Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**Form 10-Q**

 

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

** **

**Forthe quarterly period ended March 31, 2010**

** **

**OR**

** **

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

 

**Commissionfile number 001-34142**

 

**OAK VALLEY BANCORP**

(Exact name ofregistrant as specified in its charter)

 

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

 

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

(Address ofprincipal executive offices)

 

**(209)848-2265**

Issuer’s telephonenumber

 

**Notapplicable**

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

 

Indicate by check markwhether the issuer (1) has filed all reports required to be filed by Section 13or 15(d) of the Exchange Act during the past 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. Yes x  No o

 

Indicate by checkmark whether the registrant has submitted electronically and posted on itscorporate 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

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See definitions of “largeaccelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2of 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) |   |                              |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  Yes o No x

 

**APPLICABLEONLY TO CORPORATE ISSUERS**

 

State the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date:  7,681,877 shares of common stock outstandingas of April 30, 2010.

 

 

 

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Table of Contents

 

**OakValley Bancorp**

**March 31,2010**

 

**Index**

 
| ** **                                                                                                                                                                 | ** **                                                                                      | **Page** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------|----------|
| **PART I –  FINANCIAL INFORMATION**                                                                                                                              | 3                                                                                               |
|                                                                                                                                                                       |                                                                                            |
| **Item 1.**                                                                                                                                                                | **Financial Statements**                                                                        | 3        |
|                                                                                                                                                                       |                                                                                            |     |
| Condensed  Consolidated Balance Sheets at March 31, 2010, and December 31,  2009                                                                                 | 4                                                                                               |
|                                                                                                                                                                       |                                                                                            |     |
| Condensed Consolidated  Statements of Operations for the Three Month Periods Ended March 31,  2010 and March 31, 2009                                                 | 5                                                                                               |
|                                                                                                                                                                       |                                                                                            |     |
| Condensed Consolidated Statements of Changes of  Shareholders’ Equity for the Three-Month Period Ended March 31, 2010 and  the Year Ended December 31, 2009 | 6                                                                                               |
|                                                                                                                                                                       |                                                                                            |     |
| Condensed Consolidated Statements of Cash Flows for  the Three-Month Periods Ended March 31, 2010 and March 31, 2009                                             | 7                                                                                               |
|                                                                                                                                                                       |                                                                                            |     |
| Notes to Consolidated Financial Statements                                                                                                                                 | 8                                                                                               |
|                                                                                                                                                                       |                                                                                            |     |
| **Item 2.**                                                                                                                                                                | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations** | 17       |
| ** **                                                                                                                                                                 | ** **                                                                                      |     |
| **Item 3.**                                                                                                                                                                | **Quantitative  and Qualitative Disclosures About Market Risk**                                 | 30       |
| ** **                                                                                                                                                                 | ** **                                                                                      |     |
| **Item 4T.**                                                                                                                                                               | **Controls and Procedures**                                                                     | 30       |
|                                                                                                                                                                       |                                                                                            |     |
| **PART II  – OTHER INFORMATION**                                                                                                                                 | 31                                                                                              |
|                                                                                                                                                                       |                                                                                            |     |
| **Item 1.**                                                                                                                                                                | **Legal Proceedings**                                                                           | 31       |
| **Item 2.**                                                                                                                                                                | **Unregistered  Sales of Equity Securities and Use of Proceeds**                                | 31       |
| **Item 3.**                                                                                                                                                                | **Defaults Upon  Senior Securities**                                                            | 31       |
| **Item 4.**                                                                                                                                                                | **Reserved**                                                                                    | 31       |
| **Item 5.**                                                                                                                                                                | **Other Information**                                                                           | 31       |
| **Item 6.**                                                                                                                                                                | **Exhibits**                                                                                    | 31       |
|                                                                                                                                                                            |                                                                                                 |          |  |

 

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Table of Contents

 

**PART I — FINANCIAL STATEMENTS**

 

**Item 1.Financial Statements**

 

3

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**OAKVALLEY BANCORP**

**CONDENSEDCONSOLIDATED BALANCE SHEETS (UNAUDITED)**

**AT MARCH 31,2010 AND DECEMBER 31, 2009**

** **
| ** **                                                                                                                                                                                                                 | ** ** | **March 31,** | ** **  | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|-------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                 | ** ** | **2010**           | ** **  | **2009**              | ** ** |
| **ASSETS**                                                                                                                                                                                                                 |       |               |        |                  |       |
| Cash and due from banks                                                                                                                                                                                                    |       | $                  | 23,945,896  |                  | $          | 20,003,548 |   |
| Federal funds sold                                                                                                                                                                                                         |       | 6,515,000          |        | 1,645,000             |       |
| Cash and cash equivalents                                                                                                                                                                                                  |       | 30,460,896         |        | 21,648,548            |       |
|                                                                                                                                                                                                                       |       |               |        |                  |       |
| Securities available for  sale                                                                                                                                                                                             |       | 50,991,219         |        | 50,765,314            |       |
| Loans, net of allowance  for loan loss of $6,762,255 in 2010 and $7,020,222 in 2009                                                                                                                                        |       | 403,503,347        |        | 417,795,686           |       |
| Bank premises and  equipment, net                                                                                                                                                                                          |       | 10,453,962         |        | 10,167,297            |       |
| Other real estate owned  (OREO)                                                                                                                                                                                            |       | 2,456,401          |        | 2,149,514             |       |
| Accrued interest and  other assets                                                                                                                                                                                         |       | 22,409,541         |        | 22,195,354            |       |
|                                                                                                                                                                                                                       |       |               |        |                  |       |
|                                                                                                                                                                                                                       |       | $                  | 520,275,366 |                  | $          | 524,721,713 |   |
|                                                                                                                                                                                                                       |       |               |        |                  |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                                                                                             | ** ** | ** **         | ** **  | ** **            | ** ** |
|                                                                                                                                                                                                                       |       |               |        |                  |       |
| Deposits                                                                                                                                                                                                                   |       | $                  | 431,624,097 |                  | $          | 429,210,284 |   |
| Accrued interest and  other liabilities                                                                                                                                                                                    |       | 2,947,676          |        | 2,619,178             |       |
| FHLB advances                                                                                                                                                                                                              |       | 24,300,000         |        | 32,200,000            |       |
|                                                                                                                                                                                                                       |       |               |        |                  |       |
| Total liabilities                                                                                                                                                                                                          |       | 458,871,773        |        | 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 Series A  Preferred shares issued and outstanding at March 31, 2010 and  December 31, 2009 |       | 12,888,958         |        | 12,847,297            |       |
| Common stock, no par value; 50,000,000 shares  authorized, 7,681,877 shares issued and outstanding at March 31, 2010  and December 31, 2009                                                                      |       | 23,933,440         |        | 23,933,440            |       |
| Additional paid-in  capital                                                                                                                                                                                                |       | 2,019,417          |        | 1,997,747             |       |
| Retained earnings                                                                                                                                                                                                          |       | 20,967,913         |        | 20,230,683            |       |
| Accumulated other  comprehensive income, net of tax                                                                                                                                                                        |       | 1,593,865          |        | 1,683,084             |       |
|                                                                                                                                                                                                                       |       |               |        |                  |       |
| Total shareholders’  equity                                                                                                                                                                                           |       | 61,403,593         |        | 60,692,251            |       |
|                                                                                                                                                                                                                       |       |               |        |                  |       |
|                                                                                                                                                                                                                       |       | $                  | 520,275,366 |                  | $          | 524,721,713 |   |

 

*Theaccompanying notes are an integral part of these consolidated financialstatements.*

 

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**OAKVALLEY BANCORP**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)**

**FOR THETHREE MONTH PERIODS ENDED MARCH 31, 2010 AND MARCH 31, 2009**

 
| ** **                                           | ** ** | **3 MONTHS ENDED** | ** ** |
|------------------------------------------------------|------------|--------------------|------------|
| ** **                                           | ** ** | **MARCH 31,** | ** ** |
| ** **                                           | ** ** | **2010**           | ** ** | **2009** | ** ** |
| INTEREST INCOME                                      |       |               |       |   |   |
| Interest and fees on  loans                          |       | $                  | 6,438,525  |   | $ | 6,596,208 |   |
| Interest on securities  available for sale           |       | 584,275            |       | 612,158 |   |
| Interest on federal funds  sold                      |       | 1,558              |       | 903 |   |
| Interest on deposits with  banks                     |       | 4,281              |       | 763 |   |
| Total interest income                                |       | 7,028,639          |       | 7,210,032 |   |
|                                                 |       |               |       |   |   |
| INTEREST EXPENSE                                     |       |               |       |   |   |
| Deposits                                             |       | 869,406            |       | 1,323,920 |   |
| FHLB advances                                        |       | 98,375             |       | 229,452 |   |
| Federal funds purchased                              |       | 110                |       | 264 |   |
| Total interest expense                               |       | 967,891            |       | 1,553,636 |   |
|                                                 |       |               |       |   |   |
| Net interest income                                  |       | 6,060,748          |       | 5,656,396 |   |
| PROVISION FOR LOAN LOSSES                            |       | 1,005,000          |       | 1,900,000 |   |
|                                                 |       |               |       |   |   |
| Net interest income after  provision for loan losses |       | 5,055,748          |       | 3,756,396 |   |
|                                                 |       |               |       |   |   |
| OTHER INCOME                                         |       |               |       |   |   |
| Service charges on  deposits                         |       | 255,640            |       | 282,385 |   |
| Earnings on cash  surrender value of life insurance  |       | 103,986            |       | 101,057 |   |
| Mortgage commissions                                 |       | 19,127             |       | 42,544 |   |
| Other                                                |       | 267,847            |       | 172,323 |   |
| Total non-interest income                            |       | 646,600            |       | 598,309 |   |
|                                                 |       |               |       |   |   |
| OTHER EXPENSES                                       |       |               |       |   |   |
| Salaries and employee  benefits                      |       | 2,190,328          |       | 2,049,884 |   |
| Occupancy expenses                                   |       | 681,508            |       | 695,398 |   |
| Data processing fees                                 |       | 236,533            |       | 218,516 |   |
| OREO expenses                                        |       | 347,800            |       | 125,029 |   |
| Assessments  (FDIC & DFI)                   |       | 258,000            |       | 137,961 |   |
| Other operating expenses                             |       | 731,090            |       | 711,519 |   |
| Total non-interest  expense                          |       | 4,445,259          |       | 3,938,307 |   |
|                                                 |       |               |       |   |   |
| Net income before  provision for income taxes        |       | 1,257,089          |       | 416,398 |   |
|                                                 |       |               |       |   |   |
| PROVISION (BENEFIT)  INCOME TAXES                    |       | 309,448            |       | (13,912 | ) |
| NET INCOME                                           |       | $                  | 947,641    |   | $ | 430,310 |   |
|                                                 |       |               |       |   |   |
| Preferred stock dividends  and accretion             |       | 210,411            |       | 210,411 |   |
|                                                 |       |               |       |   |   |
| NET INCOME AVAILABLE TO  COMMON SHAREHOLDERS         |       | $                  | 737,230    |   | $ | 219,899 |   |
|                                                 |       |               |       |   |   |
| NET EARNINGS PER COMMON  SHARE                       |       | $                  | 0.10       |   | $ | 0.03 |   |
| NET EARNINGS PER DILUTED  COMMON SHARE               |       | $                  | 0.10       |   | $ | 0.03 |   |

 

*Theaccompanying notes are an integral part of these consolidated financialstatements*

 

