
 
 10.8
              Sonoma
      Valley Bank Severance Agreement with Mary Dieter dated October 21, 1998,
      filed as Exhibit 10.8 to the From 10-KSB for the year ended December 31,
      1998.
  10.10
              Sonoma
      Valley Bancorp Assumption of Severance Agreement [Form of], filed as
      Exhibit 10.1 to the Form 10-KSB for the year ended December 31,
      2001.
 10.11
              Sonoma
      Valley Bancorp 2002 Equity Incentive Plan, filed as Exhibit A to the
      Company's Proxy Statement for the Annual Meeting held on May 14,
      2002.
  
  10.12
              Sonoma
      Valley Bank Severance Agreement with Sean Cutting dated March 18, 2004,
      filed as Exhibit 10.12 to the Form 10-K for the year ended December 31,
      2003.
  
 23.1
              Consent
      of Richardson and Co., Independent
Auditors.
 
 31.1
              Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act
 
 31.2
              Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act
 
 32
              Certification
      of Chief Executive Officer and Chief Financial Officer pursuant to Section
      906 of the Sarbanes-Oxley Act
 
  84
  SIGNATURES
 
 Pursuant
to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
 
 SONOMA
VALLEY BANCORP,
 A
California corporation
  
 /s/
      Mel Switzer, Jr.
              
              March
      20, 2008Mel
      Switzer, Jr.President
      andChief Executive
      Officer(Principal
      Executive Officer)
  
 /s/
      Mary Dieter Smith
              
              March
      20, 2008Mary
      Dieter SmithExecutive
      Vice President andChief
      Operating Officer(Principal
      Finance and Accounting Officer)
 
 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.
 
 
 /s/
      Suzanne Brangham
              
              March
      20, 2008Suzanne
      Brangham, Secretaryof
      the Board and Director
 
 
 /s/
      Dale T. Downing
              
              March
      20, 2008Dale
      T. Downing, Director
 
 
 /s/
      Robert B. Hitchcock
              
              March
      20, 2008Robert
      B. Hitchcock, Director
 
 
 /s/
      Robert J. Nicholas
              
              March
      20, 2008Robert
      J. Nicholas, Chairmanof
      the Board and Director
   /s/
      Valerie Pistole
              
              March
      20, 2008Valerie
      Pistole, Director
 85
   
 /s/
      Mel Switzer, Jr.
              
              March
      20, 2008Mel
      Switzer, Jr., President, ChiefExecutive
      Officer and Director(Principal
      Executive Officer)
 
 
 /s/ Mary Dieter
      Smith
              
              March
      20, 2008Mary
      Dieter Smith, Executive VicePresident,
      Chief Operating Officer andChief
      Financial Officer (PrincipalFinance
      and Accounting Officer)


86