Tableof Contents

 

 

 

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**Form 10-Q**

 

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

** **

**Forthe quarterly period ended March 31, 2009**

** **

**OR**

** **

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

 

**Commissionfile number 001-34142**

 

**OAKVALLEY BANCORP**

(Exact name ofregistrant as specified in its charter)

 

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

 

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

(Address ofprincipal executive offices)

 

**(209)848-2265**

Issuer’s telephonenumber

 

**Notapplicable**

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

 

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

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateweb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T during the preceding 12months (or for such shorter period that the registrant was required to submitand post such files).   Yes  o     No  o

 

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

 

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

 

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

 

**APPLICABLEONLY TO CORPORATE ISSUERS**

 

State the number ofshares outstanding of each of the issuer’s classes of common equity, as of thelatest practicable date:   **7,661,627 shares of common stock outstanding as of April 30,2009.**

 

 

 

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**OakValley Bancorp**

**March 31,2009**

 

**Index**

** **
| ** **                                                                                                                                                             | ** **                                                                                      | ** ** | **Page**   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------|------------|------------|
| **PART I  — FINANCIAL INFORMATION**                                                                                                                          | ** **                                                                                      | ** ** |
|                                                                                                                                                                   |                                                                                            |       |
| **Item  1.**                                                                                                                                                           | **Financial  Statements**                                                                       | ** ** | ** ** |
|                                                                                                                                                                   |                                                                                            |       |       |
| Condensed  Consolidated Balance Sheets at March 31, 2009, December 31, 2008                                                                                  |                                                                                            | 3          |
|                                                                                                                                                                   |                                                                                            |       |
| Condensed  Consolidated Statements of Earnings for the Three Month Periods Ended  March 31, 2009 and 2008                                                         |                                                                                            | 4          |
|                                                                                                                                                                   |                                                                                            |       |
| Condensed Consolidated Statements of Changes of  Shareholders’ Equity for the Three-Month Period Ended March 31, 2009 and  Year Ended December 31, 2008 |                                                                                            | 5          |
|                                                                                                                                                                   |                                                                                            |       |
| Condensed Consolidated Statements of Cash Flows for  the Three-Month Periods Ended March 31, 2009 and 2008                                                        |                                                                                            | 6          |
|                                                                                                                                                                   |                                                                                            |       |
| Notes to Consolidated Financial Statements                                                                                                                             |                                                                                            | 7          |
|                                                                                                                                                                   |                                                                                            |       |       |
| **Item 2.**                                                                                                                                                            | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations** |       | 13         |
| ** **                                                                                                                                                             | ** **                                                                                      | ** ** |       |
| **Item 3.**                                                                                                                                                            | **Quantitative  and Qualitative Disclosures About Market Risk**                                 |       | 24         |
| ** **                                                                                                                                                             | ** **                                                                                      | ** ** |       |
| **Item 4T.**                                                                                                                                                           | **Controls and  Procedures**                                                                    |       | 24         |
|                                                                                                                                                                   |                                                                                            |       |       |
| **PART II  — OTHER INFORMATION**                                                                                                                             |                                                                                            | 25         |
|                                                                                                                                                                   |                                                                                            |       |       |
| **Item 1.**                                                                                                                                                            | **Legal Proceedings**                                                                           |       | 25         |
| **Item 2.**                                                                                                                                                            | **Unregistered  Sales of Equity Securities and Use of Proceeds**                                |       | 25         |
| **Item 3.**                                                                                                                                                            | **Defaults Upon  Senior Securities**                                                            |       | 25         |
| **Item 4.**                                                                                                                                                            | **Submission of  Matters to a Vote of Security Holders**                                        |       | 25         |
| **Item 5.**                                                                                                                                                            | **Other Information**                                                                           |       | 25         |
| **Item 6.**                                                                                                                                                            | **Exhibits**                                                                                    |       | 25         |

 

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**OAKVALLEY BANCORP**

**CONDENSEDBALANCE SHEETS (UNAUDITED)**

** **
| ** **                                                                                                                                                                             | ** ** | **March 31,** | ** **        | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|-------------------|-----------------------|------------|
| ** **                                                                                                                                                                             | ** ** | **2009**           | ** **        | **2008**              | ** ** |
| **ASSETS**                                                                                                                                                                             |       |               |              |                  |       |
|                                                                                                                                                                                   |       |               |              |                  |       |
| Cash and due from banks                                                                                                                                                                |       | $                  | 11,132,482        |                  | $          | 9,072,860 |   |
| Federal funds sold                                                                                                                                                                     |       | 2,080              |              | 765,000               |       |
| Cash and cash equivalents                                                                                                                                                              |       | 11,134,562         |              | 9,837,860             |       |
|                                                                                                                                                                                   |       |               |              |                  |       |
| Securities available for sale                                                                                                                                                          |       | 52,494,281         |              | 41,448,877            |       |
| Loans, net of allowance for loan loss of $6,603,064 in 2009 and  $5,569,496 in 2008                                                                                                    |       | 422,876,602        |              | 421,572,911           |       |
| Bank premises and equipment, net                                                                                                                                                       |       | 10,836,776         |              | 11,093,967            |       |
| Other real estate owned                                                                                                                                                                |       | 3,267,019          |              | 2,745,575             |       |
| Accrued interest and other assets                                                                                                                                                      |       | 23,137,291         |              | 21,503,821            |       |
|                                                                                                                                                                                   |       |               |              |                  |       |
|                                                                                                                                                                                   |       | $                  |  523,746,531 |                  | $          | 508,203,011 |   |
|                                                                                                                                                                                   |       |               |              |                  |       |
| **LIABILITIES AND  SHAREHOLDERS’ EQUITY**                                                                                                                                         | ** ** | ** **         | ** **        | ** **            | ** ** |
|                                                                                                                                                                                   |       |               |              |                  |       |
| Deposits                                                                                                                                                                               |       | $                  | 410,089,212       |                  | $          | 378,248,467 |   |
| Accrued interest and other liabilities                                                                                                                                                 |       | 2,870,865          |              | 2,968,465             |       |
| FHLB advances                                                                                                                                                                          |       | 52,000,000         |              | 69,000,000            |       |
|                                                                                                                                                                                   |       |               |              |                  |       |
| Total liabilities                                                                                                                                                                      |       | 464,960,077        |              | 450,216,932           |       |
|                                                                                                                                                                                   |       |               |              |                  |       |
| Shareholders’ equity                                                                                                                                                              |       |               |              |                  |       |
| Preferred stock, no par value; $1,000 per share liquidation  preference, 10,000 shares authorized and 13,500 issued and outstanding at March 31,  2009 and December 31, 2009 |       | 12,722,311         |              | 12,680,649            |       |
| Common stock, no par value; 10,000,000 shares authorized and 7,661,627  shares issued and outstanding at March 31, 2009 and December 31,  2008                               |       | 23,863,331         |              | 23,863,331            |       |
| Additional paid-in capital                                                                                                                                                             |       | 1,949,224          |              | 1,925,224             |       |
| Retained earnings                                                                                                                                                                      |       | 19,292,501         |              | 19,226,645            |       |
| Accumulated other comprehensive income, net of tax                                                                                                                                     |       | 959,087            |              | 290,230               |       |
|                                                                                                                                                                                   |       |               |              |                  |       |
| Total shareholders’ equity                                                                                                                                                        |       | 58,786,454         |              | 57,986,079            |       |
|                                                                                                                                                                                   |       |               |              |                  |       |
|                                                                                                                                                                                   |       | $                  |  523,746,531 |                  | $          | 508,203,011 |   |

