Table of Contents

 

 

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**Form 10-Q**

 
| **x**                                             | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|---------------------------------------------------|---------------------------------------------------------------------------------------------------------|
| ** **                                        | ** **                                                                                              |
| **For  the quarterly period ended June 30, 2010** |
| ** **                                        |
| **OR**                                            |
| ** **                                        |
| **o**                                             | **TRANSITION  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**      |

 

**Commission file number 001-34142**

 

**OAK VALLEY BANCORP**

(Exact name of registrant as specified in itscharter)

 

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

 

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

(Address of principal executive offices)

 

**(209) 848-2265**

Issuer’s telephone number

 

**Not applicable**

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

 

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

 

Indicate by check mark whether the registrant hassubmitted electronically and posted on its corporate web site, if any, everyInteractive Data File required to be submitted and posted pursuant to Rule 405of Regulation S-T during the preceding 12 months (or for such shorter periodthat the registrant was required to submit and post such files).   Yes**o**   No**o**

** **

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, a non-accelerated filer, or asmaller reporting company. See definitions of “large accelerated filer,” “acceleratedfiler,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.(Check one):

 

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

 

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

 

**APPLICABLE ONLY TO CORPORATEISSUERS**

 

Statethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date:  7,692,002 shares of common stock outstanding as of July 31, 2010.

 

 

 

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**Oak Valley Bancorp**

**June 30, 2010**

 

**Index**

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

 

2

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**PART I — FINANCIAL STATEMENTS**

 

**Item1. Financial Statements**

 

3

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**OAK VALLEY BANCORP**

**CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)**

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

** **
| ** **                                                                                                                                                                      | ** ** | **June 30,** | ** **  | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------|-------------|------------------|------------|
| ** **                                                                                                                                                                      | ** ** | **2010**     | ** **  | **2009**         | ** ** |
|                                                                                                                                                                            |       |         |        |             |       |
| **ASSETS**                                                                                                                                                                      |       |         |        |             |       |
|                                                                                                                                                                            |       |         |        |             |       |
| Cash and due from banks                                                                                                                                                         |       | $            | 21,588,538  |             | $          | 20,003,548 |   |
| Federal funds sold                                                                                                                                                              |       | 8,500,000    |        | 1,645,000        |       |
| Cash and cash equivalents                                                                                                                                                       |       | 30,088,538   |        | 21,648,548       |       |
|                                                                                                                                                                            |       |         |        |             |       |
| Securities available for sale                                                                                                                                                   |       | 52,243,890   |        | 50,765,314       |       |
| Loans, net of allowance for loan loss of  $7,614,138 in 2010 and $7,020,222 in 2009                                                                                             |       | 402,653,307  |        | 417,795,686      |       |
| Bank premises and equipment, net                                                                                                                                                |       | 10,392,433   |        | 10,167,297       |       |
| Other real estate owned (OREO)                                                                                                                                                  |       | 1,811,889    |        | 2,149,514        |       |
| Accrued interest and other assets                                                                                                                                               |       | 22,013,231   |        | 22,195,354       |       |
|                                                                                                                                                                            |       |         |        |             |       |
|                                                                                                                                                                            |       | $            | 519,203,288 |             | $          | 524,721,713 |   |
|                                                                                                                                                                            |       |         |        |             |       |
|                                                                                                                                                                            |       |         |        |             |       |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                                                                                                                  | ** ** | ** **   | ** **  | ** **       | ** ** |
|                                                                                                                                                                            |       |         |        |             |       |
| Deposits                                                                                                                                                                        |       | $            | 435,755,504 |             | $          | 429,210,284 |   |
| Accrued interest and other liabilities                                                                                                                                          |       | 2,463,999    |        | 2,619,178        |       |
| FHLB advances                                                                                                                                                                   |       | 18,500,000   |        | 32,200,000       |       |
|                                                                                                                                                                            |       |         |        |             |       |
| Total liabilities                                                                                                                                                               |       | 456,719,503  |        | 464,029,462      |       |
|                                                                                                                                                                            |       |         |        |             |       |
| Commitments and contingencies                                                                                                                                                   |       |         |        |             |       |
|                                                                                                                                                                            |       |         |        |             |       |
| Shareholders’ equity                                                                                                                                                       |       |         |        |             |       |
| Preferred stock, no par value; $1,000 per share  liquidation preference, 10,000,000 shares authorized and 13,500 issued and  outstanding at June 30, 2010 and December 31, 2009 |       | 12,930,621   |        | 12,847,297       |       |
| Common stock, no par value; 50,000,000 shares  authorized, 7,681,877 shares issued and outstanding at June 30, 2010 and  December 31, 2009                                      |       | 23,933,440   |        | 23,933,440       |       |
| Additional paid-in capital                                                                                                                                                      |       | 2,043,123    |        | 1,997,747        |       |
| Retained earnings                                                                                                                                                               |       | 21,796,285   |        | 20,230,683       |       |
| Accumulated other comprehensive income, net of tax                                                                                                                              |       | 1,780,316    |        | 1,683,084        |       |
|                                                                                                                                                                            |       |         |        |             |       |
| Total shareholders’ equity                                                                                                                                                 |       | 62,483,785   |        | 60,692,251       |       |
|                                                                                                                                                                            |       |         |        |             |       |
|                                                                                                                                                                            |       | $            | 519,203,288 |             | $          | 524,721,713 |   |

 

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

 

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**OAK VALLEY BANCORP**

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

**FOR THE THREE AND SIX MONTH PERIODS ENDED JUNE 30, 2010 ANDJUNE 30, 2009**

** **
| ** **                                           | ** ** | **THREE MONTHS ENDED** | ** ** | **SIX MONTHS ENDED** | ** ** |
|------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                           | ** ** | **JUNE 30,**           | ** ** | **JUNE 30,**         | ** ** |
| ** **                                           | ** ** | **2010**               | ** ** | **2009**             | ** ** | **2010** | ** ** | **2009** | ** ** |
| INTEREST INCOME                                      |       |                   |       |                 |       |   |   |   |   |
| Interest and fees on loans                           |       | $                      | 6,388,670  |                 | $          | 6,716,008 |   | $ | 12,827,195 |   | $ | 13,312,216 |   |
| Interest on securities available for sale            |       | 592,369                |       | 676,522              |       | 1,176,644 |   | 1,288,679 |   |
| Interest on federal funds sold                       |       | 2,316                  |       | 692                  |       | 3,874 |   | 1,596 |   |
| Interest on deposits with banks                      |       | 3,507                  |       | 869                  |       | 7,788 |   | 1,632 |   |
| Total interest income                                |       | 6,986,862              |       | 7,394,091            |       | 14,015,501 |   | 14,604,123 |   |
|                                                 |       |                   |       |                 |       |   |   |   |   |
| INTEREST EXPENSE                                     |       |                   |       |                 |       |   |   |   |   |
| Deposits                                             |       | 657,887                |       | 1,349,347            |       | 1,527,293 |   | 2,673,266 |   |
| FHLB advances                                        |       | 84,880                 |       | 157,686              |       | 183,255 |   | 387,139 |   |
| Federal funds purchased                              |       | 0                      |       | 79                   |       | 110 |   | 343 |   |
| Total interest expense                               |       | 742,767                |       | 1,507,112            |       | 1,710,658 |   | 3,060,748 |   |
|                                                 |       |                   |       |                 |       |   |   |   |   |
| Net interest income                                  |       | 6,244,095              |       | 5,886,979            |       | 12,304,843 |   | 11,543,375 |   |
| PROVISION FOR LOAN LOSSES                            |       | 1,005,000              |       | 2,137,012            |       | 2,010,000 |   | 4,037,012 |   |
|                                                 |       |                   |       |                 |       |   |   |   |   |
| Net interest income after provision for loan  losses |       | 5,239,095              |       | 3,749,967            |       | 10,294,843 |   | 7,506,363 |   |
|                                                 |       |                   |       |                 |       |   |   |   |   |
| OTHER INCOME                                         |       |                   |       |                 |       |   |   |   |   |
| Service charges on deposits                          |       | 259,366                |       | 292,562              |       | 515,005 |   | 574,947 |   |
| Earnings on cash surrender value of life insurance   |       | 100,699                |       | 101,057              |       | 204,685 |   | 202,114 |   |
| Mortgage commissions                                 |       | 25,008                 |       | 46,472               |       | 44,135 |   | 89,017 |   |
| Other                                                |       | 347,121                |       | 207,286              |       | 614,970 |   | 379,607 |   |
| Total non-interest income                            |       | 732,194                |       | 647,377              |       | 1,378,795 |   | 1,245,685 |   |
|                                                 |       |                   |       |                 |       |   |   |   |   |
| OTHER EXPENSES                                       |       |                   |       |                 |       |   |   |   |   |
| Salaries and employee benefits                       |       | 2,150,184              |       | 1,865,341            |       | 4,340,511 |   | 3,915,225 |   |
| Occupancy expenses                                   |       | 659,410                |       | 677,518              |       | 1,340,918 |   | 1,372,916 |   |
| Data processing fees                                 |       | 236,662                |       | 233,901              |       | 473,195 |   | 452,416 |   |
| OREO expenses                                        |       | 216,043                |       | 933,724              |       | 563,844 |   | 1,058,752 |   |
| Assessments (FDIC & DFI)                         |       | 258,000                |       | 299,124              |       | 516,000 |   | 437,086 |   |
| Other operating expenses                             |       | 796,132                |       | 776,990              |       | 1,527,223 |   | 1,488,509 |   |
| Total non-interest expense                           |       | 4,316,431              |       | 4,786,598            |       | 8,761,691 |   | 8,724,904 |   |
|                                                 |       |                   |       |                 |       |   |   |   |   |
| Net income (loss) before provision for income  taxes |       | 1,654,858              |       | (389,254             | )          | 2,911,947 |   | 27,144 |   |
|                                                 |       |                   |       |                 |       |   |   |   |   |
| PROVISION (BENEFIT) FOR INCOME TAXES                 |       | 616,073                |       | (344,191             | )          | 925,521 |   | (358,103 | ) |
| NET INCOME (LOSS)                                    |       | $                      | 1,038,785  |                 | $          | (45,063 | ) | $ | 1,986,426 |   | $ | 385,247 |   |
|                                                 |       |                   |       |                 |       |   |   |   |   |
| Preferred stock dividends and accretion              |       | 210,411                |       | 210,411              |       | 420,824 |   | 420,822 |   |
| NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS   |       | $                      | 828,374    |                 | $          | (255,474 | ) | $ | 1,565,602 |   | $ | (35,575 | ) |
|                                                 |       |                   |       |                 |       |   |   |   |   |
| NET EARNINGS (LOSS) PER COMMON SHARE                 |       | $                      | 0.11       |                 | $          | (0.03 | ) | $ | 0.20 |   | $ | 0.00 |   |
|                                                 |       |                   |       |                 |       |   |   |   |   |
| NET EARNINGS (LOSS) PER DILUTED COMMON SHARE         |       | $                      | 0.11       |                 | $          | (0.03 | ) | $ | 0.20 |   | $ | 0.00 |   |