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**OAKVALLEY BANCORP**

**CONDENSEDCONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)**

**FOR THEYEAR ENDED DECEMBER 31, 2009 AND THE THREE-MONTH PERIOD ENDED MARCH 31,2010**

 
| ** **                                                                                       | ** ** | **THREE MONTHS ENDED MARCH 31, 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 |   |
|                                                                                             |       |                                                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Preferred stock accretion                                                                        |       |                                                                         |       |   |   |   |   | $ | 41,661 |   |   |   | $ | (41,661 | ) |   |   |   |   | 0 |   |
| Preferred stock dividend payments                                                                |       |                                                                         |       |   |   |   |   |   |   |   |   | (168,750 | ) |   |   |   |   | (168,750 | ) |
| Stock based compensation                                                                         |       |                                                                         |       |   |   |   |   |   |   | 21,670 |   |   |   |   |   |   |   | 21,670 |   |
| Comprehensive income:                                                                            |       |                                                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net changes in unrealized gain on available-for-sale  securities (net of income tax of $62,384)  |       |                                                                         |       |   |   |   |   |   |   |   |   |   |   | (89,219 | ) | (89,219 | ) | (89,219 | ) |
| Net income                                                                                       |       |                                                                         |       |   |   |   |   |   |   |   |   | 947,641 |   | 947,641 |   |   |   | 947,641 |   |
| Comprehensive income                                                                             |       |                                                                         |       |   |   |   |   |   |   |   |   |   |   | $ | 858,422 |   |   |   |   |   |
| Balances, March 31, 2010                                                                    |       | 7,681,877                                                                    |       | $ | 23,933,440 |   | 13,500 |   | $ | 12,888,958 |   | $ | 2,019,417 |   | $ | 20,967,913 |   |   |   | $ | 1,593,865 |   | $ | 61,403,593 |   |

 

*Theaccompanying notes are an integral part of these consolidated financialstatements*

 

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**OAKVALLEY BANCORP**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)**

**FOR THE THREE-MONTH PERIODS ENDEDMARCH 31, 2010 AND MARCH 31, 2009**

** **
| ** **                                                                                 | ** ** | **THREE MONTHS ENDED********MARCH 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2010**                                     | ** ** | **2009** | ** ** |
|                                                                                       |       |                                         |       |   |   |
| CASH  FLOWS FROM OPERATING ACTIVITIES:                                                     |       |                                         |       |   |   |
| Net  income                                                                                |       | $                                            | 947,641    |   | $ | 430,310 |   |
| Adjustments  to reconcile net earnings to net cash from operating activities:              |       |                                         |       |   |   |
| Provision  for loan losses                                                                 |       | 1,005,000                                    |       | 1,900,000 |   |
| Depreciation                                                                               |       | 239,300                                      |       | 274,062 |   |
| Amortization  and accretion, net                                                           |       | (2,410                                       | )          | (12,655 | ) |
| Stock-based  compensation expense                                                          |       | 21,670                                       |       | 24,000 |   |
| OREO  Write downs and losses on sale                                                       |       | 211,996                                      |       | 63,395 |   |
| Gain  on called available for sale securities                                              |       | (55,838                                      | )          | (35,826 | ) |
| Increase  in BOLI cash surrender value                                                     |       | (103,986                                     | )          | (101,057 | ) |
| Increase  (decrease) in accrued interest payable and other liabilities                     |       | 328,498                                      |       | (97,600 | ) |
| (Increase)  decrease in accrued interest receivable                                        |       | (16,173                                      | )          | 63,877 |   |
| (Increase)  decrease in other assets                                                       |       | (31,644                                      | )          | 46,764 |   |
| Net  cash from operating activities                                                        |       | 2,544,054                                    |       | 2,555,270 |   |
|                                                                                       |       |                                         |       |   |   |
| CASH  FLOWS FROM INVESTING ACTIVITIES:                                                     |       |                                         |       |   |   |
| Purchases  of available for sale securities                                                |       | (3,022,258                                   | )          | (11,924,601 | ) |
| Proceeds  from maturities, calls, and principal paydowns of securities available for  sale |       | 2,702,998                                    |       | 2,031,402 |   |
| Net  decrease (increase) in loans                                                          |       | 12,758,640                                   |       | (3,788,530 | ) |
| Proceeds  from sale of OREO                                                                |       | 9,816                                        |       | 0 |   |
| Net  purchases of premises and equipment                                                   |       | (525,965                                     | )          | (16,871 | ) |
| Net  cash from investing activities                                                        |       | 11,923,231                                   |       | (13,698,600 | ) |
|                                                                                       |       |                                         |       |   |   |
| CASH  FLOWS FROM FINANCING ACTIVITIES:                                                     |       |                                         |       |   |   |
| FHLB  advanced funds                                                                       |       | 480,000                                      |       | 24,100,000 |   |
| FHLB  payments                                                                             |       | (480,000                                     | )          | (41,100,000 | ) |
| Federal  funds advances                                                                    |       | 100,000                                      |       | 6,285,000 |   |
| Federal  funds payments                                                                    |       | (8,000,000                                   | )          | (6,285,000 | ) |
| Shareholder  cash dividends paid                                                           |       | 0                                            |       | (191,542 | ) |
| Preferred  stock dividend payment                                                          |       | (168,750                                     | )          | (131,250 | ) |
| Net  increase in demand deposits and savings accounts                                      |       | 5,888,075                                    |       | 15,075,860 |   |
| Net  (decrease) increase in time deposits                                                  |       | (3,474,262                                   | )          | 16,764,885 |   |
| Net  cash from financing activities                                                        |       | (5,654,937                                   | )          | 14,517,953 |   |
|                                                                                       |       |                                         |       |   |   |
| NET  INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                      |       | 8,812,348                                    |       | 3,374,623 |   |
|                                                                                       |       |                                         |       |   |   |
| CASH  AND CASH EQUIVALENTS, beginning of period                                            |       | 21,648,548                                   |       | 9,837,860 |   |
|                                                                                       |       |                                         |       |   |   |
| CASH  AND CASH EQUIVALENTS, end of period                                                  |       | $                                            | 30,460,896 |   | $ | 13,212,483 |   |
|                                                                                       |       |                                         |       |   |   |
| SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION:                                        |       |                                         |       |   |   |
| Cash  paid during the year for:                                                            |       |                                         |       |   |   |
| Interest                                                                                   |       | $                                            | 1,071,830  |   | $ | 1,613,368 |   |
| Income  taxes                                                                              |       | $                                            | 451,000    |   | $ | 0 |   |
|                                                                                       |       |                                         |       |   |   |
| NON-CASH  INVESTING ACTIVITIES:                                                            |       |                                         |       |   |   |
| Real  estate acquired through foreclosure                                                  |       | $                                            | 528,699    |   | $ | 584,839 |   |
| Change  in unrealized gain/loss on available-for-sale securities                           |       | $                                            | (151,603   | ) | $ | 1,103,724 |   |
|                                                                                       |       |                                         |       |   |   |
| NON-CASH  FINANCING ACTIVITIES:                                                            |       |                                         |       |   |   |
| Accretion  of preferred stock                                                              |       | $                                            | 41,661     |   | $ | 41,662 |   |

 

*Theaccompanying notes are an integral part of these consolidated financialstatements.*

 

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**OAKVALLEY BANCORP**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

 

**NOTE 1 –BASIS OF PRESENTATION**

 

On July 3, 2008 (the“Effective Date”), a bank holding company reorganization was completed wherebyOak Valley Bancorp became the parent holding company for Oak Valley CommunityBank ( the “Bank”).  On the Effective Date, each outstanding share ofthe Bank was converted into one share of Oak Valley Bancorp and the Bank becamea wholly-owned subsidiary of the holding company. The condensed consolidatedfinancial statements and accompanying footnotes are presented as if thereorganization occurred as of the earliest periods presented and are consistentwith those of Oak Valley Community Bank, since prior to the Effective Date, OakValley Bancorp had no material assets, liabilities or operations.

 

The accounting principlesfollowed by the Company and the methods of applying these principles conformwith accounting principles generally accepted in the United States of America(GAAP) and with general practices within the banking industry. In preparingfinancial statements in conformity with GAAP, management is required to makeestimates and assumptions that affect the reported amounts in the financialstatements. Actual results could differ significantly from those estimates. Materialestimates common to the banking industry that are particularly susceptible tosignificant change in the near term include, but are not limited to, thedetermination of the allowance for loan losses, the estimation of compensationexpense related to stock options granted to employees and directors, andvaluation allowances associated with deferred tax assets, the recognition ofwhich are based on future taxable income.

 

The interim consolidatedfinancial statements included in this report are unaudited but reflect alladjustments which, in the opinion of management, are necessary for a fairpresentation of the financial position and results of operations for theinterim periods presented. All such adjustments are of a normal recurringnature. The results of operations for the three month period ended March 31,2010 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 –CURRENT ACCOUNTING PRONOUNCEMENTS**

 

*AccountingStandards Codification*. The Financial Accounting StandardsBoard’s (FASB) Accounting Standards Codification (ASC) became effective on July 1,2009. At that date, the ASC became FASB’s officially recognized source ofauthoritative U.S. generally accepted accounting principles (GAAP) applicableto all public and non-public non-governmental entities, superseding existingFASB, American Institute of Certified Public Accountants (AICPA), EmergingIssues Task Force (EITF) and related literature. Rules and interpretivereleases of the SEC under the authority of federal securities laws are alsosources of authoritative GAAP for SEC registrants. All other accounting literatureis considered non-authoritative. The switch to the ASC affects the awaycompanies refer to U.S. GAAP in financial statements and accounting policies.Citing particular content in the ASC involves specifying the unique numericpath to the content through the Topic, Subtopic, Section and Paragraphstructure.

 

*FASB ASC Topic 815,“Derivatives and Hedging.”* New authoritative accountingguidance under ASC Topic 815, “Derivatives and Hedging,” amends prior guidanceto amend and expand the disclosure requirements for derivatives and hedgingactivities to provide greater transparency about (i) how and why an entityuses derivative instruments, (ii) how derivative instruments and relatedhedge items are accounted for under ASC Topic 815, and (iii) how derivativeinstruments and related hedged items affect an entity’s financial position,results of operations and cash flows. To meet those objectives, the newauthoritative accounting guidance requires qualitative disclosures aboutobjectives and strategies for using derivatives, quantitative disclosures aboutfair value amounts of gains and losses on derivative instruments anddisclosures about credit-risk-related contingent features in derivativeagreements. The new authoritative accounting guidance under ASC Topic 815became effective for the Company on January 1, 2009 and did not have asignificant impact on the Company’s financial statements.

 

*FASB ASC Topic 820,“Fair Value Measurements and Disclosures.”*New authoritativeaccounting guidance under ASC Topic 820,”Fair Value Measurements andDisclosures,” affirms that the objective of fair value when the market for anasset is not active is the price that would be received to sell the asset in anorderly transaction, and clarifies and includes additional factors fordetermining whether there has been a significant decrease in market activityfor an asset when the market for that asset is not active. ASC Topic 820requires an entity to base its conclusion about whether a transaction was notorderly on the weight of the evidence. The new accounting guidance amendedprior guidance to expand certain disclosure requirements. The Company adoptedthe new authoritative accounting guidance under ASC Topic 820 during the firstquarter of 2009. Adoption of the new guidance did not significantly impact theCompany’s financial statements.

 

Further new authoritative accounting guidance(Accounting Standards Update No. 2009-5) under ASC Topic 820 providesguidance for measuring the fair value of a liability in circumstances in whicha 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 quoted price ofthe identical liability when traded as an asset, (ii) quoted prices forsimilar liabilities 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 

 

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entityis not required to include a separate input or adjustment to other inputsrelating to the existence of a restriction that prevents the transfer of theliability. The forgoing new authoritative accounting guidance under ASC Topic820 became effective for the Company’s financial statements beginning October 1,2009 and did not have a significant impact on the Company’s financialstatements.