 

*Seeaccompanying notes*

 

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**OAKVALLEY BANCORP**

**CONDENSEDSTATEMENTS OF EARNINGS (UNAUDITED)**

 
| ** **                                          | ** ** | **3 MONTHS ENDED** | ** ** |
|-----------------------------------------------------|------------|--------------------|------------|
| ** **                                          | ** ** | **MARCH 31,** | ** ** |
| ** **                                          | ** ** | **2009**           | ** ** | **2008** | ** ** |
|                                                |       |               |       |   |   |
| Interest and fees on loans                          |       | $                  | 6,596,208  |   | $ | 6,934,131 |   |
| Interest on securities available for sale           |       | 612,158            |       | 394,682 |   |
| Interest on federal funds sold                      |       | 903                |       | 5,104 |   |
| Interest on deposits with banks                     |       | 763                |       | 718 |   |
| Total interest income                               |       | 7,210,032          |       | 7,334,635 |   |
|                                                |       |               |       |   |   |
| Deposits                                            |       | 1,323,920          |       | 2,157,558 |   |
| FHLB advances                                       |       | 229,452            |       | 361,672 |   |
| Federal funds purchased                             |       | 264                |       | 6,372 |   |
| Total interest expense                              |       | 1,553,636          |       | 2,525,602 |   |
|                                                |       |               |       |   |   |
| Net interest income                                 |       | 5,656,396          |       | 4,809,033 |   |
|                                                |       |               |       |   |   |
| Provision for loan losses                           |       | 1,900,000          |       | 145,000 |   |
| Net interest income after provision for loan losses |       | 3,756,396          |       | 4,664,033 |   |
|                                                |       |               |       |   |   |
| Service charges on deposits                         |       | 282,385            |       | 302,927 |   |
| Earnings on cash surrender value of life insurance  |       | 101,057            |       | 81,276 |   |
| Mortgage commissions                                |       | 42,544             |       | 49,730 |   |
| Other income                                        |       | 172,323            |       | 179,650 |   |
| Total non-interest income                           |       | 598,309            |       | 613,583 |   |
|                                                |       |               |       |   |   |
| Salaries and employee benefits                      |       | 2,049,884          |       | 2,446,427 |   |
| Occupancy expenses                                  |       | 695,398            |       | 669,553 |   |
| Data processing fees                                |       | 218,516            |       | 178,559 |   |
| OREO expenses                                       |       | 125,029            |       | — |   |
| Other operating expenses                            |       | 849,480            |       | 762,031 |   |
| Total non-interest expense                          |       | 3,938,307          |       | 4,056,570 |   |
|                                                |       |               |       |   |   |
| Net income before provision for income taxes        |       | 416,398            |       | 1,221,046 |   |
|                                                |       |               |       |   |   |
| (Tax benefit) provision for income taxes            |       | (13,912            | )          | 445,249 |   |
|                                                |       |               |       |   |   |
| Net income                                          |       | $                  | 430,310    |   | $ | 775,797 |   |
|                                                |       |               |       |   |   |
| Preferred stock dividends and accretion             |       | 210,411            |       | — |   |
| Net income available to common shareholders         |       | $                  | 219,899    |   | $ | 775,797 |   |
|                                                |       |               |       |   |   |
| Net income per common share                         |       | $                  | 0.03       |   | $ | 0.10 |   |
| Net income per common diluted share                 |       | $                  | 0.03       |   | $ | 0.10 |   |

 

*Seeaccompanying notes*

 