 

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

 

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**OAKVALLEY BANCORP**

**CONDENSED CONSOLIDATED STATEMENT OF CHANGES INSHAREHOLDERS’ EQUITY (UNAUDITED)**

**FORTHE YEAR ENDED DECEMBER 31, 2009 AND THE SIX-MONTH PERIOD ENDED JUNE 30, 2010**

** **
| ** **                                                                                       | ** ** | **SIX MONTHS ENDED JUNE 30, 2010 AND YEAR ENDED  DECEMBER 31, 2009** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                                                                                       | ** ** | ** **                                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
| ** **                                                                                       | ** ** | ** **                                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Additional** | ** ** | ** ** | ** ** | ** ** | ** ** | **Other** | ** ** | **Total** | ** ** |
| ** **                                                                                       | ** ** | **Common Stock**                                                     | ** ** | **Preferred Stock** | ** ** | **Paid-in** | ** ** | **Retained** | ** ** | **Comprehensive** | ** ** | **Comprehensive** | ** ** | **Shareholders’** | ** ** |
| ** **                                                                                       | ** ** | **Shares**                                                           | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Capital** | ** ** | **Earnings** | ** ** | **Income** | ** ** | **Income** | ** ** | **Equity** | ** ** |
|                                                                                             |       |                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Balances, January 1, 2009                                                                   |       | 7,661,627                                                            |       | $ | 23,863,331 |   | 13,500 |   | $ | 12,680,649 |   | $ | 1,925,224 |   | $ | 19,226,645 |   |   |   | $ | 290,230 |   | $ | 57,986,079 |   |
| Stock options exercised                                                                          |       | 20,250                                                               |       | $ | 70,109 |   |   |   |   |   |   |   |   |   |   |   |   |   | 70,109 |   |
| Preferred stock accretion                                                                        |       |                                                                 |       |   |   |   |   | $ | 166,648 |   |   |   | $ | (166,648 | ) |   |   |   |   | 0 |   |
| Preferred stock dividend payments                                                                |       |                                                                 |       |   |   |   |   |   |   |   |   | (637,500 | ) |   |   |   |   | (637,500 | ) |
| Cash dividends ($0.025 per share)                                                                |       |                                                                 |       |   |   |   |   |   |   |   |   | (191,542 | ) |   |   |   |   | (191,542 | ) |
| Stock based compensation                                                                         |       |                                                                 |       |   |   |   |   |   |   | 72,523 |   |   |   |   |   |   |   | 72,523 |   |
| Comprehensive income:                                                                            |       |                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net changes in unrealized gain on  available-for-sale securities (net of income tax of $988,188) |       |                                                                 |       |   |   |   |   |   |   |   |   |   |   | 1,392,854 |   | 1,392,854 |   | 1,392,854 |   |
| Net income                                                                                       |       |                                                                 |       |   |   |   |   |   |   |   |   | 1,999,728 |   | 1,999,728 |   |   |   | 1,999,728 |   |
| Comprehensive income                                                                             |       |                                                                 |       |   |   |   |   |   |   |   |   |   |   | $ | 3,392,582 |   |   |   |   |   |
| Balances, December 31, 2009                                                                 |       | 7,681,877                                                            |       | $ | 23,933,440 |   | 13,500 |   | $ | 12,847,297 |   | $ | 1,997,747 |   | $ | 20,230,683 |   |   |   | $ | 1,683,084 |   | $ | 60,692,251 |   |
|                                                                                             |       |                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Preferred stock accretion                                                                        |       |                                                                 |       |   |   |   |   | $ | 83,324 |   |   |   | $ | (83,324 | ) |   |   |   |   | 0 |   |
| Preferred stock dividend payments                                                                |       |                                                                 |       |   |   |   |   |   |   |   |   | (337,500 | ) |   |   |   |   | (337,500 | ) |
| Stock based compensation                                                                         |       |                                                                 |       |   |   |   |   |   |   | 45,376 |   |   |   |   |   |   |   | 45,376 |   |
| Comprehensive income:                                                                            |       |                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net changes in unrealized gain on  available-for-sale securities (net of income tax of $67,989)  |       |                                                                 |       |   |   |   |   |   |   |   |   |   |   | 97,232 |   | 97,232 |   | 97,232 |   |
| Net income                                                                                       |       |                                                                 |       |   |   |   |   |   |   |   |   | 1,986,426 |   | 1,986,426 |   |   |   | 1,986,426 |   |
| Comprehensive income                                                                             |       |                                                                 |       |   |   |   |   |   |   |   |   |   |   | $ | 2,083,658 |   |   |   |   |   |
| Balances, June 30, 2010                                                                     |       | 7,681,877                                                            |       | $ | 23,933,440 |   | 13,500 |   | $ | 12,930,621 |   | $ | 2,043,123 |   | $ | 21,796,285 |   |   |   | $ | 1,780,316 |   | $ | 62,483,785 |   |

 

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

 

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**OAK VALLEY BANCORP**

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

**FORTHE SIX-MONTH PERIODS ENDED JUNE 30, 2010 AND JUNE 30, 2009**

** **
| ** **                                                                                | ** ** | **SIX MONTHS ENDED JUNE 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                                | ** ** | **2010**                      | ** ** | **2009** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                     |       |                          |       |   |   |
| Net income                                                                                |       | $                             | 1,986,426  |   | $ | 385,247 |   |
| Adjustments to reconcile net earnings to net cash  from operating activities:             |       |                          |       |   |   |
| Provision for loan losses                                                                 |       | 2,010,000                     |       | 4,037,012 |   |
| Depreciation                                                                              |       | 474,744                       |       | 542,780 |   |
| Amortization and accretion, net                                                           |       | (2,926                        | )          | (22,486 | ) |
| Stock-based compensation expense                                                          |       | 45,376                        |       | 40,200 |   |
| OREO Write downs and losses on sale                                                       |       | 390,732                       |       | 909,189 |   |
| Gain on called available for sale securities                                              |       | (126,531                      | )          | (54,380 | ) |
| Increase in BOLI cash surrender value                                                     |       | (204,685                      | )          | (202,114 | ) |
| Decrease in accrued interest payable and other  liabilities                               |       | (155,179                      | )          | (33,213 | ) |
| Decrease in accrued interest receivable                                                   |       | 77,188                        |       | 69,392 |   |
| Decrease (increase) in other assets                                                       |       | 241,631                       |       | (1,696,134 | ) |
| Net cash from operating activities                                                        |       | 4,736,776                     |       | 3,975,493 |   |
|                                                                                      |       |                          |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                     |       |                          |       |   |   |
| Purchases of available for sale securities                                                |       | (6,886,836                    | )          | (15,674,108 | ) |
| Proceeds from maturities, calls, and principal  paydowns of securities available for sale |       | 5,702,938                     |       | 3,971,251 |   |
| Net decrease (increase) in loans                                                          |       | 12,490,979                    |       | (1,464,888 | ) |
| Proceeds from sale of OREO                                                                |       | 588,293                       |       | 209,467 |   |
| Net purchases of premises and equipment                                                   |       | (699,880                      | )          | (69,277 | ) |
| Net cash from (used in) investing activities                                              |       | 11,195,494                    |       | (13,027,555 | ) |
|                                                                                      |       |                          |       |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                     |       |                          |       |   |   |
| FHLB advanced funds                                                                       |       | 7,100,000                     |       | 43,700,000 |   |
| FHLB payments                                                                             |       | (20,800,000                   | )          | (68,600,000 | ) |
| Federal funds advances                                                                    |       | 480,000                       |       | 7,655,000 |   |
| Federal funds payments                                                                    |       | (480,000                      | )          | (7,655,000 | ) |
| Shareholder cash dividends paid                                                           |       | 0                             |       | (191,543 | ) |
| Preferred stock dividend payment                                                          |       | (337,500                      | )          | (300,000 | ) |
| Net increase in demand deposits and savings  accounts                                     |       | 14,121,613                    |       | 29,076,007 |   |
| Net (decrease) increase in time deposits                                                  |       | (7,576,393                    | )          | 12,616,284 |   |
| Net cash from (used in) financing activities                                              |       | (7,492,280                    | )          | 16,300,748 |   |
|                                                                                      |       |                          |       |   |   |
| NET INCREASE IN CASH AND CASH EQUIVALENTS                                                 |       | 8,439,990                     |       | 7,248,686 |   |
|                                                                                      |       |                          |       |   |   |
| CASH AND CASH EQUIVALENTS, beginning of period                                            |       | 21,648,548                    |       | 9,837,860 |   |
|                                                                                      |       |                          |       |   |   |
| CASH AND CASH EQUIVALENTS, end of period                                                  |       | $                             | 30,088,538 |   | $ | 17,086,546 |   |
|                                                                                      |       |                          |       |   |   |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:                                        |       |                          |       |   |   |
| Cash paid during the year for:                                                            |       |                          |       |   |   |
| Interest                                                                                  |       | $                             | 1,911,309  |   | $ | 3,191,610 |   |
| Income taxes                                                                              |       | $                             | 1,611,000  |   | $ | 1,014,000 |   |
|                                                                                      |       |                          |       |   |   |
| NON-CASH INVESTING ACTIVITIES:                                                            |       |                          |       |   |   |
| Real estate acquired through foreclosure                                                  |       | $                             | 641,400    |   | $ | 1,186,263 |   |
| Change in unrealized gain/loss on  available-for-sale securities                          |       | $                             | 165,221    |   | $ | 1,171,751 |   |
|                                                                                      |       |                          |       |   |   |
| NON-CASH FINANCING ACTIVITIES:                                                            |       |                          |       |   |   |
| Accretion of preferred stock                                                              |       | $                             | 83,324     |   | $ | 83,324 |   |

 

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

 

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**OAK VALLEY BANCORP**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1 — BASIS OF PRESENTATION**

 

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

 

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

 

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

 

**NOTE 2 — CURRENT ACCOUNTING PRONOUNCEMENTS**

 

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

 

*FASB ASCTopic 815, “Derivatives and Hedging.”*New authoritative accounting guidance under ASC Topic 815, “Derivatives andHedging,” amends prior guidance to amend and expand the disclosure requirementsfor derivatives and hedging activities to provide greater transparency about(i) how and why an entity uses derivative instruments, (ii) howderivative instruments and related hedge items are accounted for under ASCTopic 815, and (iii) how derivative instruments and related hedged itemsaffect an entity’s financial position, results of operations and cash flows. Tomeet those objectives, the new authoritative accounting guidance requiresqualitative disclosures about objectives and strategies for using derivatives,quantitative disclosures about fair value amounts of gains and losses onderivative instruments and disclosures about credit-risk-related contingentfeatures in derivative agreements. The new authoritative accounting guidance underASC Topic 815 became effective for the Company on January 1, 2009 and didnot have a significant impact on the Company’s financial statements.