 

*FASB ASC Topic 320,“Investments - Debt and Equity Securities.”* New authoritativeaccounting guidance under ASC Topic 320, “Investments - Debt and EquitySecurities,” (i) changes existing guidance for determining whether animpairment is other than temporary to debt securities and (ii) replacesthe existing requirement that the entity’s management assert it has both theintent and ability to hold an impaired security until recovery with arequirement that management assert: (a) it does not have the intent tosell the security; and (b) it is more likely than not it will not have tosell the security before recovery of its cost basis. Under ASC Topic 320,declines in the fair value of held-to-maturity and available-for-salesecurities below their cost that are deemed to be other than temporary arereflected in earnings as realized losses to the extent the impairment isrelated to credit losses. The amount of the impairment related to other factorsis recognized in other comprehensive income. The Company adopted the provisionsof the new authoritative accounting guidance under ASC Topic 320 during thesecond quarter of 2009. Adoption of the new guidance did not significantlyimpact the Company’s financial statements.

 

*FASB ASC Topic 825 “FinancialInstruments.”* New authoritative accounting guidance under ASC Topic825, “Financial Instruments,” requires an entity to provide disclosures aboutthe fair value of financial instruments in interim financial information andamends prior guidance to require those disclosures in summarized financialinformation at interim reporting periods. The new interim disclosures requiredunder Topic 825 were included in the Company’s Form 10-Q beginning June 30,2009.

 

*FASB ASC Topic 825 “FairValue Measurements and Disclosures.” * In January 2010,the FASB issued ASU No. 2010-06, *FairValue Measurements and Disclosures (Topic 820): Improving Disclosures aboutFair Value Measurements.* This ASU requires: (1) disclosure ofthe amounts of significant transfers in and out of Level 1 and Level 2 fairvalue measurement categories and the reasons for the transfers; and (2) separatepresentation of purchases, sales, issuances, and settlements in thereconciliation for fair value measurements using significant unobservableinputs (Level 3). In addition, ASU 2010-06 clarifies the requirements of thefollowing existing disclosures set forth in the Codification Subtopic 820-10: (1) Forpurposes of reporting fair value measurement for each class of assets andliabilities, a reporting entity needs to use judgment in determining theappropriate classes of assets and liabilities; and (2) a reporting entityshould provide disclosures about the valuation techniques and inputs used tomeasure fair value for both recurring and non-recurring fair valuemeasurements. ASU 2010-06 is effective for interim and annual reporting periodsbeginning January 1, 2010, except for the disclosures about purchases,sales, issuances, and settlements in the roll forward of activity in Level 3fair value measurements, which are effective for fiscal years beginning January 1,2011, and for interim periods within those fiscal years. As ASU 2010-06 isdisclosure-related only, our adoption of this ASU in the first quarter of 2010did not impact our financial condition or results of operations.

 

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**NOTE 3 –SECURITIES**

 

The amortized cost andestimated fair values of debt securities as of March 31, 2010 are asfollows:

 
| ** **                           | ** ** | **Amortized Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated Fair  Value** | ** ** |
|--------------------------------------|------------|--------------------|------------|------------------------------|------------|-------------------------------|------------|---------------------------|------------|
| Available-for-sale  securities:      |       |               |       |                         |       |                          |       |                      |       |
| U.S.  agencies                       |       | $                  | 28,167,181 |                         | $          | 1,494,982                     |       | $                         | —     |   | $ | 29,662,163 |   |
| Collateralized  mortgage obligations |       | 5,713,664          |       | 86,277                       |       | (4,624                        | )          | 5,795,317                 |       |
| Municipalities                       |       | 11,268,651         |       | 1,133,556                    |       | (1,339                        | )          | 12,400,868                |       |
| SBA  Pools                           |       | 1,566,519          |       | —                       |       | (23,465                       | )          | 1,543,054                 |       |
| Mutual  Fund                         |       | 1,566,379          |       | 23,438                       |       | —                        |       | 1,589,817                 |       |
|                                 |       | $                  | 48,282,394 |                         | $          | 2,738,253                     |       | $                         | (29,428    | ) | $ | 50,991,219 |   |

 

The following tables detail the gross unrealized losses and fair valuesaggregated by investment category and length of time that individual securitieshave been in a continuous unrealized loss position at March 31, 2010.

 
| ** **                             | ** ** | **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                         |       | $                       | —     |                  | $          | —          |       | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Collateralized  mortgage obligations   |       | 994,650                 |       | (4,624                | )          | —          |       | — |   | 994,650 |   | (4,624 | ) |
| Municipalities                         |       | 412,728                 |       | (1,339                | )          | —          |       | — |   | 412,728 |   | (1,339 | ) |
| SBA  Pools                             |       | —                  |       | —                |       | 1,537,456       |       | (23,465 | ) | 1,537,456 |   | (23,465 | ) |
| Asset  Backed Securities               |       | —                  |       | —                |       | —          |       | — |   | — |   | — |   |
| Total  temporarily impaired securities |       | $                       | 1,407,378  |                  | $          | (5,963          | )          | $ | 1,537,456 |   | $ | (23,465 | ) | $ | 2,944,834 |   | $ | (29,428 | ) |

 

At March 31, 2010, atotal of two SBA pools make up the total amount of securities in an unrealizedloss position for greater than 12 months. Management periodically evaluates each available-for-sale investmentsecurity in an unrealized loss position to determine if the impairment is temporaryor other than temporary.  Management hasdetermined that no investment security is other than temporarily impaired. Theunrealized losses are due solely to interest rate changes and the Bank does notintend to sell the securities and it is not likely that we will be required tosell the securities before the earlier of the forecasted recovery or thematurity of the underlying investment security.

 

The amortized cost andestimated fair value of debt securities at March 31, 2010, by contractualmaturity or call date, are shown below. Expected maturities will differ fromcontractual maturities because borrowers may have the right to call or prepayobligations with or without call or prepayment penalties.

 
| ** **                             | ** ** | ** **    | ** ** | **Estimated** | ** ** |
|----------------------------------------|------------|---------------|------------|---------------|------------|
| ** **                             | ** ** | **Amortized** | ** ** | **Fair**      | ** ** |
| ** **                             | ** ** | **Cost**      | ** ** | **Value**     | ** ** |
| Available-for-sale securities:         |       |          |       |          |       |
| 3 Months or Less                       |       | $             | 510,000    |          | $          | 512,752 |   |
| Due after one year through five years  |       | 1,904,864     |       | 1,949,055     |       |
| Due after five years through ten years |       | 12,611,339    |       | 13,337,142    |       |
| Due after ten years                    |       | 33,256,191    |       | 35,192,270    |       |
|                                   |       | $             | 48,282,394 |          | $          | 50,991,219 |   |

 

The amortized cost andestimated fair values of debt securities as of December 31, 2009, are asfollows:

 

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| ** **                          | ** ** | **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-Back Security                 |       | 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 |   |
|                                     |            |                     |            |                              |            |                               |            |                 |            |  |  |  |  |

 

The following tables detail the gross unrealized losses and fair valuesaggregated by investment category and length of time that individual securitieshave been in 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 | ) |
|                                       |            |                         |            |                       |            |                 |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

At December 31,2009, two SBA pools make up the total amount of securities in an unrealizedloss position for greater than 12 months. Management periodically evaluateseach available-for-sale investment security in an unrealized loss position todetermine if the impairment is temporary or other than temporary. Managementhas determined that no investment security is other than temporarily impaired.The unrealized losses are due solely to interest rate changes and the Bank doesnot intend to sell the securities and it is not likely that we will be requiredto sell the securities before the earlier of the forecasted recovery or thematurity of the underlying investment security.

 

There were no realizedgains or losses on sales of available-for-sale securities during 2010 and 2009,however the Company did recognize a gain of $55,838 and $35,826 for the threemonth periods ended March 31, 2010 and 2009, respectively, on certainavailable-for-sale securities that were partially called. There were no othersales of available-for-sale securities during 2010 and 2009.

 

Securities carried at$42,446,448 and $34,545,513 at March 31, 2010 and December 31, 2009,respectively, were pledged to secure deposits of public funds.

 

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**NOTE 4 –LOANS**

 

Loan totals were asfollows:

 
| ** **                            | ** ** | **MARCH 31,** | ** **  | **DECEMBER 31,** | ** ** |
|---------------------------------------|------------|--------------------|-------------|------------------|------------|
| ** **                            | ** ** | **2010**           | ** **  | **2009**         | ** ** |
| Loans                                 |       |               |        |             |       |
| Commercial  real estate               |       | $                  | 279,260,247 |             | $          | 283,387,329 |   |
| Commercial                            |       | 34,933,957         |        | 38,159,590       |       |
| Real  estate construction             |       | 48,139,839         |        | 52,951,968       |       |
| Agriculture                           |       | 27,152,734         |        | 29,659,656       |       |
| Residential  real estate and consumer |       | 21,526,550         |        | 21,468,468       |       |
| Total  loans                          |       | 411,013,327        |        | 425,627,011      |       |
| Less:                                 |       |               |        |             |       |
| Deferred  loan fees and costs, net    |       | (747,725           | )           | (811,103         | )          |
| Allowance  for loan losses            |       | (6,762,255         | )           | (7,020,222       | )          |
|                                  |       |               |        |             |       |
| Net  loans                            |       | $                  | 403,503,347 |             | $          | 417,795,686 |   |

 

Changes in the allowancefor loan losses were as follows:

 
| ** **                       | ** ** | **MARCH 31,** | ** ** | **DECEMBER 31,** | ** ** |
|----------------------------------|------------|--------------------|------------|------------------|------------|
| ** **                       | ** ** | **2010**           | ** ** | **2009**         | ** ** |
|                             |       |               |       |             |       |
| Balance,  beginning of year      |       | $                  | 7,020,222  |             | $          | 5,569,496 |   |
| Provision  charged to operations |       | 1,005,000          |       | 5,862,012        |       |
| Loans  charged off               |       | (1,263,862         | )          | (4,419,335       | )          |
| Loan  recoveries                 |       | 895                |       | 8,049            |       |
|                             |       |               |       |             |       |
| Balance,  end of period          |       | $                  | 6,762,255  |             | $          | 7,020,222 |   |

 

The total recordedinvestment in impaired loans at March 31, 2010, was $12,368,210 which hada loan loss reserve of $892,723.  The totalrecorded investment in impaired loans at December 31, 2009, was$14,418,204 which had a loan loss reserve of $1,256,329.  No interest income was recognized on impairedloans, while considered impaired during 2010 and 2009.  As of March 31,2010, we had undisbursed funding commitments on ****one**** impaired loan to ****one****borrower totaling $359,579 with a maturity date of ****October 2010******.**

 

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**OAKVALLEY BANCORP**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 5 –OTHER REAL ESTATE OWNED**

 

As of March 31,2010, eight loans with outstanding balances of $2,456,401 were reclassified toother real estate owned, as compared to six loans with outstanding balances of$2,149,514 as of December 31, 2009.

 

Real estate propertiesacquired through, or in lieu of, loan foreclosure are to be sold and areinitially recorded at the lower of carrying amount of the loan or fair value ofthe property at the date of foreclosure less selling costs.  Subsequent toforeclosure, valuations are periodically performed and any subject revisions inthe estimate of fair value are reported as adjustment to the carrying value ofthe real estate, provided the adjusted carrying amount does not exceed theoriginal amount at foreclosure.  Revenues and expenses from operations andchanges in the valuation allowance are included in other operating expenses.

 

**NOTE 6– OTHERPOST-RETIREMENT BENEFIT PLANS**

 

During January 2008,the Bank awarded certain officers a salary continuation plan (the “Plan”).  Under the Plan, the participants will beprovided with a fixed annual retirement benefit for twenty years afterretirement. The Bank is also responsible for certain pre-retirement deathbenefits under the Plan. In connection with the implementation of the Plan, theBank purchased single premium life insurance policies on the life of each ofthe officers covered under the Plan. The Bank is the owner and partial beneficiaryof these life insurance policies. The assets of the Plan, under InternalRevenue Service regulations, are owned by the Bank and are available to satisfythe Bank’s general creditors.