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**OAKVALLEY BANCORP**

**CONDENSEDSTATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)**

** **
| ** **                                                                                        | ** ** | **YEAR  ENDED DECEMBER 31, 2008 AND THE THREE MONTH PERIOD ENDED MARCH 31, 2009** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **                                                                                        | ** ** | ** **                                                                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
| ** **                                                                                        | ** ** | ** **                                                                             | ** ** | ** ** | ** ** | ** ** | ** ** | **Additional** | ** ** | ** ** | ** ** | ** ** | ** ** | **Other** | ** ** | **Total** | ** ** |
| ** **                                                                                        | ** ** | **Common  Stock**                                                                      | ** ** | **Preferred** | ** ** | **Paid-in** | ** ** | **Retained** | ** ** | **Comprehensive** | ** ** | **Comprehensive** | ** ** | **Shareholders’** | ** ** |
| ** **                                                                                        | ** ** | **Shares**                                                                             | ** ** | **Amount** | ** ** | **Stock** | ** ** | **Capital** | ** ** | **Earnings** | ** ** | **Income** | ** ** | **Income** | ** ** | **Equity** | ** ** |
|                                                                                              |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Balances,  January 1, 2008                                                                   |       | 7,607,780                                                                              |       | $ | 22,843,171 |   | $ |   |   | $ | 1,748,380 |   | $ | 17,723,646 |   |   |   | $ | 46,193 |   | $ | 42,361,390 |   |
| Stock options  exercised                                                                          |       | 53,847                                                                                 |       | 186,922 |   |   |   |   |   |   |   |   |   |   |   | 186,922 |   |
| Issuance of  preferred stock                                                                      |       |                                                                                   |       |   |   | 12,666,762 |   |   |   |   |   |   |   |   |   | 12,666,762 |   |
| Issuance of TCPP  warrants                                                                        |       |                                                                                   |       | 833,238 |   |   |   |   |   |   |   |   |   |   |   | 833,238 |   |
| Preferred stock  accretion                                                                        |       |                                                                                   |       |   |   | 13,887 |   |   |   | (13,887 | ) |   |   |   |   | 0 |   |
| Tax benefit of  stock options exercised                                                           |       |                                                                                   |       |   |   |   |   | 54,195 |   |   |   |   |   |   |   | 54,195 |   |
| Cash dividends  ($0.075 per share)                                                                |       |                                                                                   |       |   |   |   |   |   |   | (574,484 | ) |   |   |   |   | (574,484 | ) |
| Stock based  compensation                                                                         |       |                                                                                   |       |   |   |   |   | 122,649 |   |   |   |   |   |   |   | 122,649 |   |
| Cumulative effect  of adopting EITF 06-04                                                         |       |                                                                                   |       |   |   |   |   |   |   | (70,459 | ) |   |   |   |   | (70,459 | ) |
| Comprehensive  income                                                                             |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net changes in  unrealized gain on available-for-sale securities (net of income tax of  $158,664) |       |                                                                                   |       |   |   |   |   |   |   |   |   | 244,037 |   | 244,037 |   | 244,037 |   |
| Net income                                                                                        |       |                                                                                   |       |   |   |   |   |   |   | 2,161,829 |   | 2,161,829 |   |   |   | 2,161,829 |   |
| Comprehensive  income                                                                             |       |                                                                                   |       |   |   |   |   |   |   |   |   | $ | 2,405,866 |   |   |   |   |   |
| Balances,  December 31, 2008                                                                 |       | 7,661,627                                                                              |       | $ | 23,863,331 |   | $ | 12,680,649 |   | $ | 1,925,224 |   | $ | 19,226,645 |   |   |   | $ | 290,230 |   | $ | 57,986,079 |   |
| Preferred stock  accretion                                                                        |       |                                                                                   |       |   |   | 41,662 |   |   |   | (41,662 | ) |   |   |   |   | 0 |   |
| Preferred stock  dividend payment                                                                 |       |                                                                                   |       |   |   |   |   |   |   | (131,250 | ) |   |   |   |   | (131,250 | ) |
| Cash dividends  ($0.025 per share)                                                                |       |                                                                                   |       |   |   |   |   |   |   | (191,542 | ) |   |   |   |   | (191,542 | ) |
| Stock based  compensation                                                                         |       |                                                                                   |       |   |   |   |   | 24,000 |   |   |   |   |   |   |   | 24,000 |   |
| Comprehensive  income                                                                             |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net changes in  unrealized gain on available-for-sale securities (net of income tax of  $434,867) |       |                                                                                   |       |   |   |   |   |   |   |   |   | 668,857 |   | 668,857 |   | 668,857 |   |
| Net income                                                                                        |       |                                                                                   |       |   |   |   |   |   |   | 430,310 |   | 430,310 |   |   |   | 430,310 |   |
| Comprehensive  income                                                                             |       |                                                                                   |       |   |   |   |   |   |   |   |   | $ | 1,099,167 |   |   |   |   |   |
| Balances,  March 31, 2009                                                                    |       | 7,661,627                                                                              |       | $ | 23,863,331 |   | $ | 12,722,311 |   | $ | 1,949,224 |   | $ | 19,292,501 |   |   |   | $ | 959,087 |   | $ | 58,786,454 |   |

 

*Seeaccompanying notes*

 

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**OAKVALLEY BANCORP**

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

** **
| ** **                                                                                | ** ** | **3 MONTHS ENDED MARCH 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                | ** ** | **2009**                          | ** ** | **2008** | ** ** |
|                                                                                      |       |                              |       |   |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                     |       |                              |       |   |   |
| Net income                                                                                |       | $                                 | 430,310    |   | $ | 775,797 |   |
| Adjustments to reconcile net earnings to net cash from operating  activities:             |       |                              |       |   |   |
| Provision for loan losses                                                                 |       | 1,900,000                         |       | 145,000 |   |
| Depreciation, amortization and accretion, net                                             |       | 261,407                           |       | 282,299 |   |
| Stock-based compensation expense                                                          |       | 24,000                            |       | 32,709 |   |
| Loss on sale of premises and equipment                                                    |       | —                            |       | 1,434 |   |
| Gain on called available for sale securities                                              |       | (35,826                           | )          | — |   |
| Decrease (increase) in accrued interest receivable                                        |       | 63,877                            |       | (67,544 | ) |
| Decrease in accrued interest payable and other liabilities                                |       | (97,600                           | )          | (688,000 | ) |
| (Increase) decrease in other assets                                                       |       | (2,068,819                        | )          | 672,821 |   |
| Net cash from operating activities                                                        |       | 477,349                           |       | 1,154,516 |   |
|                                                                                      |       |                              |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                     |       |                              |       |   |   |
| Purchases of available for sale securities                                                |       | (11,924,601                       | )          | (2,013,739 | ) |
| Proceeds from maturities, calls, and principal paydowns of securities  available for sale |       | 2,031,402                         |       | 1,089,808 |   |
| Net increase in loans                                                                     |       | (3,788,530                        | )          | (3,120,588 | ) |
| Purchase of BOLI policies                                                                 |       | —                            |       | (4,740,000 | ) |
| Net purchases of premises and equipment                                                   |       | (16,871                           | )          | (893,849 | ) |
| Net cash used in investing activities                                                     |       | (13,698,600                       | )          | (9,678,368 | ) |
|                                                                                      |       |                              |       |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                     |       |                              |       |   |   |
| FHLB advanced funds                                                                       |       | 24,100,000                        |       | 97,645,400 |   |
| FHLB payments                                                                             |       | (41,100,000                       | )          | (74,645,400 | ) |
| Federal funds advances                                                                    |       | 6,285,000                         |       | (43,335,000 | ) |
| Federal funds payments                                                                    |       | (6,285,000                        | )          | 43,335,000 |   |
| Shareholder cash dividends paid                                                           |       | (191,542                          | )          | — |   |
| Preferred stock dividend payment                                                          |       | (131,250                          | )          | — |   |
| Net increase in demand deposits and savings accounts                                      |       | 15,075,860                        |       | 1,634,997 |   |
| Net increase (decrease) in time deposits                                                  |       | 16,764,885                        |       | (16,222,290 | ) |
| Proceeds from sale of common stock and exercise of stock options                          |       | —                            |       | 12,143 |   |
| Net cash from financing activities                                                        |       | 14,517,953                        |       | 8,424,850 |   |
|                                                                                      |       |                              |       |   |   |
| NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS                                      |       | 1,296,702                         |       | (99,002 | ) |
|                                                                                      |       |                              |       |   |   |
| CASH AND CASH EQUIVALENTS, beginning of period                                            |       | 9,837,860                         |       | 14,202,951 |   |
|                                                                                      |       |                              |       |   |   |
| CASH AND CASH EQUIVALENTS, end of period                                                  |       | $                                 | 11,134,562 |   | $ | 14,103,949 |   |
|                                                                                      |       |                              |       |   |   |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:                                        |       |                              |       |   |   |
| Cash paid during the year for:                                                            |       |                              |       |   |   |
| Interest                                                                                  |       | $                                 | 1,613,368  |   | $ | 3,087,895 |   |
| Income taxes                                                                              |       | $                                 | —     |   | $ | — |   |
|                                                                                      |       |                              |       |   |   |
| NON-CASH INVESTING ACTIVITIES:                                                            |       |                              |       |   |   |
| Real estate acquired through foreclosure                                                  |       | $                                 | 584,839    |   | $ | 2,850,237 |   |
| Net change in unrealized gain on available-for-sale securities                            |       | $                                 | 1,103,724  |   | $ | 314,890 |   |
|                                                                                      |       |                              |       |   |   |
| NON-CASH FINANCING ACTIVITIES:                                                            |       |                              |       |   |   |
| Cumulative effect of adopting EITF 06-04                                                  |       | $                                 | —     |   | $ | 119,842 |   |
| Accretion of preferred stock                                                              |       | $                                 | 41,662     |   | $ | — |   |