 

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

 

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Further new authoritative accountingguidance (Accounting Standards Update No. 2009-5) under ASC Topic 820provides guidance for measuring the fair value of a liability in circumstancesin which a quoted price in an active market for the identical liability is notavailable. In such instances, a reporting entity is required to measure fairvalue utilizing a valuation technique that uses (i) the quoted price ofthe identical liability when traded as an asset, (ii) quoted prices forsimilar liabilities or similar liabilities when traded as assets, or(iii) another valuation technique that is consistent with the existingprinciples of ASC Topic 820, such as an income approach or market approach. Thenew authoritative accounting guidance also clarifies that when estimating thefair value of a liability, a reporting entity is not required to include aseparate input or adjustment to other inputs relating to the existence of arestriction that prevents the transfer of the liability. The forgoing newauthoritative accounting guidance under ASC Topic 820 became effective for theCompany’s financial statements beginning October 1, 2009 and did not havea significant impact on the Company’s financial statements.

 

*FASB ASCTopic 320, “Investments - Debt and Equity Securities.”* New authoritative accounting guidance under ASC Topic 320, “Investments- Debt and Equity Securities,” (i) changes existing guidance fordetermining whether an impairment is other than temporary to debt securitiesand (ii) replaces the existing requirement that the entity’s management assertit has both the intent and ability to hold an impaired security until recoverywith a requirement that management assert: (a) it does not have the intentto sell the security; and (b) it is more likely than not it will not haveto sell 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 the secondquarter of 2009. Adoption of the new guidance did not significantly impact theCompany’s financial statements.

 

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

 

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

 

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**NOTE 3 — SECURITIES**

 

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

 
| ** **                           | ** ** | **Amortized Cost** | ** ** | **Gross Unrealized  Gains** | ** ** | **Gross Unrealized  Losses** | ** ** | **Estimated Fair  Value** | ** ** |
|--------------------------------------|------------|--------------------|------------|-----------------------------|------------|------------------------------|------------|---------------------------|------------|
| Available-for-sale  securities:      |       |               |       |                        |       |                         |       |                      |       |
| U.S.  agencies                       |       | $                  | 26,775,596 |                        | $          | 1,747,392                    |       | $                         | —     |   | $ | 28,522,988 |   |
| Collateralized  mortgage obligations |       | 8,372,057          |       | 214,496                     |       | (8,360                       | )          | 8,578,193                 |       |
| Municipalities                       |       | 10,934,272         |       | 1,055,918                   |       | (5,274                       | )          | 11,984,916                |       |
| SBA  Pools                           |       | 1,549,734          |       | —                      |       | (22,273                      | )          | 1,527,461                 |       |
| Mutual  Fund                         |       | 1,586,582          |       | 43,750                      |       | —                       |       | 1,630,332                 |       |
|                                 |       | $                  | 49,218,241 |                        | $          | 3,061,556                    |       | $                         | (35,907    | ) | $ | 52,243,890 |   |

 

Thefollowing tables detail the gross unrealized losses and fair values aggregatedby investment category and length of time that individual securities have beenin a continuous unrealized loss position at June 30, 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   |       | 2,994,150               |       | (8,360                | )          | —          |       | — |   | 2,994,150 |   | (8,360 | ) |
| Municipalities                        |       | 413,838                 |       | (5,274                | )          | —          |       | — |   | 413,838 |   | (5,274 | ) |
| SBA Pools                             |       | —                  |       | —                |       | 1,521,854       |       | (22,273 | ) | 1,521,854 |   | (22,273 | ) |
| Asset Backed Securities               |       | —                  |       | —                |       | —          |       | — |   | — |   | — |   |
| Total temporarily impaired securities |       | $                       | 3,407,988  |                  | $          | (13,634         | )          | $ | 1,521,854 |   | $ | (22,273 | ) | $ | 4,929,842 |   | $ | (35,907 | ) |

 

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

 

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

 
| ** **                             | ** ** | ** **    | ** ** | **Estimated** | ** ** |
|----------------------------------------|------------|---------------|------------|---------------|------------|
| ** **                             | ** ** | **Amortized** | ** ** | **Fair**      | ** ** |
| ** **                             | ** ** | **Cost**      | ** ** | **Value**     | ** ** |
| Available-for-sale securities:         |       |          |       |          |       |
| Due in one year or less                |       | $             | 510,000    |          | $          | 516,889 |   |
| Due after one year through five years  |       | 3,833,332     |       | 3,958,536     |       |
| Due after five years through ten years |       | 18,381,855    |       | 20,015,681    |       |
| Due after ten years                    |       | 26,493,054    |       | 27,752,784    |       |
|                                   |       | $             | 49,218,241 |          | $          | 52,243,890 |   |

 

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

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

 

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

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

 

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

 

Therewere no realized gains or losses on sales of available-for-sale securitiesduring 2010 and 2009, however the Company did recognize a gain of $70,692 and$126,531 for the three and six month periods ended June 30, 2010,respectively, on certain available-for-sale securities that were partiallycalled, which compares to $18,554 and $54,380 in the same periods of 2009,respectively. There were no other sales of available-for-sale securities during2010 and 2009.

 

Securitiescarried at $44,756,795 and $34,545,513 at June 30, 2010 and December 31,2009, respectively, were pledged to secure deposits of public funds.

 

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**NOTE 4 — LOANS**

 

Loantotals were as follows:

 
| ** **                           | ** ** | **JUNE 30,** | ** **  | **DECEMBER 31,** | ** ** |
|--------------------------------------|------------|--------------|-------------|------------------|------------|
| ** **                           | ** ** | **2010**     | ** **  | **2009**         | ** ** |
| Loans                                |       |         |        |             |       |
| Commercial real estate               |       | $            | 282,980,987 |             | $          | 283,387,329 |   |
| Commercial                           |       | 36,536,604   |        | 38,159,590       |       |
| Real estate construction             |       | 40,166,234   |        | 52,951,968       |       |
| Agriculture                          |       | 28,534,626   |        | 29,659,656       |       |
| Residential real estate and consumer |       | 22,848,547   |        | 21,468,468       |       |
| Total loans                          |       | 411,066,998  |        | 425,627,011      |       |
|                                 |       |         |        |             |       |
| Deferred loan fees and costs, net    |       | (799,553     | )           | (811,103         | )          |
| Allowance for loan losses            |       | (7,614,138   | )           | (7,020,222       | )          |
| Net loans                            |       | $            | 402,653,307 |             | $          | 417,795,686 |   |

 

Changesin the allowance for loan losses were as follows:

 
| ** **                      | ** ** | **JUNE 30,** | ** ** | **DECEMBER 31,** | ** ** |
|---------------------------------|------------|--------------|------------|------------------|------------|
| ** **                      | ** ** | **2010**     | ** ** | **2009**         | ** ** |
|                            |       |         |       |             |       |
| Balance, beginning of year      |       | $            | 7,020,222  |             | $          | 5,569,496 |   |
| Provision charged to operations |       | 2,010,000    |       | 5,862,012        |       |
| Loans charged off               |       | (1,419,399   | )          | (4,419,335       | )          |
| Loan recoveries                 |       | 3,315        |       | 8,049            |       |
|                            |       |         |       |             |       |
| Balance, end of period          |       | $            | 7,614,138  |             | $          | 7,020,222 |   |

 

Thetotal recorded investment in impaired loans at June 30, 2010, was$10,070,063 which had a loan loss reserve of $1,301,496.  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 interestincome was recognized on impaired loans, while considered impaired during 2010and 2009.  As of June 30, 2010, we had undisbursed fundingcommitments on one impaired loanto one borrower totaling$353,133 with a maturity date of October 2010**. **As of June 30,2010, we had three loans considered troubled debt restructurings totaling $1.4million, which are included in nonaccrual loans.

 

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**OAK VALLEY BANCORP**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 5 — OTHER REAL ESTATE OWNED**

 

Asof June 30, 2010, six loans with outstanding balances of $1,811,889 werereclassified to other real estate owned, as compared to six loans withoutstanding balances of $2,149,514 as of December 31, 2009.

 

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

 

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

 

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

 

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

 

Futurecompensation under both plans is earned for services rendered throughretirement. The Bank accrues for the salary continuation liability based onanticipated years of service and vesting schedules provided under the plans.The Bank’s current benefit liability is determined based on vesting and thepresent value of the benefits at a corresponding discount rate. The discountrate used is an equivalent rate for investment-grade bonds with lives matchingthose of the service periods remaining for the salary continuation contracts,which average approximately 20 years. The salary continuation liability as of June 30, 2010 and December 31,2009 was $1,186,636 and $1,147,125, respectively, and is reported in accruedinterest and other liabilities in the consolidated balance sheet.

 

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

 

Thecombined cash surrender value of all Bank-owned life insurance policiesrecorded in other assets on the balance sheet was $10,296,776 and $10,267,862at June 30, 2010 and December 31, 2009, respectively.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 
| ** **                                  | ** ** | ** **   | ** ** | **Estimated** | ** ** |
|---------------------------------------------|------------|--------------|------------|---------------|------------|
| ** **                                  | ** ** | **Carrying** | ** ** | **Fair**      | ** ** |
| ** **                                  | ** ** | **Amount**   | ** ** | **Value**     | ** ** |
| **Financial assets:**                       | ** ** | ** **   | ** ** | ** **    | ** ** |
| Cash and cash equivalents                   |       | $            | 30,088,538 |          | $          | 30,088,538 |   |
| Securities available for sale               |       | 52,243,890   |       | 52,243,890    |       |
| Loans                                       |       | 411,066,998  |       | 417,279,249   |       |
| Accrued interest receivable                 |       | 1,657,144    |       | 1,657,144     |       |
|                                        |       |         |       |          |       |
| **Financial liabilities:**                  |       |         |       |          |       |
| Deposits                                    |       | (435,755,504 | )          | (436,070,443  | )          |
| FHLB advance                                |       | (18,500,000  | )          | (18,614,760   | )          |
| Accrued interest payable                    |       | (199,518     | )          | (199,518      | )          |
|                                        |       |         |       |          |       |
| **Off-balance-sheet assets (liabilities):** |       |         |       |          |       |
|                                        |       |         |       |          |       |
| Commitments and standby letters of credit   |       |         |       | (560,792      | )          |
|                                             |            |              |            |               |            |  |  |

 

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

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

 

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**OAK VALLEY BANCORP**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

 

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

 

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

 

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

 

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

 

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

 