 

During January 2008the Bank awarded two of its directors a director retirement plan (“DRP”). Underthe DRP, the participants will be provided with a fixed annual retirementbenefit for ten years after retirement. The Bank is also responsible forcertain pre-retirement death benefits under the DRP. In connection with theimplementation of the DRP, the Bank purchased single premium life insurancepolicies on the life of each director covered under the DRP. The Bank is theowner and partial beneficiary of these life insurance policies. The assets ofthe DRP, under Internal Revenue Service regulations, are the property of theBank and are available to satisfy the Bank’s general creditors.

 

Future compensation underboth plans is earned for services rendered through retirement. The Bank accruesfor the salary continuation liability based on anticipated years of service andvesting schedules provided under the plans. The Bank’s current benefitliability is determined based on vesting and the present value of the benefitsat a corresponding discount rate. The discount rate used is an equivalent ratefor investment-grade bonds with lives matching those of the service periodsremaining for the salary continuation contracts, which average approximately20 years.

 

During January 2008,the Bank purchased $4.7 million in bank owned life insurance policies andentered into split-dollar life insurance agreements with certain officers anddirectors.  In connection with theimplementation of the split-dollar agreements, the Bank purchased single premiumlife insurance policies on the life of each of the officers and directorscovered by the split-dollar life insurance agreements. The Bank is the owner ofthe policies and the partial beneficiary in an amount equal to the cashsurrender value of the policies.

 

The combined cashsurrender value of all Bank-owned life insurance policies recorded in otherassets on the balance sheet was $10,371,848 and $10,267,862 at March 31,2010 and December 31, 2009, respectively.

 

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

 

**Fairvalues of financial instruments —** The financial statements include various estimatedfair value information as of March 31, 2010 and December 31, 2009.Such information, 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, andsubjective considerations, which vary widely among different financialinstitutions and which are subject to change. The following methods and assumptionsare used by the Bank.

 

*Cashand 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 quotedmarket prices, where available. If quoted market prices are not available, fairvalues are based on quoted market prices of comparable instruments.

 

*Loansreceivable* — Forvariable-rate loans that reprice frequently and have no significant change incredit risk, fair values are based on carrying values. The fair values forother loans (e.g., real estate construction and mortgage, commercial, andinstallment loans) are estimated using discounted cash flow analyses, usinginterest rates currently being offered for loans with similar terms toborrowers of similar credit quality.

 

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*Depositliabilities* — Thefair values estimated for demand deposits (interest and non-interest checking,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.

 

*FederalHome Loan Bank (FHLB) advances* — Rates currently available to the Bank forborrowings with similar terms and remaining maturities are used to estimate thefair value of the existing debt.

 

*Accruedinterest* — Thecarrying amounts of accrued interest approximate their fair value.

 

*Off-balance-sheetinstruments* —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.

 

The estimated fair valuesof the Bank’s financial instruments at March 31, 2010 are as follows:

 
| ** **                                   | ** ** | ** **   | ** ** | **Estimated** | ** ** |
|----------------------------------------------|------------|--------------|------------|---------------|------------|
| ** **                                   | ** ** | **Carrying** | ** ** | **Fair**      | ** ** |
| ** **                                   | ** ** | **Amount**   | ** ** | **Value**     | ** ** |
| **Financial assets:**                        | ** ** | ** **   | ** ** | ** **    | ** ** |
| Cash and cash equivalents                    |       | $            | 30,460,896 |          | $          | 30,460,896 |   |
| Securities available for sale                |       | 50,991,219   |       | 50,991,219    |       |
| Loans                                        |       | 411,013,327  |       | 417,224,529   |       |
| Accrued interest receivable                  |       | 1,750,505    |       | 1,750,505     |       |
|                                         |       |         |       |          |       |
| **Financial liabilities:**                   |       |         |       |          |       |
| Deposits                                     |       | (431,624,097 | )          | (426,222,688  | )          |
| FHLB advance                                 |       | (24,300,000  | )          | (24,463,725   | )          |
| Accrued interest payable                     |       | (296,230     | )          | (296,230      | )          |
|                                         |       |         |       |          |       |
| **Off-balance-sheet assets  (liabilities):** |       |         |       |          |       |
|                                         |       |         |       |          |       |
| Commitments and standby letters of credit    |       |         |       | (560,705      | )          |
|                                              |            |              |            |               |            |  |  |

 

The estimated fair valuesof 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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**OAKVALLEY BANCORP**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

Fair Value Measurementsdefines fair value, establishes a framework for measuring fair value,establishes a three-level valuation hierarchy for disclosure of fair valuemeasurement and enhances disclosure requirements for fair value measurements.The valuation hierarchy is based upon the transparency of inputs to thevaluation of an asset or liability as of the measurement date. The three levelsare defined as follow:

 

Level 1:  Inputs tothe valuation methodology are quoted prices (unadjusted) for identical assetsor liabilities in active markets.

Level 2:  Inputs tothe valuation methodology include quoted prices for similar assets andliabilities in active markets and inputs that are observable for the asset orliability, either directly or indirectly, for substantially the full term ofthe financial instrument.

Level 3:  Inputs tothe valuation methodology are unobservable and significant to the fair valuemeasurement.

 

In certain cases, theinputs used to measure fair value may fall into different levels of the fairvalue hierarchy.  In such cases, the level in the fair value hierarchywithin which the fair value measurement in its entirety falls has beendetermined based on the lowest level input that is significant to the fairvalue 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.

 

Assets and liabilitiesmeasured at fair value on a recurring and non-recurring basis are summarizedbelow:

 
| ** **                                                 | ** ** | **Fair Value Measurements at March 31,  2010** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **March 31,  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                                              |       | $                                                                       | 29,475,777 |   | $ |   |   | $ | 29,475,777 |   | $ |   |   |
| Collateralized mortgage obligations                        |       | $                                                                       | 2,883,988  |   | $ |   |   | $ | 2,883,988 |   | $ |   |   |
| Municipalities                                             |       | $                                                                       | 12,327,922 |   | $ |   |   | $ | 12,327,922 |   | $ |   |   |
| SBA Pools                                                  |       | $                                                                       | 1,588,867  |   | $ |   |   | $ | 1,588,867 |   | $ |   |   |
| Asset-Back Security                                        |       | $                                                                       | 81,867     |   | $ |   |   | $ | 81,867 |   | $ |   |   |
| Mutual Fund                                                |       | $                                                                       | 1,546,465  |   | $ |   |   | $ | 1,546,465 |   | $ |   |   |
|                                                       |       |                                                                    |       |   |   |   |   |   |   |
| Assets and liabilities measured on a non-recurring  basis: |       |                                                                    |       |   |   |   |   |   |   |
| Impaired Loans                                             |       | $                                                                       | 6,830,416  |   | $ | — |   | $ | — |   | $ | 6,830,416 |   |
| Other real estate owned                                    |       | $                                                                       | 2,456,401  |   | $ | — |   | $ | — |   | $ | 2,456,401 |   |

 
| ** **                                                 | ** ** | **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                              |       | $                                                                              | 50,765,314 |   | $ | — |   | $ | 50,765,314 |   | $ | — |   |
|                                                       |       |                                                                           |       |   |   |   |   |   |   |
| 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 |   |

 

The fair value ofsecurities available for sale equals quoted market price, if available. If quoted market prices are not available, fair value is determined usingquoted market prices for similar securities.  Changes in fair market valueare recorded in other comprehensive income net of tax.

 

The fair valuemeasurement applies to impaired loans, which includes impaired loans measuredat an observable market price (if available), or at the fair value of the loan’scollateral (if the loan is collateral dependent). Fair value of the loan’scollateral, 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 March 31,2010, impaired loans that had a specific loan loss reserve had a principalbalance of $7,723,139, with a

 

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valuation allowance of$892,723.  Upon being classified asimpaired, either a charge off or a specific reserve or both may be taken toreduce the balance of each loan to an estimate of the collateral fair marketvalue less cost to dispose. This estimate was a level 3 valuation.  Therewas no direct impact on the income statement.  The charge-offs wererecorded as a debit to the allowance for loan losses.

 

Fair value of other realestate owned is determined by appraisals or independent valuation which is thenadjusted for the cost related to liquidation of the property.  Total fair market value at March 31,2010 was $2,456,401 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**

 

Earnings per share (EPS)is calculated based on the weighted average common shares outstanding during theperiod.  Basic EPS excludes dilution andis calculated by dividing net income available to common shareholders by theweighted average common shares outstanding. Diluted EPS reflects the potential dilution that could occur ifsecurities or other contracts to issue common stock were exercised or convertedinto common stock.

 
| ** **                                                                           | ** ** | **THREE MONTHS ENDED** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                           | ** ** | **MARCH 31,**               | ** ** |
| **In thousands (except share and per  share amounts)** | ** ** | **2010**                         | ** ** | **2009** | ** ** |
| BASIC EARNINGS PER SHARE                                                             |       |                             |       |   |   |
|                                                                                 |       |                             |       |   |   |
| Net income available to common shareholders                                          |       | $                                | 737,230    |   | $ | 219,899 |   |
| Weighted average shares outstanding                                                  |       | 7,681,877                        |       | 7,661,627 |   |
| Net income per common share                                                          |       | $                                | 0.10       |   | $ | 0.03 |   |
|                                                                                 |       |                             |       |   |   |
| DILUTED EARNINGS PER SHARE                                                           |       |                             |       |   |   |
|                                                                                 |       |                             |       |   |   |
| Net income available to common shareholders                                          |       | $                                | 737,230    |   | $ | 219,899 |   |
| Weighted average shares outstanding                                                  |       | 7,681,877                        |       | 7,661,627 |   |
| Effect of dilutive stock options                                                     |       | 23,611                           |       | 42,265 |   |
| Weighted average shares of common stock and common  stock equivalents                |       | 7,705,488                        |       | 7,703,892 |   |
| Net income per diluted common share                                                  |       | $                                | 0.10       |   | $ | 0.03 |   |

 

During the three monthperiod ended March 31, 2010, anti-dilutive weighted average options topurchase 240,187 shares of common stock with prices ranging from $4.58 to$15.67 were outstanding.   Anti-dilutive weighted average options of242,963 were outstanding during the same three month period of 2009 with pricesranging from $5.20 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 in2013.  In addition, weighted averagewarrants of 350,346 issued to the U.S. Treasury Capital Purchase Program wereanti-dilutive for the three-month periods of 2010 and 2009, as the price of$5.78 was more than the average market price of common shares.

 

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**Item2.   Management’s Discussion and Analysis of Financial Condition andResults of Operations**

 

The following discussionexplains the significant factors affecting our operations and financialposition for the periods presented. The discussion should be read inconjunction with our financial statements and the notes related thereto whichappear or that are referenced to elsewhere in this report, and with the auditedconsolidated financial statements and accompanying notes included in our 2009Annual Report on Form 10-K, as amended.

 

**Forward-LookingStatements**

 

*Somematters discussed in this Form 10-Q may be “forward-looking statements”within the meaning of the Private Litigation Reform Act of 1995 and thereforemay involve risks, uncertainties and other factors which may cause our actualresults to be materially different from the results expressed or implied by ourforward-looking statements.  These statements generally appear with wordssuch as “anticipate,” “believe,” “estimate,” “may,” “intend,” and “expect.” Although management believes that the assumptions and expectations reflected insuch forward-looking statements are reasonable, it can give no assurance thatsuch expectations will prove to be correct.  Factors that could causeactual results to differ from results discussed in forward-looking statementsinclude, but are not limited to: economic conditions (both generally and in themarkets where the Bank operates); competition from other providers of financialservices offered by the Bank; government regulation and legislation; changes ininterest rates; material unforeseen changes in the financial stability andliquidity of the Bank’s credit customers;*risks associated with concentrations in real estaterelated loans; changes in accounting standards and interpretations*; and other risks as may be detailed from time totime in the Company’s filings with the Securities and Exchange Commission, allof which are difficult to predict and which may be beyond the control of theCompany or the Bank.  The Company undertakes no obligation to reviseforward-looking statements to reflect events or changes after the date of thisdiscussion or to reflect the occurrence of unanticipated events.*

 

**CriticalAccounting Estimates**

 

The discussion andanalysis of our financial condition and results of operations is based upon ourfinancial statements, which have been prepared in accordance with accountingprinciples generally accepted in the United States of America. The preparationof these financial statements requires management to make estimates andjudgments that affect the reported amounts of assets and liabilities, revenuesand expenses, and related disclosures of contingent assets and liabilities atthe date of our financial statements. Actual results may differ from theseestimates under different assumptions or conditions.

