Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**Form 10-Q**

 

**x****     ****QUARTERLY REPORT PURSUANTTO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period endedSeptember 30, 2010**

 

**OR**

 

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

 

**Commission file number 001-34142**

 

**OAK VALLEY BANCORP**

(Exact name of registrant as specified in itscharter)

 

| **California**                 | ** ** | **26-2326676**     |
|--------------------------------|------------|--------------------|
| State or other jurisdiction of |       | I.R.S. Employer    |
| incorporation or organization  |       | Identification No. |

 

**125 N. Third Ave., Oakdale,CA  95361**

(Address of principal executive offices)

 

**(209) 848-2265**

Issuer’s telephone number

 

**Not applicable**

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

 

Indicateby check mark whether the issuer (1) has filed all reports required to befiled by Section 13 or 15(d) of the Exchange Act during the past 12months (or for such shorter period that the registrant was required to file suchreports), and (2) has been subject to such filing requirements for thepast 90 days.  Yes  **x**  No  **o**

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T during thepreceding 12 months (or for such shorter period that the registrant wasrequired to submit and post such files). Yes  **o**  No  **o**

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seedefinitions of “large accelerated filer,” “accelerated filer,” and “smallerreporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

| Large accelerated filer **o**            |   | Accelerated filer **o**         |
|-----------------------------------------------|--------|--------------------------------------|
|                                          |   |                                 |
| Non-accelerated filer **o**              |   | Smaller reporting company **x** |
| (Do not check if a smaller reporting company) |   |                                 |

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).  Yes  **o**  No**  ****x**

 

**APPLICABLE ONLY TO CORPORATEISSUERS**

 

Statethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date:  7,702,127 shares of common stock outstanding as of October 31,2010.

 

 

 

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**Oak Valley Bancorp**

**September 30, 2010**

** **

**Index**

 
| ** **                                                                                                                                                                    | ** **                                                                                      | **Page**   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------|------------|
| **PART I — FINANCIAL INFORMATION**                                                                                                                                  |                                                                                            | 3          |
|                                                                                                                                                                          |                                                                                            |       |
| **Item 1.**                                                                                                                                                                   | **Financial Statements**                                                                        |       | 3 |
|                                                                                                                                                                          |                                                                                            |       |
| Condensed  Consolidated Balance Sheets at September 30, 2010, and December 31,  2009                                                                                |                                                                                            | 4          |
|                                                                                                                                                                          |                                                                                            |       |
| Condensed  Consolidated Statements of Operations for the Three and Nine Month Periods  Ended September 30, 2010 and September 30, 2009                              |                                                                                            | 5          |
|                                                                                                                                                                          |                                                                                            |       |
| Condensed Consolidated Statements of Changes of  Shareholders’ Equity for the Nine-Month Period Ended September 30, 2010  and the Year Ended December 31, 2009 |                                                                                            | 6          |
|                                                                                                                                                                          |                                                                                            |       |
| Condensed Consolidated Statements of Cash Flows for  the Nine-Month Periods Ended September 30, 2010 and September 30,  2009                                        |                                                                                            | 7          |
|                                                                                                                                                                          |                                                                                            |       |
| Notes to Consolidated Financial Statements                                                                                                                                    |                                                                                            | 8          |
|                                                                                                                                                                          |                                                                                            |       |
| **Item 2.**                                                                                                                                                                   | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations** |       | 18 |
| ** **                                                                                                                                                                    | ** **                                                                                      | ** ** | ** ** |
| **Item 3.**                                                                                                                                                                   | **Quantitative  and Qualitative Disclosures About Market Risk**                                 |       | 33 |
| ** **                                                                                                                                                                    | ** **                                                                                      | ** ** | ** ** |
| **Item 4T.**                                                                                                                                                                  | **Controls and  Procedures**                                                                    |       | 33 |
|                                                                                                                                                                          |                                                                                            |       |
| **PART II — OTHER INFORMATION**                                                                                                                                     |                                                                                            | 34         |
|                                                                                                                                                                          |                                                                                            |       |
| **Item  1.**                                                                                                                                                                  | **Legal  Proceedings**                                                                          |       | 34 |
| **Item 2.**                                                                                                                                                                   | **Unregistered  Sales of Equity Securities and Use of Proceeds**                                |       | 34 |
| **Item 3.**                                                                                                                                                                   | **Defaults  Upon Senior Securities**                                                            |       | 34 |
| **Item  4.**                                                                                                                                                                  | **Reserved**                                                                                    |       | 34 |
| **Item  5.**                                                                                                                                                                  | **Other  Information**                                                                          |       | 34 |
| **Item 6.**                                                                                                                                                                   | **Exhibits**                                                                                    |       | 34 |

 

2

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**PART I — FINANCIALSTATEMENTS**

 

**Item1. Financial Statements**

 

3

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**OAK VALLEY BANCORP**

**CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)**

**AT SEPTEMBER 30, 2010 AND DECEMBER 31, 2009**

 
| ** **                                                                                                                                                                                      | ** ** | **September 30,** | ** **  | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|-------------|-----------------------|------------|
| ** **                                                                                                                                                                                      | ** ** | **2010**               | ** **  | **2009**              | ** ** |
| **ASSETS**                                                                                                                                                                                      |       |                   |        |                  |       |
|                                                                                                                                                                                            |       |                   |        |                  |       |
| Cash and  due from banks                                                                                                                                                                        |       | $                      | 36,321,885  |                  | $          | 20,003,548 |   |
| Federal  funds sold                                                                                                                                                                             |       | 10,170,000             |        | 1,645,000             |       |
| Cash and  cash equivalents                                                                                                                                                                      |       | 46,491,885             |        | 21,648,548            |       |
|                                                                                                                                                                                            |       |                   |        |                  |       |
| Securities  available for sale                                                                                                                                                                  |       | 55,023,463             |        | 50,765,314            |       |
| Loans,  net of allowance for loan loss of $7,700,206 in 2010 and $7,020,222 in 2009                                                                                                             |       | 400,459,919            |        | 417,795,686           |       |
| Bank  premises and equipment, net                                                                                                                                                               |       | 10,334,633             |        | 10,167,297            |       |
| Other  real estate owned (OREO)                                                                                                                                                                 |       | 1,142,887              |        | 2,149,514             |       |
| Accrued  interest and other assets                                                                                                                                                              |       | 21,426,083             |        | 22,195,354            |       |
|                                                                                                                                                                                            |       |                   |        |                  |       |
|                                                                                                                                                                                            |       | $                      | 534,878,870 |                  | $          | 524,721,713 |   |
|                                                                                                                                                                                            |       |                   |        |                  |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                                                   | ** ** | ** **             | ** **  | ** **            | ** ** |
|                                                                                                                                                                                            |       |                   |        |                  |       |
| Deposits                                                                                                                                                                                        |       | $                      | 448,904,177 |                  | $          | 429,210,284 |   |
| Accrued  interest and other liabilities                                                                                                                                                         |       | 3,369,731              |        | 2,619,178             |       |
| FHLB  advances                                                                                                                                                                                  |       | 18,500,000             |        | 32,200,000            |       |
|                                                                                                                                                                                            |       |                   |        |                  |       |
| Total  liabilities                                                                                                                                                                              |       | 470,773,908            |        | 464,029,462           |       |
|                                                                                                                                                                                            |       |                   |        |                  |       |
| Commitments  and contingencies                                                                                                                                                                  |       |                   |        |                  |       |
|                                                                                                                                                                                            |       |                   |        |                  |       |
| Shareholders’  equity                                                                                                                                                                      |       |                   |        |                  |       |
| Preferred  stock, no par value; $1,000 per share liquidation preference, 10,000,000  shares authorized and 13,500 issued and outstanding at September 30,  2010 and December 31, 2009 |       | 12,972,283             |        | 12,847,297            |       |
| Common  stock, no par value; 50,000,000 shares authorized, 7,702,127 and 7,681,877  shares issued and outstanding at September 30, 2010 and  December 31, 2009, respectively          |       | 24,003,550             |        | 23,933,440            |       |
| Additional  paid-in capital                                                                                                                                                                     |       | 2,067,431              |        | 1,997,747             |       |
| Retained  earnings                                                                                                                                                                              |       | 22,726,795             |        | 20,230,683            |       |
| Accumulated  other comprehensive income, net of tax                                                                                                                                             |       | 2,334,903              |        | 1,683,084             |       |
|                                                                                                                                                                                            |       |                   |        |                  |       |
| Total  shareholders’ equity                                                                                                                                                                |       | 64,104,962             |        | 60,692,251            |       |
|                                                                                                                                                                                            |       |                   |        |                  |       |
|                                                                                                                                                                                            |       | $                      | 534,878,870 |                  | $          | 524,721,713 |   |

 

*The accompanying notes are an integral part of theseconsolidated financial statements.*

 

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**OAK VALLEY BANCORP**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)**

**FOR THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2010AND SEPTEMBER 30, 2009**

 
| ** **                                           | ** ** | **THREE MONTHS ENDED** | ** ** | **NINE MONTHS ENDED** | ** ** |
|------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                           | ** ** | **SEPTEMBER 30,**           | ** ** | **SEPTEMBER 30,**          | ** ** |
| ** **                                           | ** ** | **2010**                         | ** ** | **2009**                        | ** ** | **2010** | ** ** | **2009** | ** ** |
| INTEREST  INCOME                                     |       |                             |       |                            |       |   |   |   |   |
| Interest  and fees on loans                          |       | $                                | 6,405,225  |                            | $          | 6,736,602 |   | $ | 19,232,421 |   | $ | 20,048,818 |   |
| Interest  on securities available for sale           |       | 592,553                          |       | 678,379                         |       | 1,769,197 |   | 1,967,059 |   |
| Interest  on federal funds sold                      |       | 3,346                            |       | 1,334                           |       | 7,220 |   | 2,929 |   |
| Interest  on deposits with banks                     |       | 13,370                           |       | 1,942                           |       | 21,158 |   | 3,574 |   |
| Total  interest income                               |       | 7,014,494                        |       | 7,418,257                       |       | 21,029,996 |   | 22,022,380 |   |
|                                                 |       |                             |       |                            |       |   |   |   |   |
| INTEREST  EXPENSE                                    |       |                             |       |                            |       |   |   |   |   |
| Deposits                                             |       | 570,347                          |       | 1,245,576                       |       | 2,097,640 |   | 3,918,842 |   |
| FHLB  advances                                       |       | 85,370                           |       | 152,841                         |       | 268,625 |   | 539,979 |   |
| Federal  funds purchased                             |       | 0                                |       | 38                              |       | 110 |   | 381 |   |
| Total  interest expense                              |       | 655,717                          |       | 1,398,455                       |       | 2,366,375 |   | 4,459,202 |   |
|                                                 |       |                             |       |                            |       |   |   |   |   |
| Net  interest income                                 |       | 6,358,777                        |       | 6,019,802                       |       | 18,663,621 |   | 17,563,178 |   |
| PROVISION  FOR LOAN LOSSES                           |       | 1,005,000                        |       | 925,000                         |       | 3,015,000 |   | 4,962,012 |   |
|                                                 |       |                             |       |                            |       |   |   |   |   |
| Net  interest income after provision for loan losses |       | 5,353,777                        |       | 5,094,802                       |       | 15,648,621 |   | 12,601,166 |   |
|                                                 |       |                             |       |                            |       |   |   |   |   |
| NON-INTEREST  INCOME                                 |       |                             |       |                            |       |   |   |   |   |
| Service  charges on deposits                         |       | 272,136                          |       | 300,282                         |       | 787,142 |   | 875,229 |   |
| Earnings  on cash surrender value of life insurance  |       | 103,986                          |       | 101,057                         |       | 308,671 |   | 303,170 |   |
| Mortgage  commissions                                |       | 30,849                           |       | 38,143                          |       | 74,984 |   | 127,160 |   |
| Other                                                |       | 269,078                          |       | 338,154                         |       | 884,047 |   | 717,763 |   |
| Total  non-interest income                           |       | 676,049                          |       | 777,636                         |       | 2,054,844 |   | 2,023,322 |   |
|                                                 |       |                             |       |                            |       |   |   |   |   |
| NON-INTEREST  EXPENSE                                |       |                             |       |                            |       |   |   |   |   |
| Salaries  and employee benefits                      |       | 2,143,094                        |       | 1,974,022                       |       | 6,483,605 |   | 5,889,247 |   |
| Occupancy  expenses                                  |       | 690,209                          |       | 658,928                         |       | 2,031,127 |   | 2,031,844 |   |
| Data  processing fees                                |       | 233,694                          |       | 220,181                         |       | 706,889 |   | 672,597 |   |
| OREO  expenses                                       |       | 35,051                           |       | 915,623                         |       | 598,894 |   | 1,974,375 |   |
| Assessments  (FDIC & DFI)                   |       | 258,000                          |       | 230,269                         |       | 774,000 |   | 667,355 |   |
| Other  operating expenses                            |       | 828,155                          |       | 745,563                         |       | 2,355,381 |   | 2,234,073 |   |
| Total  non-interest expense                          |       | 4,188,203                        |       | 4,744,586                       |       | 12,949,896 |   | 13,469,491 |   |
|                                                 |       |                             |       |                            |       |   |   |   |   |
| Net  income before provision for income taxes        |       | 1,841,623                        |       | 1,127,852                       |       | 4,753,569 |   | 1,154,997 |   |
|                                                 |       |                             |       |                            |       |   |   |   |   |
| PROVISION  (BENEFIT) FOR INCOME TAXES                |       | 700,700                          |       | 248,701                         |       | 1,626,221 |   | (109,401 | ) |
| NET  INCOME                                          |       | $                                | 1,140,923  |                            | $          | 879,151 |   | $ | 3,127,348 |   | $ | 1,264,398 |   |
|                                                 |       |                             |       |                            |       |   |   |   |   |
| Preferred  stock dividends and accretion             |       | 210,412                          |       | 210,411                         |       | 631,236 |   | 631,233 |   |
| NET  INCOME AVAILABLE TO COMMON SHAREHOLDERS         |       | $                                | 930,511    |                            | $          | 668,740 |   | $ | 2,496,112 |   | $ | 633,165 |   |
|                                                 |       |                             |       |                            |       |   |   |   |   |
| NET  EARNINGS PER COMMON SHARE                       |       | $                                | 0.12       |                            | $          | 0.09 |   | $ | 0.32 |   | $ | 0.08 |   |
|                                                 |       |                             |       |                            |       |   |   |   |   |
| NET  EARNINGS PER DILUTED COMMON SHARE               |       | $                                | 0.12       |                            | $          | 0.09 |   | $ | 0.32 |   | $ | 0.08 |   |

 

*The accompanying notes are an integral part of theseconsolidated financial statements.*

 