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

 
| ** **                                                 | ** ** | **Fair Value Measurements at June 30,  2010** | ** ** |
|------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **June 30, 2010**                                                 | ** ** | **Quoted Prices  in Active  Markets for  Identical Assets  (Level 1)** | ** ** | **Significant  Other  Observable  Inputs  (Level 2)** | ** ** | **Significant  Unobservable  Inputs  (Level 3)** | ** ** |
| Assets and liabilities measured on a recurring  basis:     |       |                                                                   |       |   |   |   |   |   |   |
| Available-for-sale securities:                             |       |                                                                   |       |   |   |   |   |   |   |
| U.S. agencies                                              |       | $                                                                      | 28,522,988 |   | $ |   |   | $ | 28,522,988 |   | $ |   |   |
| Collateralized mortgage obligations                        |       | $                                                                      | 8,578,193  |   | $ |   |   | $ | 8,578,193 |   | $ |   |   |
| Municipalities                                             |       | $                                                                      | 11,984,916 |   | $ |   |   | $ | 11,984,916 |   | $ |   |   |
| SBA Pools                                                  |       | $                                                                      | 1,527,461  |   | $ |   |   | $ | 1,527,461 |   | $ |   |   |
| Mutual Fund                                                |       | $                                                                      | 1,630,332  |   | $ |   |   | $ | 1,630,332 |   | $ |   |   |
|                                                       |       |                                                                   |       |   |   |   |   |   |   |
| Assets and liabilities measured on a  non-recurring basis: |       |                                                                   |       |   |   |   |   |   |   |
| Impaired Loans                                             |       | $                                                                      | 7,611,559  |   | $ | — |   | $ | — |   | $ | 7,611,559 |   |
| Other real estate owned                                    |       | $                                                                      | 1,811,889  |   | $ | — |   | $ | — |   | $ | 1,811,889 |   |

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

 

Thefair value of securities available for sale equals quoted market price, ifavailable.  If quoted market prices are not available, fair value isdetermined using quoted market prices for similar securities.  Changes infair market value are recorded in other comprehensive income net of tax.

 

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Thefair value measurement applies to impaired loans, which includes impaired loansmeasured at an observable market price (if available), or at the fair value ofthe loan’s collateral (if the loan is collateral dependent). Fair value of theloan’s collateral, when the loan is dependent on collateral, is determined byappraisals or independent valuation which is then adjusted for the cost relatedto liquidation of the collateral.  At June 30,2010, impaired loans that had a specific loan loss reserve had a principalbalance of $8,913,055 with a valuation allowance of $1,301,496.  Upon being classified as impaired, either acharge off or a specific reserve or both may be taken to reduce the balance ofeach loan to an estimate of the collateral fair market value less cost todispose. This estimate was a level 3 valuation.  There was no directimpact on the income statement.  The charge-offs were recorded as a debitto the allowance for loan losses.

 

Fairvalue of other real estate owned is determined by appraisals or independentvaluation which is then adjusted for the cost related to liquidation of theproperty.  Total fair market value at June 30,2010 was $1,811,889 which was a level 3 valuation.  There is a direct impact to the incomestatement as any market value write downs are charged directly to operatingexpenses.  The Bank is required byinternal bank policies to order real estate appraisals on OREO properties everysix months.  In addition, managementevaluates the book values on a quarterly basis for reasonableness and makesfair value adjustments as necessary.

 

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

 

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

 
| ** **                                                                               | ** ** | **THREE MONTHS ENDED** | ** ** |
|------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                               | ** ** | **JUNE  30,**                    | ** ** |
| **In thousands (except share and per share amounts)** | ** ** | **2010**                         | ** ** | **2009** | ** ** |
| BASIC EARNINGS PER  SHARE                                                                |       |                             |       |   |   |
|                                                                                     |       |                             |       |   |   |
| Net income available to  common shareholders                                             |       | $                                | 828,374    |   | $ | (255,474 | ) |
| Weighted average shares  outstanding                                                     |       | 7,681,877                        |       | 7,661,627 |   |
| Net income per common  share                                                             |       | $                                | 0.11       |   | $ | (0.03 | ) |
|                                                                                     |       |                             |       |   |   |
| DILUTED EARNINGS PER  SHARE                                                              |       |                             |       |   |   |
|                                                                                     |       |                             |       |   |   |
| Net income available to  common shareholders                                             |       | $                                | 828,374    |   | $ | (255,474 | ) |
| Weighted average shares  outstanding                                                     |       | 7,681,877                        |       | 7,661,627 |   |
| Effect of dilutive  stock options                                                        |       | 38,563                           |       | — |   |
| Weighted average shares  of common stock and common stock equivalents                    |       | 7,720,440                        |       | 7,661,627 |   |
| Net income per diluted  common share                                                     |       | $                                | 0.11       |   | $ | (0.03 | ) |

 

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| ** **                                                                           | ** ** | **SIX MONTHS ENDED** | ** ** |
|--------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                           | ** ** | **JUNE 30,**                   | ** ** |
| **In thousands (except share and per  share amounts)** | ** ** | **2010**                       | ** ** | **2009** | ** ** |
| BASIC EARNINGS PER SHARE                                                             |       |                           |       |   |   |
|                                                                                 |       |                           |       |   |   |
| Net income available to common shareholders                                          |       | $                              | 1,565,602  |   | $ | (35,575 | ) |
| Weighted average shares outstanding                                                  |       | 7,681,877                      |       | 7,661,627 |   |
| Net income per common share                                                          |       | $                              | 0.20       |   | $ | 0.00 |   |
|                                                                                 |       |                           |       |   |   |
| DILUTED EARNINGS PER SHARE                                                           |       |                           |       |   |   |
|                                                                                 |       |                           |       |   |   |
| Net income available to common shareholders                                          |       | $                              | 1,565,602  |   | $ | (35,575 | ) |
| Weighted average shares outstanding                                                  |       | 7,681,877                      |       | 7,661,627 |   |
| Effect of dilutive stock options                                                     |       | 31,435                         |       | — |   |
| Weighted average shares of common stock and  common stock equivalents                |       | 7,713,312                      |       | 7,661,627 |   |
| Net income per diluted common share                                                  |       | $                              | 0.20       |   | $ | 0.00 |   |

 

Duringthe three and six month periods ended June 30, 2010, anti-dilutiveweighted average options to purchase 231,187 shares of common stock, withprices ranging from $4.58 to $15.67 were outstanding for bothperiods.    These options were not included in the computationof diluted EPS because the options’ exercise price was greater than the averagemarket price of the common shares. During the three and six month periods ended June 30, 2009, all ofthe Company’s weighted average stock options of 413,310 and 414,970,respectively, to purchase shares of common stock were considered anti-dilutivebecause the Company recognized a net loss in both of these periods.  These options begin to expire in 2013.  In addition, weighted average warrants of 350,346issued to the U.S. Treasury Capital Purchase Program were anti-dilutive for thethree and six-month periods of 2010 and 2009, as the price of $5.78 was morethan the average market price of common shares.

 

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

 

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

 

**Forward-Looking Statements**

 

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

 

**Critical Accounting Estimates**

 

Thediscussion and analysis of our financial condition and results of operations isbased upon our financial statements, which have been prepared in accordancewith accounting principles generally accepted in the United States of America.The preparation of these financial statements requires management to makeestimates and judgments that affect the reported amounts of assets andliabilities, revenues and expenses, and related disclosures of contingentassets and liabilities at the date of our financial statements. Actual resultsmay differ from these estimates under different assumptions or conditions.

 

*Allowance for Loan Losses*

 

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

 

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

 

· the specific review of individual loans,

 

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

 

· our judgmental estimate based on various subjective factors.

 

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

 

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

 

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

 

· concentration of credits,

 

· nature and volume of the loan portfolio,

 

· delinquency trends,

 

· non-accrual loan trend,

 

· problem loan trend,

 

· loss and recovery trend,

 

· quality of loan review,

 

· lending and management staff,

 

· lending policies and procedures,

 

· economic and business conditions, and

 

· other external factors including regulatory review.

 

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

 

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

 

*Non-Accrual Loan Policy*

 

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

 

*Stock-Based Compensation*

 

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

 

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*Other Real Estate Owned*

 

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

 

**Introduction**

 

Oak Valley Community Bank commencedoperations in May 1991.  We are an insured bank under the FederalDeposit Insurance Act and are a member of the Federal Reserve.  Since itsformation, the Bank has provided basic banking services to individuals andbusiness enterprises in Oakdale, California and the surrounding areas. Thefocus of the Bank is to offer a range of commercial banking services designedfor both individuals and small to medium-sized businesses in the two main areasof 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 other servicesfor both individuals and businesses including online banking, remote depositcapture, merchant services, night depository, extended hours, traveler’schecks, wire transfer of funds, note collection, and automated teller machinesin a national network.  The Bank does not currently offer internationalbanking or trust services although the Bank may make such services available tothe Bank’s customers through financial institutions with which the Bank hascorrespondent banking relationships.  The Bank does not offer stocktransfer services nor does it directly issue credit cards.

 

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

 

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

 

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

 

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

 

·                  Thanksto our deep roots in the communities that we serve, our focus on customer careand our selectivity in lending, during the first six months of 2010, ourperformance has been better than most institutions of our size that compete inour market.  Despite the severity of therecession affecting our primary market areas, we have been able to increase ourcore deposits to $391.6 million and have posted net income available to commonshareholders of $0.11 and $0.20 for the three and six month periods of 2010,respectively.

 

·                  Whilerecently published economic data indicate that the current downturn may beeasing, it is not clear when or at what speed the recession will end. To theextent that the recession continues, it will affect the market areas that weserve and our results accordingly.

 

·                  TheCompany recognized net income available to common shareholders of $828,000 and$1,566,000 for the three and six month periods ended June 30, 2010,respectively, as compared to a net loss to common shareholders of $255,000 and$36,000 for the same periods in 2009.  The Company recognized net incomebefore preferred stock dividends and accretion of $1,039,000 and $1,986,000,respectively, for the second quarter and six month period of 2010.  The factors contributing to these results willbe discussed below.

 

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·                  TheCompany recognized $210,000 and $421,000, respectively, in the second quarterand six month period of 2010 and 2009 associated with the accrual for preferredstock dividends and accretion of the preferred stock discount in connectionwith the 13,500 shares of Series A Preferred Stock that the U.S. Treasurypurchased from the Company in December 2008 under the TARP Program. Solong as such preferred stock remains outstanding, it will pay quarterlycumulative dividends at a rate of 5% per year for the first five years andthereafter at a rate of 9% per year.

 

·               TheCompany has taken significant steps to reduce the risk of loanlosses.   In the three and six month periods ended June 30,2010, the provision for loan loss was $1,005,000 and $2,010,000, respectively,which was a decrease of $1,132,000 and $2,027,000 compared to the same periodsof 2009.  These decreases were mainly dueto management’s assessment of theappropriatelevel for the allowance for loan losses and an decrease in the level ofnon-accrual loans. The Company continues to monitor its loan portfolio with theobjective of avoiding defaults or write-downs.  Despite theseactions, the possibility of additional losses can not be eliminated, but theBoard of Directors and all employees continue to work hard to make the best ofthese continuing challenging conditions.