 

*Allowancefor Loan Losses*

 

Accounting for allowancefor loan losses involves significant judgment and assumptions by management andis based on historical data and management’s view of the current economicenvironment. 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.

 

We base our allowance forloan losses on an estimation of probable losses inherent in our loan portfolio.Our methodology for assessing loan loss allowances are intended to reduce thedifferences between estimated and actual losses and involves a detailedanalysis of our loan portfolio in three phases:

 

· the specific review of individual loans,

 

· the segmenting and review of loan poolswith similar characteristics and,

 

· our judgmental estimate based on varioussubjective factors.

 

The first phase of ourmethodology involves the specific review of individual loans to identify andmeasure impairment. We evaluate each loan by use of a risk rating system,except for homogeneous loans, such as automobile loans and home mortgages.Specific risk rated loans are deemed impaired if all amounts, includingprincipal and interest, will likely not be collected in accordance with thecontractual terms of the related loan agreement. Impairment for commercial andreal estate loans is measured either based on the present value of the loan’sexpected future cash flows or, if collection on the loan is collateraldependent, the estimated fair value of the collateral, less selling and holdingcosts.

 

The second phase involvesthe segmenting of the remainder of the risk rated loan portfolio into groups orpools of loans, together with loans with similar characteristics, forevaluation. We determine the calculated loss ratio to each loan pool based onits historical net losses and benchmark it against the levels of other peerbanks.

 

In the third phase, weconsider relevant internal and external factors that may affect thecollectibility of loan portfolio and each group of loan pool. The factorsconsidered are, but are not limited to:

 

· concentration of credits,

 

· nature and volume of the loan portfolio,

 

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· 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 includingregulatory review.

 

Our management estimatesthe probable effect of such conditions based on our judgment, experience andknown or anticipated trends. Such estimation may be reflected as an additionalallowance to each group of loans, if necessary. Management reviews theseconditions with our senior credit officers. To the extent that any of theseconditions is evidenced by a specifically identifiable problem credit orportfolio segment as of the evaluation date, management’s estimate of theeffect of such condition may be reflected as a specific allowance applicable tosuch credit or portfolio segment. Where any of these conditions is notevidenced by a specific, identifiable problem credit or portfolio segment as ofthe evaluation date, management’s evaluation of the inherent loss related tosuch condition is reflected in the unallocated allowance.

 

Central to our creditrisk management and our assessment of appropriate loss allowance is our loanrisk rating system. Under this system, the originating credit officer assignsborrowers an initial risk rating based on a thorough analysis of each borrower’sfinancial capacity in conjunction with industry and economic trends. Approvalsare made based upon the amount of inherent credit risk specific to thetransaction and are reviewed for appropriateness by senior line and creditadministration 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-AccrualLoan Policy*

 

Interest on loans iscredited to income as earned and is accrued only if deemed collectible. Accrualof interest is discontinued when a loan is over 90 days delinquent or ifmanagement believes that collection is highly uncertain. Generally, paymentsreceived on nonaccrual loans are recorded as principal reductions. Interestincome is recognized after all principal has been repaid or an improvement inthe condition of the loan has occurred that would warrant resumption ofinterest accruals.

 

*Stock-BasedCompensation*

 

The Company recognizes inthe income statement the grant-date fair value of stock options and otherequity-based forms of compensation issued to employees over the employees’requisite service period (generally the vesting period).  The Bank usesthe straight-line recognition of expenses for awards with graded vesting. The Bank utilizes a binomial pricing model for all grants.  Expected volatility is based on thehistorical volatility of the price of the Bank’s stock for the period equal tothe contractual stock option term. The Bank uses historical data to estimateoption exercise and stock option forfeiture rates within the valuation model.The expected term of options granted for the binomial model is derived fromapplying a historical suboptimal exercise factor to the contractual term of thegrant. For binomial pricing, the risk-free rate for periods is equal to theU.S. Treasury yield at the time of grant and commensurate with the contractualterm of the grant.

 

*OtherReal Estate Owned*

 

Other real estate owned,which represents real estate acquired through foreclosure, or deed in lieu offoreclosure in satisfaction of commercial and real estate loans, is carried atthe lower of cost or estimated fair value less the estimated selling costs ofthe real estate. The fair value of the property is based upon a currentappraisal. The difference between the fair value of the real estate collateraland the loan balance at the time of transfer is recorded as a loan charge offif fair value is lower. Subsequent to foreclosure, management periodicallyperforms valuations and the OREO property is carried at the lower of carryingvalue or fair value, less costs to sell. The  determination of a property’s estimated fairvalue incorporates (1) revenues projected to be realized from disposal ofthe property, (2) construction and renovation costs, (3) marketing andtransaction costs, and (4) holding costs (e.g., property taxes, insuranceand homeowners’ association dues). Any subsequent declines in the fair value ofthe OREO property after the date of transfer are recorded 

 

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through a write-down ofthe asset. Any subsequent operating expenses or income, reduction in estimatedfair values, and gains or losses on disposition of such properties are chargedor credited to current operations.

 

**Introduction**

 

Oak Valley Community Bankcommenced operations in May 1991.  We are an insured bank under theFederal Deposit Insurance Act and are a member of the Federal Reserve. Since its formation, the Bank has provided basic banking services toindividuals and business enterprises in Oakdale, California and the surroundingareas. The focus of the Bank is to offer a range of commercial banking servicesdesigned for both individuals and small to medium-sized businesses in the twomain areas of service 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 otherservices for both individuals and businesses including online banking, remotedeposit capture, 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.

 

Effective July 3,2008, Oak Valley Community Bank became a subsidiary of Oak Valley Bancorp, anewly established bank holding company. Oak Valley Bancorp operates Oak ValleyCommunity Bank as a community bank in the general commercial banking business,with our primary market encompassing the California Central Valley aroundOakdale and Modesto, and the Eastern Sierras. As such, unless otherwise noted,all references are about Oak Valley Bancorp.

 

**Overviewof Results of Operations and Financial Condition**

 

The purpose of thissummary is to provide an overview of the items management focuses on whenevaluating the condition of the Company and its success in implementing itsbusiness and shareholder value strategies. The Company’s business strategy isto operate the Bank as a well-capitalized, profitable and independent communityoriented bank.  The Company’s shareholders value strategy has threemajor themes: (1) enhancing shareholders’ value; (2) making itsretail banking franchise more valuable; and (3) efficiently utilizing itscapital.

 

Management believes thefollowing were important factors in the Company’s performance during thequarter March 31, 2010:

 

·                  Thanks to our deep roots in the communities that weserve, our focus on customer care and our selectivity in lending, during thefirst three months of 2010, our performance has been better than mostinstitutions of our size that compete in our market.  Despite the severity of the recessionaffecting our primary market areas, we have been able to increase our coredeposits to $386.3 million and have posted net income per common share of$0.10.

 

·                  While recently published economic data indicate thatthe current downturn may be easing, it is not clear when or at what speed therecession will end. To the extent that the recession continues, it will affectthe market areas that we serve and our results accordingly.

 

·                  The Company recognized net income available to commonshareholders of $737,000 for the three month period ended March 31, 2010as compared with net income available to common shareholders of $220,000 forthe same period in 2009.  The Company recognized net income beforepreferred stock dividends and accretion of $948,000 for the first quarter of2010.  The factors contributing to theseresults will be discussed below.

 

·                  The Company recognized $210,000 in the first quarterof 2010 and 2009 associated with the accrual for preferred stock dividends andaccretion of the preferred stock discount in connection with the 13,500 sharesof Series A Preferred Stock that the U.S. Treasury purchased from theCompany in December 2008 under the TARP Program. So long as such preferredstock remains outstanding, it will pay quarterly cumulative dividends at a rateof 5% per year for the first five years and thereafter at a rate of 9% peryear.

 

·                  The Company has taken significant steps to reduce therisk of loan losses.   In the three month period ended March 31,2010, the provision for loan loss was $1,005,000 which was a decrease of$895,000 compared to the first quarter of 2009 but an increase of $105,000 and$80,000 over the prior two quarters (4th and 3rd quarter of 2009, respectively).  These increases were mainly due to management’sassessment of the appropriate level for the allowance for loan losses and anincrease in the level of non-accrual loans. The Company continues to monitorits loan portfolio with the objective of avoiding defaults orwrite-downs.  Despite these actions, the possibility of additionallosses can not be eliminated, but the Board of Directors and

 

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all employees continue towork hard to make the best of these continuing challenging conditions.

 

·                  Net interest income increased $404,000 or 7.1% for thethree month period ended March 31, 2010, compared to the same period in2009.  This increase was primarily due to the net interest margin increaseof 36 basis points, which was offset by a decrease in average earning assets of$2.7 million for the three month periods ended March 31, 2010, as comparedto the same period 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.

 

·                  For the three month period ended March 31, 2010,non-interest income increased by $48,000 or 8.1% from the same period in2009.  The increase was primarily due toan increase in other income which included the gain on called securities, whichwas partially offset by a decrease in NSF fee income and mortgage commissionsas described below.

 

·                  Non-interest expense increased by $507,000 or 12.9%for the three month period ended March 31, 2010, as compared to the sameperiod in 2009, primarily due to write downs of OREO property values, increasedFDIC Assessments and increased salaries and benefits as described below.

 

·                  Total assets decreased $4.4 million or 0.8% from December 31,2009.  Total net loans decreased by $14.3 million or 3.4% and investmentsecurities increased by $0.2 million or 0.4% from December 31, 2009 to March 31,2010, while deposits increased by $2.4 million or 0.6%.

 

**IncomeSummary**

 

For the three monthperiod ended March 31, 2010, the Company recorded net income available tocommon shareholders of $737,000, an increase of $517,000 for the quarter, ascompared to $220,000 for the same period in 2009.  Return on averageassets (annualized) was 0.75% for the first quarter of 2010, as compared with0.34% for the same period in 2009.  Annualized return on average commonequity was 6.22% for the first quarter of 2010, as compared to 1.97% for thesame period of 2009.

 

Net income beforeprovisions for income taxes and preferred stock dividends and accretion was up$840,000 for the first quarter of 2010 from the comparable 2009 period. The income statement components of these variances are as follows:

 

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

***(In thousands)***

*** ***
| ** **                           | ** ** | **Effect on Pre-Tax  Income** | ** ** |
|--------------------------------------|------------|-------------------------------|------------|
| ** **                           | ** ** | **Increase (Decrease)**       | ** ** |
| ** **                           | ** ** | **Three Months**         | ** ** |
| Change from 2008 to 2009 in:         | ** ** | ** **                    | ** ** |
| Net interest income                  |       | $                             | 404,000    |   |
| Provision for loan losses            |       | 895,000                       |       |
| Non-interest income                  |       | 48,000                        |       |
| Non-interest expense                 |       | (507,000                      | )          |
| Change in income before income taxes |       | $                             | 840,000    |   |

 

These variances will beexplained in the discussion below.

 

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**NetInterest Income**

 

Net interest income isthe largest source of the Bank’s operating income.  For the three monthperiod ended March 31, 2010, net interest income was $6.06 million, whichrepresented an increase of $404,000 or 7.1% from the comparable period in 2009.