 

*Seeaccompanying notes*

 

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**OAKVALLEY BANCORP**

**NOTES TO CONDENSED FINANCIALSTATEMENTS**

 

**NOTE 1 –BASIS OF PRESENTATION**

 

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

 

The accounting principlesfollowed by the Company and the methods of applying these principles conformwith accounting principles generally accepted in the United States of America(GAAP) and with general practices within the banking industry. In preparingfinancial statements in conformity with GAAP, management is required to makeestimates and assumptions that affect the reported amounts in the financialstatements. Actual results could differ significantly from those estimates.Material estimates common to the banking industry that are particularlysusceptible to significant change in the near term include, but are not limitedto, the determination of the allowance for loan losses, the estimation ofcompensation expense related to stock options granted to employees anddirectors, and valuation allowances associated with deferred tax assets, therecognition of which are based on future taxable income.

 

The interim financialstatements included in this report are unaudited but reflect all adjustmentswhich, in the opinion of management, are necessary for a fair presentation ofthe financial position and results of operations for the interim periodspresented. All such adjustments are of a normal recurring nature. The resultsof operations for the three month period ended March 31, 2009 are notnecessarily indicative of the results of a full year’s operations. For furtherinformation, refer to the audited financial statements and footnotes includedin the Company’s Form 10-K for the year ended December 31, 2008.

 

**NOTE 2 –CURRENT ACCOUNTING PRONOUNCEMENTS**

 

In September 2006the Emerging Issues Task Force (“EITF”) ratified EITF issue 06-04, “Accountingfor Deferred Compensation and Postretirement Benefit Aspect of EndorsementSplit-Dollar Life Insurance Arrangements”.   This ruling providesthat the Company should recognize a liability for future benefits based on theagreements held with employees.  The issue was effective for fiscal yearsbeginning after December 17, 2007.  The Company adopted thispronouncement effective January 1, 2008 and has recorded an initialliability of $119,842 with an offsetting adjustment to retained earnings of$70,459 and deferred taxes of $49,383, pursuant to this accountingpronouncement.

 

In November 2007, the SEC issuedStaff Accounting Bulletin No. 109, WrittenLoan Commitments Recorded at Fair Value through Earnings (SAB 109). SAB109 provides guidance on the accounting for written loan commitments recordedat fair value under generally accepted accounting principles (GAAP).Specifically, the SAB revises the Staff’s views on incorporating expected netfuture cash flows related to loan servicing activities in the fair valuemeasurement of a written loan commitment.  SAB 109, whichsupersedes SAB 105, Applicationof Accounting Principles to Loan Commitments, requires theexpected net future cash flows related to the associated servicing of theloan be included in the measurement of all written loan commitments that areaccounted for at fair value through earnings. SAB 109 was effective on January 1,2008 for the Company. Adoption of SAB 109 did not have a material impact on theCompany’s financial statements.

 

InDecember 2007, the FASB issued FASB Statement of Financial AccountingStandards**No. 141 (revised), BusinessCombinations (SFAS 141R). SFAS 141R replaces SFAS 141. SFAS 141R retainsthe fundamental requirements in SFAS 141 that the acquisition method ofaccounting (which SFAS 141 called the purchase method) be used for all businesscombinations and for an acquirer to be identified for each businesscombination. SFAS 141R also retains the guidance in SFAS 141 for identifyingand recognizing intangible assets separately from goodwill. SFAS 141R requiresan acquirer to recognize the assets acquired, the liabilities assumed, and anynoncontrolling interest in the acquiree at the acquisition date, measured attheir fair values as of that date, with limited exceptions specified in theStatement. SFAS 141R replaces the cost-allocation process of SFAS 141, whichrequired the cost of an acquisition to be allocated to the individual assetsacquired and liabilities assumed based on their estimated fair values. SFAS 141required the acquirer to include the costs incurred to effect the acquisition(acquisition-related costs) in the cost of the acquisition that was allocatedto the assets acquired and the liabilities assumed. SFAS 141R requires thosecosts to be recognized separately from the acquisition. In addition, inaccordance with SFAS 141, restructuring costs that the acquirer expected butwas not obligated to incur were recognized as if they were a liability assumedat the acquisition date. SFAS 141R requires the acquirer to recognize thosecosts separately from the business combination. SFAS 141R applies prospectivelyto business combinations for which the acquisition date is on or after thebeginning of the first annual reporting period beginning on or after December 15,2008. The impact of SFAS 141R on the Company’s financial statements will becontingent on the terms and conditions of future business combinations.

 

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InFebruary 2008, the FASB issued Financial Accounting Standards Board StaffPosition FAS SFAS157-2 (FSP 157-2), Effective Date of FASB Statement No. 157.  FSP SFAS 157-2 delayed the Company’s January 1,2008, effective date of FAS 157 for all nonfinancial assets and nonfinancialliabilities, except those recognized or disclosed at fair value in thefinancial statements on a recurring basis (at least annually), until January 1,2009.  Implementation of this standarddid not have a material effect on the Company’s financial statements.