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**OAK VALLEY BANCORP**

**CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’EQUITY (UNAUDITED)**

**FOR THE YEAR ENDED DECEMBER 31, 2009 AND THE NINE-MONTHPERIOD ENDED SEPTEMBER 30, 2010**

 
| ** **                                                                                       | ** ** | **NINE MONTHS ENDED SEPTEMBER 30, 2010 AND YEAR ENDED DECEMBER 31, 2009** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                       | ** ** | ** **                                                                                                                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
| ** **                                                                                       | ** ** | ** **                                                                                                                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Additional** | ** ** | ** ** | ** ** | ** ** | ** ** | **Other** | ** ** | **Total** | ** ** |
| ** **                                                                                       | ** ** | **Common Stock**                                                                                                            | ** ** | **Preferred Stock** | ** ** | **Paid-in** | ** ** | **Retained** | ** ** | **Comprehensive** | ** ** | **Comprehensive** | ** ** | **Shareholders’** | ** ** |
| ** **                                                                                       | ** ** | **Shares**                                                                                                                       | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Capital** | ** ** | **Earnings** | ** ** | **Income** | ** ** | **Income** | ** ** | **Equity** | ** ** |
|                                                                                             |       |                                                                                                                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Balances, January 1, 2009                                                                   |       | 7,661,627                                                                                                                        |       | $ | 23,863,331 |   | 13,500 |   | $ | 12,680,649 |   | $ | 1,925,224 |   | $ | 19,226,645 |   |   |   | $ | 290,230 |   | $ | 57,986,079 |   |
| Stock options exercised                                                                          |       | 20,250                                                                                                                           |       | $ | 70,109 |   |   |   |   |   |   |   |   |   |   |   |   |   | 70,109 |   |
| Preferred stock accretion                                                                        |       |                                                                                                                             |       |   |   |   |   | $ | 166,648 |   |   |   | $ | (166,648 | ) |   |   |   |   | 0 |   |
| Preferred stock dividend payments                                                                |       |                                                                                                                             |       |   |   |   |   |   |   |   |   | (637,500 | ) |   |   |   |   | (637,500 | ) |
| Cash dividends ($0.025 per share)                                                                |       |                                                                                                                             |       |   |   |   |   |   |   |   |   | (191,542 | ) |   |   |   |   | (191,542 | ) |
| Stock based compensation                                                                         |       |                                                                                                                             |       |   |   |   |   |   |   | 72,523 |   |   |   |   |   |   |   | 72,523 |   |
| Comprehensive income:                                                                            |       |                                                                                                                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net changes in unrealized gain on  available-for-sale securities (net of income tax of $988,188) |       |                                                                                                                             |       |   |   |   |   |   |   |   |   |   |   | 1,392,854 |   | 1,392,854 |   | 1,392,854 |   |
| Net income                                                                                       |       |                                                                                                                             |       |   |   |   |   |   |   |   |   | 1,999,728 |   | 1,999,728 |   |   |   | 1,999,728 |   |
| Comprehensive income                                                                             |       |                                                                                                                             |       |   |   |   |   |   |   |   |   |   |   | $ | 3,392,582 |   |   |   |   |   |
| Balances, December 31, 2009                                                                 |       | 7,681,877                                                                                                                        |       | $ | 23,933,440 |   | 13,500 |   | $ | 12,847,297 |   | $ | 1,997,747 |   | $ | 20,230,683 |   |   |   | $ | 1,683,084 |   | $ | 60,692,251 |   |
|                                                                                             |       |                                                                                                                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Stock options exercised                                                                          |       | 20,250                                                                                                                           |       | $ | 70,110 |   |   |   |   |   |   |   |   |   |   |   |   |   | $ | 70,110 |   |
| Preferred stock accretion                                                                        |       |                                                                                                                             |       |   |   |   |   | $ | 124,986 |   |   |   | $ | (124,986 | ) |   |   |   |   | 0 |   |
| Preferred stock dividend payments                                                                |       |                                                                                                                             |       |   |   |   |   |   |   |   |   | (506,250 | ) |   |   |   |   | (506,250 | ) |
| Stock based compensation                                                                         |       |                                                                                                                             |       |   |   |   |   |   |   | 69,684 |   |   |   |   |   |   |   | 69,684 |   |
| Comprehensive income:                                                                            |       |                                                                                                                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net changes in unrealized gain on  available-for-sale securities (net of income tax of $455,775) |       |                                                                                                                             |       |   |   |   |   |   |   |   |   |   |   | 651,819 |   | 651,819 |   | 651,819 |   |
| Net income                                                                                       |       |                                                                                                                             |       |   |   |   |   |   |   |   |   | 3,127,348 |   | 3,127,348 |   |   |   | 3,127,348 |   |
| Comprehensive income                                                                             |       |                                                                                                                             |       |   |   |   |   |   |   |   |   |   |   | $ | 3,779,167 |   |   |   |   |   |
| Balances, September 30, 2010                                                                |       | 7,702,127                                                                                                                        |       | $ | 24,003,550 |   | 13,500 |   | $ | 12,972,283 |   | $ | 2,067,431 |   | $ | 22,726,795 |   |   |   | $ | 2,334,903 |   | $ | 64,104,962 |   |

 

*The accompanying notes are an integral part of theseconsolidated financial statements*

 

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**OAK VALLEY BANCORP**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)**

**FORTHE NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010 AND SEPTEMBER 30, 2009**

 
| ** **                                                                                 | ** ** | **NINE MONTHS ENDED  SEPTEMBER 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2010**                                            | ** ** | **2009** | ** ** |
|                                                                                       |       |                                                |       |   |   |
| CASH  FLOWS FROM OPERATING ACTIVITIES:                                                     |       |                                                |       |   |   |
| Net  income                                                                                |       | $                                                   | 3,127,348  |   | $ | 1,264,398 |   |
| Adjustments  to reconcile net earnings to net cash from operating activities:              |       |                                                |       |   |   |
| Provision  for loan losses                                                                 |       | 3,015,000                                           |       | 4,962,012 |   |
| Depreciation                                                                               |       | 720,632                                             |       | 806,526 |   |
| Amortization  and accretion, net                                                           |       | 660                                                 |       | (30,778 | ) |
| Stock-based  compensation expense                                                          |       | 69,684                                              |       | 56,400 |   |
| OREO  Write downs and losses on sale                                                       |       | 413,275                                             |       | 1,974,375 |   |
| Gain on  called available for sale securities                                              |       | (172,561                                            | )          | (132,192 | ) |
| Earnings  from BOLI cash surrender value                                                   |       | (308,671                                            | )          | (302,634 | ) |
| Decrease  (increase) in accrued interest payable and other liabilities                     |       | 750,553                                             |       | (385,587 | ) |
| Decrease  in accrued interest receivable                                                   |       | 76,316                                              |       | 113,663 |   |
| Decrease  (increase) in other assets                                                       |       | 370,080                                             |       | (1,545,829 | ) |
| Net cash  from operating activities                                                        |       | 8,062,316                                           |       | 6,780,354 |   |
|                                                                                       |       |                                                |       |   |   |
| CASH  FLOWS FROM INVESTING ACTIVITIES:                                                     |       |                                                |       |   |   |
| Purchases  of available for sale securities                                                |       | (11,090,604                                         | )          | (16,925,358 | ) |
| Proceeds  from maturities, calls, and principal paydowns of securities available for  sale |       | 8,111,950                                           |       | 7,275,261 |   |
| Net  decrease (increase) in loans                                                          |       | 13,679,367                                          |       | (2,697,451 | ) |
| Proceeds  from sale of OREO                                                                |       | 1,234,752                                           |       | 209,467 |   |
| Proceeds  from redemption of BOLI policies                                                 |       | 175,771                                             |       | 0 |   |
| Net  purchases of premises and equipment                                                   |       | (887,968                                            | )          | (82,872 | ) |
| Net cash  from (used in) investing activities                                              |       | 11,223,268                                          |       | (12,220,953 | ) |
|                                                                                       |       |                                                |       |   |   |
| CASH  FLOWS FROM FINANCING ACTIVITIES:                                                     |       |                                                |       |   |   |
| FHLB  advanced funds                                                                       |       | 7,100,000                                           |       | 50,700,000 |   |
| FHLB  payments                                                                             |       | (20,800,000                                         | )          | (92,700,000 | ) |
| Federal  funds advances                                                                    |       | 480,000                                             |       | 8,770,000 |   |
| Federal  funds payments                                                                    |       | (480,000                                            | )          | (8,770,000 | ) |
| Shareholder  cash dividends paid                                                           |       | 0                                                   |       | (191,541 | ) |
| Preferred  stock dividend payment                                                          |       | (506,250                                            | )          | (468,750 | ) |
| Net  increase in demand deposits and savings accounts                                      |       | 28,797,189                                          |       | 48,137,511 |   |
| Net  (decrease) increase in time deposits                                                  |       | (9,103,296                                          | )          | 5,146,855 |   |
| Proceeds  from sale of common stock and exercise of stock options                          |       | 70,110                                              |       | 70,110 |   |
| Net cash  from financing activities                                                        |       | 5,557,753                                           |       | 10,694,185 |   |
|                                                                                       |       |                                                |       |   |   |
| NET  INCREASE IN CASH AND CASH EQUIVALENTS                                                 |       | 24,843,337                                          |       | 5,253,586 |   |
|                                                                                       |       |                                                |       |   |   |
| CASH AND  CASH EQUIVALENTS, beginning of period                                            |       | 21,648,548                                          |       | 9,837,860 |   |
|                                                                                       |       |                                                |       |   |   |
| CASH AND  CASH EQUIVALENTS, end of period                                                  |       | $                                                   | 46,491,885 |   | $ | 15,091,446 |   |
|                                                                                       |       |                                                |       |   |   |
| SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION:                                        |       |                                                |       |   |   |
| Cash  paid during the year for:                                                            |       |                                                |       |   |   |
| Interest                                                                                   |       | $                                                   | 2,597,190  |   | $ | 4,766,247 |   |
| Income  taxes                                                                              |       | $                                                   | 1,646,000  |   | $ | 1,014,000 |   |
|                                                                                       |       |                                                |       |   |   |
| NON-CASH  INVESTING ACTIVITIES:                                                            |       |                                                |       |   |   |
| Real  estate acquired through foreclosure                                                  |       | $                                                   | 641,400    |   | $ | 1,186,263 |   |
| Change  in unrealized gain/loss on available-for-sale securities                           |       | $                                                   | 1,107,594  |   | $ | 2,302,718 |   |
|                                                                                       |       |                                                |       |   |   |
| NON-CASH  FINANCING ACTIVITIES:                                                            |       |                                                |       |   |   |
| Accretion  of preferred stock                                                              |       | $                                                   | 124,986    |   | $ | 124,986 |   |

 

*The accompanying notes are an integral part of theseconsolidated financial statements.*

 

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**OAK VALLEY BANCORP**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1 — BASIS OF PRESENTATION**

 

OnJuly 3, 2008 (the “Effective Date”), a bank holding company reorganizationwas completed whereby Oak Valley Bancorp became the parent holding company forOak Valley Community Bank ( the “Bank”).  On the Effective Date, eachoutstanding share of the Bank was converted into one share of Oak ValleyBancorp and the Bank became a wholly-owned subsidiary of the holding company.The condensed consolidated financial statements and accompanying footnotes arepresented as if the reorganization occurred as of the earliest periodspresented and are consistent with those of Oak Valley Community Bank, sinceprior to the Effective Date, Oak Valley Bancorp had no material assets,liabilities or operations.

 

Theaccounting principles followed by the Company and the methods of applying theseprinciples conform with accounting principles generally accepted in the UnitedStates of America (GAAP) and with general practices within the bankingindustry. In preparing financial statements in conformity with GAAP, managementis required to make estimates and assumptions that affect the reported amountsin the financial statements. Actual results could differ significantly fromthose estimates. Material estimates common to the banking industry that areparticularly susceptible to significant change in the near term include, butare not limited to, the determination of the allowance for loan losses, theestimation of compensation expense related to stock options granted toemployees and directors, and valuation allowances associated with deferred taxassets, the recognition of which are based on future taxable income.

 

Theinterim consolidated financial statements included in this report are unauditedbut reflect all adjustments which, in the opinion of management, are necessaryfor a fair presentation of the financial position and results of operations forthe interim periods presented. All such adjustments are of a normal recurringnature. The results of operations for the three and nine month periods ended September 30,2010 are not necessarily indicative of the results of a full year’soperations.  For further information,refer to the audited financial statements and footnotes included in the Company’sForm 10-K for the year ended December 31, 2009.

 

**NOTE 2 — RECENT ACCOUNTING PRONOUNCEMENTS**

 

*AccountingStandards Codification*.The Financial Accounting Standards Board’s (FASB) Accounting StandardsCodification (ASC) became effective on July 1, 2009. At that date, the ASCbecame FASB’s officially recognized source of authoritative U.S. generallyaccepted accounting principles (GAAP) applicable to all public and non-publicnon-governmental entities, superseding existing FASB, American Institute ofCertified Public Accountants (AICPA), Emerging Issues Task Force (EITF) andrelated literature. Rules and interpretive releases of the SEC under theauthority of federal securities laws are also sources of authoritative GAAP forSEC registrants. All other accounting literature is considered non-authoritative.The switch to the ASC affects the away companies refer to U.S. GAAP infinancial statements and accounting policies. Citing particular content in theASC involves specifying the unique numeric path to the content through theTopic, Subtopic, Section and Paragraph structure.

 

*FASB ASCTopic 815, “Derivatives and Hedging.”*New authoritative accounting guidance under ASC Topic 815, “Derivatives andHedging,” amends prior guidance to amend and expand the disclosure requirementsfor derivatives and hedging activities to provide greater transparency about(i) how and why an entity uses derivative instruments, (ii) howderivative instruments and related hedge items are accounted for under ASCTopic 815, and (iii) how derivative instruments and related hedged itemsaffect an entity’s financial position, results of operations and cash flows. Tomeet those objectives, the new authoritative accounting guidance requiresqualitative disclosures about objectives and strategies for using derivatives,quantitative disclosures about fair value amounts of gains and losses onderivative instruments and disclosures about credit-risk-related contingentfeatures in derivative agreements. The new authoritative accounting guidanceunder ASC Topic 815 became effective for the Company on January 1, 2009and did not have a significant impact on the Company’s financial statements.

 

*FASB ASCTopic 820, “Fair Value Measurements and Disclosures.”*New authoritative accounting guidance under ASC Topic 820,”FairValue Measurements and Disclosures,” affirms that the objective of fair valuewhen the market for an asset is not active is the price that would be receivedto sell the asset in an orderly transaction, and clarifies and includesadditional factors for determining whether there has been a significantdecrease in market activity for an asset when the market for that asset is notactive. ASC Topic 820 requires an entity to base its conclusion about whether atransaction was not orderly on the weight of the evidence. The new accountingguidance amended prior guidance to expand certain disclosure requirements. TheCompany adopted the new authoritative accounting guidance under ASC Topic 820during the first quarter of 2009. Adoption of the new guidance did notsignificantly impact the Company’s financial statements.

 

Further new authoritative accountingguidance (Accounting Standards Update No. 2009-5) under ASC Topic 820provides guidance for measuring the fair value of a liability in circumstancesin which a quoted price in an active market for the identical liability is notavailable. In such instances, a reporting entity is required to measure fairvalue utilizing a valuation technique that uses (i) the

 

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quoted price of the identicalliability when traded as an asset, (ii) quoted prices for similarliabilities or similar liabilities when traded as assets, or (iii) anothervaluation technique that is consistent with the existing principles of ASCTopic 820, such as an income approach or market approach. The new authoritativeaccounting guidance also clarifies that when estimating the fair value of aliability, a reporting entity is not required to include a separate input oradjustment to other inputs relating to the existence of a restriction thatprevents the transfer of the liability. The forgoing new authoritativeaccounting guidance under ASC Topic 820 became effective for the Company’s financialstatements beginning October 1, 2009 and did not have a significant impacton the Company’s financial statements.

 

*FASB ASCTopic 320, “Investments - Debt and Equity Securities.”* New authoritative accounting guidance under ASC Topic 320, “Investments- Debt and Equity Securities,” (i) changes existing guidance fordetermining whether an impairment is other than temporary to debt securitiesand (ii) replaces the existing requirement that the entity’s managementassert it has both the intent and ability to hold an impaired security untilrecovery with a requirement that management assert: (a) it does not havethe intent to sell the security; and (b) it is more likely than not itwill not have to sell the security before recovery of its cost basis. Under ASCTopic 320, declines in the fair value of held-to-maturity andavailable-for-sale securities below their cost that are deemed to be other thantemporary are reflected in earnings as realized losses to the extent theimpairment is related to credit losses. The amount of the impairment related toother factors is recognized in other comprehensive income. The Company adoptedthe provisions of the new authoritative accounting guidance under ASC Topic 320during the second quarter of 2009. Adoption of the new guidance did notsignificantly impact the Company’s financial statements.

 

*FASB ASCTopic 825 “Financial Instruments.”*New authoritative accounting guidance under ASC Topic 825, “FinancialInstruments,” requires an entity to provide disclosures about the fair value offinancial instruments in interim financial information and amends priorguidance to require those disclosures in summarized financial information atinterim reporting periods. The new interim disclosures required under Topic 825were included in the Company’s Form 10-Q beginning September 30,2009.

 

*FASB ASCTopic 825 “Fair Value Measurements and Disclosures.” * In January 2010, the FASB issued ASU No. 2010-06, *Fair Value Measurements and Disclosures (Topic 820):Improving Disclosures about Fair Value Measurements.* This ASUrequires: (1) disclosure of the amounts of significant transfers in and out ofLevel 1 and Level 2 fair value measurement categories and the reasons for thetransfers; and (2) separate presentation of purchases, sales, issuances,and settlements in the reconciliation for fair value measurements usingsignificant unobservable inputs (Level 3). In addition, ASU 2010-06 clarifiesthe requirements of the following existing disclosures set forth in theCodification Subtopic 820-10: (1) For purposes of reporting fair valuemeasurement for each class of assets and liabilities, a reporting entity needsto use judgment in determining the appropriate classes of assets andliabilities; and (2) a reporting entity should provide disclosures aboutthe valuation techniques and inputs used to measure fair value for bothrecurring and non-recurring fair value measurements. ASU 2010-06 is effectivefor interim and annual reporting periods beginning January 1, 2010, exceptfor the disclosures about purchases, sales, issuances, and settlements in theroll forward of activity in Level 3 fair value measurements, which areeffective for fiscal years beginning January 1, 2011, and for interimperiods within those fiscal years. As ASU 2010-06 is disclosure-related only,our adoption of this ASU in the first quarter of 2010 did not impact ourfinancial condition or results of operations.