 

The net interest margin(net interest income as a percentage of average interest earning assets) was5.22% for the three month period ended March 31, 2010, an increase of 36basis points as compared to the same period in 2009.  The increase in thenet interest margin in 2010 was primarily attributable to the impact that thedecline in market interest rates had on our liability sensitive balance sheetwhich caused interest-bearing liabilities to decrease faster than the yields onearning assets.  The total cost of fundsdecreased 58 basis points in the first quarter 2010 compared to 2009 due to ashift from high cost CDs and FHLB borrowed funds into money market accountswhich realized the highest rate decrease of 68 basis points.  The decrease in our earning asset yield wasminimal at only 14 basis points, partly due to the portion of our loanportfolio that was at the contractual rate floors.  Yield on loans remained relatively flat at6.24% for the first quarter 2010 versus 6.23% in the first quarter of 2009.

 

The following tablesshows the relative impact of changes in average balances of interest earningassets and interest bearing liabilities, and interest rates earned and paid bythe Company on those assets and liabilities for the three and nine monthperiods ended March 31, 2010 and 2009:

 

***Net Interest Analysis***

*(Dollarsin thousands)*

* *
| ** **                                       | ** ** | **Three months ended** | ** ** | **Three months ended**     | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|--------------------------------------|------------|
| ** **                                       | ** ** | **March 31, 2010**     | ** ** | **March 31, 2009**         | ** ** |
| ** **                                       | ** ** | **Average  Balance**             | ** ** | **Interest  Income /  Expense** | ** ** | **Avg  Rate/  Yield** | ** ** | **Average  Balance** | ** ** | **Interest  Income /  Expense** | ** ** | **Avg  Rate/  Yield** | ** ** |
| **Assets:**                                      |       |                             |       |                                 |       |   |   |   |   |   |   |   |   |
| Earning  assets:                                 |       |                             |       |                                 |       |   |   |   |   |   |   |   |   |
| Gross  loans (1) (2)                        |       | $                                | 419,029    |                                 | $          | 6,452 |   | 6.24 | % | $ | 429,860 |   | $ | 6,604 |   | 6.23 | % |
| Investment  securities (2)                       |       | 47,055                           |       | 651                                  |       | 5.61 | % | 46,999 |   | 698 |   | 6.11 | % |
| Federal  funds sold                              |       | 2,936                            |       | 2                                    |       | 0.22 | % | 1,383 |   | 1 |   | 0.27 | % |
| Interest-earning  deposits                       |       | 8,066                            |       | 4                                    |       | 0.22 | % | 1,525 |   | 1 |   | 0.21 | % |
| Total  interest-earning assets                   |       | 477,086                          |       | 7,109                                |       | 6.04 | % | 479,767 |   | 7,304 |   | 6.18 | % |
| Total  noninterest earning assets                |       | 38,237                           |       |                                 |       |   |   | 37,768 |   |   |   |   |   |
| Total  Assets                                    |       | 515,323                          |       |                                 |       |   |   | 517,535 |   |   |   |   |   |
| **Liabilities and Shareholders’ Equity:**   |       |                             |       |                                 |       |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                   |       |                             |       |                                 |       |   |   |   |   |   |   |   |   |
| Money  market deposits                           |       | 208,710                          |       | 453                                  |       | 0.88 | % | 163,514 |   | 628 |   | 1.56 | % |
| NOW  deposits                                    |       | 57,817                           |       | 48                                   |       | 0.34 | % | 53,950 |   | 75 |   | 0.56 | % |
| Savings  deposits                                |       | 14,429                           |       | 16                                   |       | 0.46 | % | 13,595 |   | 34 |   | 1.02 | % |
| Time  certificates of deposit $100,000 or more   |       | 30,247                           |       | 172                                  |       | 2.30 | % | 41,964 |   | 287 |   | 2.77 | % |
| Other  time deposits                             |       | 48,528                           |       | 181                                  |       | 1.51 | % | 51,450 |   | 301 |   | 2.37 | % |
| Other  borrowings                                |       | 24,599                           |       | 98                                   |       | 1.62 | % | 70,075 |   | 229 |   | 1.32 | % |
| Total  interest-bearing liabilities              |       | 384,330                          |       | 968                                  |       | 1.02 | % | 394,548 |   | 1,554 |   | 1.60 | % |
| Noninterest-bearing  liabilities:                |       |                             |       |                                 |       |   |   |   |   |   |   |   |   |
| Noninterest-bearing  deposits                    |       | 66,706                           |       |                                 |       |   |   | 61,285 |   |   |   |   |   |
| Other  liabilities                               |       | 2,734                            |       |                                 |       |   |   | 2,928 |   |   |   |   |   |
| Total  noninterest-bearing liabilities           |       | 69,440                           |       |                                 |       |   |   | 64,213 |   |   |   |   |   |
| Shareholders’  equity                       |       | 61,553                           |       |                                 |       |   |   | 58,774 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity |       | $                                | 515,323    |                                 |       |   |   |   | $ | 517,535 |   |   |   |   |   |
| Net  interest income                             |       |                             |       | $                                    | 6,141      |   |   |   |   |   | $ | 5,750 |   |   |   |
| Net  interest spread (3)                         |       |                             |       |                                 |       | 5.02 | % |   |   |   |   | 4.59 | % |
| Net  interest margin (4)                         |       |                             |       |                                 |       | 5.22 | % |   |   |   |   | 4.86 | % |

 

----

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

 

*(2) *Yields on municipal securities and loanshave been adjusted to their fully-taxable equivalents, based on a federalmarginal tax rate of 34.0%.

 

*(3) *Represents the average rate earned oninterest-earning assets less the average rate paid on interest-bearingliabilities.

 

*(4) *Represents net interest income as apercentage of average interest-earning assets.

 

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Shown in the followingtables are the relative impacts on net interest income of changes in theaverage outstanding balances (volume) of earning assets and interestbearing liabilities and the rates earned and paid by the Company on thoseassets and liabilities for the three month period ended March 31, 2010 and2009.  Changes in interest income and expense that are not attributablespecifically to either rate or volume are allocated to the rate column below.

 

***Rate / Volume Variance Analysis***

*(Inthousands)*

* *
| ** **                         | ** ** | **For the Three Months Ended  March 31,** | ** ** |
|------------------------------------|------------|------------------------------------------------|------------|
| ** **                         | ** ** | **2010 vs 2009**                               | ** ** |
| ** **                         | ** ** | **Increase (Decrease)**                        | ** ** |
| ** **                         | ** ** | **in interest income and  expense**            | ** ** |
| ** **                         | ** ** | **due to changes in:**                         | ** ** |
| ** **                         | ** ** | **Volume**                                     | ** ** | **Rate** | ** ** | **Total** | ** ** |
| **Interest income:**               |       |                                           |       |   |   |   |   |
| Gross  loans (1)                   |       | $                                              | (166       | ) | $ | 14 |   | $ | (152 | ) |
| Investment  securities             |       | 1                                              |       | (48 | ) | (47 | ) |
| Federal  funds sold                |       | 1                                              |       | 0 |   | 1 |   |
| Interest-earning  deposits         |       | 3                                              |       | 0 |   | 3 |   |
| **Total interest income**          |       | $                                              | **(161**   | **)** | $ | **(34** | **)** | $ | **(195** | **)** |
|                               |       |                                           |       |   |   |   |   |
| **Interest expense:**              |       |                                           |       |   |   |   |   |
| Money  market deposits             |       | 174                                            |       | (350 | ) | (176 | ) |
| NOW  deposits                      |       | 5                                              |       | (32 | ) | (27 | ) |
| Savings  deposits                  |       | 2                                              |       | (20 | ) | (18 | ) |
| Time  CD $100K or more             |       | (80                                            | )          | (35 | ) | (115 | ) |
| Other  time deposits               |       | (17                                            | )          | (103 | ) | (120 | ) |
| Other  borrowings                  |       | (148                                           | )          | 18 |   | (130 | ) |
| **Total interest expense**         |       | $                                              | **(64**    | **)** | $ | **(522** | **)** | $ | **(586** | **)** |
| ** **                         | ** ** | ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Change in net interest  income** |       | $                                              | **(97**    | **)** | $ | **488** |   | $ | **391** |   |

 

----

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

 

The table above reflectsthe market interest rate decline has impacted liabilities slightly more thanassets as indicated by the increase of $488,000 in net interest income due tothe rate change for the three month period of 2010.  The decreased loanvolume and the overall change in mix of balances resulted in a decrease of$97,000 to net interest income.

 

**Non-InterestIncome**

 

Non-interest incomerepresents service charges on deposit accounts and other non-interest relatedcharges and fees, including fees from mortgage commissions and investmentservice fee income.  For the three month period ended March 31, 2010,non-interest income was $647,000, an increase of $48,000 or 8.1%, compared tothe same period in 2009.

 

The following table showsthe major components of non-interest income:

 

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| ** **                                          | ** ** | **For the Three Months Ended  March 31,** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                          | ** ** | **2010**                                       | ** ** | **2009** | ** ** | **$ change** | ** ** | **% change** | ** ** |
| Service  charges on deposits                        |       | $                                              | 255,640    |   | $ | 282,385 |   | $ | (26,745 | ) | (9.5 | )% |
| Earnings  on cash surrender value of life insurance |       | 103,986                                        |       | 101,057 |   | 2,929 |   | 2.9 | % |
| Mortgage  commissions                               |       | 19,127                                         |       | 42,544 |   | (23,417 | ) | (55.0 | )% |
| Other                                               |       | 267,847                                        |       | 172,323 |   | 95,524 |   | 55.4 | % |
| Total  non-interest income                          |       | $                                              | 646,600    |   | $ | 598,309 |   | $ | 48,291 |   | 8.1 | % |

 

The increase to totalnon-interest income is due in part to the gain on called securities of $56,000in the first quarter of 2010, compared to $36,000 recorded in the same periodof 2009. In addition, investment service fee income increased by $17,000 andbank debit card fees increased by $24,000 for the three month period ended March 31,2010 compared to the same period in 2009. Gain on called securities, investmentservice fee income and bank debit card fees are all included in the “otherincome” line item in the above table. Offsetting these increases was a decreasein service charges on deposits of $27,000 or 9.5% and a decrease in mortgagecommissions of $23,000 or 55.0% in the three month period ended March 31,2010, as compared to the same period in 2009. The Bank continues to expand itsofferings to the consumer and business depositor.

 

**Non-InterestExpense**

 

Non-interest expenserepresents salaries and benefits, occupancy expenses, professional expenses,outside services, and other miscellaneous expenses necessary to conductbusiness.

 

The following table showsthe major components of non-interest expenses:

 
| ** **                         | ** ** | **For the Three Months Ended  March 31,** | ** ** |
|------------------------------------|------------|------------------------------------------------|------------|
| ** **                         | ** ** | **2010**                                       | ** ** | **2009** | ** ** | **$ change** | ** ** | **% change** | ** ** |
| Salaries  and employee benefits    |       | $                                              | 2,190,328  |   | $ | 2,049,884 |   | $ | 140,444 |   | 6.9 | % |
| Occupancy  expenses                |       | 681,508                                        |       | 695,398 |   | (13,890 | ) | (2.0 | )% |
| Data  processing fees              |       | 236,533                                        |       | 218,516 |   | 18,017 |   | 8.2 | % |
| OREO  expenses                     |       | 347,800                                        |       | 125,029 |   | 222,771 |   | 178.2 | % |
| Assessments  (FDIC & DFI) |       | 258,000                                        |       | 137,961 |   | 120,039 |   | 87.0 | % |
| Other  operating expenses          |       | 731,090                                        |       | 711,519 |   | 19,571 |   | 2.8 | % |
| Total  non-interest expense        |       | $                                              | 4,445,259  |   | $ | 3,938,307 |   | $ | 506,952 |   | 12.9 | % |

 

Non-interest expensesincreased by $507,000 or 12.9% for the three months ended March 31, 2010,as compared to the same period of 2009.  Salaries and employee benefitsincreased $140,000 for the three months ended March 31, 2010, as comparedto the same periods of 2009 as a result of hiring existing openpositions.  Data processing fees increased by $18,000 for the three monthperiod of 2010 as a result of an increased number of transaction accounts.