 

In March 2008, theFASB issued FASB Statement of Financial Accounting Standards**No. 161, DisclosuresAbout Derivative Instruments and Hedging Activities, an Amendment of FASB StatementNo. 133 (SFAS 161).  SFAS 161amends SFAS 133, Accounting for Derivative Instruments and Hedging Activities,to amend and expand the disclosure requirements of SFAS 133 to providegreater transparency about (i) how and why an entity uses derivativeinstruments, (ii) how derivative instruments and related hedge items areaccounted for under SFAS 133 and its related interpretations, and (iii) howderivative instruments and related hedged items affect an entity’s financialposition, results of operations and cash flows. To meet those objectives,SFAS 161 requires qualitative disclosures about objectives and strategiesfor using derivatives, quantitative disclosures about fair value amounts ofgains and losses on derivative instruments and disclosures aboutcredit-risk-related contingent features in derivative agreements. SFAS 161is effective for the Company on January 1, 2009 and is not expected tohave a significant impact on the Company’s financial statements.

 

In May 2008, theFASB issued FASB Statement of Financial Accounting Standards**No. 162, TheHierarchy of Generally Accepted Accounting Principles (SFAS 162).SFAS 162 identifies the sources of accounting principles and the frameworkfor selecting the principles to be used in the preparation of financialstatements of nongovernmental entities that are presented in conformity withgenerally accepted accounting principles (GAAP) in the United States (the GAAPhierarchy). The hierarchical guidance provided by SFAS 162 did not have asignificant impact on the Company’s financial statements.

 

In April 2009, theFASB issued Financial Accounting Standards Board Staff Position FAS SFAS 157-4(FSP SFAS 157-4), Determining FairValue When the Volume and Level of Activity for the Asset or Liability HaveSignificantly Decreased and Identifying Transactions That Are Not Orderly.FSP SFAS 157-4 affirms that the objective of fair value when the marketfor an asset is not active is the price that would be received to sell theasset in an orderly transaction, and clarifies and includes additional factorsfor determining whether there has been a significant decrease in marketactivity for an asset when the market for that asset is not active.FSP SFAS 157-4 requires an entity to base its conclusion about whether atransaction was not orderly on the weight of the evidence. FSP SFAS 157-4also amended SFAS 157, Fair Value Measurements, to expand certaindisclosure requirements. The Company adopted the provisions of FSP SFAS157-4 during the first quarter of 2009. Adoption of FSP SFAS 157-4 did notsignificantly impact the Company’s financial statements.

 

In April 2009, theFASB issued Financial Accounting Standards Board Staff Position FAS SFAS 115-2and SFAS 124-2 (FSP SFAS 115-2 andSFAS 124-2), Recognition and Presentation of Other-Than-Temporary Impairments.FSP SFAS 115-2 and SFAS 124-2 (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 FSP  SFAS115-2 and SFAS 124-2, declines in the fair value of held-to-maturity andavailable-for-sale securities below their cost that are deemed to be other thantemporary are reflected in earnings as realized losses to the extent theimpairment is related to credit losses. The amount of the impairment related toother factors is recognized in other comprehensive income. The Company adoptedthe provisions of FSP SFAS 115-2 and SFAS 124-2 during the first quarterof 2009. Adoption of FSP SFAS 115-2 and SFAS 124-2 did not significantly impactthe Company’s financial statements.

 

In April 2009, theFASB issued Financial Accounting Standards Board Staff Position FAS SFAS 107-1and APB 28-1 (FSP SFAS 107-1 and APB28-1), Interim Disclosures about Fair Value of Financial Instruments.  FSP SFAS 107-1 and APB 28-1 amendsSFAS 107, Disclosures about Fair Value of Financial Instruments, torequire an entity to provide disclosures about fair value of financialinstruments in interim financial information and amends Accounting PrinciplesBoard (APB) Opinion No. 28, Interim Financial Reporting, torequire those disclosures in summarized financial information at interimreporting periods. Under FSP SFAS 107-1 and APB 28-1, a publiclytraded company shall include disclosures about the fair value of its financialinstruments whenever it issues summarized financial information for interimreporting periods. In addition, entities must disclose, in the body or in theaccompanying notes of its summarized financial information for interimreporting periods and in its financial statements for annual reporting periods,the fair value of all financial instruments for which it is practicable toestimate that value, whether recognized or not recognized in the statement offinancial position, as required by SFAS 107. The new interim disclosuresrequired by FSP SFAS 107-1 and APB 28-1 will be included in theCompany’s interim financial statements beginning with the second quarter of2009.

 

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**OAKVALLEY BANCORP**

** NOTESTO CONDENSED FINANCIAL STATEMENTS**

 

**NOTE 3 –LOANS**

 

Loan totals were asfollows:

 
| ** **                           | ** ** | **MARCH 31,** | ** **  | **DECEMBER 31,** | ** ** |
|--------------------------------------|------------|--------------------|-------------|------------------|------------|
| ** **                           | ** ** | **2009**           | ** **  | **2008**         | ** ** |
| Loans                                |       |               |        |             |       |
| Commercial real estate               |       | $                  | 272,173,842 |             | $          | 268,741,826 |   |
| Commercial                           |       | 40,656,036         |        | 37,302,286       |       |
| Real estate construction             |       | 68,542,486         |        | 73,321,446       |       |
| Agriculture                          |       | 26,398,122         |        | 25,916,928       |       |
| Residential real estate and consumer |       | 22,645,688         |        | 22,894,644       |       |
|                                 |       |               |        |             |       |
| Total loans                          |       | 430,416,174        |        | 428,177,130      |       |
|                                 |       |               |        |             |       |
| Less:                                |       |               |        |             |       |
| Deferred loan fees and costs, net    |       | (936,508           | )           | (1,034,723       | )          |
| Allowance for loan losses            |       | (6,603,064         | )           | (5,569,496       | )          |
|                                 |       |               |        |             |       |
| Net loans                            |       | $                  | 422,876,602 |             | $          | 421,572,911 |   |

 

Changes in the allowancefor loan losses were as follows:

 
| ** **                                                           | ** ** | **MARCH 31,** | ** ** | **DECEMBER 31,** | ** ** |
|----------------------------------------------------------------------|------------|--------------------|------------|------------------|------------|
| ** **                                                           | ** ** | **2009**           | ** ** | **2008**         | ** ** |
|                                                                 |       |               |       |             |       |
| Balance, beginning of year                                           |       | $                  | 5,569,496  |             | $          | 4,506,753 |   |
| Provision charged to operations                                      |       | 1,900,000          |       | 2,188,139        |       |
| Loans charged off                                                    |       | (867,005           | )          | (1,114,534       | )          |
| Loan recoveries                                                      |       | 573                |       | 4,745            |       |
| Reclassification of reserve related to off-balance-sheet commitments |       | —             |       | (15,608          | )          |
|                                                                 |       |               |       |             |       |
| Balance, end of period                                               |       | $                  | 6,603,064  |             | $          | 5,569,496 |   |

 

Effective July 1,2008, the expense associated with the allowance for off-balance-sheetcommitments is recorded separately as a component of other expenses.  In2008, the $15,608 reclassification from the allowance for loan losses to otherliabilities is a non-recurring adjustment.