 

*FASB ASCTopic 310 “Disclosures about the Credit Quality of Fincancing Receivables andthe Allowance for Credit Losses.” *In July 2010, FASB issued Accounting Standards Update2010-20, *Disclosures about the Credit Quality of FinancingReceivables and the Allowance for Credit Losses (Topic 310)*.  This standard expands disclosures aboutcredit quality of financing receivables and the allowance for loan losses. Thestandard will require the Company to expand disclosures about the creditquality of our loans and the related reserves against them. The extradisclosures will include disaggregated matters related to our past due loans,credit quality indicators, and modifications of loans. The Company will adoptthe standard beginning with our December 31, 2010 financial statements.This standard will not have an impact on the Company’s financial position orresults of operations.

 

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**NOTE 3 — SECURITIES**

 

Theamortized cost and estimated fair values of debt securities as of September 30,2010 are as follows:

 
| ** **                           | ** ** | **Amortized Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated Fair  Market Value** | ** ** |
|--------------------------------------|------------|-------------------------|------------|------------------------------|------------|-------------------------------|------------|--------------------------------------------|------------|
| Available-for-sale  securities:      |       |                    |       |                         |       |                          |       |                                       |       |
| U.S.  agencies                       |       | $                       | 29,699,856 |                         | $          | 2,256,113                     |       | $                                          | —     |   | $ | 31,955,969 |   |
| Collateralized  mortgage obligations |       | 8,039,954               |       | 490,957                      |       | (6                            | )          | 8,530,905                                  |       |
| Municipalities                       |       | 10,175,326              |       | 1,201,242                    |       |                          |       | 11,376,568                                 |       |
| SBA  Pools                           |       | 1,532,923               |       | —                       |       | (11,529                       | )          | 1,521,394                                  |       |
| Mutual  Fund                         |       | 1,607,382               |       | 31,245                       |       | —                        |       | 1,638,627                                  |       |
|                                 |       | $                       | 51,055,441 |                         | $          | 3,979,557                     |       | $                                          | (11,535    | ) | $ | 55,023,463 |   |

 

Thefollowing tables detail the gross unrealized losses and fair values aggregatedby investment category and length of time that individual securities have beenin a continuous unrealized loss position at September 30, 2010.

 
| ** **                             | ** ** | **Less than 12 months** | ** ** | **12 months or more** | ** ** | **Total**       | ** ** |
|----------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|-----------------|------------|
| ** **                             | ** ** | **Fair  Value**                        | ** ** | **Unrealized  Loss**                 | ** ** | **Fair  Value** | ** ** | **Unrealized  Loss** | ** ** | **Fair  Value** | ** ** | **Unrealized  Loss** | ** ** |
|                                   |       |                                   |       |                                 |       |            |       |   |   |   |   |   |   |
| U.S.  agencies                         |       | $                                      | —     |                                 | $          | —          |       | $ | — |   | — |   | $ | — |   | $ | — |   |
| Collateralized  mortgage obligations   |       | 79,428                                 |       | (6                                   | )          | —          |       | — |   | 79,428 |   | (6 | ) |
| Municipalities                         |       | —                                 |       | —                               |       | —          |       | — |   | — |   | — |   |
| SBA  Pools                             |       | —                                 |       | —                               |       | 1,515,779       |       | (11,529 | ) | 1,515,779 |   | (11,529 | ) |
| Asset  Backed Securities               |       | —                                 |       | —                               |       | —          |       | — |   | — |   | — |   |
| Total  temporarily impaired securities |       | $                                      | 79,428     |                                 | $          | (6              | )          | $ | 1,515,779 |   | $ | (11,529 | ) | $ | 1,595,207 |   | $ | (11,535 | ) |
|                                        |            |                                        |            |                                      |            |                 |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

AtSeptember 30, 2010, a total of two SBA pools make up the total amount ofsecurities in an unrealized loss position for greater than 12 months.  Management periodically evaluates eachavailable-for-sale investment security in an unrealized loss position todetermine if the impairment is temporary or other than temporary.  Management has determined that no investmentsecurity is other than temporarily impaired. The unrealized losses are duesolely to interest rate changes and the Bank does not intend to sell thesecurities and it is not likely that we will be required to sell the securitiesbefore the earlier of the forecasted recovery or the maturity of the underlyinginvestment security.

 

Theamortized cost and estimated fair value of debt securities at September 30,2010, by contractual maturity or call date, are shown below. Expectedmaturities will differ from contractual maturities because borrowers may havethe right to call or prepay obligations with or without call or prepaymentpenalties.

 
| ** **                             | ** ** | ** **    | ** ** | **Estimated** | ** ** |
|----------------------------------------|------------|---------------|------------|---------------|------------|
| ** **                             | ** ** | **Amortized** | ** ** | **Fair**      | ** ** |
| ** **                             | ** ** | **Cost**      | ** ** | **Value**     | ** ** |
| Available-for-sale securities:         |       |          |       |          |       |
| Due in one year or less                |       | $             | 1,025,000  |          | $          | 1,039,616 |   |
| Due after one year through five years  |       | 5,408,997     |       | 5,992,891     |       |
| Due after five years through ten years |       | 20,084,019    |       | 21,983,253    |       |
| Due after ten years                    |       | 24,537,425    |       | 26,007,703    |       |
|                                   |       | $             | 51,055,441 |          | $          | 55,023,463 |   |

 

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Theamortized cost and estimated fair values of debt securities as ofDecember 31, 2009, are as follows:

 
| ** **                          | ** ** | **Amortized Cost** | ** ** | **Gross Unrealized  Gains** | ** ** | **Gross Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|-------------------------------------|------------|-------------------------|------------|----------------------------------|------------|-----------------------------------|------------|---------------------|------------|
| Available-for-sale securities:      |       |                    |       |                             |       |                              |       |                |       |
| U.S. agencies                       |       | $                       | 29,475,777 |                             | 1,511,122  |                              | $          | (2,181              | )          | $ | 30,984,718 |   |
| Collateralized mortgage obligations |       | 2,883,988               |       | 110,758                          |       | —                            |       | 2,994,746           |       |
| Municipalities                      |       | 12,327,922              |       | 1,235,683                        |       | (6,454                            | )          | 13,557,151          |       |
| SBA Pools                           |       | 1,588,867               |       | —                           |       | (9,519                            | )          | 1,579,348           |       |
| Asset backed securities             |       | 81,867                  |       | 707                              |       | —                            |       | 82,574              |       |
| Mutual Fund                         |       | 1,546,465               |       | 20,312                           |       | —                            |       | 1,566,777           |       |
|                                |       | $                       | 47,904,886 |                             | $          | 2,878,582                         |       | $                   | (18,154    | ) | $ | 50,765,314 |   |
|                                     |            |                         |            |                                  |            |                                   |            |                     |            |  |  |  |  |

 

Thefollowing tables detail the gross unrealized losses and fair values aggregatedby investment category and length of time that individual securities have beenin a continuous unrealized loss position at December 31, 2009.

 
| ** **                              | ** ** | **Less than 12 months** | ** ** | **12 months or more** | ** ** | **Total**       | ** ** |
|-----------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|-----------------|------------|
| **Description of Securities** | ** ** | **Fair  Value**                        | ** ** | **Unrealized  Loss**                 | ** ** | **Fair  Value** | ** ** | **Unrealized  Loss** | ** ** | **Fair  Value** | ** ** | **Unrealized  Loss** | ** ** |
| U.S. agencies                           |       | $                                      | 425,908    |                                 | $          | (2,181          | )          | $ | — |   | $ | — |   | $ | 425,908 |   | $ | (2,181 | ) |
| Collateralized mortgage obligations     |       | —                                 |       | —                               |       | —          |       | — |   | — |   | — |   |
| Municipalities                          |       | 402,628                                |       | (6,454                               | )          | —          |       | — |   | 402,628 |   | (6,454 | ) |
| SBA pools                               |       | —                                 |       | —                               |       | 1,579,348       |       | (9,519 | ) | 1,579,348 |   | (9,519 | ) |
| Asset backed securities                 |       | —                                 |       | —                               |       | —          |       | — |   | — |   | — |   |
| Total temporarily impaired securities   |       | $                                      | 828,536    |                                 | $          | (8,635          | )          | $ | 1,579,348 |   | $ | (9,519 | ) | $ | 2,407,884 |   | $ | (18,154 | ) |

 

AtDecember 31, 2009, two SBA pools make up the total amount of securities inan unrealized loss position for greater than 12 months. Management periodicallyevaluates each available-for-sale investment security in an unrealized lossposition to determine if the impairment is temporary or other than temporary.Management has determined that no investment security is other than temporarilyimpaired. The unrealized losses are due solely to interest rate changes and theBank does not intend to sell the securities and it is not likely that we willbe required to sell the securities before the earlier of the forecastedrecovery or the maturity of the underlying investment security.

 

Therewere no realized gains or losses on sales of available-for-sale securitiesduring 2010 and 2009, however the Company did recognize a gain of $46,030 and$172,561 for the three and nine month periods ended September 30, 2010,respectively, on certain available-for-sale securities that were partiallycalled, which compares to $77,811 and $132,192 in the same periods of 2009,respectively. There were no other sales of available-for-sale securities during2010 and 2009.

 

Securitiescarried at $49,023,289 and $34,545,513 at September 30, 2010 andDecember 31, 2009, respectively, were pledged to secure deposits of publicfunds.

 

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**NOTE 4 — LOANS**

 

Loantotals were as follows:

 
| ** **                           | ** ** | **SEPTEMBER 30,** | ** **  | **DECEMBER 31,** | ** ** |
|--------------------------------------|------------|------------------------|-------------|-----------------------|------------|
| ** **                           | ** ** | **2010**               | ** **  | **2009**              | ** ** |
| Loans                                |       |                   |        |                  |       |
| Commercial real estate               |       | $                      | 293,203,342 |                  | $          | 283,387,329 |   |
| Commercial                           |       | 32,719,129             |        | 38,159,590            |       |
| Real estate construction             |       | 32,168,954             |        | 52,951,968            |       |
| Agriculture                          |       | 28,093,824             |        | 29,659,656            |       |
| Residential real estate and consumer |       | 22,786,210             |        | 21,468,468            |       |
| Total loans                          |       | 408,971,459            |        | 425,627,011           |       |
|                                 |       |                   |        |                  |       |
| Deferred loan fees and costs, net    |       | (811,334               | )           | (811,103              | )          |
| Allowance for loan losses            |       | (7,700,206             | )           | (7,020,222            | )          |
| Net loans                            |       | $                      | 400,459,919 |                  | $          | 417,795,686 |   |

 

Changes in the allowance for loan losses were asfollows:

 
| ** **                      | ** ** | **SEPTEMBER 30,** | ** ** | **DECEMBER 31,** | ** ** |
|---------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2010**               | ** ** | **2009**              | ** ** |
|                            |       |                   |       |                  |       |
| Balance, beginning of year      |       | $                      | 7,020,222  |                  | $          | 5,569,496 |   |
| Provision charged to operations |       | 3,015,000              |       | 5,862,012             |       |
| Loans charged off               |       | (2,340,217             | )          | (4,419,335            | )          |
| Loan recoveries                 |       | 5,201                  |       | 8,049                 |       |
|                            |       |                   |       |                  |       |
| Balance, end of period          |       | $                      | 7,700,206  |                  | $          | 7,020,222 |   |

 

Thetotal recorded investment in impaired loans at September 30, 2010, was$9,547,201 which had a loan loss reserve of $694,590.  The total recordedinvestment in impaired loans at December 31, 2009, was $14,418,204 whichhad a loan loss reserve of $1,256,329.  No interest income was recognizedon impaired loans, while considered impaired during 2010 and 2009.  As of September 30, 2010, we hadundisbursed funding commitments on oneimpaired loan to one borrowertotaling $151,738 with a maturity date of May 2010**. **As of September 30, 2010, wehad three loans considered troubled debt restructurings totaling $1.4 million,which are included in nonaccrual loans.

 

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**OAK VALLEY BANCORP**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 5 — OTHER REAL ESTATE OWNED**

 

Asof September 30, 2010, four loans with outstanding balances of $1,142,887were reclassified to other real estate owned, as compared to six loans withoutstanding balances of $2,149,514 as of December 31, 2009.

 

Realestate properties acquired through, or in lieu of, loan foreclosure are to besold and are initially recorded at the lower of carrying amount of the loan orfair value of the property at the date of foreclosure less selling costs. Subsequent to foreclosure, valuations are periodically performed and anysubject revisions in the estimate of fair value are reported as adjustment tothe carrying value of the real estate, provided the adjusted carrying amountdoes not exceed the original amount at foreclosure.  Revenues and expensesfrom operations and changes in the valuation allowance are included in otheroperating expenses.

 

**NOTE 6 OTHER POST-RETIREMENT BENEFIT PLANS**

 

DuringJanuary 2008, the Bank awarded certain officers a salary continuation plan(the “Plan”).  Under the Plan, theparticipants will be provided with a fixed annual retirement benefit for twentyyears after retirement. The Bank is also responsible for certain pre-retirementdeath benefits under the Plan. In connection with the implementation of thePlan, the Bank purchased single premium life insurance policies on the life ofeach of the officers covered under the Plan. The Bank is the owner and partialbeneficiary of these life insurance policies. The assets of the Plan, underInternal Revenue Service regulations, are owned by the Bank and are availableto satisfy the Bank’s general creditors.

 

DuringJanuary 2008 the Bank awarded two of its directors a director retirementplan (“DRP”). Under the DRP, the participants will be provided with a fixedannual retirement benefit for ten years after retirement. The Bank is alsoresponsible for certain pre-retirement death benefits under the DRP. Inconnection with the implementation of the DRP, the Bank purchased singlepremium life insurance policies on the life of each director covered under theDRP. The Bank is the owner and partial beneficiary of these life insurancepolicies. The assets of the DRP, under Internal Revenue Service regulations,are the property of the Bank and are available to satisfy the Bank’s generalcreditors.

 

Futurecompensation under both plans is earned for services rendered throughretirement. The Bank accrues for the salary continuation liability based onanticipated years of service and vesting schedules provided under the plans.The Bank’s current benefit liability is determined based on vesting and thepresent value of the benefits at a corresponding discount rate. The discountrate used is an equivalent rate for investment-grade bonds with lives matchingthose of the service periods remaining for the salary continuation contracts,which average approximately 20 years. The salary continuation liability as of September 30, 2010 and December 31,2009 was $1,247,251 and $1,147,125, respectively, and is reported in accrued interestand other liabilities in the consolidated balance sheet.

 

DuringJanuary 2008, the Bank purchased $4.7 million in bank owned life insurancepolicies and entered into split-dollar life insurance agreements with certainofficers and directors.  In connectionwith the implementation of the split-dollar agreements, the Bank purchasedsingle premium life insurance policies on the life of each of the officers anddirectors covered by the split-dollar life insurance agreements. The Bank isthe owner of the policies and the partial beneficiary in an amount equal to thecash surrender value of the policies.

 

Thecombined cash surrender value of all Bank-owned life insurance policiesrecorded in other assets on the balance sheet was $10,400,761 and $10,267,862at September 30, 2010 and December 31, 2009, respectively.

 

**NOTE 7 — FINANCIAL INSTRUMENTS AND FAIR VALUE MEASUREMENTS**

 

**Fair values of financial instruments —** The financial statements include various estimated fair valueinformation as of September 30, 2010 and December 31, 2009. Suchinformation, which pertains to the Bank’s financial instruments, does notpurport to represent the aggregate net fair value of the Bank. Further, thefair value estimates are based on various assumptions, methodologies, and subjectiveconsiderations, which vary widely among different financial institutions andwhich are subject to change. The following methods and assumptions are used bythe Bank.

 

*Cash and cash equivalents*— The carrying amounts of cash and cash equivalents approximate their fairvalue.

 

*Securities (including mortgage-backed securities)* — Fair values for securities are based on quoted market prices, whereavailable. If quoted market prices are not available, fair values are based onquoted market prices of comparable instruments.

 

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*Loans receivable*— For variable-rate loans that reprice frequently and have no significantchange in credit risk, fair values are based on carrying values. The fairvalues for other loans (e.g., real estate construction and mortgage,commercial, and installment loans) are estimated using discounted cash flowanalyses, using interest rates currently being offered for loans with similarterms to borrowers of similar credit quality.