 

·                  Netinterest income increased $357,000 or 6.1% and $761,000 or 6.6% for the threeand six month periods ended June 30, 2010, respectively, compared to thesame periods in 2009.  This increase was primarily due to the net interestmargin increase of 40 and 37 basis points, which was offset by a decrease inaverage earning assets of $11.3 million and $7.0 million, respectively, for thethree and six month periods ended June 30, 2010, as compared to the sameperiods of 2009.  The net interest margin increase is attributableprimarily to liabilities repricing faster than assets in the declining rateenvironment as described in further detail below.

 

·                  Forthe three and six month periods ended June 30, 2010, non-interest incomeincreased by $85,000 or 13.1% and $133,000 or 10.7%, respectively, from thesame periods in 2009.  The increase wasprimarily due to an increase in other income which included the gain on calledsecurities, which was partially offset by a decrease in NSF fee income andmortgage commissions as described below.

 

·                  Non-interestexpense decreased by $470,000 or 9.8% for the three month period ended June 30,2010 and increased by $37,000 or 0.4% for the six month period ended June 30,2010, as compared to the same periods in 2009. The primary reason for the decrease in the second quarter was asignificant reduction in the write downs of OREO property values of $718,000,which was offset in part by increased salaries and benefits as described below.

 

·                  Totalassets decreased $5.5 million or 1.1% from December 31, 2009.  Totalnet loans decreased by $15.1 million or 3.6% and investment securitiesincreased by $1.5 million or 2.9% from December 31, 2009 to June 30,2010, while deposits increased by $6.5 million or 1.5% for the same period.

 

**Income Summary**

 

Forthe three and six month periods ended June 30, 2010, the Company recordednet income available to common shareholders of $828,000 and $1,566,000,respectively, representing increases of $1,083,000 and $1,601,000, as comparedto the same periods in 2009.  Return on average assets (annualized) was0.81% and 0.78% for the second quarter and six month periods of 2010,respectively, as compared with -0.03% and 0.15% for the same periods in 2009. Annualized return on average common equity was 6.84% and 6.54% for the secondquarter and six month period of 2010, respectively, as compared to -2.23% and-0.17% for the same periods of 2009.

 

Netincome before provisions for income taxes and preferred stock dividends andaccretion was up $2,044,000 and $2,885,000 for the second quarter and six monthperiod of 2010, respectively, from the comparable 2009 periods.  Theincome statement components of these variances are as follows:

 

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

*** ***
| ** **                            | ** ** | **Effect on Pre-Tax  Income** | ** ** | **Effect on Pre-Tax  Income** | ** ** |
|---------------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| ** **                            | ** ** | **Increase  (Decrease)**      | ** ** | **Increase  (Decrease)**      | ** ** |
| **(In  thousands)**                   | ** ** | **Three Months**         | ** ** | **Six Months**           | ** ** |
| Change from 2009 to  2010 in:         | ** ** | ** **                    | ** ** | ** **                    | ** ** |
| Net interest income                   |       | $                             | 357        |                          | $          | 761 |   |
| Provision for loan  losses            |       | 1,132                         |       | 2,027                         |       |
| Non-interest income                   |       | 85                            |       | 133                           |       |
| Non-interest expense                  |       | 470                           |       | (36                           | )          |
| Change in income before  income taxes |       | $                             | 2,044      |                          | $          | 2,885 |   |

 

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Thesevariances will be explained in the discussion below.

 

**Net Interest Income**

 

Netinterest income is the largest source of the Bank’s operating income.  Forthe three and six month periods ended June 30, 2010, net interest incomewas $6.24 million and $12.30 million, respectively, which represented anincrease of $357,000 or 6.1% and $761,000 or 6.6%, respectively, from thecomparable periods in 2009.

 

Thenet interest margin (net interest income as a percentage of average interestearning assets) was 5.36% and 5.29% for the three and six month periods ended June 30,2010, an increase of 40 and 37 basis points, respectively, as compared to thesame periods in 2009.  The increase in the net interest margin in 2010 wasprimarily attributable to the impact that the decline in market interest rateshad on our liability sensitive balance sheet which caused interest-bearingliabilities to decrease faster than the yields on earning assets.  The total cost of funds decreased 73 and 65basis points in the second quarter and six month period of 2010, respectively,compared to 2009 due to a shift from high cost CDs and FHLB borrowed funds intomoney market accounts which realized the highest rate decrease of 78 and 73basis points, respectively.  Further contributingto the decrease in cost of funds was an increase in non-interest bearing demanddeposit balances of $10.3 million and $7.9 million for the three and six monthperiods of 2010, respectively, as compared to the same periods of 2009.  The decrease in our earning asset yield wasminimal at only 22 and 18 basis points for the three and six month periods of2010, respectively, compared to the same periods of 2009, partly due to theportion of our loan portfolio that was at the contractual rate floors.  Yield on loans remained relatively flat at6.24% for the second quarter 2010 versus 6.29% in the second quarter of 2009,as a result of the contractual rate floors.

 

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

 

***Net Interest Analysis***

*(Dollars in thousands)*

* *
| ** **                                      | ** ** | **Three Months Ended June 30, 2010** | ** ** | **Three Months Ended June 30, 2009** | ** ** |
|-------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                      | ** ** | **Average  Balance**                      | ** ** | **Interest  Income /  Expense**           | ** ** | **Avg  Rate/  Yield** | ** ** | **Average  Balance** | ** ** | **Interest  Income /  Expense** | ** ** | **Avg  Rate/  Yield** | ** ** |
| **Assets:**                                     |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Earning assets:                                 |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Gross loans (1) (2)                        |       | $                                         | 411,593    |                                      | $          | 6,402 |   | 6.24 | % | $ | 428,797 |   | $ | 6,725 |   | 6.29 | % |
| Investment securities (2)                       |       | 49,379                                    |       | 654                                       |       | 5.31 | % | 52,402 |   | 771 |   | 5.90 | % |
| Federal funds sold                              |       | 3,983                                     |       | 2                                         |       | 0.23 | % | 1,497 |   | 1 |   | 0.19 | % |
| Interest-earning deposits                       |       | 8,160                                     |       | 4                                         |       | 0.17 | % | 1,738 |   | 1 |   | 0.20 | % |
| Total interest-earning assets                   |       | 473,115                                   |       | 7,062                                     |       | 5.99 | % | 484,434 |   | 7,498 |   | 6.21 | % |
| Total noninterest earning assets                |       | 39,574                                    |       |                                      |       |   |   | 37,975 |   |   |   |   |   |
| Total Assets                                    |       | 512,689                                   |       |                                      |       |   |   | 522,409 |   |   |   |   |   |
| **Liabilities and Shareholders’  Equity:** |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                   |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Money market deposits                           |       | 209,087                                   |       | 371                                       |       | 0.71 | % | 175,067 |   | 652 |   | 1.49 | % |
| NOW deposits                                    |       | 59,474                                    |       | 49                                        |       | 0.33 | % | 57,317 |   | 70 |   | 0.49 | % |
| Savings deposits                                |       | 14,573                                    |       | 15                                        |       | 0.42 | % | 15,057 |   | 33 |   | 0.87 | % |
| Time certificates of deposit $100,000 or more   |       | 38,134                                    |       | 112                                       |       | 1.18 | % | 50,089 |   | 298 |   | 2.39 | % |
| Other time deposits                             |       | 35,845                                    |       | 111                                       |       | 1.25 | % | 54,961 |   | 296 |   | 2.16 | % |
| Other borrowings                                |       | 19,126                                    |       | 85                                        |       | 1.78 | % | 45,961 |   | 158 |   | 1.38 | % |
| Total interest-bearing liabilities              |       | 376,239                                   |       | 743                                       |       | 0.79 | % | 398,452 |   | 1,507 |   | 1.52 | % |
| Noninterest-bearing liabilities:                |       |                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Noninterest-bearing deposits                    |       | 71,790                                    |       |                                      |       |   |   | 61,533 |   |   |   |   |   |
| Other liabilities                               |       | 2,613                                     |       |                                      |       |   |   | 2,912 |   |   |   |   |   |
| Total noninterest-bearing liabilities           |       | 74,403                                    |       |                                      |       |   |   | 64,445 |   |   |   |   |   |
| Shareholders’ equity                       |       | 62,047                                    |       |                                      |       |   |   | 59,512 |   |   |   |   |   |
| Total liabilities and shareholders’ equity |       | $                                         | 512,689    |                                      |       |   |   |   | $ | 522,409 |   |   |   |   |   |
| Net interest income                             |       |                                      |       | $                                         | 6,319      |   |   |   |   |   | $ | 5,991 |   |   |   |
| Net interest spread (3)                         |       |                                      |       |                                      |       | 5.20 | % |   |   |   |   | 4.69 | % |
| Net interest margin (4)                         |       |                                      |       |                                      |       | 5.36 | % |   |   |   |   | 4.96 | % |

 

----

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

 

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

 

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

 

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

 