 

The total recordedinvestment in impaired loans at March 31, 2009, was $10,639,118 which hada loan loss reserve of $2,208,280.  The total recorded investment inimpaired loans at December 31, 2008, was $4,078,765 which had a loan lossreserve of $768,719.  No interest income was recognized on impaired loans,while considered impaired during 2009 and 2008.  As of March 31,2009, we had undisbursed funding commitments on three impaired loans to twoborrowers totaling $2,003,403 with maturity dates of April 2010 and October 2010.

 

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**OAKVALLEY BANCORP**

** NOTESTO CONDENSED FINANCIAL STATEMENTS**

 

**NOTE 4 –OTHER REAL ESTATE OWNED**

 

As of March 31,2009, seven loans with outstanding balances of $3,267,019 were reclassified toother real estate owned.

 

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

 

**NOTE 5–OTHER POST-RETIREMENT BENEFIT PLANS**

 

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

 

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

 

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

 

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

 

The combined cashsurrender value of all Bank-owned life insurance policies was $9,960,291 and$9,859,234 at March 31, 2009 and December 31, 2008, respectively.

 

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**OAKVALLEY BANCORP**

**NOTESTO CONDENSED FINANCIAL STATEMENTS**

 

**NOTE 6–FAIR VALUE MEASUREMENTS**

 

SFAS No. 157, FairValue Measurements, which the Company adopted effective January 1, 2008,defines fair value, establishes a framework for measuring fair value,establishes a three-level valuation hierarchy for disclosure of fair valuemeasurement and enhances disclosure requirements for fair value measurements.The valuation hierarchy is based upon the transparency of inputs to the valuationof an asset or liability as of the measurement date. The three levels aredefined as follow:

 

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

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

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

 

In certain cases, theinputs used to measure fair value may fall into different levels of the fairvalue hierarchy.  In such cases, the level in the fair value hierarchywithin which the fair value measurement in its entirety falls has beendetermined based on the lowest level input that is significant to the fairvalue measurement in its entirety.  The Company’s assessment of thesignificance of a particular input to the fair value measurement in itsentirety requires judgment , and considers factors specific to the asset orliability.

 

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

 
| ** **                                                 | ** ** | **Fair Value Measurements at March 31,  2009 Using** | ** ** |
|------------------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **March 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                             |       | $                                                                                  | 52,494,281 |   | $ | — |   | $ | 52,494,281 |   | $ | — |   |
|                                                       |       |                                                                               |       |   |   |   |   |   |   |
| Assets and  liabilities measured on a non-recurring basis: |       |                                                                               |       |   |   |   |   |   |   |
| Impaired Loans                                             |       | $                                                                                  | 8,430,838  |   | $ | — |   | $ | — |   | $ | 8,430,838 |   |

 

The fair value ofsecurities available for sale equals quoted market price, if available. If quoted market prices are not available, fair value is determined usingquoted market prices for similar securities.  Changes in fair market valueare recorded in other comprehensive income net of tax.  SFAS No. 157applies to loans measured for impairment using the practical expedientspermitted by SFAS No. 114, Accounting by Creditors for Impairment of aLoan, including impaired loans measured at an observable market price (ifavailable), or at the fair value of the loan’s collateral (if the loan iscollateral dependent). Fair value of the loan’s collateral, when the loan isdependent on collateral, is determined by appraisals or independent valuationwhich is then adjusted for the cost related to liquidation of the collateral.At March 31, 2009, impaired loans had a principal balance of $10,639,118,with a valuation allowance of $2,208,280. Upon being classified as impaired, charge offs were taken to reduce thebalance of each loan to an estimate of the collateral fair market value lesscost to dispose. This estimate was a level 3 valuation.  There was nodirect impact on the income statement.  The charge-offs were recorded as adebit to the allowance for loan losses.

 

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**OAKVALLEY BANCORP**

**NOTES TO CONDENSED FINANCIALSTATEMENTS**

 

**NOTE 7 —EARNINGS PER SHARE**

 

The Bank computesearnings per share (“EPS”) in accordance with SFAS No. 128,*Earnings per Share.* SFAS No. 128requires the presentation of basic EPS, which does not consider the effect ofcommon stock equivalents and diluted EPS, which considers all dilutive commonstock equivalents.

 
| ** **                                                            | ** ** | **THREE MONTHS ENDED** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------|------------|
| **In thousands (except share and per**       | ** ** | **MARCH 31,**               | ** ** |
| **share amounts)**                                               | ** ** | **2009**                         | ** ** | **2008** | ** ** |
| BASIC EARNINGS  PER SHARE                                             |       |                             |       |   |   |
|                                                                  |       |                             |       |   |   |
| Net income  available to common shareholders                          |       | $                                | 219,899    |   | $ | 775,797 |   |
| Weighted average  shares outstanding                                  |       | 7,661,627                        |       | 7,610,039 |   |
| Net income per  share                                                 |       | $                                | 0.03       |   | $ | 0.10 |   |
|                                                                  |       |                             |       |   |   |
| DILUTED EARNINGS  PER SHARE                                           |       |                             |       |   |   |
|                                                                  |       |                             |       |   |   |
| Net income  available to common shareholders                          |       | $                                | 219,899    |   | $ | 775,797 |   |
| Weighted average  shares outstanding                                  |       | 7,661,627                        |       | 7,610,039 |   |
| Effect of  dilutive stock options                                     |       | 42,265                           |       | 86,269 |   |
| Weighted average  shares of common stock and common stock equivalents |       | 7,703,892                        |       | 7,696,308 |   |
| Net income per  diluted share                                         |       | $                                | 0.03       |   | $ | 0.10 |   |

 

During the three monthperiod ended March 31, 2009, anti-dilutive weighted average options topurchase 242,963 shares of common stock, respectively, in prices ranging from$5.20 to $15.67 were outstanding.   Anti-dilutive weighted averageoptions of 122,047 were outstanding during the same three month period of 2008with prices ranging from $8.25 to $15.67.  They were not included in thecomputation of diluted EPS because the options’ exercise price was greater thanthe average market price of the common shares. These options begin to expire in2013.