 

FDIC and DFI assessmentsincreased by $120,000 compared to the same three month period 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 new initial base assessment rates for RiskCategory 1 institutions range from twelve to sixteen basis points, on anannualized basis.  The increase of FDIC insurance in 2010 over 2009is primarily due to an increase in the industry-wide FDIC assessment rate andgrowth in our deposit level. In addition, in November 2008, we elected toparticipate in the FDIC Transaction Account Guarantee Program, which providesunlimited insurance coverage on non-interest-bearing transaction accountsdefined by the FDIC, on which we currently pay a 15 basis point surcharge per$100 covered balances in excess of $250 thousand through June 30, 2010, atwhich time the program expires.

 

OREO expenses were$348,000 in the first quarter of 2010, compared to $125,000 for the comparableperiod of 2009. These expenses resulted from various overhead costs and marketvalue write downs associated with the eight properties classified as other realestate owned.

 

Management anticipatesthat noninterest expense will continue to increase as we continue togrow.  However, management remains committed to cost-control andefficiency, and we expect to keep these increases to a minimum relative togrowth.

 

**IncomeTaxes**

 

Provision for incometaxes for the first quarter of 2010 was $309,000, an increase of $323,000compared to the tax benefit of $14,000 in the same period of 2009. Theeffective tax rates of 24.6% and -3.3% for the first quarter of 2010 and 2009,respectively, are considerably lower compared to some of our peers and ourhistorical tax rates, and are disproportional compared to pre-tax incomeassuming marginal

 

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tax rates or historicaleffective tax rates are applied to pre-tax income. This is primarily due to taxcredits 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 taxcredits and deductions are recognized by the Company regardless of the amountof pre-tax income or loss, which further increases the tax benefit andexaggerates the effective tax rates.

 

**AssetQuality**

 

Nonperforming assetsconsist of loans on non-accrual status, loans 90 days or more past due andstill accruing interest, loans restructured, where the terms of repayment havebeen renegotiated resulting in a reduction or deferral of interest orprincipal, and other real estate owned (“OREO”).

 

Loans are generallyplaced on non-accrual status when they become 90 days past due, unlessmanagement believes the loan is adequately collateralized and in the process ofcollection. The past due loans may or may not be adequately collateralized, butcollection efforts are continuously pursued. Loans may be restructured bymanagement when a borrower has experienced some changes in financial status,causing an inability to meet the original repayment terms, and where we believethe borrower will eventually overcome those circumstances and repay the loan infull. OREO consists of properties acquired by foreclosure or similar means andwhich management intends to offer for sale.

 

Non-accrual loans totaled$12.4 million at March 31, 2010, as compared to $14.4 million at December 31,2009.  The non-accrual loans as of March 31, 2010 are loans made tonine borrowers primarily for purposes of real estate construction andcommercial real estate.

 

OREO totaled $2.5 millionas of March 31, 2010 and consists of eight properties that were acquiredthrough foreclosure including residential land lots and a commercial realestate property.

 

The following tablepresents information about the Company’s non-performing loans, including assetquality ratios as of March 31, 2010 and December 31, 2009:

 

***Non-Performing Assets***

*(inthousands)*

 
| ** **                                               | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                               | ** ** | **2010**           | ** ** | **2009**              | ** ** |
| Loans in nonaccrual status                               |       | $                  | 12,368     |                  | $          | 14,418 |   |
| Loans past due 90 days or more and accruing              |       | 30                 |       | —                |       |
| Restructured loans                                       |       | —             |       | —                |       |
| Total nonperforming loans                                |       | 12,398             |       | 14,418                |       |
| Other real estate owned                                  |       | 2,456              |       | 2,150                 |       |
| Total nonperforming assets                               |       | $                  | 14,854     |                  | $          | 16,568 |   |
|                                                     |       |               |       |                  |       |
| Allowance for loan losses                                |       | $                  | 6,762      |                  | $          | 7,020 |   |
|                                                     |       |               |       |                  |       |
| Asset quality ratios:                                    |       |               |       |                  |       |
| Non-performing assets to total assets                    |       | 2.85               | %          | 3.16                  | %          |
| Non-performing loans to total loans                      |       | 2.38               | %          | 3.39                  | %          |
| Allowance for loan losses to total loans                 |       | 1.65               | %          | 1.65                  | %          |
| Allowance for loan losses to total non-performing  loans |       | 54.54              | %          | 48.69                 | %          |

 

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

 

In anticipation of creditrisk inherent in our lending business, we routinely set aside allowancesthrough charges to earnings. Such charges are not only made for the outstandingloan portfolio, but also for off-balance sheet items, such as commitments toextend credits or letters of credit. Charges made for the outstanding loanportfolio have been credited to the allowance for loan losses, whereas chargesfor off-balance sheet items have been credited to the reserve for off-balancesheet items, which is presented as a component of other liabilities.  TheBank recorded loan loss provisions of $1,005,000 for the three month period in2010, which represented a $895,000 decrease from the provisions recorded in thesame period of 2009.

 

The allowance for loanlosses decreased by $258,000 or 3.7%, to $6.76 million at March 31,2010, as compared with $7.02 million at December 31, 2009.  TheBank recognized the decrease in the allowance for loan losses during the firstthree months of the year due to 

 

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the net loan charge-offsof $1.26 million which was offset by the loan loss provisions.  The weakbusiness climate adversely impacted the financial conditions of certain Bankclients in addition to decreases in collateral values. The decrease to theallowance for loan losses combined with the decrease in our loan portfolioresulted in having no impact on the allowance for loan losses as a percentageof total loans of 1.65% at March 31, 2010, as compared to 1.65% at December 31,2009.

 

The Bank will continue tomonitor the adequacy of the allowance for loan losses and make additions to theallowance in accordance with the analysis referred to above. Because of uncertaintiesinherent in estimating the appropriate level of the allowance for loan losses,actual results may differ from management’s estimate of credit losses and therelated allowance.

 

The following tableprovides an analysis of the changes in the ALLL for the three month periodsended March 31, 2010 and 2009:

 

***Allowance for Loan and Lease Losses***

*(dollarsin thousands)*

 
| ** **                                               | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                               | ** ** | **March 31,**               | ** ** |
| ** **                                               | ** ** | **2010**                         | ** ** | **2009** | ** ** |
| Balance  at beginning of period                          |       | $                                | 7,020      |   | $ | 5,569 |   |
| Provision  for loan losses                               |       | 1,005                            |       | 1,900 |   |
| Loans  charged off                                       |       | (1,264                           | )          | (867 | ) |
| Recoveries  of previous charge-offs                      |       | 1                                |       | 1 |   |
| Net  charge-offs                                         |       | (1,263                           | )          | (866 | ) |
| Balance  at end of period                                |       | $                                | 6,762      |   | $ | 6,603 |   |
|                                                     |       |                             |       |   |   |
| Allowance  for loan losses to total loans                |       | 1.65                             | %          | 1.53 | % |
| Net  charge-offs to average loans (annualized)           |       | 1.22                             | %          | 0.82 | % |
| Provision  for loan losses to average loans (annualized) |       | 0.97                             | %          | 1.79 | % |

 

The Bank makes provisionsfor loan losses when required to bring the total allowance for loan and leaselosses to a level deemed appropriate for the level of risk in the loanportfolio.  At least quarterly, management conducts an assessment of theoverall quality of the loan portfolio and general economic trends in the localmarket.  The determination of the appropriate level for the allowance isbased on that review, considering such factors as historical experience, thevolume and type of lending conducted, the amount of and identified potentialloss associated with specific nonperforming loans, regulatory policies, generaleconomic conditions, and other factors related to the collectibility of loansin the portfolio.

 

Although managementbelieves the allowance at March 31, 2010 was adequate to absorb probablelosses from any known and inherent risks in the portfolio, no assurance can begiven that economic conditions which adversely affect our service areas orother variables will not result in increased losses in the loan portfolio inthe future.

 

**InvestmentActivities**

 

Investments are a keysource of interest income. Management of our investment portfolio is set inaccordance with strategies developed and overseen by our Investment Committee.Investment balances, including cash equivalents and interest-bearing depositsin other financial institutions, are subject to change over time based on ourasset/liability funding needs and interest rate risk management objectives. Ourliquidity levels take into consideration anticipated future cash flows and allavailable sources of credits, and are maintained at levels management believesare appropriate to assure future flexibility in meeting anticipated fundingneeds.

 

*CashEquivalents and Interest-bearing Deposits in other Financial Institutions*

 

The Bank holds federal funds sold, unpledged available-for-salesecurities and salable government guaranteed loans to help meet liquidityrequirements and provide temporary holdings until the funds can be otherwisedeployed or invested. As of March 31, 2010, and December 31, 2009, wehad $30.5 million and $21.6 million, respectively, in cash and cashequivalents.

 

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*InvestmentSecurities*

 

Management of ourinvestment securities portfolio focuses on providing an adequate level ofliquidity and establishing an interest rate-sensitive position, while earningan adequate level of investment income without taking undue risk. Investmentsecurities 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.

 

Management has evaluatedthe investment securities portfolio to determine if the impairment of anysecurity in an unrealized loss position 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.

 

**Deposits**

 

Total deposits at March 31,2010 were $431.6 million, a $2.4 million or 0.6% increase from the deposittotal of $429.2 million at December 31, 2009.  Average depositsincreased $40.6 million to $426.4 million for the three month period ended March 31,2010 as compared to the same period in 2009. We attracted deposits due to thesafety and soundness of the Bank and our focus on customer service.

*** ***

***Deposits***

***(in thousands)***

 
| ** **       | ** ** | **March 31,** | ** **  | **December 31,** | ** ** | **Three months change** | ** ** |
|------------------|------------|--------------------|-------------|-----------------------|------------|-------------------------|------------|
| ** **       | ** ** | **2010**           | ** **  | **2009**              | ** ** | **$**                   | ** ** | **%** | ** ** |
| Demand           |       | $                  | 68,483      |                  | $          | 69,647                  |       | $ | (1,164 | ) | (1.7 | )% |
| NOW              |       | 60,564             |        | 57,378                |       | 3,186                   |       | 5.6 | % |
| MMDA             |       | 210,636            |        | 202,947               |       | 7,689                   |       | 3.8 | % |
| Savings          |       | 13,355             |        | 17,178                |       | (3,823                  | )          | (22.3 | )% |
| Time  < 100K  |       | 33,137             |        | 36,215                |       | (3,078                  | )          | (8.5 | )% |
| Time  > $100K |       | 45,449             |        | 45,845                |       | (396                    | )          | (0.9 | )% |
|             |       |               |        |                  |       |                    |       |   |   |
|             |       | $                  | **431,624** |                  | $          | **429,210**             |       | $ | **2,414** | ** ** | **0.6** | **%** |

 

Because our client baseis comprised primarily of commercial and industrial accounts, individualaccount balances are generally higher than those of consumer-oriented banks.Four of our clients carry deposit balances of more than 1% of our totaldeposits, none of which had a deposit balance of more than 3% of total depositsat March 31, 2010.

 

Since our deposit growthstrategy emphasizes core deposit growth we have avoided relying on brokereddeposits as a consistent source of funds.  The only brokered deposits theBank holds are from CDARS, a certificate of deposit program that exchangesfunds with other network banks to offer full FDIC insurance coverage to thecustomer.  The Bank had $9.7 million in brokered deposits as of March 31,2010 as compared to $11.4 million at December 31, 2009.