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| ** **                                      | ** ** | **Six months ended**   | ** ** | **Six months ended**            | ** ** |
|-------------------------------------------------|------------|------------------------|------------|---------------------------------|------------|
| ** **                                      | ** ** | **June 30, 2010** | ** ** | **June 30, 2009**          | ** ** |
| ** **                                      | ** ** | **Average  Balance**   | ** ** | **Interest  Income /  Expense** | ** ** | **Avg  Rate/  Yield** | ** ** | **Average  Balance** | ** ** | **Interest  Income /  Expense** | ** ** | **Avg  Rate/  Yield** | ** ** |
| **Assets:**                                     |       |                   |       |                            |       |   |   |   |   |   |   |   |   |
| Earning assets:                                 |       |                   |       |                            |       |   |   |   |   |   |   |   |   |
| Gross loans (1) (2)                        |       | $                      | 415,290    |                            | $          | 12,855 |   | 6.24 | % | $ | 429,326 |   | $ | 13,330 |   | 6.26 | % |
| Investment securities (2)                       |       | 48,223                 |       | 1,305                           |       | 5.46 | % | 49,716 |   | 1,491 |   | 6.05 | % |
| Federal funds sold                              |       | 3,463                  |       | 4                               |       | 0.23 | % | 1,440 |   | 2 |   | 0.22 | % |
| Interest-earning deposits                       |       | 8,113                  |       | 8                               |       | 0.19 | % | 1,619 |   | 2 |   | 0.20 | % |
| Total interest-earning assets                   |       | 475,089                |       | 14,171                          |       | 6.02 | % | 482,101 |   | 14,825 |   | 6.20 | % |
| Total noninterest earning assets                |       | 38,910                 |       |                            |       |   |   | 37,884 |   |   |   |   |   |
| Total Assets                                    |       | 513,999                |       |                            |       |   |   | 519,985 |   |   |   |   |   |
| **Liabilities and Shareholders’  Equity:** |       |                   |       |                            |       |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                   |       |                   |       |                            |       |   |   |   |   |   |   |   |   |
| Money market deposits                           |       | 208,910                |       | 821                             |       | 0.79 | % | 169,324 |   | 1,280 |   | 1.52 | % |
| NOW deposits                                    |       | 58,650                 |       | 98                              |       | 0.34 | % | 55,643 |   | 145 |   | 0.53 | % |
| Savings deposits                                |       | 14,501                 |       | 32                              |       | 0.44 | % | 14,330 |   | 67 |   | 0.94 | % |
| Time certificates of deposit $100,000 or more   |       | 39,396                 |       | 303                             |       | 1.55 | % | 46,049 |   | 586 |   | 2.57 | % |
| Other time deposits                             |       | 36,967                 |       | 274                             |       | 1.49 | % | 53,214 |   | 595 |   | 2.25 | % |
| Other borrowings                                |       | 21,847                 |       | 183                             |       | 1.69 | % | 57,951 |   | 387 |   | 1.35 | % |
| Total interest-bearing liabilities              |       | 380,271                |       | 1,711                           |       | 0.91 | % | 396,511 |   | 3,061 |   | 1.56 | % |
| Noninterest-bearing liabilities:                |       |                   |       |                            |       |   |   |   |   |   |   |   |   |
| Noninterest-bearing deposits                    |       | 69,262                 |       |                            |       |   |   | 61,409 |   |   |   |   |   |
| Other liabilities                               |       | 2,664                  |       |                            |       |   |   | 2,920 |   |   |   |   |   |
| Total noninterest-bearing liabilities           |       | 71,926                 |       |                            |       |   |   | 64,329 |   |   |   |   |   |
| Shareholders’ equity                       |       | 61,802                 |       |                            |       |   |   | 59,145 |   |   |   |   |   |
| Total liabilities and shareholders’ equity |       | $                      | 513,999    |                            |       |   |   |   | $ | 519,985 |   |   |   |   |   |
| Net interest income                             |       |                   |       | $                               | 12,461     |   |   |   |   |   | $ | 11,764 |   |   |   |
| Net interest spread (3)                         |       |                   |       |                            |       | 5.11 | % |   |   |   |   | 4.64 | % |
| Net interest margin (4)                         |       |                   |       |                            |       | 5.29 | % |   |   |   |   | 4.92 | % |

 

----

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

 

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

 

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

 

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

 

23

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

 

***Rate / Volume Variance Analysis***

*(In thousands)*

 
| ** **                         | ** ** | **For the Three Months Ended June 30,** | ** ** |
|------------------------------------|------------|----------------------------------------------|------------|
| ** **                         | ** ** | **2010 vs 2009**                             | ** ** |
| ** **                         | ** ** | **Increase (Decrease)**                      | ** ** |
| ** **                         | ** ** | **in interest income and expense**           | ** ** |
| ** **                         | ** ** | **due to changes in:**                       | ** ** |
| ** **                         | ** ** | **Volume**                                   | ** ** | **Rate** | ** ** | **Total** | ** ** |
| **Interest income:**               |       |                                         |       |   |   |   |   |
| Gross loans (1)                    |       | $                                            | (270       | ) | $ | (54 | ) | $ | (324 | ) |
| Investment securities              |       | (44                                          | )          | (72 | ) | (116 | ) |
| Federal funds sold                 |       | 1                                            |       | 0 |   | 1 |   |
| Interest-earning deposits          |       | 3                                            |       | (1 | ) | 2 |   |
| **Total  interest income**         |       | $                                            | **(310**   | **)** | $ | **(127** | **)** | $ | **(437** | **)** |
|                               |       |                                         |       |   |   |   |   |
| **Interest expense:**              |       |                                         |       |   |   |   |   |
| Money market deposits              |       | 127                                          |       | (412 | ) | (285 | ) |
| NOW deposits                       |       | 3                                            |       | (23 | ) | (20 | ) |
| Savings deposits                   |       | (1                                           | )          | (16 | ) | (17 | ) |
| Time CD $100K or more              |       | (71                                          | )          | (115 | ) | (186 | ) |
| Other time deposits                |       | (103                                         | )          | (82 | ) | (185 | ) |
| Other borrowings                   |       | (92                                          | )          | 20 |   | (72 | ) |
| **Total  interest expense**        |       | $                                            | **(137**   | **)** | $ | **(628** | **)** | $ | **(765** | **)** |
| ** **                         | ** ** | ** **                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Change in  net interest income** |       | $                                            | **(173**   | **)** | $ | **501** |   | $ | **328** |   |

 

----

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

 

Thetable above reflects the market interest rate decline has impacted liabilitiesmore than assets as indicated by the increase of $501,000 in net interestincome due to the rate change for the three month period of 2010.  Thedecreased loan volume and the overall change in mix of balances resulted in adecrease of $173,000 to net interest income over the same period.

 
| ** **                         | ** ** | **For the Six Months Ended June 30,** | ** ** |
|------------------------------------|------------|--------------------------------------------|------------|
| ** **                         | ** ** | **2010 vs 2009**                           | ** ** |
| ** **                         | ** ** | **Increase (Decrease)**                    | ** ** |
| ** **                         | ** ** | **in interest income and expense**         | ** ** |
| ** **                         | ** ** | **due to changes in:**                     | ** ** |
| ** **                         | ** ** | **Volume**                                 | ** ** | **Rate** | ** ** | **Total** | ** ** |
| **Interest income:**               |       |                                       |       |   |   |   |   |
| Gross loans (1)                    |       | $                                          | (436       | ) | $ | (40 | ) | $ | (476 | ) |
| Investment securities              |       | (45                                        | )          | (142 | ) | (187 | ) |
| Federal funds sold                 |       | 2                                          |       | 0 |   | 2 |   |
| Interest-earning deposits          |       | 7                                          |       | 0 |   | 7 |   |
| **Total  interest income**         |       | $                                          | **(472**   | **)** | $ | **(182** | **)** | $ | **(654** | **)** |
|                               |       |                                       |       |   |   |   |   |
| **Interest expense:**              |       |                                       |       |   |   |   |   |
| Money market deposits              |       | 299                                        |       | (758 | ) | (459 | ) |
| NOW deposits                       |       | 8                                          |       | (55 | ) | (47 | ) |
| Savings deposits                   |       | 1                                          |       | (36 | ) | (35 | ) |
| Time CD $100K or more              |       | (85                                        | )          | (199 | ) | (284 | ) |
| Other time deposits                |       | (182                                       | )          | (140 | ) | (322 | ) |
| Other borrowings                   |       | (241                                       | )          | 37 |   | (204 | ) |
| **Total  interest expense**        |       | $                                          | **(200**   | **)** | $ | **(1,151** | **)** | $ | **(1,351** | **)** |
| ** **                         | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Change in  net interest income** |       | $                                          | **(272**   | **)** | $ | **969** |   | $ | **697** |   |

 

----

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

 

Thetable above reflects the market interest rate decline has impacted liabilitiesmore than assets as indicated by the increase of $969,000 in net interestincome due to the rate change for the six month period of 2010.  Thedecreased loan volume and the overall change in mix of balances resulted in adecrease of $272,000 to net interest income over the same period.

 

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**Non-Interest Income**

 

Non-interestincome represents service charges on deposit accounts and other non-interestrelated charges and fees, including fees from mortgage commissions andinvestment service fee income.  For the three and six month periods ended June 30,2010, non-interest income was $732,000 and $1,379,000, respectively, anincrease of $85,000 or 13.1% and $133,000 or 10.7%, compared to the sameperiods in 2009.

 

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

 
| ** **                                         | ** ** | **For the Three Months Ended June 30,** | ** ** |
|----------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                         | ** ** | **2010**                                     | ** ** | **2009** | ** ** | **$ change** | ** ** | **% change** | ** ** |
| Service charges on deposits                        |       | $                                            | 259,366    |   | $ | 292,562 |   | $ | (33,196 | ) | (11.3 | )% |
| Earnings on cash surrender value of life insurance |       | 100,699                                      |       | 101,057 |   | (358 | ) | (0.4 | )% |
| Mortgage commissions                               |       | 25,008                                       |       | 46,472 |   | (21,464 | ) | (46.2 | )% |
| Other                                              |       | 347,121                                      |       | 207,286 |   | 139,835 |   | 67.5 | % |
| Total non-interest income                          |       | $                                            | 732,194    |   | $ | 647,377 |   | $ | 84,817 |   | 13.1 | % |

 
| ** **                                         | ** ** | **For the Six Months Ended June 30,** | ** ** |
|----------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                         | ** ** | **2010**                                   | ** ** | **2009** | ** ** | **$ change** | ** ** | **% change** | ** ** |
| Service charges on deposits                        |       | $                                          | 515,005    |   | $ | 574,947 |   | $ | (59,942 | ) | (10.4 | )% |
| Earnings on cash surrender value of life insurance |       | 204,685                                    |       | 202,114 |   | 2,571 |   | 1.3 | % |
| Mortgage commissions                               |       | 44,135                                     |       | 89,017 |   | (44,882 | ) | (50.4 | )% |
| Other                                              |       | 614,970                                    |       | 379,607 |   | 235,363 |   | 62.0 | % |
| Total non-interest income                          |       | $                                          | 1,378,795  |   | $ | 1,245,685 |   | $ | 133,110 |   | 10.7 | % |

 

Theincrease to total non-interest income is due in part to the gain on calledsecurities of $71,000 and $127,000 in the second quarter and six month periodof 2010, respectively, compared to $19,000 and $54,000 recorded in the sameperiods of 2009.  In addition, investmentservice fee income increased by $26,000 and $43,000, while bank debit card feesincreased by $25,000 and $49,000, respectively, for the three and six monthperiods ended June 30, 2010, compared to the same periods in 2009. Gain oncalled securities, investment service fee income and bank debit card fees areall included in the “other income” line item in the above table.  Offsetting these increases was a decrease inservice charges on deposits of $33,000 or 11.3% and $60,000 or 10.4%,respectively, combined with a decrease in mortgage commissions of $21,000 or46.2% and $45,000 or 50.4%, respectively, in the three and six month periodsended June 30, 2010, as compared to the same periods in 2009.  The Bank continues to expand its offerings tothe consumer and business depositor.