 

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

 

The following discussionexplains the significant factors affecting our operations and financial positionfor the periods presented. The discussion should be read in conjunction withour financial statements and the notes related thereto which appear elsewherein this report.

 

**Forward-LookingStatements**

 

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

 

**CriticalAccounting Estimates**

 

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

 

*Allowancefor Loan Losses*

 

Accounting for allowancefor loan losses involves significant judgment and assumptions by management andis based on historical data and management’s view of the current economicenvironment. At least on a quarterly basis, our management reviews themethodology and adequacy of allowance for loan losses and reports itsassessment to the Board of Directors for its review and approval.

 

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

 

· the specific review of individual loans,

 

· the segmenting and review of loan poolswith similar characteristics in accordance with SFAS No. 5, “Accountingfor Contingencies,” and

 

· our judgmental estimate based on varioussubjective factors:

 

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

 

The second phase involvesthe segmenting of the remainder of the risk rated loan portfolio into groups orpools of loans, together with loans with similar characteristics, forevaluation in accordance with SFAS No. 5. We determine the calculated lossratio to each loan pool based on its historical net losses and benchmark itagainst the levels of other peer banks.

 

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

 

· concentration of credits,

 

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· 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.

 

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

 

Central to our creditrisk management and our assessment of appropriate loss allowance is our loanrisk rating system. Under this system, the originating credit officer assignsborrowers an initial risk rating based on a thorough analysis of each borrower’sfinancial capacity in conjunction with industry and economic trends. Approvalsare made based upon the amount of inherent credit risk specific to thetransaction and are reviewed for appropriateness by senior line and creditadministration personnel. Credits are monitored by line and creditadministration personnel for deterioration in a borrower’s financial conditionwhich may impact the ability of the borrower to perform under the contract.Although management has allocated a portion of the allowance to specific loans,specific loan pools, and off-balance sheet credit exposures (which are reportedseparately as part of other liabilities), the adequacy of the allowance isconsidered in its entirety.

 

*Non-AccrualLoan Policy*

 

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

 

*Stock-BasedCompensation*

 

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

 

*OtherReal Estate Owned*

 

Other real estate owned,which represents real estate acquired through foreclosure, or deed in lieu offoreclosure in satisfaction of commercial and real estate loans, is carried atthe lower of cost or estimated fair value less the estimated selling costs ofthe real estate. The fair value of the property is based upon a currentappraisal. The difference between the fair value of the real estate collateraland the 

 

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loan balance at the timeof transfer is recorded as a loan charge off if fair value is lower. Subsequentto foreclosure, management periodically performs valuations and the OREOproperty is carried at the lower of carrying value or fair value, less costs tosell. The  determination of a property’s estimated fair value incorporates(1) revenues projected to be realized from disposal of the property, (2) constructionand renovation costs, (3) marketing and transaction costs, and (4) holdingcosts (e.g., property taxes, insurance and homeowners’ association dues). Anysubsequent declines in the fair value of the OREO property after the date oftransfer are recorded through a write-down of the asset. Any subsequentoperating expenses or income, reduction in estimated fair values, and gains orlosses on disposition of such properties are charged or credited to currentoperations.

 

**Introduction**

 

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

 

**Overviewof Results of Operations and Financial Condition**

 

·                      The Company recognized net incomeavailable to common shareholders of $219,899 for the three month period ended March 31,2009 as compared with $775,797 for the same period in 2008.  Net incomebefore preferred stock dividends and accretion was $430,310 for the firstquarter of 2009.  The factors resultingin this decrease will be discussed below.

 

·                      The Company recognized expense of$210,411 in the first quarter of 2009 associated with the accrual for preferredstock dividends and accretion of the preferred stock discount.  No expense was recognized in the firstquarter of 2008, as the preferred stock was issued in December 2008.

 

·                      Net interest income increased $847,363 or17.6% for the three month period ended March 31, 2009 compared to the sameperiod in 2008.  This increase was primarily due to the net interestmargin increase of 28 basis points from 4.59% in the first quarter of 2008 to4.87% in the first quarter of 2009.  Inaddition, average earning assets increased by $57.8 million for the three monthperiod ended March 31, 2009.  The net interest margin increase isattributable primarily to liabilities repricing faster than assets in thecurrent declining rate environment as described in further detail below.

 

·                      The provision for loan losses in thethree month period ended March 31, 2009 increased by $1,755,000, comparedto the same period in 2008, due to loan growth, an increase in the level ofnon-accrual loans and management’s assessment of the appropriate level for theallowance for loan losses.

 

·                      For the three month period ended March 31,2009, non-interest income decreased by $15,274 or 2.5%, from the same period in2008, primarily due to decreased service charges on deposits of $20,542 asdescribed below.

 

·                      Non-interest expense decreased by$118,263 or 2.9% for the three month period ended March 31, 2009, ascompared to the same period in 2008, primarily due to a decrease in salariesand benefits as described below.

 

·                      Total assets increased $15.5 million or3.1% from December 31, 2008.  Total net loans increased by $1.3million or 0.3% and investment securities increased by $11.0 million or 26.6%from December 31, 2008 to March 31, 2009, while deposits increased by$31.8 million or 8.4%.

 

**IncomeSummary**

 

For the three monthperiod ended March 31, 2009, the Company recorded net income available toshareholders of $219,899, a decrease of $555,898, as compared to the $775,797for the same period in 2008.  Return on average assets (annualized) was0.34% for the first quarter of 2009, as compared with 0.68% for the same periodin 2008.  Annualized return on average common equity was 1.97% for thefirst quarter of 2009, as compared with 7.16% for the same period of 2008.

 

Net income beforeprovisions for income taxes and preferred stock dividends and accretion for thefirst quarter of 2009 was down $804,648 from the comparable 2008 period. The income statement components of these variances are as follows:

 

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

***(In thousands)***

*** ***
| ** **                                                                            | ** ** | **Effect on Pre-Tax  Income** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                            | ** ** | **Increase (Decrease)**            | ** ** |
| ** **                                                                            | ** ** | **Three Months**                   | ** ** |
| Change from 2008  to 2009 in:                                                         | ** ** | ** **                              | ** ** |
| Net interest  income                                                                  |       | $                                       | 847        |   |
| Provision for  loan losses                                                            |       | (1,755                                  | )          |
| Non-interest  income                                                                  |       | (15                                     | )          |
| Non-interest  expense                                                                 |       | 118                                     |       |
| Change in net  income before income taxes and preferred stock dividends and accretion |       | $                                       | (805       | ) |

 

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These variances will beexplained in the discussion below.