 

*Deposit liabilities*— The fair values estimated for demand deposits (interest and non-interestchecking, passbook savings, and certain types of money market accounts) are, bydefinition, equal to the amount payable on demand at the reporting date (i.e.their carrying amounts). The carrying amounts for variable-rate, fixed-termmoney market accounts and certificates of deposit approximate their fair valuesat the reporting date. Fair values for fixed-rate certificates of deposit areestimated using a discounted cash flow calculation that applies interest ratescurrently being offered on certificates to a schedule of the aggregate expectedmonthly maturities on time deposits.

 

*Federal Home Loan Bank (FHLB) advances* — Rates currently available to the Bank for borrowings with similarterms and remaining maturities are used to estimate the fair value of theexisting debt.

 

*Accrued interest*— The carrying amounts of accrued interest approximate their fair value.

 

*Off-balance-sheet instruments*— Fair values for the Bank’s off-balance-sheet lending commitments are based onfees currently charged to enter into similar agreements, taking into accountthe remaining terms of the agreements and the credit standing of thecounterparties.

 

Theestimated fair values of the Bank’s financial instruments at September 30,2010 are as follows:

 
| ** **                                  | ** ** | ** **   | ** ** | **Estimated** | ** ** |
|---------------------------------------------|------------|--------------|------------|---------------|------------|
| ** **                                  | ** ** | **Carrying** | ** ** | **Fair**      | ** ** |
| ** **                                  | ** ** | **Amount**   | ** ** | **Value**     | ** ** |
| **Financial assets:**                       | ** ** | ** **   | ** ** | ** **    | ** ** |
| Cash and cash equivalents                   |       | $            | 46,491,885 |          | 46,491,885 |   |
| Securities available for sale               |       | 55,023,463   |       | 55,023,463    |       |
| Loans                                       |       | 408,971,459  |       | 414,347,568   |       |
| Accrued interest receivable                 |       | 1,658,016    |       | 1,658,016     |       |
|                                        |       |         |       |          |       |
| **Financial liabilities:**                  |       |         |       |          |       |
| Deposits                                    |       | (448,904,177 | )          | (449,552,905  | )          |
| FHLB advance                                |       | (18,500,000  | )          | (18,573,636   | )          |
| Accrued interest payable                    |       | (169,354     | )          | (169,354      | )          |
|                                        |       |         |       |          |       |
| **Off-balance-sheet assets (liabilities):** |       |         |       |          |       |
|                                        |       |         |       |          |       |
| Commitments and standby letters of credit   |       |         |       | (543,390      | )          |
|                                             |            |              |            |               |            |  |

 

Theestimated fair values of the Bank’s financial instruments at December 31,2009 are as follows:

 
| ** **                                  | ** ** | **Carrying** | ** ** | **Fair**     | ** ** |
|---------------------------------------------|------------|--------------|------------|--------------|------------|
| ** **                                  | ** ** | **Amount**   | ** ** | **Value**    | ** ** |
| **Financial assets:**                       |       |         |       |         |       |
| Cash and cash equivalents                   |       | $            | 21,648,548 |         | $          | 21,648,548 |   |
| Securities available for sale               |       | 50,765,314   |       | 50,765,314   |       |
| Loans                                       |       | 425,627,011  |       | 434,698,550  |       |
| Accrued interest receivable                 |       | 1,734,332    |       | 1,734,332    |       |
|                                        |       |         |       |         |       |
| **Financial liabilities:**                  |       |         |       |         |       |
| Deposits                                    |       | (429,210,284 | )          | (429,780,364 | )          |
| FHLB advance                                |       | (32,200,000  | )          | (32,367,049  | )          |
| Accrued interest payable                    |       | (400,169     | )          | (400,169     | )          |
|                                        |       |         |       |         |       |
| **Off-balance-sheet assets (liabilities):** |       |         |       |         |       |
| Commitments and standby letters of credit   |       |         |       | (631,324     | )          |
|                                             |            |              |            |              |            |  |  |

 

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**OAK VALLEY BANCORP**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

 

FairValue Measurements defines fair value, establishes a framework for measuringfair value, establishes a three-level valuation hierarchy for disclosureof fair value measurement and enhances disclosure requirements for fair valuemeasurements. The valuation hierarchy is based upon the transparency of inputsto the valuation of an asset or liability as of the measurement date. The threelevels are defined as follow:

 

Level1:  Inputs to the valuation methodology are quoted prices (unadjusted) foridentical assets or liabilities in active markets.

 

Level2:  Inputs to the valuation methodology include quoted prices for similarassets and liabilities in active markets and inputs that are observable for theasset or liability, either directly or indirectly, for substantially the fullterm of the financial instrument.

 

Level3:  Inputs to the valuation methodology are unobservable and significantto the fair value measurement.

 

Incertain cases, the inputs used to measure fair value may fall into differentlevels of the fair value hierarchy.  In such cases, the level in the fairvalue hierarchy within which the fair value measurement in its entirety fallshas been determined based on the lowest level input that is significant to thefair value measurement in its entirety.  The Company’s assessment of thesignificance of a particular input to the fair value measurement in itsentirety requires judgment , and considers factors specific to the asset orliability.

 

Assetsand liabilities measured at fair value on a recurring and non-recurring basisare summarized below:

 
| ** **                                                 | ** ** | **Fair Value Measurements at September 30, 2010** | ** ** |
|------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **September 30,  2010**                                                    | ** ** | **Quoted Prices  in Active  Markets for  Identical Assets  (Level 1)** | ** ** | **Significant  Other  Observable  Inputs  (Level 2)** | ** ** | **Significant  Unobservable  Inputs  (Level 3)** | ** ** |
| Assets and liabilities measured on a recurring  basis:     |       |                                                                            |       |   |   |   |   |   |   |
| Available-for-sale securities:                             |       |                                                                            |       |   |   |   |   |   |   |
| U.S. agencies                                              |       | $                                                                               | 31,955,969 |   | $ |   |   | $ | 31,955,969 |   | $ |   |   |
| Collateralized mortgage obligations                        |       | $                                                                               | 8,530,905  |   | $ |   |   | $ | 8,530,905 |   | $ |   |   |
| Municipalities                                             |       | $                                                                               | 11,376,568 |   | $ |   |   | $ | 11,376,568 |   | $ |   |   |
| SBA Pools                                                  |       | $                                                                               | 1,521,394  |   | $ |   |   | $ | 1,521,394 |   | $ |   |   |
| Mutual Fund                                                |       | $                                                                               | 1,638,627  |   | $ |   |   | $ | 1,638,627 |   | $ |   |   |
|                                                       |       |                                                                            |       |   |   |   |   |   |   |
| Assets and liabilities measured on a  non-recurring basis: |       |                                                                            |       |   |   |   |   |   |   |
| Impaired Loans                                             |       | $                                                                               | 3,781,621  |   | $ | — |   | $ | — |   | $ | 3,781,621 |   |
| Other real estate owned                                    |       | $                                                                               | 1,142,887  |   | $ | — |   | $ | — |   | $ | 1,142,887 |   |

 
| ** **                                                 | ** ** | **Fair Value Measurements at December 31, 2009** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **December 31,  2009**                                                    | ** ** | **Quoted Prices  in Active  Markets for  Identical Assets  (Level 1)** | ** ** | **Significant  Other  Observable  Inputs  (Level 2)** | ** ** | **Significant  Unobservable  Inputs  (Level 3)** | ** ** |
| Assets and liabilities measured on a recurring  basis:     |       |                                                                           |       |   |   |   |   |   |   |
| Available-for-sale securities:                             |       |                                                                           |       |   |   |   |   |   |   |
| U.S. agencies                                              |       | $                                                                              | 30,984,718 |   | $ |   |   | $ | 30,984,718 |   | $ |   |   |
| Collateralized mortgage obligations                        |       | $                                                                              | 2,994,746  |   | $ |   |   | $ | 2,994,746 |   | $ |   |   |
| Municipalities                                             |       | $                                                                              | 13,557,151 |   | $ |   |   | $ | 13,557,151 |   | $ |   |   |
| Asset backed securities                                    |       | $                                                                              | 1,579,348  |   | $ |   |   | $ | 1,579,348 |   | $ |   |   |
| SBA Pools                                                  |       | $                                                                              | 82,574     |   | $ |   |   | $ | 82,574 |   | $ |   |   |
| Mutual Fund                                                |       | $                                                                              | 1,566,777  |   | $ |   |   | $ | 1,566,777 |   | $ |   |   |
|                                                       |       |                                                                           |       |   |   |   |   |   |   |
| Assets and liabilities measured on a  non-recurring basis: |       |                                                                           |       |   |   |   |   |   |   |
| Impaired Loans                                             |       | $                                                                              | 10,372,613 |   | $ | — |   | $ | — |   | $ | 10,372,613 |   |
| Other real estate owned                                    |       | $                                                                              | 2,149,514  |   | $ | — |   | $ | — |   | $ | 2,149,514 |   |

 

Thefair value of securities available for sale equals quoted market price, ifavailable.  If quoted market prices are not available, fair value

 

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isdetermined using quoted market prices for similar securities.  Changes infair market value are recorded in other comprehensive income net of tax.

 

Thefair value measurement applies to impaired loans, which includes impaired loansmeasured at an observable market price (if available), or at the fair value ofthe loan’s collateral (if the loan is collateral dependent). Fair value of theloan’s collateral, when the loan is dependent on collateral, is determined byappraisals or independent valuation which is then adjusted for the cost relatedto liquidation of the collateral.  At September 30,2010, impaired loans that had a specific loan loss reserve had a principalbalance of $4,476,211 with a valuation allowance of $694,590.  Upon being classified as impaired, either acharge off or a specific reserve or both may be taken to reduce the balance ofeach loan to an estimate of the collateral fair market value less cost todispose. This estimate was a level 3 valuation.  There was no directimpact on the income statement.  The charge-offs were recorded as a debitto the allowance for loan losses.

 

Fairvalue of other real estate owned is determined by appraisals or independentvaluation which is then adjusted for the cost related to liquidation of theproperty.  Total fair market value at September 30,2010 was $1,142,887 which was a level 3 valuation.  There is a direct impact to the incomestatement as any market value write downs are charged directly to operatingexpenses.  The Bank is required byinternal bank policies to order real estate appraisals on OREO properties everysix months.  In addition, managementevaluates the book values on a quarterly basis for reasonableness and makesfair value adjustments as necessary.

 

**NOTE 8 — EARNINGS (LOSS) PER SHARE**

** **

Earningsper share (EPS) is calculated based on the weighted average common sharesoutstanding during the period.  Basic EPSexcludes dilution and is calculated by dividing net income available to commonshareholders by the weighted average common shares outstanding.  Diluted EPS reflects the potential dilutionthat could occur if securities or other contracts to issue common stock wereexercised or converted into common stock.

 
| ** **                                                                               | ** ** | **THREE MONTHS ENDED** | ** ** |
|------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                               | ** ** | **SEPTEMBER 30,**           | ** ** |
| **In thousands (except share and per share amounts)** | ** ** | **2010**                         | ** ** | **2009** | ** ** |
| BASIC EARNINGS PER SHARE                                                                 |       |                             |       |   |   |
|                                                                                     |       |                             |       |   |   |
| Net income available to common shareholders                                              |       | $                                | 930,511    |   | $ | 668,740 |   |
| Weighted average shares outstanding                                                      |       | 7,692,900                        |       | 7,668,891 |   |
| Net income per common share                                                              |       | $                                | 0.12       |   | $ | 0.09 |   |
|                                                                                     |       |                             |       |   |   |
| DILUTED EARNINGS PER SHARE                                                               |       |                             |       |   |   |
|                                                                                     |       |                             |       |   |   |
| Net income available to common shareholders                                              |       | $                                | 930,511    |   | $ | 668,740 |   |
| Weighted average shares outstanding                                                      |       | 7,692,900                        |       | 7,668,891 |   |
| Effect of dilutive stock options                                                         |       | 36,275                           |       | 25,167 |   |
| Weighted average shares of common stock and  common stock equivalents                    |       | 7,729,175                        |       | 7,694,058 |   |
| Net income per diluted common share                                                      |       | $                                | 0.12       |   | $ | 0.09 |   |

 

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| ** **                                                                               | ** ** | **NINE MONTHS ENDED** | ** ** |
|------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                               | ** ** | **SEPTEMBER 30,**          | ** ** |
| **In thousands (except share and per share amounts)** | ** ** | **2010**                        | ** ** | **2009** | ** ** |
| BASIC EARNINGS PER SHARE                                                                 |       |                            |       |   |   |
|                                                                                     |       |                            |       |   |   |
| Net income available to common shareholders                                              |       | $                               | 2,496,112  |   | $ | 633,165 |   |
| Weighted average shares outstanding                                                      |       | 7,685,592                       |       | 7,664,075 |   |
| Net income per common share                                                              |       | $                               | 0.32       |   | $ | 0.08 |   |
|                                                                                     |       |                            |       |   |   |
| DILUTED EARNINGS PER SHARE                                                               |       |                            |       |   |   |
|                                                                                     |       |                            |       |   |   |
| Net income available to common shareholders                                              |       | $                               | 2,496,112  |   | $ | 633,165 |   |
| Weighted average shares outstanding                                                      |       | 7,685,592                       |       | 7,664,075 |   |
| Effect of dilutive stock options                                                         |       | 34,024                          |       | 28,035 |   |
| Weighted average shares of common stock and  common stock equivalents                    |       | 7,719,616                       |       | 7,692,110 |   |
| Net income per diluted common share                                                      |       | $                               | 0.32       |   | $ | 0.08 |   |

 

Duringthe three and nine month periods ended September 30, 2010, anti-dilutiveweighted average options to purchase 223,386 and 234,517 shares of commonstock, respectively, were outstanding with prices ranging from $5.20 to $15.67. Anti-dilutive weighted average stockoptions of 240,187 and 241,888 were outstanding during the same three and ninemonth periods of 2009, respectively, with prices ranging from $4.58 to $15.67.  These options were not included in thecomputation of diluted EPS because the options’ exercise price was greater thanthe average market price of the common shares. These options begin to expire in 2013. In addition, weighted average warrants of 350,346 issued to the U.S.Treasury Capital Purchase Program were anti-dilutive for the three andsix-month periods of 2010 and 2009, as the price of $5.78 was more than theaverage market price of common shares.

 

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**Item 2.   Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

Thefollowing discussion explains the significant factors affecting our operationsand financial position for the periods presented. The discussion should be readin conjunction with our financial statements and the notes related theretowhich appear or that are referenced to elsewhere in this report, and with theaudited consolidated financial statements and accompanying notes included inour 2009 Annual Report on Form 10-K, as amended.  Average balances, including balances used incalculating certain financial ratios, are generally comprised of average dailybalances.

 

Thediscussion and analysis of our financial condition and results of operations isbased upon our financial statements, which have been prepared in accordancewith accounting principles generally accepted in the United States of America.The preparation of these financial statements requires management to makeestimates and judgments that affect the reported amounts of assets andliabilities, revenues and expenses, and related disclosures of contingentassets and liabilities at the date of our financial statements. Actual resultsmay differ from these estimates under different assumptions or conditions. Thisdiscussion and analysis includes executive management’s (“Management”) insightof the Company’s financial condition and results of operations of Oak ValleyBancorp and its subsidiary.  Unless otherwise stated, the “Company”refers to the consolidated entity, Oak Valley Bancorp, while the “Bank” refersto Oak Valley Community Bank

 

***Forward-Looking Statements***

 

*Some matters discussed in this Form 10-Q may be “forward-lookingstatements” within the meaning of the Private Litigation Reform Act of 1995 andtherefore may involve risks, uncertainties and other factors which may causeour actual results to be materially different from the results expressed orimplied by our forward-looking statements.  These statements generallyappear with words such as “anticipate,” “believe,” “estimate,” “may,” “intend,”and “expect.”  Although management believes that the assumptions andexpectations reflected in such forward-looking statements are reasonable, itcan give no assurance that such expectations will prove to be correct. Factors that could cause actual results to differ from results discussed inforward-looking statements include, but are not limited to: economic conditions(both generally and in the markets where the Bank operates); competition fromother providers of financial services offered by the Bank; changes ingovernment regulation and legislation; changes in interest rates; materialunforeseen changes in the financial stability and liquidity of the Bank’s creditcustomers;**risks associated withconcentrations in real estate related loans; changes in accounting standardsand interpretations**;and other risks as may be detailed from time to time in the Company’s filingswith the Securities and Exchange Commission, all of which are difficult topredict and which may be beyond the control of the Company or the Bank. The Company undertakes no obligation to revise forward-looking statements toreflect events or changes after the date of this discussion or to reflect theoccurrence of unanticipated events.*

 

*Forward-looking statements speak only as of the date theyare made, and the Company does not undertake to update forward-lookingstatements to reflect circumstances or events that occur after the date theforward-looking statements are made, whether as a result of new information,future developments or otherwise, except as may be required by law.*

 

**Critical Accounting Estimates**

 

*Management has determined the following four accountingpolicies to be critical:*

 

*Allowance for Loan Losses*

 

Accountingfor allowance for loan losses involves significant judgment and assumptions bymanagement and is based on historical data and management’s view of the currenteconomic environment. At least on a quarterly basis, our management reviews themethodology and adequacy of allowance for loan losses and reports itsassessment to the Board of Directors for its review and approval.