 

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**Non-Interest Expense**

 

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

 

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

 
| ** **                        | ** ** | **For the Three Months Ended June 30,** | ** ** |
|-----------------------------------|------------|----------------------------------------------|------------|
| ** **                        | ** ** | **2010**                                     | ** ** | **2009** | ** ** | **$ change** | ** ** | **% change** | ** ** |
| Salaries and employee benefits    |       | $                                            | 2,150,184  |   | $ |  1,865,341 |   | $ |  284,843 |   | 15.3 | % |
| Occupancy expenses                |       | 659,410                                      |       | 677,518 |   | (18,108 | ) | (2.7 | )% |
| Data processing fees              |       | 236,662                                      |       | 233,901 |   | 2,761 |   | 1.2 | % |
| OREO expenses                     |       | 216,043                                      |       | 933,724 |   | (717,681 | ) | (76.9 | )% |
| Assessments (FDIC & DFI) |       | 258,000                                      |       | 299,124 |   | (41,124 | ) | (13.7 | )% |
| Other operating expenses          |       | 796,132                                      |       | 776,990 |   | 19,142 |   | 2.5 | % |
| Total non-interest expense        |       | $                                            | 4,316,431  |   | $ |  4,786,598 |   | $ |  (470,167 | ) | (9.8 | )% |

 
| ** **                        | ** ** | **For the Six Months Ended June 30,** | ** ** |
|-----------------------------------|------------|--------------------------------------------|------------|
| ** **                        | ** ** | **2010**                                   | ** ** | **2009** | ** ** | **$ change** | ** ** | **% change** | ** ** |
| Salaries and employee benefits    |       | $                                          | 4,340,511  |   | $ |  3,915,225 |   | $ |  425,286 |   | 10.9 | % |
| Occupancy expenses                |       | 1,340,918                                  |       | 1,372,916 |   | (31,998 | ) | (2.3 | )% |
| Data processing fees              |       | 473,195                                    |       | 452,416 |   | 20,779 |   | 4.6 | % |
| OREO expenses                     |       | 563,844                                    |       | 1,058,752 |   | (494,908 | ) | (46.7 | )% |
| Assessments (FDIC & DFI) |       | 516,000                                    |       | 437,086 |   | 78,914 |   | 18.1 | % |
| Other operating expenses          |       | 1,527,223                                  |       | 1,488,509 |   | 38,714 |   | 2.6 | % |
| Total non-interest expense        |       | $                                          | 8,761,691  |   | $ |  8,724,904 |   | $ |  36,787 |   | 0.4 | % |

 

Non-interestexpenses decreased by $470,000 or 9.8% for the three months ended June 30,2010, as compared to the same period of 2009, and increased by $37,000 or 0.4%for the six months ended June 30, 2010, as compared to the same period of2009.  Salaries and employee benefitsincreased $285,000 and $425,000 for the three and six months ended June 30,2010, respectively, as compared to the same periods of 2009 as a result ofhiring existing open positions.  Data processing fees decreased by $18,000for the three month period of 2010, but increased by $21,000 for the six monthperiod of 2010, as compared to the same periods of 2009, as a result of anincreased number of transaction accounts.

 

FDICand DFI assessments decreased by $41,000 for the three months ended June 30,2010, but increased by $79,000 for the six month ended June 30, 2010, ascompared to the same periods of 2009.  The decrease of $41,000 in thesecond quarter of 2010 was the result of a special assessment paid on September 30,2009 that was accrued for during the second and third quarter of 2009.  Effective April 1, 2009, the FDICadopted a final rule revising its risk-based insurance assessment systemand effectively increasing the overall assessment rate. The new initial baseassessment rates for Risk Category 1 institutions range from twelve to sixteenbasis points, on an annualized basis.  The year-to-date increase ofFDIC insurance in 2010 over 2009 is primarily due to an increase in theindustry-wide FDIC assessment rate and growth in our deposit level. Inaddition, in November 2008, we elected to participate in the FDICTransaction Account Guarantee Program, which provides unlimited insurancecoverage on non-interest-bearing transaction accounts defined by the FDIC, onwhich we currently pay a 15 basis point surcharge per $100 covered balances inexcess of $250 thousand through December 30, 2010, at which time theprogram expires.

 

OREOexpenses were $216,000 and $564,000 in the second quarter and six month periodof 2010, respectively, compared to $934,000 and $1,059,000 for the comparableperiods of 2009.  These expenses resultedfrom various overhead costs and market value write downs associated with thesix properties classified as other real estate owned.  OREO expenses are decreasing compared to 2009as a result of managements effort to actively conduct market valuations on theproperties and record writedowns to bring carrying balances to the appropriatemarket values, which were higher in 2009, as well as selling various propertiesto bring our OREO balance down to $1.8 million compared to the $2.8 million at June 30,2009.

 

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

 

**Income Taxes**

 

Provisionfor income taxes for the second quarter and six month periods of 2010 were$616,000 and $926,000, respectively, an increase of $960,000 and $1,284,000compared to the tax benefit of $344,000 and $358,000, respectively, in the sameperiods of 2009.  The effective tax ratesof 37.23% and 31.78% for the second quarter and six month period of 2010, respectively,are returning to a more normal level compared to 2009 in which we recorded taxbenefits.  The 2009 tax rates, inparticular, are considerably lower compared to some of our peers and ourhistorical tax rates, and are disproportional compared to pre-tax incomeassuming marginal tax rates or historical effective tax rates are applied topre-tax income.  This is primarily due totax credits from California Enterprise Zones and low income housing projects aswell as tax free-income on loans within these enterprise zones and municipalsecurities and loans that comprise a larger proportion of pre-tax income in2010 and 2009 as compared other historical periods or peers.  Certain tax credits and deductions arerecognized by the Company regardless of the amount of pre-tax income or loss,which further increases the tax benefit and exaggerates the effective taxrates.

 

**Asset Quality**

 

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

 

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

 

Non-accrualloans totaled $10.1 million at June 30, 2010, as compared to $14.4 millionat December 31, 2009.  The non-accrual loans as of June 30, 2010are loans made to ten borrowers primarily for purposes of real estateconstruction and commercial real estate. As of June 30, 2010, we had three loans considered troubled debtrestructurings totaling $1.4 million, which are included in nonaccrual loans.

 

OREOtotaled $1.8 million as of June 30, 2010 and consists of six propertiesthat were acquired through foreclosure including residential land lots and acommercial real estate property.

 

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

 

***Non-Performing Assets***

*(in thousands)*

 
| ** **                                               | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                               | ** ** | **2010**          | ** ** | **2009**              | ** ** |
| Loans in nonaccrual status                               |       | $                 | 10,070     |                  | $          | 14,418 |   |
| Loans past due 90 days or more and accruing              |       | —            |       | —                |       |
| Restructured loans                                       |       | —            |       | —                |       |
| Total nonperforming loans                                |       | 10,070            |       | 14,418                |       |
| Other real estate owned                                  |       | 1,812             |       | 2,150                 |       |
| Total nonperforming assets                               |       | $                 | 11,882     |                  | $          | 16,568 |   |
|                                                     |       |              |       |                  |       |
| Allowance for loan losses                                |       | $                 | 7,614      |                  | $          | 7,020 |   |
|                                                     |       |              |       |                  |       |
| Asset quality ratios:                                    |       |              |       |                  |       |
| Non-performing assets to total assets                    |       | 2.29              | %          | 3.16                  | %          |
| Non-performing loans to total loans                      |       | 2.45              | %          | 3.39                  | %          |
| Allowance for loan losses to total loans                 |       | 1.85              | %          | 1.65                  | %          |
| Allowance for loan losses to total non-performing  loans |       | 75.61             | %          | 48.69                 | %          |

 

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

 

Inanticipation of credit risk inherent in our lending business, we routinely setaside allowances through charges to earnings. Such charges are not only madefor the outstanding loan portfolio, but also for off-balance sheet items, suchas commitments to extend credits or letters of credit. Charges made for theoutstanding loan portfolio have been credited to the allowance for loan losses,whereas charges for off-balance sheet items have been credited to the reservefor off-balance sheet items, which is presented as a component of otherliabilities.  The Bank recorded loan loss provisions of $1,005,000 and$2,010,000 for the three and six month periods in 2010, respectively, whichrepresented a $1,132,000 and $2,027,000 decrease from the provisions recordedin the same periods of 2009.

 

Theallowance for loan losses increased by $594,000 or 8.5%, to $7.61 millionat June 30, 2010, as compared with $7.02 million at December 31,2009.  The Bank recognized the increase in the allowance for loan lossesduring the first six months of the year due to the loan loss provision of $2.01million which was partially offset by net loan charge-offs of $1.42million.  The weak business climate has continued to adversely impact thefinancial conditions of certain Bank clients in addition to decrease collateralvalues.  The increase to the allowancefor loan losses combined with the decrease in our loan portfolio resulted in anincrease in the allowance for loan losses as a percentage of total loans to1.85% at June 30, 2010, as compared to 1.65% at December 31, 2009.

 

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

 

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

 

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

*(dollars in thousands)*

* *
| ** **                                               | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                               | ** ** | **June 30,**              | ** ** |
| ** **                                               | ** ** | **2010**                       | ** ** | **2009** | ** ** |
| Balance at beginning of period                           |       | $                              | 7,020      |   | $ | 5,569 |   |
| Provision for loan losses                                |       | 2,010                          |       | 4,037 |   |
| Loans charged off                                        |       | (1,419                         | )          | (3,907 | ) |
| Recoveries of previous charge-offs                       |       | 3                              |       | 2 |   |
| Net charge-offs                                          |       | (1,416                         | )          | (3,905 | ) |
| Balance at end of period                                 |       | $                              | 7,614      |   | $ | 5,701 |   |
|                                                     |       |                           |       |   |   |
| Allowance for loan losses to total loans                 |       | 1.85                           | %          | 1.34 | % |
| Net charge-offs to average loans (annualized)            |       | 0.69                           | %          | 1.83 | % |
| Provision for loan losses to average loans  (annualized) |       | 0.98                           | %          | 1.90 | % |

 

TheBank makes provisions for loan losses when required to bring the totalallowance for loan and lease losses to a level deemed appropriate for the levelof risk in the loan portfolio.  At least quarterly, management conducts anassessment of the overall quality of the loan portfolio and general economictrends in the local market.  The determination of the appropriate levelfor the allowance is based on that review, considering such factors ashistorical experience, the volume and type of lending conducted, the amount ofand identified potential loss associated with specific nonperforming loans,regulatory policies, general economic conditions, and other factors related tothe collectibility of loans in the portfolio.

 

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

 

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**Investment Activities**

 

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

 

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

 

TheBank holds federal funds sold, unpledged available-for-sale securities andsalable government guaranteed loans to help meet liquidity requirements andprovide temporary holdings until the funds can be otherwise deployed orinvested. As of June 30, 2010, and December 31, 2009, we had $30.1million and $21.6 million, respectively, in cash and cash equivalents.

 

*Investment Securities*

 

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

 

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

 

**Deposits**

 

Totaldeposits at June 30, 2010 were $435.8 million, a $6.5 million or 1.5%increase from the deposit total of $429.2 million at December 31,2009.  Average deposits increased $27.7 million to $427.7 million for thesix month period ended June 30, 2010 as compared to the same period in2009. We attracted deposits due to the safety and soundness of the Bank and ourfocus on customer service.