 

**Borrowings**

 

Although deposits are theprimary source of funds for our lending and investment activities and forgeneral business purposes, we may obtain advances from the Federal Home LoanBank of San Francisco (“FHLB”) as an alternative to retail deposit funds. Ouroutstanding FHLB advances decreased by $7.9 million at March 31, 2010 to$24.3 million, compared to $32.2 million at December 31, 2009 due to theincrease in deposits. See “Liquidity Management” below for the details on theFHLB borrowings program.

 

**CapitalRatios**

 

We are subject to variousregulatory capital requirements administered by federal banking agencies.Failure to meet minimum capital requirements can trigger regulatory actionsthat could have a material adverse effect on our financial statements andoperations. Under capital adequacy guidelines and the regulatory framework forprompt corrective action, we must meet specific capital guidelines that rely onquantitative measures of our assets, liabilities and certain off-balance-sheetitems as calculated under regulatory accounting practices. Our capital amountsand classification are also subject to qualitative judgments by the regulatorsabout components, risk weightings, and other factors.

 

The following table showsthe Oak Valley Community Bank’s and Oak Valley Bancorp’s capital ratios, ascalculated under regulatory 

 

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guidelines, compared tothe regulatory minimum capital ratios and the regulatory minimum capital ratiosneeded to qualify as a “well-capitalized” institution at March 31, 2010and December 31, 2009:

 

***Oak Valley Community Bank Capital Ratios —***

***(dollars in thousands)***

 
| ** **                                | ** ** | ** ** | ** ** | ** **                       | ** ** | **Amount of Capital Required** | ** ** |
|-------------------------------------------|------------|------------|------------|----------------------------------|------------|-----------------------------------------------|------------|
| ** **                                | ** ** | **Actual** | ** ** | **To Be  Well-Capitalized** | ** ** | **To Be Adequately  Capitalized**   | ** ** |
| ** **                                | ** ** | **Amount** | ** ** | **Ratio**                        | ** ** | **Amount**                                    | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **As of March 31, 2010:**            |       |       |       |                             |       |                                          |       |   |   |   |   |   |   |
| Total  Capital (to Risk-Weighted Assets)  |       | $          | 65,534     |                             | 13.9       | %                                             | $          | 47,056 |   | 10 | % | $ | 37,645 |   | 8 | % |
| Tier  1 Capital (to Risk-Weighted Assets) |       | $          | 59,628     |                             | 12.7       | %                                             | $          | 28,234 |   | 6 | % | $ | 18,882 |   | 4 | % |
| Tier  1 Capital (to Average Assets)       |       | $          | 59,628     |                             | 11.6       | %                                             | $          | 25,760 |   | 5 | % | $ | 20,608 |   | 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 in thousands)***

 
| ** **                                | ** ** | ** ** | ** ** | ** **           | ** ** | **Amount of Capital Required** | ** ** |
|-------------------------------------------|------------|------------|------------|----------------------|------------|-----------------------------------------------|------------|
| ** **                                | ** ** | ** ** | ** ** | ** **           | ** ** | **To Be**                                | ** ** | **To Be Adequately** | ** ** |
| ** **                                | ** ** | **Actual** | ** ** | **Well-Capitalized** | ** ** | **Capitalized**                               | ** ** |
| ** **                                | ** ** | **Amount** | ** ** | **Ratio**            | ** ** | **Amount**                                    | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **As of  March 31, 2010**            | ** ** | ** ** | ** ** | ** **           | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total  Capital (to Risk-Weighted Assets)  |       | $          | 65,717     |                 | 14.0       | %                                             | N/A        |   | N/A |   | $ | 37,655 |   | 8 | % |
| Tier  1 Capital (to Risk-Weighted Assets) |       | $          | 59,810     |                 | 12.7       | %                                             | N/A        |   | N/A |   | $ | 18,828 |   | 4 | % |
| Tier  1 Capital (to Average Assets)       |       | $          | 59,810     |                 | 11.6       | %                                             | N/A        |   | N/A |   | $ | 20,613 |   | 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 | % |

 

**LiquidityManagement**

 

Since the Company is aholding company and does not conduct regular banking operations, its primarysources of liquidity are dividends from the Bank. Under the CaliforniaFinancial Code, payment of a dividend from the Bank to the Company is restrictedto the lesser of the Bank’s retained earnings or the amount of the Bank’sundistributed net profits from the previous three fiscal years. The primaryuses of funds for the Company are stockholder dividends, investment in the Bankand ordinary operating expenses. Management anticipates that there will be sufficient earnings at theBank level to provide dividends to the Company to meet its funding requirementsfor the foreseeable future.

 

Maintenance of adequateliquidity requires that sufficient resources be available at all time to meetour cash flow requirements. Liquidity in a banking institution is requiredprimarily to provide for deposit withdrawals and the credit needs of itscustomers 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 March 31, 2010 were $89.4 million compared to $80.1 million at December 31,2009.  Our liquidity level measured as the percentage of liquid assets tototal assets was 17.2% and 15.3% at March 31, 2010 and December 31,2009, respectively. We anticipate that cash and cash equivalents on hand andother sources of funds will provide adequate 

 

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liquidity for ouroperating, 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.

 

As a secondary source ofliquidity, we rely on advances from the FHLB to supplement our supply oflendable funds and to meet deposit withdrawal requirements. Advances from theFHLB are typically secured by a portion of our loan portfolio. The FHLBdetermines limitations on the amount of advances by assigning a percentage toeach eligible loan category that will count towards the borrowing capacity. Asof March 31, 2010, our borrowing capacity from the FHLB was approximately$118.7 million and the .outstanding balance was $24.3 million, orapproximately 20.5% of our borrowing capacity. We also maintain 2 lines ofcredit with correspondent banks to purchase up to $20 million in federalfunds, for which there were no advances as of March 31, 2010.

 

**Off-Balance-SheetArrangements**

 

During the ordinarycourse of business, we provide various forms of credit lines to meet thefinancing needs of our customers. These commitments, which represent a creditrisk to us, are not represented in any form on our balance sheets.

 

As of March 31, 2010and December 31, 2009, we had commitments to extend credit of $56.1million and $63.1 million, respectively, which includes obligations underletters of credit of $2.7 million and $2.8 million, respectively.

 

The effect on ourrevenues, expenses, cash flows and liquidity from the unused portion of thecommitments to provide credit cannot be reasonably predicted because there isno guarantee that the lines of credit will be used.

 

**RecentLegislation and Other Regulatory Initiatives**

 

On February 17,2009, the American Recovery and Reinvestment Act of 2009 (“ARRA”) went intoeffect and amended certain provisions of the Emergency Economic StabilizationAct of 2008 (“EESA”), including replacing Section 111 of EESA in itsentirety.  The new Section 111 allows a participant in the TARP —Capital Purchase Program (“TARP-CPP”), such as the Company, to repay anyassistance previously received pursuant to the TARP-CPP without regard to thesource of replacement funds or any waiting period subject to consultation withthe appropriate Federal banking agency.  In addition, the new Section 111set forth in ARRA includes standards and requirements regarding executivecompensation and corporate governance.  On June 10, 2009,Treasury issued an interim final rule implementing and providing guidanceon the executive compensation and corporate governance provisions of EESA, asamended by ARRA. The regulations were published in the Federal Register on June 15,2009.  In addition, on February 18, 2010, certain amendments tothe proxy rules went into effect and implemented the ARRA’s requirementthat TARP-CPP participants provide a separate shareholder vote to approve thecompensation of the company’s executives.  Together, the Treasury’sinterim final rule and ’’these amendments impose:

 

·                  Limits on compensation that exclude incentives for theCompany’s Senior Executive Officers to take unnecessary and excessive risksthat threaten the value of the Company;

 

·                  A provision for the recovery of any bonus, retentionaward, or incentive compensation paid to the Company’s Senior ExecutiveOfficers or to any of the Company’s next twenty most highly compensatedemployees based on certain financial statements or other criteria that arelater found to be materially inaccurate;

 

·                  A prohibition on the Company from making any paymentsto the Senior Executive Officers or to any of the next five most highlycompensated employees for departure from the Company for any reason, except forpayments for services performed or benefits accrued;

 

·                  A prohibition on the Company’s ability to pay bonusesand certain other compensation to the Company’s Chief Executive Officer, exceptwith respect to certain restricted stock awards or to the extent that a bonusis required by a valid employment contract;

 

·                  A prohibition on any compensation plan that wouldencourage manipulation of the Company’s reported earnings for the purposes ofenhancing employee compensation;

 

·                  A requirement for the Company’s Chief ExecutiveOfficer and Chief Financial Officer to provide certain certifications regardingthe foregoing;

 

·                  Certain requirements with respect to the Company’sPersonnel and Compensation Committee;

 

·                  A requirement to adopt a company-wide policy regardingexcessive or luxury expenditures;

 

·                  A requirement to permit a nonbinding “say on pay”shareholder vote to be included in the Company’s proxy statement with respectto an annual meeting of stockholders; and

 

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·                  Authorizing the Secretary of the Treasury to reviewcertain compensation paid to the Company’s Senior Executive Officers and thenext 20 most highly-compensated employees to determine whether any suchpayments were inconsistent with the purposes of the foregoing.

 

The actions describedabove, together with additional actions announced by the Treasury and otherregulatory agencies continue to develop.  It is not clear at thistime what impact EESA, ARRA, TARP, the Treasury’s interim final rule andthe SEC’s amended proxy rules and other liquidity and funding initiativesof the Treasury and other bank regulatory agencies that have been previouslyannounced, and any additional programs that may be initiated in the future willhave on the financial markets and the financial servicesindustry.  The extreme levels of volatility and limited creditavailability currently being experienced could continue to effect the U.S.banking industry and the broader U.S. and global economies, which will have anaffect on all financial institutions, including the Company.  Wecannot predict the full effect that this wide-ranging legislation will have onthe national economy or on financial institutions.

 

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

 

Not applicable.

 

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

 

The Company’s ChiefExecutive Officer and its Chief Financial Officer, after evaluating theeffectiveness of the Company’s disclosure controls and procedures, as definedin Exchange Act Rules 13 a-15(e)and 15(d)-15(e) promulgatedunder the Exchange Act, as of the end of the period covered by this report (the“Evaluation Date”) have concluded that as of the Evaluation Date, the Company’sdisclosure controls and procedures were adequate and effective to ensure thatmaterial information relating to the Company would be made known to them byothers within the Company, particularly during the period in which this reportwas being prepared.  Disclosure controls and procedures are designed toensure that information required to be disclosed by us in the reports that wefile or submit under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in the Securities and ExchangeCommission’s rules and forms.  Disclosure controls and proceduresinclude, without limitation, controls and procedures designed to ensure thatinformation required to be disclosed by us in the reports that we file underthe Exchange Act is accumulated and communicated to our management, includingour Chief Executive Officer and Chief Financial Officer, as appropriate toallow timely decisions regarding required disclosure.

 

There were no significantchange in the our internal control over financial reporting during the lastfiscal quarter that have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting subsequent tothe Evaluation Date, nor there were any significant deficiencies or materialweaknesses in such controls requiring corrective actions.

 

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**PART II - OTHER INFORMATION**

 

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

 

There are no pending, orto management’s knowledge, any threatened, material legal proceedings to whichwe are a defendant, or to which any of our properties are subject.  There are no material legal proceedings towhich any director, any nominee for election as a director, any executiveofficer, or any associate of any such director, nominee or officer is a partyadverse to us.

 

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

 

Not applicable.

 

**Item 2.****                   ****Unregistered Sales ofEquity Securities and Use of Proceeds**

 

We did not have anyunregistered sales of our equity securities during the three months ended March 31,2010.

 

**Item 3.****                   ****Defaults Upon SeniorSecurities**

 

None.

 

**Item 4.****                   ****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**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, as amended, the registranthas duly caused this report to be signed on its behalf by the undersignedthereunto duly authorized.

 
|                    | **Oak  Valley Bancorp** |
|-------------------------|-------------------------|
| Date: May 14, 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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**EXHIBITINDEX**

 
| **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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