 

Webase our allowance for loan losses on an estimation of probable losses inherentin our loan portfolio. Our methodology for assessing loan loss allowances areintended to reduce the differences between estimated and actual losses andinvolves a detailed analysis of our loan portfolio in three phases:

 

· the specific review of individual loans,

 

· the segmenting and review of loan pools with similar characteristicsand,

 

· our judgmental estimate based on various subjective factors.

 

Thefirst phase of our methodology involves the specific review of individual loansto identify and measure impairment. We evaluate each loan by use of a riskrating system, except for homogeneous loans, such as automobile loans and homemortgages. Specific

 

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riskrated loans are deemed impaired if all amounts, including principal andinterest, will likely not be collected in accordance with the contractual termsof the related loan agreement. Impairment for commercial and real estate loansis measured either based on the present value of the loan’s expected futurecash flows or, if collection on the loan is collateral dependent, the estimatedfair value of the collateral, less selling and holding costs.

 

Thesecond phase involves the segmenting of the remainder of the risk rated loanportfolio into groups or pools of loans, together with loans with similarcharacteristics, for evaluation. We determine the calculated loss ratio to eachloan pool based on its historical net losses and benchmark it against thelevels of other peer banks.

 

Inthe third phase, we consider relevant internal and external factors that mayaffect the collectibility of loan portfolio and each group of loan pool. Thefactors considered are, but are not limited to:

 

· concentration of credits,

 

· nature and volume of the loan portfolio,

 

· delinquency trends,

 

· non-accrual loan trend,

 

· problem loan trend,

 

· loss and recovery trend,

 

· quality of loan review,

 

· lending and management staff,

 

· lending policies and procedures,

 

· economic and business conditions, and

 

· other external factors including regulatory review.

 

Ourmanagement estimates the probable effect of such conditions based on ourjudgment, experience and known or anticipated trends. Such estimation may bereflected as an additional allowance to each group of loans, if necessary.Management reviews these conditions with our senior credit officers. To theextent that any of these conditions is evidenced by a specifically identifiableproblem credit or portfolio segment as of the evaluation date, management’sestimate of the effect of such condition may be reflected as a specificallowance applicable to such credit or portfolio segment. Where any of theseconditions is not evidenced by a specific, identifiable problem credit orportfolio segment as of the evaluation date, management’s evaluation of theinherent loss related to such condition is reflected in the unallocatedallowance.

 

Centralto our credit risk management and our assessment of appropriate loss allowanceis our loan risk rating system. Under this system, the originating creditofficer assigns borrowers an initial risk rating based on a thorough analysisof each borrower’s financial capacity in conjunction with industry and economictrends. Approvals are made based upon the amount of inherent credit riskspecific to the transaction and are reviewed for appropriateness by senior lineand credit administration personnel. Credits are monitored by line and creditadministration personnel for deterioration in a borrower’s financial conditionwhich may impact the ability of the borrower to perform under the contract.Although management has allocated a portion of the allowance to specific loans,specific loan pools, and off-balance sheet credit exposures (which are reportedseparately as part of other liabilities), the adequacy of the allowance isconsidered in its entirety.

 

*Non-Accrual Loan Policy*

 

Intereston loans is credited to income as earned and is accrued only if deemedcollectible. Accrual of interest is discontinued when a loan is over90 days delinquent or if management believes that collection is highlyuncertain. Generally, payments received on nonaccrual loans are recorded asprincipal reductions. Interest income is recognized after all principal hasbeen repaid or an improvement in the condition of the loan has occurred thatwould warrant resumption of interest accruals.

 

*Stock-Based Compensation*

 

TheCompany recognizes in the income statement the grant-date fair value of stockoptions and other equity-based forms of compensation issued to employees overthe employees’ requisite service period (generally the vesting period). The Bank uses the

 

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straight-linerecognition of expenses for awards with graded vesting.  The Bank utilizesa binomial pricing model for all grants. Expected volatility is based on the historical volatility of the priceof the Bank’s stock for the period equal to the contractual stock option term.The Bank uses historical data to estimate option exercise and stock optionforfeiture rates within the valuation model. The expected term of optionsgranted for the binomial model is derived from applying a historical suboptimalexercise factor to the contractual term of the grant. For binomial pricing, therisk-free rate for periods is equal to the U.S. Treasury yield at the time ofgrant and commensurate with the contractual term of the grant.

 

*Other Real Estate Owned*

 

Otherreal estate owned, which represents real estate acquired through foreclosure,or deed in lieu of foreclosure in satisfaction of commercial and real estateloans, is carried at the lower of cost or estimated fair value less theestimated selling costs of the real estate. The fair value of the property isbased upon a current appraisal. The difference between the fair value of thereal estate collateral and the loan balance at the time of transfer is recordedas a loan charge off if fair value is lower. Subsequent to foreclosure,management periodically performs valuations and the OREO property is carried atthe lower of carrying value or fair value, less costs to sell. The determination of a property’s estimated fair value incorporates(1) revenues projected to be realized from disposal of the property,(2) construction and renovation costs, (3) marketing and transactioncosts, and (4) holding costs (e.g., property taxes, insurance and homeowners’association dues). Any subsequent declines in the fair value of the OREOproperty after the date of transfer are recorded through a write-down of theasset. Any subsequent operating expenses or income, reduction in estimated fairvalues, and gains or losses on disposition of such properties are charged orcredited to current operations.

 

**Introduction**

 

Oak Valley Community Bank commencedoperations in May 1991.  We are an insured bank under the FederalDeposit Insurance Act and are a member of the Federal Reserve.  Since its formation,the Bank has provided basic banking services to individuals and businessenterprises in Oakdale, California and the surrounding areas. The focus of theBank is to offer a range of commercial banking services designed for bothindividuals and small to medium-sized businesses in the two main areas ofservice of the Bank: the Central Valley and the Eastern Sierras.

 

The Bank offers a complement ofbusiness checking and savings accounts for its business customers.  TheBank also offers commercial and real estate loans, as well as lines ofcredit.  Real estate loans are generally of a short-term nature for bothresidential and commercial purposes.  Longer-term real estate loans aregenerally made with adjustable interest rates and contain normal provisions foracceleration.  In addition, the Bank offers traditional residentialmortgages through a partner financial institution under Community Bank LendingExchange (“CBLX”).

 

The Bank also offers other servicesfor both individuals and businesses including online banking, remote depositcapture, merchant services, night depository, extended hours, traveler’schecks, wire transfer of funds, note collection, and automated teller machinesin a national network.  The Bank does not currently offer internationalbanking or trust services although the Bank may make such services available tothe Bank’s customers through financial institutions with which the Bank hascorrespondent banking relationships.  The Bank does not offer stocktransfer services nor does it directly issue credit cards.

 

EffectiveJuly 3, 2008, Oak Valley Community Bank became a subsidiary of Oak ValleyBancorp, a newly established bank holding company. Oak Valley Bancorp operatesOak Valley Community Bank as a community bank in the general commercial bankingbusiness, with our primary market encompassing the California Central Valleyaround Oakdale and Modesto, and the Eastern Sierras. As such, unless otherwisenoted, all references are about Oak Valley Bancorp.

 

**Overview of Results of Operations and Financial Condition**

 

Thepurpose of this summary is to provide an overview of the items managementfocuses on when evaluating the condition of the Company and its success inimplementing its business and shareholder value strategies. The Company’s businessstrategy is to operate the Bank as a well-capitalized, profitable andindependent community oriented bank.  The Company’s shareholdersvalue strategy has three major themes: (1) enhancing shareholders’ value; (2) makingits retail banking franchise more valuable; and (3) efficiently utilizingits capital.

 

Managementbelieves the following were important factors in the Company’s performanceduring the three and nine month periods ended September 30, 2010:

 

·                  Thanksto our deep roots in the communities that we serve, our focus on customer careand our selectivity in lending, during the first nine months of 2010, ourperformance has been better than most institutions of our size that compete inour market.  Despite the severity of therecession affecting our primary market areas, we have been able to increase ourcore deposits to $405.3 million and have posted net income available to commonshareholders of $0.12 and $0.32 per diluted share for the three and nine monthperiods of 2010, respectively.

 

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·                        While recently published economic data indicate that the currentdownturn may be easing, it is not clear when or at what speed the recessionwill end. To the extent that the recession continues, it will affect the marketareas that we serve and our results accordingly.

 

·                      The Company recognized net income available to common shareholders of$931,000 and $2,496,000 for the three and nine month periods ended September 30,2010, respectively, as compared to $669,000 and $633,000 for the same periodsin 2009.  The Company recognized net income before preferred stockdividends and accretion of $1,141,000 and $3,127,000, respectively, for thethird quarter and nine month period of 2010. The factors contributing to these results will be discussed below.

 

·                  TheCompany recognized $210,000 and $631,000, respectively, in the third quarterand nine month period of 2010 and 2009 associated with the accrual forpreferred stock dividends and accretion of the preferred stock discount inconnection with the 13,500 shares of Series A Preferred Stock that theU.S. Treasury purchased from the Company in December 2008 under the TARPProgram. So long as such preferred stock remains outstanding, it will payquarterly cumulative dividends at a rate of 5% per year for the first fiveyears and thereafter at a rate of 9% per year.

 

·                  TheCompany has taken significant steps to reduce the risk of loanlosses.   In the three and nine month periods ended September 30,2010, the provision for loan loss was $1,005,000 and $3,015,000, respectively,which was an increase of $80,000 for the quarter and a decrease of $1,947,000for the nine month period compared to 2009. The year-to-date decrease was mainly due to management’s assessment ofthe appropriate level for the allowance for loan losses and a decrease in thelevel of non-accrual loans. The Company continues to monitor its loan portfoliowith the objective of avoiding defaults or write-downs.  Despitethese actions, the possibility of additional losses cannot be eliminated, butthe Board of Directors and all employees continue to work hard to make the bestof these continuing challenging conditions.

 

·                      Net interest income increased $339,000 or 5.6% and $1,100,000 or 6.3%for the three and nine month periods ended September 30, 2010, respectively,compared to the same periods in 2009.  This increase was primarily due tothe net interest margin increase of 17 and 31 basis points, respectively, forthe three and nine month periods ended September 30, 2010, as compared tothe same periods of 2009.  The net interest margin increase isattributable primarily to liabilities repricing faster than assets in thedeclining rate environment as described in further detail below.

 

·                      Non-interest income decreased by $102,000 or 13.1% for the third quarterand increased by $32,000 or 1.6% for the nine month period of 2010 as comparedto the same periods in 2009. Year-to-date results show an increase in other income which includes thegain on called securities and bank debit card fees.  This was partially offset by a decrease inNSF fee income and mortgage commissions as described below.

 

·                      Non-interest expense decreased by $556,000 or 11.7% and $520,000 or 3.9%for the three and nine month periods ended September 30, 2010,respectively, as compared to the same periods in 2009.  The primary reason for the decrease was asignificant reduction in the write downs of OREO property values, which wasoffset in part by increased salaries and benefits as described below.

 

·                      Total assets increased $10.2 million or 1.9% from December 31,2009.  Total net loans decreased by $17.3 million or 4.1% and investmentsecurities increased by $4.3 million or 8.4% from December 31, 2009 to September 30,2010, while deposits increased by $19.7 million or 4.6% for the same period.

 

**Income Summary**

 

Forthe three and nine month periods ended September 30, 2010, the Companyrecorded net income available to common shareholders of $931,000 and$2,496,000, respectively, representing increases of $262,000 and $1,863,000, ascompared to the same periods in 2009.  Return on average assets(annualized) was 0.86% and 0.81% for the third quarter and nine month periodsof 2010, respectively, as compared with 0.67% and 0.32% for the same periods in2009.  Annualized return on average common equity was 7.38% and 6.83% forthe third quarter and nine month period of 2010, respectively, as compared to5.73% and 1.85% for the same periods of 2009.

 

Netincome before provisions for income taxes and preferred stock dividends andaccretion was up $714,000 and $3,599,000 for the third quarter and nine monthperiod of 2010, respectively, from the comparable 2009 periods.  Theincome statement components of these variances are as follows:

 

21

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***Pre-Tax Income Variance Summary***

 
| ** **                            | ** ** | **Effect on Pre-Tax  Income** | ** ** | **Effect on Pre-Tax  Income** | ** ** |
|---------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
| ** **                            | ** ** | **Increase (Decrease)**            | ** ** | **Increase (Decrease)**            | ** ** |
| **(In thousands)**               | ** ** | **Three Months**                   | ** ** | **Nine months**                    | ** ** |
| Change from 2009 to  2010 in:         | ** ** | ** **                              | ** ** | ** **                              | ** ** |
| Net interest income                   |       | $                                       | 339        |                                    | $          | 1,100 |   |
| Provision for loan  losses            |       | (80                                     | )          | 1,947                                   |       |
| Non-interest income                   |       | (102                                    | )          | 32                                      |       |
| Non-interest expense                  |       | 557                                     |       | 520                                     |       |
| Change in income before  income taxes |       | $                                       | 714        |                                    | $          | 3,599 |   |

 

Thesevariances will be explained in the discussion below.

 

**Net Interest Income**

 

Netinterest income is the largest source of the Bank’s operating income.  Forthe three and nine month periods ended September 30, 2010, net interestincome was $6.4 million and $18.7 million, respectively, which represented anincrease of $339,000 or 5.6% and $1,100,000 or 6.3%, respectively, from thecomparable periods in 2009.

 

Thenet interest margin (net interest income as a percentage of average interestearning assets) was 5.23% and 5.27% for the three and nine month periods ended September 30,2010, an increase of 17 and 31 basis points, respectively, as compared to thesame periods in 2009.  The increase in the net interest margin in 2010 wasprimarily attributable to the impact that the decline in market interest rateshad on our liability sensitive balance sheet which caused interest-bearingliabilities to decrease faster than the yields on earning assets.  The total cost of funds decreased 71 and 67basis points in the third quarter and nine month period of 2010, respectively,compared to 2009 due to a shift from high cost CDs and FHLB borrowed funds intodemand deposit and money market accounts. Average non-interest-bearing demand deposit balances increased by $17.7million and $11.1 million for the three and nine month periods of 2010,respectively, as compared to the same periods of 2009.  Compared to cost of funds, the decrease inour earning asset yield was not as significant at only 44 and 27 basis pointsfor the three and nine month periods of 2010, respectively, compared to thesame periods of 2009.  Yield on loansremained relatively flat at 6.20% for the third quarter 2010 versus 6.32% inthe third quarter of 2009, partly as a result of the significant portion of ourloans that are at their contractual rate floors.