*** ***

***Deposits***

***(in thousands)***

** **
| ** **      | ** ** | **June 30,** | ** **         | **December 31,** | ** ** | **Six month change** | ** ** |
|-----------------|------------|-------------------|--------------------|-----------------------|------------|----------------------|------------|
| ** **      | ** ** | **2010**          | ** **         | **2009**              | ** ** | **$**                | ** ** | **%** | ** ** |
| Demand          |       | $                 | 77,267             |                  | $          |  69,647         |       | $ |  7,620 |   | 10.9 | % |
| NOW             |       | 59,133            |               | 57,378                |       | 1,755                |       | 3.1 | % |
| MMDA            |       | 209,325           |               | 202,947               |       | 6,378                |       | 3.1 | % |
| Savings         |       | 15,547            |               | 17,178                |       | (1,631               | )          |  (9.5 | )% |
| Time < 100K  |       | 30,214            |               | 36,215                |       | (6,001               | )          |  (16.6 | )% |
| Time > $100K |       | 44,270            |               | 45,845                |       | (1,575               | )          |  (3.4 | )% |
|            |       | $                 |   **435,756** |                  | $          |  **429,210**    |       | $ |  **6,546** | ** ** | **1.5** | **%** |

 

Becauseour client base is comprised primarily of commercial and industrial accounts,individual account balances are generally higher than those ofconsumer-oriented banks. Three of our clients carry deposit balances of morethan 1% of our total deposits, one of which had a deposit balance of more than3% of total deposits at June 30, 2010.

 

Sinceour deposit growth strategy emphasizes core deposit growth we have avoidedrelying on brokered deposits as a consistent source of funds.  The onlybrokered deposits the Bank holds are from CDARS, a certificate of depositprogram that exchanges funds with other network banks to offer full FDICinsurance coverage to the customer.  The Bank had $8.4 million in brokereddeposits as of June 30, 2010 as compared to $11.4 million atDecember 31, 2009.

 

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**Borrowings**

 

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

 

**Capital Ratios**

 

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

 

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

 

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

***(dollars inthousands)***

 
| ** **                               | ** ** | ** ** | ** **   | ** **           | ** ** | **Amount of Capital Required** | ** ** |
|------------------------------------------|------------|------------|--------------|----------------------|------------|-----------------------------------------------|------------|
| ** **                               | ** ** | ** ** | ** **   | ** **           | ** ** | **To Be**                                | ** ** | **To Be Adequately** | ** ** |
| ** **                               | ** ** | **Actual** | ** **   | **Well-Capitalized** | ** ** | **Capitalized**                               | ** ** |
| ** **                               | ** ** | **Amount** | ** **   | **Ratio**            | ** ** | **Amount**                                    | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **As of June 30, 2010:**            |       |       |         |                 |       |                                          |       |   |   |   |   |   |   |
| Total Capital (to Risk-Weighted Assets)  |       | $          |  66,395 |                 | 14.3       | %                                             | $          |  46,381 |   | 10 | % | $ |  37,105 |   | 8 | % |
| Tier 1 Capital (to Risk-Weighted Assets) |       | $          |  60,554 |                 | 13.1       | %                                             | $          |  27,829 |   | 6 | % | $ |  18,552 |   | 4 | % |
| Tier 1 Capital (to Average Assets)       |       | $          |  60,554 |                 | 11.8       | %                                             | $          |  25,632 |   | 5 | % | $ |  20,505 |   | 4 | % |
|                                     |       |       |         |                 |       |                                          |       |   |   |   |   |   |   |
| **As of December 31,  2009:**       |       |       |         |                 |       |                                          |       |   |   |   |   |   |   |
| Total Capital (to Risk-Weighted Assets)  |       | $          |  64,821 |                 | 13.6       | %                                             | $          |  47,844 |   | 10 | % | $ |  38,275 |   | 8 | % |
| Tier 1 Capital (to Risk-Weighted Assets) |       | $          |  58,817 |                 | 12.3       | %                                             | $          |  28,706 |   | 6 | % | $ |  19,137 |   | 4 | % |
| Tier 1 Capital (to Average Assets)       |       | $          |  58,817 |                 | 11.3       | %                                             | $          |  26,024 |   | 5 | % | $ |  20,819 |   | 4 | % |

 

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

***(dollars inthousands)***

 
| ** **                               | ** ** | ** ** | ** **   | ** **           | ** ** | **Amount of Capital Required** | ** ** |
|------------------------------------------|------------|------------|--------------|----------------------|------------|-----------------------------------------------|------------|
| ** **                               | ** ** | ** ** | ** **   | ** **           | ** ** | **To Be**                                | ** ** | **To Be Adequately** | ** ** |
| ** **                               | ** ** | **Actual** | ** **   | **Well-Capitalized** | ** ** | **Capitalized**                               | ** ** |
| ** **                               | ** ** | **Amount** | ** **   | **Ratio**            | ** ** | **Amount**                                    | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **As of June 30, 2010:**            |       |       |         |                 |       |                                          |       |   |   |   |   |   |   |
| Total Capital (to Risk-Weighted Assets)  |       | $          |  66,545 |                 | 14.4       | %                                             | N/A        |   | N/A |   | $ |  37,108 |   | 8 | % |
| Tier 1 Capital (to Risk-Weighted Assets) |       | $          |  60,704 |                 | 13.1       | %                                             | N/A        |   | N/A |   | $ |  18,554 |   | 4 | % |
| Tier 1 Capital (to Average Assets)       |       | $          |  60,704 |                 | 11.8       | %                                             | N/A        |   | N/A |   | $ |  20,508 |   | 4 | % |
|                                     |       |       |         |                 |       |                                          |       |   |   |   |   |   |   |
| **As of December 31,  2009:**       |       |       |         |                 |       |                                          |       |   |   |   |   |   |   |
| Total Capital (to Risk-Weighted Assets)  |       | $          |  65,014 |                 | 13.6       | %                                             | N/A        |   | N/A |   | $ |  38,285 |   | 8 | % |
| Tier 1 Capital (to Risk-Weighted Assets) |       | $          |  59,009 |                 | 12.3       | %                                             | N/A        |   | N/A |   | $ |  19,142 |   | 4 | % |
| Tier 1 Capital (to Average Assets)       |       | $          |  59,009 |                 | 11.3       | %                                             | N/A        |   | N/A |   | $ |  20,824 |   | 4 | % |

 

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**Liquidity Management**

 

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

 

Maintenanceof adequate liquidity requires that sufficient resources be available at alltime to meet our cash flow requirements. Liquidity in a banking institution isrequired primarily to provide for deposit withdrawals and the credit needs ofits customers and to take advantage of investment opportunities as they arise.Liquidity management involves our ability to convert assets into cash or cashequivalents without incurring significant loss, and to raise cash or maintainfunds without incurring excessive additional cost. For this purpose, wemaintain a portion of our funds in cash and cash equivalents, salablegovernment guaranteed loans and securities available for sale. We obtain fundsfrom the repayment and maturity of loans as well as deposit inflows, investmentsecurity maturities and paydowns, Federal funds purchased, FHLB advances, andother borrowings.  Our primary uses offunds are the origination of loans, the purchase of investment securities,withdrawals of deposits, maturity of certificate of deposits, repayment ofborrowings and dividends to common and preferred stockholders. Our liquidassets at June 30, 2010 were $89.6 million compared to $80.1 million atDecember 31, 2009.  Our liquidity level measured as the percentage ofliquid assets to total assets was 17.3% and 15.3% at June 30, 2010 andDecember 31, 2009, respectively. We anticipate that cash and cashequivalents on hand and other sources of funds will provide adequate liquidityfor our operating, investing and financing needs and our regulatory liquidityrequirements for the foreseeable future. Management monitors our liquidityposition daily, balancing loan funding/payments with changes in depositactivity and overnight investments.

 

Asa secondary source of liquidity, we rely on advances from the FHLB tosupplement our supply of lendable funds and to meet deposit withdrawalrequirements. Advances from the FHLB are typically secured by a portion of ourloan portfolio. The FHLB determines limitations on the amount of advances byassigning a percentage to each eligible loan category that will count towardsthe borrowing capacity. As of June 30, 2010, our borrowing capacity fromthe FHLB was approximately $118.6 million and the outstanding balance was$18.5 million, or approximately 15.7% of our borrowing capacity. We alsomaintain 2 lines of credit with correspondent banks to purchase up to$15 million in federal funds, for which there were no advances as of June 30,2010.

 

**Off-Balance-Sheet Arrangements**

 

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

 

Asof June 30, 2010 and December 31, 2009, we had commitments to extendcredit of $56.1 million and $63.1 million, respectively, which includesobligations under letters of credit of $2.7 million and $2.8 million,respectively.

 

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

 

**Recent Legislation and Other Regulatory Initiatives**

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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**Item 3.                   Quantitative and Qualitative Disclosures AboutMarket Risk**

 

Notapplicable.

 

**Item 4.                   Controls and Procedures**

 

TheCompany’s Chief Executive Officer and its Chief Financial Officer, afterevaluating the effectiveness of the Company’s disclosure controls andprocedures, as defined in Exchange Act Rules 13 a-15(e)and15(d)-15(e) promulgated under the Exchange Act, as of the end of theperiod covered by this report (the “Evaluation Date”) have concluded that as ofthe Evaluation Date, the Company’s disclosure controls and procedures wereadequate and effective to ensure that material information relating to theCompany would be made known to them by others within the Company, particularlyduring the period in which this report was being prepared.  Disclosurecontrols and procedures are designed to ensure that information required to bedisclosed by us in the reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls andprocedures designed to ensure that information required to be disclosed by usin the reports that we file under the Exchange Act is accumulated andcommunicated to our management, including our Chief Executive Officer and ChiefFinancial Officer, as appropriate to allow timely decisions regarding requireddisclosure.

 

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

 

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**PART II - OTHERINFORMATION**

 

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

 

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

 

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

 

Notapplicable.

 

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

 

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

 

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

 

None.

 

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

 

None.

 

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

 

None.

 

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

 

Thefollowing exhibits are filed as part of this report or hereby incorporated byreference to filings previously made with the SEC:

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

 

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**SIGNATURES**

 

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

 
|                        | **Oak Valley Bancorp** |
|-----------------------------|------------------------|
| Date:  August 13, 2010 | By:                    | /s/    RICHARD A. MCCARTY |
|                        | ** **             | **Richard A. McCarty** |
|                        | ** **             | **Executive Vice President and  Chief Financial Officer** |
|                        | ** **             | **(Principal Financial Officer and  duly authorized****signatory)** |

 

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**EXHIBIT INDEX**

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

 

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