 

Thefollowing tables shows the relative impact of changes in average balances ofinterest earning assets and interest bearing liabilities, and interest ratesearned and paid by the Company on those assets and liabilities for the threeand nine month periods ended September 30, 2010 and 2009:

 

***Net Interest Analysis***

*(Dollars in thousands)*

 
| ** **                                       | ** ** | **Three Months Ended   September 30, 2010** | ** ** | **Three Months Ended  September 30, 2009** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                       | ** ** | **Average  Balance**                                                 | ** ** | **Interest  Income /  Expense**                           | ** ** | **Avg  Rate/  Yield** | ** ** | **Average  Balance** | ** ** | **Interest  Income/  Expense** | ** ** | **Avg  Rate/  Yield** | ** ** |
| **Assets:**                                      |       |                                                                 |       |                                                           |       |   |   |   |   |   |   |   |   |
| Earning  assets:                                 |       |                                                                 |       |                                                           |       |   |   |   |   |   |   |   |   |
| Gross  loans (1) (2)                        |       | $                                                                    | 409,992    |                                                           | $          | 6,408 |   | 6.20% |   | $ | 423,947 |   | $ | 6,751 |   | 6.32% |   |
| Investment  securities (2)                       |       | 49,626                                                               |       | 652                                                            |       | 5.21% |   | 51,811 |   | 777 |   | 5.95% |   |
| Federal  funds sold                              |       | 5,792                                                                |       | 3                                                              |       | 0.21% |   | 2,095 |   | 1 |   | 0.25% |   |
| Interest-earning  deposits                       |       | 21,452                                                               |       | 13                                                             |       | 0.24% |   | 3,347 |   | 2 |   | 0.23% |   |
| Total  interest-earning assets                   |       | 486,862                                                              |       | 7,076                                                          |       | 5.77% |   | 481,200 |   | 7,531 |   | 6.21% |   |
| Total noninterest  earning assets                |       | 38,028                                                               |       |                                                           |       |   |   | 40,084 |   |   |   |   |   |
| Total  Assets                                    |       | 524,890                                                              |       |                                                           |       |   |   | 521,284 |   |   |   |   |   |
| **Liabilities and Shareholders’ Equity:**   |       |                                                                 |       |                                                           |       |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                   |       |                                                                 |       |                                                           |       |   |   |   |   |   |   |   |   |
| Money  market deposits                           |       | 207,921                                                              |       | 311                                                            |       | 0.59% |   | 191,740 |   | 630 |   | 1.30% |   |
| NOW  deposits                                    |       | 60,583                                                               |       | 48                                                             |       | 0.31% |   | 58,643 |   | 70 |   | 0.47% |   |
| Savings  deposits                                |       | 14,880                                                               |       | 15                                                             |       | 0.40% |   | 13,362 |   | 20 |   | 0.58% |   |
| Time  certificates of deposit $100,000 or more   |       | 40,528                                                               |       | 98                                                             |       | 0.96% |   | 47,678 |   | 264 |   | 2.19% |   |
| Other  time deposits                             |       | 35,637                                                               |       | 98                                                             |       | 1.09% |   | 52,821 |   | 263 |   | 1.97% |   |
| Other  borrowings                                |       | 18,500                                                               |       | 85                                                             |       | 1.82% |   | 31,752 |   | 153 |   | 1.91% |   |
| Total  interest-bearing liabilities              |       | 378,049                                                              |       | 655                                                            |       | 0.69% |   | 395,996 |   | 1,400 |   | 1.40% |   |
| Noninterest-bearing  liabilities:                |       |                                                                 |       |                                                           |       |   |   |   |   |   |   |   |   |
| Noninterest-bearing  deposits                    |       | 80,196                                                               |       |                                                           |       |   |   | 62,498 |   |   |   |   |   |
| Other  liabilities                               |       | 3,101                                                                |       |                                                           |       |   |   | 3,020 |   |   |   |   |   |
| Total  noninterest-bearing liabilities           |       | 83,297                                                               |       |                                                           |       |   |   | 65,518 |   |   |   |   |   |
| Shareholders’  equity                       |       | 63,544                                                               |       |                                                           |       |   |   | 59,770 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity |       | $                                                                    | 524,890    |                                                           |       |   |   |   | $ | 521,284 |   |   |   |   |   |
| Net  interest income                             |       |                                                                 |       | $                                                              | 6,421      |   |   |   |   |   | $ | 6,131 |   |   |   |
| Net  interest spread (3)                         |       |                                                                 |       |                                                           |       | 5.08% |   |   |   |   |   | 4.81% |   |
| Net  interest margin (4)                         |       |                                                                 |       |                                                           |       | 5.23% |   |   |   |   |   | 5.06% |   |

 

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----

*(1) *Loan fees have been included in the calculation of interest income.

 

*(2) *Yieldson municipal securities and loans have been adjusted to their fully-taxableequivalents, based on a federal marginal tax rate of 34.0%.

 

*(3) *Representsthe average rate earned on interest-earning assets less the average rate paidon interest-bearing liabilities.

 

*(4) *Representsnet interest income as a percentage of average interest-earning assets.

* *
| ** **                                       | ** ** | **Nine months ended**  | ** ** | **Nine months ended**      | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|--------------------------------------|------------|
| ** **                                       | ** ** | **September 30, 2010** | ** ** | **September 30, 2009**     | ** ** |
| ** **                                       | ** ** | **Average  Balance**             | ** ** | **Interest  Income /  Expense** | ** ** | **Avg  Rate/  Yield** | ** ** | **Average  Balance** | ** ** | **Interest  Income /  Expense** | ** ** | **Avg  Rate/  Yield** | ** ** |
| **Assets:**                                      |       |                             |       |                                 |       |   |   |   |   |   |   |   |   |
| Earning  assets:                                 |       |                             |       |                                 |       |   |   |   |   |   |   |   |   |
| Gross  loans (1) (2)                        |       | $                                | 413,504    |                                 | $          | 19,262 |   | 6.23% |   | $ | 427,513 |   | $ | 20,081 |   | 6.28% |   |
| Investment  securities (2)                       |       | 48,696                           |       | 1,956                                |       | 5.37% |   | 50,422 |   | 2,249 |   | 5.96% |   |
| Federal  funds sold                              |       | 4,248                            |       | 7                                    |       | 0.22% |   | 1,661 |   | 3 |   | 0.24% |   |
| Interest-earning  deposits                       |       | 12,608                           |       | 21                                   |       | 0.22% |   | 2,201 |   | 4 |   | 0.22% |   |
| Total  interest-earning assets                   |       | 479,056                          |       | 21,246                               |       | 5.93% |   | 481,797 |   | 22,337 |   | 6.20% |   |
| Total  noninterest earning assets                |       | 38,613                           |       |                                 |       |   |   | 38,626 |   |   |   |   |   |
| Total  Assets                                    |       | 517,669                          |       |                                 |       |   |   | 520,423 |   |   |   |   |   |
| **Liabilities and Shareholders’ Equity:**   |       |                             |       |                                 |       |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                   |       |                             |       |                                 |       |   |   |   |   |   |   |   |   |
| Money  market deposits                           |       | 208,576                          |       | 1,133                                |       | 0.73% |   | 176,878 |   | 1,910 |   | 1.44% |   |
| NOW  deposits                                    |       | 59,301                           |       | 145                                  |       | 0.33% |   | 56,654 |   | 215 |   | 0.51% |   |
| Savings  deposits                                |       | 14,629                           |       | 47                                   |       | 0.43% |   | 14,003 |   | 86 |   | 0.83% |   |
| Time  certificates of deposit $100,000 or more   |       | 39,778                           |       | 401                                  |       | 1.35% |   | 46,598 |   | 850 |   | 2.44% |   |
| Other  time deposits                             |       | 36,519                           |       | 372                                  |       | 1.36% |   | 53,081 |   | 858 |   | 2.16% |   |
| Other  borrowings                                |       | 20,719                           |       | 269                                  |       | 1.74% |   | 49,123 |   | 540 |   | 1.47% |   |
| Total  interest-bearing liabilities              |       | 379,522                          |       | 2,367                                |       | 0.83% |   | 396,337 |   | 4,459 |   | 1.50% |   |
| Noninterest-bearing  liabilities:                |       |                             |       |                                 |       |   |   |   |   |   |   |   |   |
| Noninterest-bearing  deposits                    |       | 72,947                           |       |                                 |       |   |   | 61,776 |   |   |   |   |   |
| Other  liabilities                               |       | 2,811                            |       |                                 |       |   |   | 2,954 |   |   |   |   |   |
| Total  noninterest-bearing liabilities           |       | 75,758                           |       |                                 |       |   |   | 64,730 |   |   |   |   |   |
| Shareholders’  equity                       |       | 62,389                           |       |                                 |       |   |   | 59,356 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity |       | $                                | 517,669    |                                 |       |   |   |   | $ | 520,423 |   |   |   |   |   |
| Net interest  income                             |       |                             |       | $                                    | 18,879     |   |   |   |   |   | $ | 17,878 |   |   |   |
| Net  interest spread (3)                         |       |                             |       |                                 |       | 5.10% |   |   |   |   |   | 4.69% |   |
| Net  interest margin (4)                         |       |                             |       |                                 |       | 5.27% |   |   |   |   |   | 4.96% |   |

 

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----

*(1) *Loan fees have been included in the calculation of interest income.

 

*(2) *Yieldson municipal securities and loans have been adjusted to their fully-taxableequivalents, based on a federal marginal tax rate of 34.0%.

 

*(3) *Representsthe average rate earned on interest-earning assets less the average rate paidon interest-bearing liabilities.

 

*(4) *Representsnet interest income as a percentage of average interest-earning assets.

 

Shownin the following tables are the relative impacts on net interest income ofchanges in the average outstanding balances (volume) of earning assets andinterest bearing liabilities and the rates earned and paid by the Company onthose assets and liabilities for the three and nine month periods ended September 30,2010 and 2009.  Changes in interest income and expense that are notattributable specifically to either rate or volume are allocated to the ratecolumn below.

 

***Rate / Volume Variance Analysis***

*(In thousands)*

* *
| ** **                         | ** ** | **For the Three Months Ended September 30,** | ** ** |
|------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                         | ** ** | **2010 vs 2009**                                                 | ** ** |
| ** **                         | ** ** | **Increase (Decrease)**                                               | ** ** |
| ** **                         | ** ** | **in interest income and expense**                     | ** ** |
| ** **                         | ** ** | **due to changes in:**                                      | ** ** |
| ** **                         | ** ** | **Volume**                                                                 | ** ** | **Rate** | ** ** | **Total** | ** ** |
| **Interest income:**               |       |                                                                       |       |   |   |   |   |
| Gross loans (1)                    |       | $                                                                          | (222       | ) | $ | (121 | ) | $ | (343 | ) |
| Investment securities              |       | (33                                                                        | )          | (92 | ) | (125 | ) |
| Federal funds sold                 |       | 2                                                                          |       | (1 | ) | 1 |   |
| Interest-earning deposits          |       | 11                                                                         |       | 1 |   | 12 |   |
| **Total  interest income**         |       | $                                                                          | **(242**   | **)** | $ | **(213** | **)** | $ | **(455** | **)** |
|                               |       |                                                                       |       |   |   |   |   |
| **Interest expense:**              |       |                                                                       |       |   |   |   |   |
| Money market deposits              |       | 53                                                                         |       | (372 | ) | (319 | ) |
| NOW deposits                       |       | 2                                                                          |       | (24 | ) | (22 | ) |
| Savings deposits                   |       | 2                                                                          |       | (7 | ) | (5 | ) |
| Time CD $100K or more              |       | (40                                                                        | )          | (126 | ) | (166 | ) |
| Other time deposits                |       | (85                                                                        | )          | (79 | ) | (164 | ) |
| Other borrowings                   |       | (64                                                                        | )          | (5 | ) | (69 | ) |
| **Total  interest expense**        |       | $                                                                          | **(132**   | **)** | $ | **(613** | **)** | $ | **(745** | **)** |
| ** **                         | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Change in  net interest income** |       | $                                                                          | **(110**   | **)** | $ | **400** |   | $ | **290** |   |

 

----

*(1*)* * Loan fees have been included in thecalculation of interest income.

 

Thetable above reflects the market interest rate decline has impacted liabilitiesmore than assets as indicated by the increase of $400,000 in net interestincome due to the rate change for the three month period of 2010.  Thedecreased loan volume and the overall change in mix of balances resulted in adecrease of $110,000 to net interest income over the same period.

 

24

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| ** **                         | ** ** | **For the Nine months Ended September 30,** | ** ** |
|------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                         | ** ** | **2010 vs 2009**                                                | ** ** |
| ** **                         | ** ** | **Increase (Decrease)**                                              | ** ** |
| ** **                         | ** ** | **in interest income and expense**                    | ** ** |
| ** **                         | ** ** | **due to changes in:**                                     | ** ** |
| ** **                         | ** ** | **Volume**                                                                | ** ** | **Rate** | ** ** | **Total** | ** ** |
| **Interest income:**               |       |                                                                      |       |   |   |   |   |
| Gross loans (1)                    |       | $                                                                         | (658       | ) | $ | (163 | ) | $ | (821 | ) |
| Investment securities              |       | (77                                                                       | )          | (216 | ) | (293 | ) |
| Federal funds sold                 |       | 5                                                                         |       | 0 |   | 5 |   |
| Interest-earning deposits          |       | 17                                                                        |       | 1 |   | 18 |   |
| **Total  interest income**         |       | $                                                                         | **(713**   | **)** | $ | **(378** | **)** | $ | **(1,091** | **)** |
|                               |       |                                                                      |       |   |   |   |   |
| **Interest expense:**              |       |                                                                      |       |   |   |   |   |
| Money market deposits              |       | 342                                                                       |       | (1,120 | ) | (778 | ) |
| NOW deposits                       |       | 10                                                                        |       | (80 | ) | (70 | ) |
| Savings deposits                   |       | 4                                                                         |       | (43 | ) | (39 | ) |
| Time CD $100K or more              |       | (124                                                                      | )          | (325 | ) | (449 | ) |
| Other time deposits                |       | (268                                                                      | )          | (218 | ) | (486 | ) |
| Other borrowings                   |       | (312                                                                      | )          | 42 |   | (270 | ) |
| **Total  interest expense**        |       | $                                                                         | **(348**   | **)** | $ | **(1,744** | **)** | $ | **(2,092** | **)** |
| ** **                         | ** ** | ** **                                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Change in  net interest income** |       | $                                                                         | **(365**   | **)** | $ | **1,366** |   | $ | **1,001** |   |

 

----

*(1*)* * Loan fees have been included in thecalculation of interest income.

 

Thetable above reflects the market interest rate decline has impacted liabilitiesmore than assets as indicated by the increase of $1,366,000 in net interestincome due to the rate change for the nine month period of 2010.  Thedecreased loan volume and the overall change in mix of balances resulted in a decreaseof $365,000 to net interest income over the same period.

 

**Non-Interest Income**

 

Non-interestincome represents service charges on deposit accounts and other non-interestrelated charges and fees, including fees from mortgage commissions and investmentservice fee income.  For the three and nine month periods ended September 30,2010, non-interest income was $676,000 and $2,055,000, respectively, a decreaseof $102,000 or 13.1% and an increase of $32,000 or 1.6%, compared to the sameperiods in 2009.

 

Thefollowing tables show the major components of non-interest income:

 
| ** **                                          | ** ** | **For the Three Months Ended September 30,** | ** ** |
|-----------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **2010**                                                                   | ** ** | **2009** | ** ** | **$ change** | ** ** | **% change** | ** ** |
| Service  charges on deposits                        |       | $                                                                          | 272,136    |   | $ | 300,282 |   | $ | (28,146 | ) | (9.4)% |   |
| Earnings  on cash surrender value of life insurance |       | 103,986                                                                    |       | 101,057 |   | 2,929 |   | 2.9% |   |
| Mortgage  commissions                               |       | 30,849                                                                     |       | 38,143 |   | (7,294 | ) | (19.1)% |   |
| Other                                               |       | 269,078                                                                    |       | 338,154 |   | (69,076 | ) | (20.4)% |   |
| Total  non-interest income                          |       | $                                                                          | 676,049    |   | $ | 777,636 |   | $ | (101,587 | ) | (13.1)% |   |

 

Thedecrease to total non-interest income for the quarter is due in part to thegain on called securities of 46,000 in the third quarter of 2010 compared to$78,000 recorded in the third quarter of 2009. In addition, investment service fee income decreased by $49,000 or63.3%, mortgage commissions decreased by $7,000 or 19.1% and service charges ondeposits decreased by $28,000 or 9.4% in the third quarter of 2010 compared to2009.  Offsetting these decreases was inincrease of $30,000 in bank debit card fees in the three month period ended September 30,2010, as compared to the same period in 2009. Gain on called securities, investment service fee income and bank debitcard fees are all included in the “other income” line item in the above table.

 
| ** **                                          | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **2010**                                                                  | ** ** | **2009** | ** ** | **$ change** | ** ** | **% change** | ** ** |
| Service  charges on deposits                        |       | $                                                                         | 787,142    |   | $ | 875,229 |   | $ | (88,087 | ) | (10.1)% |   |
| Earnings  on cash surrender value of life insurance |       | 308,671                                                                   |       | 303,170 |   | 5,501 |   | 1.8% |   |
| Mortgage  commissions                               |       | 74,984                                                                    |       | 127,160 |   | (52,176 | ) | (41.0)% |   |
| Other                                               |       | 884,047                                                                   |       | 717,763 |   | 166,284 |   | 23.2% |   |
| Total  non-interest income                          |       | $                                                                         | 2,054,844  |   | $ | 2,023,322 |   | $ | 31,522 |   | 1.6% |   |

 

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Theyear-to-date increase to total non-interest income is primarily due to bankdebit card fees and the gain on called securities of $260,000 and $172,000,respectively,  in the nine month periodof 2010, which represent increases of $79,000 and $40,000, respectively.  Gain on called securities investment servicefee income and bank debit card fees are included in the “other income” lineitem in the above table.  In addition,rental income from OREO and bank owned properties increased by $33,000 comparedto prior year mainly due to the relocation of our Mammoth Lakes branch and thesubsequent lease agreement for the old branch property.  Offsetting these increases was a decrease inservice charges on deposits of $88,000 or 10.1%, combined with a decrease inmortgage commissions of $52,000 or 41.0% for the nine month period ended September 30,2010, as compared to the same period in 2009. The Bank continues to expand its offerings to the consumer and businessdepositor.

 

**Non-Interest Expense**

 

Non-interestexpense represents salaries and benefits, occupancy expenses, professionalexpenses, outside services, and other miscellaneous expenses necessary toconduct business.

 

Thefollowing tables show the major components of non-interest expenses:

 
| ** **                         | ** ** | **For the Three Months Ended September 30,** | ** ** |
|------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                         | ** ** | **2010**                                                                   | ** ** | **2009** | ** ** | **$ change** | ** ** | **% change** | ** ** |
| Salaries  and employee benefits    |       | $                                                                          | 2,143,094  |   | $ | 1,974,022 |   | $ | 169,072 |   | 8.6% |   |
| Occupancy  expenses                |       | 690,209                                                                    |       | 658,928 |   | 31,281 |   | 4.7% |   |
| Data  processing fees              |       | 233,694                                                                    |       | 220,181 |   | 13,513 |   | 6.1% |   |
| OREO  expenses                     |       | 35,051                                                                     |       | 915,623 |   | (880,572 | ) | (96.2)% |   |
| Assessments  (FDIC & DFI) |       | 258,000                                                                    |       | 230,269 |   | 27,731 |   | 12.0% |   |
| Other  operating expenses          |       | 828,155                                                                    |       | 745,563 |   | 82,592 |   | 11.1% |   |
| Total non-interest expense         |       | $                                                                          | 4,188,203  |   | $ | 4,744,586 |   | $ | (556,383 | ) | (11.7)% |   |

 
| ** **                         | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                         | ** ** | **2010**                                                                  | ** ** | **2009** | ** ** | **$ change** | ** ** | **% change** | ** ** |
| Salaries  and employee benefits    |       | $                                                                         | 6,483,605  |   | $ | 5,889,247 |   | $ | 594,358 |   | 10.1% |   |
| Occupancy  expenses                |       | 2,031,127                                                                 |       | 2,031,844 |   | (717 | ) | (0.0)% |   |
| Data  processing fees              |       | 706,889                                                                   |       | 672,597 |   | 34,292 |   | 5.1% |   |
| OREO  expenses                     |       | 598,894                                                                   |       | 1,974,375 |   | (1,375,481 | ) | (69.7)% |   |
| Assessments  (FDIC & DFI) |       | 774,000                                                                   |       | 667,355 |   | 106,645 |   | 16.0% |   |
| Other  operating expenses          |       | 2,355,381                                                                 |       | 2,234,073 |   | 121,308 |   | 5.4% |   |
| Total non-interest expense         |       | $                                                                         | 12,949,896 |   | $ | 13,469,491 |   | $ | (519,595 | ) | (3.9)% |   |

 

Non-interestexpenses decreased by $556,000 or 11.7% and $520,000 or 3.9% for the three andnine months ended September 30, 2010, respectively, as compared to thesame periods of 2009.  Salaries andemployee benefits increased $169,000 and $594,000 for the three and nine monthsended September 30, 2010, respectively, as compared to the same periods of2009 as a result of hiring to fill existing positions.  Data processingfees increased by $14,000 and $34,000 for the three and nine month periods of2010, as compared to the same periods of 2009, as a result of an increasednumber of transaction accounts.

 

FDICand DFI assessments increased by $28,000 and $107,000 for the three and ninemonths ended September 30, 2010, as compared to the same periods of 2009.  Effective April 1, 2009, the FDIC adopted a final rule revisingits risk-based insurance assessment system and effectively increasing theoverall assessment rate.  The increase of FDIC insurance in 2010 over2009 is primarily due to an increase in the industry-wide FDIC assessment rateand growth in our deposit level. In addition, in November 2008, we electedto participate in the FDIC Transaction Account Guarantee Program, whichprovides unlimited insurance coverage on non-interest-bearing transaction 

 

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accountsdefined by the FDIC, on which we currently pay a 15 basis point surcharge per$100 covered balances in excess of $250 thousand through December 31,2010, at which time the program expires. Increases to the assessment fees were also due in part to an overallincrease in deposits.

 

OREOexpenses were $35,000 and $599,000 in the third quarter and nine month periodof 2010, respectively, compared to $916,000 and $1,974,000 for the comparableperiods of 2009.  These expenses resultedfrom various overhead costs and market value write downs associated with theproperties classified as other real estate owned.  OREO expenses are decreasing compared to 2009as a result of managements effort to actively conduct market valuations on theproperties and record writedowns to bring carrying balances to the appropriatemarket values, which were higher in 2009, as well as selling various propertiesto bring our OREO balance down to $1.1 million compared to the $2.0 million at September 30,2009.

 

Managementanticipates that noninterest expense will continue to increase as we continueto grow.  However, management remains committed to cost-control andefficiency, and we expect to keep these increases to a minimum relative togrowth.

 

**Income Taxes**

 

Provisionfor income taxes for the third quarter and nine month periods of 2010 were$701,000 and $1,626,000, respectively, an increase of $452,000 and $1,736,000compared to $249,000 and a tax benefit of $109,000, respectively, in the sameperiods of 2009.  The effective tax ratesof 38.05% and 34.21% for the third quarter and nine month period of 2010,respectively, are returning to a more normal level compared to 2009 in which werecorded tax benefits.  The 2009 taxrates, in particular, are considerably lower compared to some of our peers andour historical tax rates, and are disproportional compared to pre-tax incomeassuming marginal tax rates or historical effective tax rates are applied topre-tax income.  This is primarily due totax credits from California Enterprise Zones and low income housing projects aswell as tax free-income on loans within these enterprise zones and municipalsecurities and loans that comprise a larger proportion of pre-tax income in2010 and 2009 as compared other historical periods or peers.  Certain tax credits and deductions arerecognized by the Company regardless of the amount of pre-tax income or loss,which further increases the tax benefit and exaggerates the effective taxrates.

 

**Asset Quality**

 

Nonperformingassets consist of loans on non-accrual status, loans 90 days or more pastdue and still accruing interest, loans restructured, where the terms ofrepayment have been renegotiated resulting in a reduction or deferral ofinterest or principal, and other real estate owned (“OREO”).

 

Loansare generally placed on non-accrual status when they become 90 days pastdue, unless management believes the loan is adequately collateralized and inthe process of collection. The past due loans may or may not be adequatelycollateralized, but collection efforts are continuously pursued. Loans may berestructured by management when a borrower has experienced some changes infinancial status, causing an inability to meet the original repayment terms,and where we believe the borrower will eventually overcome those circumstancesand repay the loan in full. OREO consists of properties acquired by foreclosureor similar means and which management intends to offer for sale.

 

Non-accrualloans totaled $9.5 million at September 30, 2010, as compared to $14.4million at December 31, 2009.  The non-accrual loans as of September 30,2010 are loans made to eleven borrowers primarily for purposes of real estateconstruction and commercial real estate. As of September 30, 2010, we had three loans considered troubleddebt restructurings totaling $1.4 million, which are included in nonaccrualloans.

 

OREOtotaled $1.1 million as of September 30, 2010 and consists of fourproperties that were acquired through foreclosure including residential landlots and a commercial real estate property.

 

Thefollowing table presents information about the Company’s non-performing loans,including asset quality ratios as of September 30, 2010 andDecember 31, 2009:

 

***Non-Performing Assets***

 

*(in thousands)*

 
| ** **                                               | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                               | ** ** | **2010**               | ** ** | **2009**              | ** ** |
| Loans in nonaccrual status                               |       | $                      | 8,145      |                  | $          | 14,418 |   |
| Loans past due 90 days or more and accruing              |       | —                 |       | —                |       |
| Restructured loans                                       |       | 1,402                  |       | —                |       |
| Total nonperforming loans                                |       | 9,547                  |       | 14,418                |       |
| Other real estate owned                                  |       | 1,143                  |       | 2,150                 |       |
| Total nonperforming assets                               |       | $                      | 10,690     |                  | $          | 16,568 |   |
|                                                     |       |                   |       |                  |       |
| Allowance for loan losses                                |       | $                      | 7,700      |                  | $          | 7,020 |   |
|                                                     |       |                   |       |                  |       |
| Asset quality ratios:                                    |       |                   |       |                  |       |
| Non-performing assets to total assets                    |       | 2.00%                  |       | 3.16%                 |       |
| Non-performing loans to total loans                      |       | 2.33%                  |       | 3.39%                 |       |
| Allowance for loan losses to total loans                 |       | 1.88%                  |       | 1.65%                 |       |
| Allowance for loan losses to total non-performing  loans |       | 80.66%                 |       | 48.69%                |       |

 

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***Allowance for Loan and Lease Losses (“ALLL”)***

 

Inanticipation of credit risk inherent in our lending business, we routinely setaside allowances through charges to earnings. Such charges are not only madefor the outstanding loan portfolio, but also for off-balance sheet items, suchas commitments to extend credits or letters of credit. Charges made for theoutstanding loan portfolio have been credited to the allowance for loan losses,whereas charges for off-balance sheet items have been credited to the reservefor off-balance sheet items, which is presented as a component of otherliabilities.  The Bank recorded loan loss provisions of $1,005,000 and$3,015,000 for the three and nine month periods in 2010, respectively, whichrepresented an $80,000 increase and a $1,947,000 decrease, respectively, ascompared to the provisions recorded in the same periods of 2009.

 

Theallowance for loan losses increased by $680,000 or 9.7%, to $7.7 millionat September 30, 2010, as compared with $7.02 million atDecember 31, 2009.  The Bank recognized the increase in the allowancefor loan losses during the first nine months of the year due to the loan lossprovision of $3.02 million which was partially offset by net loan charge-offsof $2.34 million.  The weak business climate has continued to adverselyimpact the financial conditions of certain Bank clients in addition to decreasecollateral values.  The increase to theallowance for loan losses combined with the decrease in our loan portfolioresulted in an increase in the allowance for loan losses as a percentage oftotal loans to 1.88% at September 30, 2010, as compared to 1.65% atDecember 31, 2009.

 

TheBank will continue to monitor the adequacy of the allowance for loan losses andmake additions to the allowance in accordance with the analysis referred toabove. Because of uncertainties inherent in estimating the appropriate level ofthe allowance for loan losses, actual results may differ from management’sestimate of credit losses and the related allowance.

 

Thefollowing table provides an analysis of the changes in the ALLL for the ninemonth periods ended September 30, 2010 and 2009:

 

*(dollars in thousands)*

 
| ** **                                               | ** ** | **Nine months Ended** | ** ** |
|----------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                               | ** ** | **September 30,**          | ** ** |
| ** **                                               | ** ** | **2010**                        | ** ** | **2009** | ** ** |
| Balance at beginning of period                           |       | $                               | 7,020      |   | $ | 5,569 |   |
| Provision for loan losses                                |       | 3,015                           |       | 4,962 |   |
| Loans charged off                                        |       | (2,340                          | )          | (4,139 | ) |
| Recoveries of previous charge-offs                       |       | 5                               |       | 4 |   |
| Net charge-offs                                          |       | (2,335                          | )          | (4,135 | ) |
| Balance at end of period                                 |       | $                               | 7,700      |   | $ | 6,396 |   |
|                                                     |       |                            |       |   |   |
| Allowance for loan losses to total loans                 |       | 1.88%                           |       | 1.50% |   |
| Net charge-offs to average loans (annualized)            |       | 0.75%                           |       | 1.29% |   |
| Provision for loan losses to average loans  (annualized) |       | 0.97%                           |       | 1.55% |   |

 

TheBank makes provisions for loan losses when required to bring the totalallowance for loan and lease losses to a level deemed appropriate for the levelof risk in the loan portfolio.  At least quarterly, management conducts anassessment of the overall quality of the loan portfolio and general economictrends in the local market.  The determination of the appropriate levelfor the allowance is based on 

 

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thatreview, considering such factors as historical experience, the volume and typeof lending conducted, the amount of and identified potential loss associatedwith specific nonperforming loans, regulatory policies, general economicconditions, and other factors related to the collectibility of loans in theportfolio.

 

Althoughmanagement believes the allowance at September 30, 2010 was adequate toabsorb probable losses from any known and inherent risks in the portfolio, noassurance can be given that the adverse effect of current and future economicconditions on our service areas, or other variables, will not result inincreased losses in the loan portfolio in the future.

 

**Investment Activities**

 

Investmentsare a key source of interest income. Management of our investment portfolio isset in accordance with strategies developed and overseen by our InvestmentCommittee. Investment balances, including cash equivalents and interest-bearingdeposits in other financial institutions, are subject to change over time basedon our asset/liability funding needs and interest rate risk managementobjectives. Our liquidity levels take into consideration anticipated futurecash flows and all available sources of credits, and are maintained at levelsmanagement believes are appropriate to assure future flexibility in meetinganticipated funding needs.

 

*Cash Equivalents and Interest-bearing Deposits in otherFinancial Institutions*

 

TheBank holds federal funds sold, unpledged available-for-sale securities andsalable government guaranteed loans to help meet liquidity requirements andprovide temporary holdings until the funds can be otherwise deployed orinvested. As of September 30, 2010, and December 31, 2009, we had$46.5 million and $21.6 million, respectively, in cash and cashequivalents.

 

*Investment Securities*

 

Managementof our investment securities portfolio focuses on providing an adequate levelof liquidity and establishing an interest rate-sensitive position, whileearning an adequate level of investment income without taking undue risk.Investment securities that we intend to hold until maturity are classified asheld-to-maturity securities, and all other investment securities are classifiedas available-for-sale.  Currently, all of our investment securities areclassified as available-for-sale. The carrying values of available-for-saleinvestment securities are adjusted for unrealized gains or losses as avaluation allowance and any gain or loss is reported on an after-tax basis as acomponent of other comprehensive income.

 

Managementhas evaluated the investment securities portfolio to determine if theimpairment of any security in an unrealized loss position istemporary or other than temporary.  Management has determined that noinvestment security is other than temporarily impaired.  The unrealizedlosses are due solely to interest rate changes.

 

**Deposits**

 

Totaldeposits at September 30, 2010 were $448.9 million, a $19.7 million or4.6% increase from the deposit total of $429.2 million at December 31,2009.  Average deposits increased $22.8 million to $431.8 million for thenine month period ended September 30, 2010 as compared to the same periodin 2009. We attracted deposits due to the safety and soundness of the Bank andour focus on customer service.

 

*(inthousands)*

 
| ** **       | ** ** | **September 30,** | ** **  | **December 31,** | ** ** | **Nine months change** | ** ** |
|------------------|------------|------------------------|-------------|-----------------------|------------|----------------------------------|------------|
| ** **       | ** ** | **2010**               | ** **  | **2009**              | ** ** | **$**                            | ** ** | **%** | ** ** |
| Demand           |       | $                      | 88,248      |                  | $          | 69,647                           |       | $ | 18,601 |   | 26.7% |   |
| NOW              |       | 58,683                 |        | 57,378                |       | 1,305                            |       | 2.3% |   |
| MMDA             |       | 214,880                |        | 202,947               |       | 11,933                           |       | 5.9% |   |
| Savings          |       | 14,136                 |        | 17,178                |       | (3,042                           | )          | (17.7)% |   |
| Time  < 100K  |       | 29,210                 |        | 36,215                |       | (7,005                           | )          | (19.3)% |   |
| Time  > $100K |       | 43,747                 |        | 45,845                |       | (2,098                           | )          | (4.6)% |   |
|             |       | $                      | **448,904** |                  | $          | **429,210**                      |       | $ | **19,694** | ** ** | **4.6%** | ** ** |

 

Becauseour client base is comprised primarily of commercial and industrial accounts,individual account balances are generally higher than those ofconsumer-oriented banks.  Four of ourclients carry deposit balances of more than 1% of our total deposits, one ofwhich had a deposit balance of more than 3% of total deposits at September 30,2010.

 

Sinceour deposit growth strategy emphasizes core deposit growth we have avoidedrelying on brokered deposits as a consistent source of funds.  The onlybrokered deposits the Bank holds are from CDARS, a certificate of depositprogram that exchanges funds with other 

 

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networkbanks to offer full FDIC insurance coverage to the customer.  The Bank had$4.8 million in brokered deposits as of September 30, 2010 as compared to$11.4 million at December 31, 2009.

 

**Borrowings**

 

Althoughdeposits are the primary source of funds for our lending and investmentactivities and for general business purposes, we may obtain advances from theFederal Home Loan Bank of San Francisco (“FHLB”) as an alternative to retaildeposit funds. Our outstanding FHLB advances decreased by $13.7 million at September 30,2010 to $18.5 million, compared to $32.2 million at December 31, 2009 dueto the increase in deposits and loan repayments. See “Liquidity Management”below for the details on the FHLB borrowings program.

 

**Capital Ratios**

 

Weare subject to various regulatory capital requirements administered by federalbanking agencies. Failure to meet minimum capital requirements can triggerregulatory actions that could have a material adverse effect on our financialstatements and operations. Under capital adequacy guidelines and the regulatoryframework for prompt corrective action, we must meet specific capitalguidelines that rely on quantitative measures of our assets, liabilities andcertain off-balance-sheet items as calculated under regulatory accountingpractices. Our capital amounts and classification are also subject toqualitative judgments by the regulators about components, risk weightings, andother factors.

 

Thefollowing table shows the Oak Valley Community Bank’s and Oak Valley Bancorp’scapital ratios, as calculated under regulatory guidelines, compared to theregulatory minimum capital ratios and the regulatory minimum capital ratiosneeded to qualify as a “well-capitalized” institution at September 30,2010 and December 31, 2009:

 

***Oak Valley Community BankCapital Ratios —***

***(dollars inthousands)***

 
| ** **                               | ** ** | ** ** | ** ** | ** **           | ** ** | **Amount of Capital Required** | ** ** |
|------------------------------------------|------------|------------|------------|----------------------|------------|-----------------------------------------------|------------|
| ** **                               | ** ** | ** ** | ** ** | ** **           | ** ** | **To Be**                                | ** ** | **To Be Adequately** | ** ** |
| ** **                               | ** ** | **Actual** | ** ** | **Well-Capitalized** | ** ** | **Capitalized**                               | ** ** |
| ** **                               | ** ** | **Amount** | ** ** | **Ratio**            | ** ** | **Amount**                                    | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **As of September 30, 2010:**       |       |       |       |                 |       |                                          |       |   |   |   |   |   |   |
| Total Capital (to Risk-Weighted Assets)  |       | $          | 67,326     |                 | 14.8%      |                                          | $          | 45,645 |   | 10% |   | $ | 36,516 |   | 8% |   |
| Tier 1 Capital (to Risk-Weighted Assets) |       | $          | 61,580     |                 | 13.5%      |                                          | $          | 27,387 |   | 6% |   | $ | 18,258 |   | 4% |   |
| Tier 1 Capital (to Average Assets)       |       | $          | 61,580     |                 | 11.7%      |                                          | $          | 26,242 |   | 5% |   | $ | 20,994 |   | 4% |   |
|                                     |       |       |       |                 |       |                                          |       |   |   |   |   |   |   |
| **As of December 31, 2009:**        |       |       |       |                 |       |                                          |       |   |   |   |   |   |   |
| Total Capital (to Risk-Weighted Assets)  |       | $          | 64,821     |                 | 13.6%      |                                          | $          | 47,844 |   | 10% |   | $ | 38,275 |   | 8% |   |
| Tier 1 Capital (to Risk-Weighted Assets) |       | $          | 58,817     |                 | 12.3%      |                                          | $          | 28,706 |   | 6% |   | $ | 19,137 |   | 4% |   |
| Tier 1 Capital (to Average Assets)       |       | $          | 58,817     |                 | 11.3%      |                                          | $          | 26,024 |   | 5% |   | $ | 20,819 |   | 4% |   |

 

***Oak Valley Bancorp Capital Ratios —***

***(dollars inthousands)***

 
| ** **                               | ** ** | ** ** | ** ** | ** **           | ** ** | **Amount of Capital Required** | ** ** |
|------------------------------------------|------------|------------|------------|----------------------|------------|-----------------------------------------------|------------|
| ** **                               | ** ** | ** ** | ** ** | ** **           | ** ** | **To Be**                                | ** ** | **To Be Adequately** | ** ** |
| ** **                               | ** ** | **Actual** | ** ** | **Well-Capitalized** | ** ** | **Capitalized**                               | ** ** |
| ** **                               | ** ** | **Amount** | ** ** | **Ratio**            | ** ** | **Amount**                                    | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **As of September 30, 2010**        |       |       |       |                 |       |                                          |       |   |   |   |   |   |   |
| Total Capital (to Risk-Weighted Assets)  |       | $          | 67,516     |                 | 14.8%      |                                          | N/A        |   | N/A |   | $ | 36,519 |   | 8% |   |
| Tier 1 Capital (to Risk-Weighted Assets) |       | $          | 61,769     |                 | 13.5%      |                                          | N/A        |   | N/A |   | $ | 18,259 |   | 4% |   |
| Tier 1 Capital (to Average Assets)       |       | $          | 61,769     |                 | 11.8%      |                                          | N/A        |   | N/A |   | $ | 20,996 |   | 4% |   |
|                                     |       |       |       |                 |       |                                          |       |   |   |   |   |   |   |
| **As of December 31, 2009:**        |       |       |       |                 |       |                                          |       |   |   |   |   |   |   |
| Total Capital (to Risk-Weighted Assets)  |       | $          | 65,014     |                 | 13.6%      |                                          | N/A        |   | N/A |   | $ | 38,285 |   | 8% |   |
| Tier 1 Capital (to Risk-Weighted Assets) |       | $          | 59,009     |                 | 12.3%      |                                          | N/A        |   | N/A |   | $ | 19,142 |   | 4% |   |
| Tier 1 Capital (to Average Assets)       |       | $          | 59,009     |                 | 11.3%      |                                          | N/A        |   | N/A |   | $ | 20,824 |   | 4% |   |

 

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**Liquidity Management**

 

Sincethe Company is a holding company and does not conduct regular bankingoperations, its primary sources of liquidity are dividends from the Bank. Underthe California Financial Code, payment of a dividend from the Bank to theCompany is restricted to the lesser of the Bank’s retained earnings or theamount of the Bank’s undistributed net profits from the previous three fiscalyears. The primary uses of funds for the Company are stockholder dividends,investment in the Bank and ordinary operating expenses.  Management anticipates that there will besufficient earnings at the Bank level to provide dividends to the Company tomeet its funding requirements for the foreseeable future.

 

Maintenanceof adequate liquidity requires that sufficient resources be available at alltime to meet our cash flow requirements. Liquidity in a banking institution isrequired primarily to provide for deposit withdrawals and the credit needs ofits customers and to take advantage of investment opportunities as they arise.Liquidity management involves our ability to convert assets into cash or cashequivalents without incurring significant loss, and to raise cash or maintainfunds without incurring excessive additional cost. For this purpose, wemaintain a portion of our funds in cash and cash equivalents, salablegovernment guaranteed loans and securities available for sale. We obtain fundsfrom the repayment and maturity of loans as well as deposit inflows, investmentsecurity maturities and paydowns, Federal funds purchased, FHLB advances, andother borrowings.  Our primary uses offunds are the origination of loans, the purchase of investment securities,withdrawals of deposits, maturity of certificate of deposits, repayment ofborrowings and dividends to common and preferred stockholders. Our liquidassets at September 30, 2010 were $108.0 million compared to $80.1 millionat December 31, 2009.  Our liquidity level measured as the percentageof liquid assets to total assets was 20.2% and 15.3% at September 30, 2010and December 31, 2009, respectively. We anticipate that cash and cashequivalents on hand and other sources of funds will provide adequate liquidityfor our operating, investing and financing needs and our regulatory liquidityrequirements for the foreseeable future. Management monitors our liquidityposition daily, balancing loan funding/payments with changes in depositactivity and overnight investments.

 

Asa secondary source of liquidity, we rely on advances from the FHLB tosupplement our supply of lendable funds and to meet deposit withdrawalrequirements. Advances from the FHLB are typically secured by a portion of ourloan portfolio. The FHLB determines limitations on the amount of advances byassigning a percentage to each eligible loan category that will count towardsthe borrowing capacity.  As of September 30,2010, our borrowing capacity from the FHLB was approximately$118.4 million and the outstanding balance was $18.5 million, orapproximately 15.6% of our borrowing capacity. We also maintain 2 lines ofcredit with correspondent banks to purchase up to $15 million in federalfunds, for which there were no advances as of September 30, 2010.

 

**Off-Balance-Sheet Arrangements**

 

Duringthe ordinary course of business, we provide various forms of credit lines tomeet the financing needs of our customers. These commitments, which represent acredit risk to us, are not represented in any form on our balance sheets.

 

Asof September 30, 2010 and December 31, 2009, we had commitments toextend credit of $54.4 million and $63.1 million, respectively, which includesobligations under letters of credit of $0.9 million and $2.8 million,respectively.

 

Theeffect on our revenues, expenses, cash flows and liquidity from the unusedportion of the commitments to provide credit cannot be reasonably predictedbecause there is no guarantee that the lines of credit will be used.

 

**Recent Legislation and Other Regulatory Initiatives**

 

OnJuly 21, 2010, President Obama signed into law the Dodd-Frank Wall StreetReform and Consumer Protection Act (the “Act”), a landmark financial reformbill comprised of new rules and restrictions that will impact banks goingforward. It includes key provisions aimed at preventing a repeat of the 2008financial crisis and a new process for winding down failing, systemicallyimportant institutions in a manner as close to a controlled bankruptcy aspossible.  The Act includes other keyprovisions as follows:

 

(1) TheAct establishes a new Financial Stability Oversight Council to monitor systemicfinancial risks. The Board of Governors of the Federal Reserve (“Fed”) aregiven extensive new authorities to impose strict controls on large bank holdingcompanies with total consolidated assets equal to or in excess of $50 billionand systemically significant nonbank financial companies to limit the risk theymight pose for the economy and to other large interconnected companies. The Fedcan also take direct control of troubled financial companies that areconsidered systemically significant.

 

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(2) TheAct also establishes a new independent Federal regulatory body for consumerprotection within the Federal Reserve System known as the Bureau of ConsumerFinancial Protection (the “Bureau”), which will assume responsibility for mostconsumer protection laws (except the Community Reinvestment Act). It will alsobe in charge of setting appropriate consumer banking fees and caps. The Officeof Comptroller of the Currency will continue to have authority to preempt statebanking and consumer protection laws if these laws “prevent or significantly”interfere with the business of banking.

 

(3) TheAct restricts the amount of trust preferred securities (“TPS”) that may beconsidered as Tier 1 Capital. For depository institution holding companiesbelow $15 billion in total assets, TPS issued before May 19, 2010 will begrandfathered, so their status as Tier 1 capital does not change. However goingforward, TPS will be disallowed as Tier 1 capital. Beginning January 1,2013, bank holding companies above $15 billion in assets will have a three-yearphase-in period to fill the capital gap caused by the disallowance of the TPSissued before May 19, 2010.

 

(4) TheAct effects changes in the FDIC assessment base with stricter oversight.  A new council of regulators led by the U.S.Treasury will set higher requirements for the amount of cash banks must keep onhand. FDIC insurance coverage is made permanent at the $250 thousand levelretroactive to January 1, 2008 and unlimited FDIC insurance is providedfor noninterest-bearing transaction accounts in all banks effective December 31,2010 through the end of 2012. Further, the Act removes the prohibition onpayments of interest on demand deposit accounts as of July 21, 2011.  Thus, if a depositor sweeps any amount inexcess of $250 thousand from a noninterest-bearing transaction account to aninterest bearing demand deposit, there is no FDIC insurance coverage on theportion that is over $250 thousand coverage limit.

 

(5) TheAct places certain limitations on investment and other activities by depositoryinstitutions, holding companies and their affiliates.

 

Theimpact of the Act on our banking operations is still uncertain due to the largevolume of new rules still subject to adoption and interpretation.

 

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**Item 3.****                                                          ****Quantitative and Qualitative Disclosures About MarketRisk**

 

Notapplicable.

 

**Item 4.****                                                          ****Controls and Procedures**

 

TheCompany’s Chief Executive Officer and its Chief Financial Officer, afterevaluating the effectiveness of the Company’s disclosure controls andprocedures, as defined in Exchange Act Rules 13 a-15(e)and15(d)-15(e) promulgated under the Exchange Act, as of the end of the periodcovered by this report (the “Evaluation Date”) have concluded that as of theEvaluation Date, the Company’s disclosure controls and procedures were adequateand effective to ensure that material information relating to the Company wouldbe made known to them by others within the Company, particularly during theperiod in which this report was being prepared.  Disclosure controls andprocedures are designed to ensure that information required to be disclosed byus in the reports that we file or submit under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms.  Disclosurecontrols and procedures include, without limitation, controls and proceduresdesigned to ensure that information required to be disclosed by us in thereports that we file under the Exchange Act is accumulated and communicated toour management, including our Chief Executive Officer and Chief FinancialOfficer, as appropriate to allow timely decisions regarding requireddisclosure.

 

Therewere no significant change in the our internal control over financial reportingduring the last fiscal quarter that have materially affected, or are reasonablylikely to materially affect, our internal control over financial reportingsubsequent to the Evaluation Date, nor there were any significant deficienciesor material weaknesses in such controls requiring corrective actions.

 

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**PART II - OTHERINFORMATION**

 

**Item 1.****                                                          ****Legal Proceedings**

 

Thereare no pending, or to management’s knowledge, any threatened, material legalproceedings to which we are a defendant, or to which any of our properties aresubject.  There are no material legalproceedings to which any director, any nominee for election as a director, anyexecutive officer, or any associate of any such director, nominee or officer isa party adverse to us.

 

**Item 1A.****                                                 ****Risk Factors**

 

Notapplicable.

 

**Item 2.****                                                          ****Unregistered Sales of Equity Securities and Use ofProceeds**

 

Wedid not have any unregistered sales of our equity securities during the threemonths ended September 30, 2010.

 

**Item 3.****                                                          ****Defaults Upon Senior Securities**

 

None.

 

**Item 4.****                                                          ****(Removed and****Reserved)**

 

None.

 

**Item 5.****                                                          ****Other Information**

 

None.

 

**Item 6.****                                                          ****Exhibits**

 

The  following exhibits are filed as part of thisreport or hereby incorporated by reference to filings previously made with theSEC:

 
|   | 3.1   |   | Articles of Incorporation  (incorporated by reference to Exhibit 3.1 to the Company’s Registration  Statement on Form 10-12B filed with the Securities and Exchange  Commission on July 31, 2008).                                                                                                                        |
|--------|-------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 3.2   |   | First Amendment to Articles of  Incorporation (incorporated by reference to Exhibit 3.2 to the Company’s  Registration Statement on Form 10-12B filed with the Securities and  Exchange Commission on July 31, 2008).                                                                                                     |
|   | 3.3   |   | Bylaws (incorporated by reference  to Exhibit 3.3 to the Company’s Registration Statement on  Form 10-12B filed with the Securities and Exchange Commission on  July 31, 2008).                                                                                                                                           |
|   | 3.4   |   | Certificate of Amendment of Bylaws  (incorporated by reference to Exhibit 3.5 to the Company’s Registration  Statement on Form 8-A12B filed with the Securities and Exchange Commission  on January 14, 2009).                                                                                                            |
|   | 4.1   |   | Certificate of Determination filed  with the California Secretary of State for Fixed Rate Cumulative Perpetual  Preferred Stock, Series A (incorporated by reference to Exhibit 3.4  to the Company’s Registration Statement on Form 8-A12B filed with the  Securities and Exchange Commission on January 14, 2009). |
|   | 4.2   |   | Warrant to Purchase Common Stock  dated December 5, 2008 (incorporated by reference to Exhibit 3.4 to  the Company’s Registration Statement on Form 8-A12B filed with the Securities  and Exchange Commission on January 14, 2009).                                                                                  |
|   | 31.01 |   | Certification of Principal  Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                      |
|   | 31.02 |   | Certification of Principal Financial  Officer pursuant to Rule 13a-14(a)/15d-14(a) as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                      |
|   | 32.01 |   | Certification pursuant to 18  U.S.C. Section 1350 as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                            |

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, as amended, theregistrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|                          | **Oak Valley Bancorp** |
|-------------------------------|------------------------|
| Date:  November 12, 2010 | By:                    | /s/    RICHARD A. MCCARTY |
|                          | ** **             | **Richard A. McCarty** |
|                          | ** **             | **Executive Vice President and  Chief Financial Officer** |
|                          | ** **             | **(Principal Financial Officer and  duly authorized****signatory)** |

 

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**EXHIBIT INDEX**

 
| **Exhibit** | ** ** | **Description**                                                                                                                                                                             |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **  | ** ** | ** **                                                                                                                                                                                  |
| 31.01       |       | Certification  of Chief Executive Officer pursuant to Exchange Act  Rules 13a-14(a) and 15d-14(a), as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2003     |
| 31.02       |       | Certification  of Chief Financial Officer pursuant to Exchange Act  Rules 13a-14(a) and 15d-14(a), as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2003     |
| 32.01       |       | Certifications  of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2003 |

 

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