 

**NetInterest Income**

 

Net interest income isthe largest source of the Bank’s operating income.  For the three monthperiod ended March 31, 2009, net interest income was $5.66 million, anincrease of $847,363 or 17.6% from the comparable period in 2008.

 

The net interest margin(net interest income as a percentage of average interest earning assets) was4.87% for the three month period ended March 31, 2009, an increase of 28basis points as compared to the same period in 2008.  The increase in thenet interest margin in 2009 was primarily attributable to the impact that thedecline in market interest rates had on our liability sensitive balance sheetwhich caused interest-bearing liabilities to decrease faster than the yields onearning assets.  The compression of theyield on interest earning assets was lessened due to a portion of our loanportfolio that was at the contractual rate floors.  In addition, yield on investments increasedby 118 basis points as a result of approximately $12.5 million municipalsecurities purchased in the fourth quarter of 2008 and first quarter 2009 andthe related fully taxable equivalent benefit.

 

The following tablesshows the relative impact of changes in average balances of interest earningassets and interest bearing liabilities, and interest rates earned and paid bythe Company on those assets and liabilities for the three month period ended March 31,2009 and 2008:

 

***Net Interest Analysis***

*(Dollarsin thousands)*

* *
| ** **                                      | ** ** | **Three months ended**  | ** ** | **Three months ended**          | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|---------------------------------|------------|
| ** **                                      | ** ** | **March 31, 2009** | ** ** | **March 31, 2008**         | ** ** |
| ** **                                      | ** ** | **Average  Balance**    | ** ** | **Interest  Income /  Expense** | ** ** | **Avg  Rate/  Yield** | ** ** | **Average  Balance** | ** ** | **Interest  Income /  Expense** | ** ** | **Avg  Rate/  Yield** | ** ** |
| **Assets:**                                     |       |                    |       |                            |       |   |   |   |   |   |   |   |   |
| Earning assets:                                 |       |                    |       |                            |       |   |   |   |   |   |   |   |   |
| Gross loans (1) (2)                        |       | $                       | 429,860    |                            | $          | 6,604 |   | 6.23 | % | $ | 388,096 |   | $ | 6,941 |   | 7.17 | % |
| Investment securities (2)                       |       | 46,999                  |       | 708                             |       | 6.11 | % | 33,099 |   | 407 |   | 4.93 | % |
| Federal funds sold                              |       | 1,383                   |       | 1                               |       | 0.27 | % | 597 |   | 5 |   | 3.43 | % |
| Interest-earning deposits                       |       | 1,525                   |       | 1                               |       | 0.21 | % | 219 |   | 1 |   | 1.31 | % |
| Total interest-earning assets                   |       | 479,767                 |       | 7,314                           |       | 6.18 | % | 422,012 |   | 7,354 |   | 6.99 | % |
| Total noninterest earning assets                |       | 37,768                  |       |                            |       |   |   | 32,202 |   |   |   |   |   |
| Total Assets                                    |       | 517,535                 |       |                            |       |   |   | 454,214 |   |   |   |   |   |
| **Liabilities and Shareholders’ Equity:**  |       |                    |       |                            |       |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                   |       |                    |       |                            |       |   |   |   |   |   |   |   |   |
| Money market deposits                           |       | 163,514                 |       | 628                             |       | 1.56 | % | 140,389 |   | 979 |   | 2.80 | % |
| NOW deposits                                    |       | 53,950                  |       | 75                              |       | 0.56 | % | 53,907 |   | 95 |   | 0.71 | % |
| Savings deposits                                |       | 13,595                  |       | 34                              |       | 1.02 | % | 15,735 |   | 107 |   | 2.72 | % |
| Time certificates of deposit $100,000 or more   |       | 41,964                  |       | 287                             |       | 2.77 | % | 47,600 |   | 525 |   | 4.43 | % |
| Other time deposits                             |       | 51,450                  |       | 301                             |       | 2.37 | % | 43,245 |   | 451 |   | 4.18 | % |
| Other borrowings                                |       | 70,075                  |       | 229                             |       | 1.32 | % | 43,055 |   | 368 |   | 3.43 | % |
| Total interest-bearing liabilities              |       | 394,548                 |       | 1,554                           |       | 1.60 | % | 343,932 |   | 2,526 |   | 2.95 | % |
| Noninterest-bearing liabilities:                |       |                    |       |                            |       |   |   |   |   |   |   |   |   |
| Noninterest-bearing deposits                    |       | 61,285                  |       |                            |       |   |   | 63,797 |   |   |   |   |   |
| Other liabilities                               |       | 2,928                   |       |                            |       |   |   | 3,123 |   |   |   |   |   |
| Total noninterest-bearing liabilities           |       | 64,213                  |       |                            |       |   |   | 66,920 |   |   |   |   |   |
| Shareholders’ equity                       |       | 58,774                  |       |                            |       |   |   | 43,362 |   |   |   |   |   |
| Total liabilities and shareholders’ equity |       | $                       | 517,535    |                            |       |   |   |   | $ | 454,214 |   |   |   |   |   |
| Net interest income                             |       |                    |       | $                               | 5,760      |   |   |   |   |   | $ | 4,828 |   |   |   |
| Net interest spread (3)                         |       |                    |       |                            |       | 4.59 | % |   |   |   |   | 4.04 | % |
| Net interest margin (4)                         |       |                    |       |                            |       | 4.87 | % |   |   |   |   | 4.59 | % |

 

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----

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

 

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

 

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

 

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

 

Shown in the followingtables are the relative impacts on net interest income of changes in theaverage outstanding balances (volume) of earning assets and interestbearing liabilities and the rates earned and paid by the Company on thoseassets and liabilities for the three month period ended March 31, 2009 and2008.  Changes in interest income and expense that are not attributablespecifically to either rate or volume are allocated to the rate column below.

 

***Rate / Volume Variance Analysis***

*(Inthousands)*

* *
| ** **                        | ** ** | **For the Three Months Ended  March 31,** | ** ** |
|-----------------------------------|------------|------------------------------------------------|------------|
| ** **                        | ** ** | **2009 vs 2008**                               | ** ** |
| ** **                        | ** ** | **Increase (Decrease)**                        | ** ** |
| ** **                        | ** ** | **in interest income and expense**             | ** ** |
| ** **                        | ** ** | **due to changes in:**                         | ** ** |
| ** **                        | ** ** | **Volume**                                     | ** ** | **Rate** | ** ** | **Total** | ** ** |
| **Interest income:**              |       |                                           |       |   |   |   |   |
| Gross loans (1)                   |       | $                                              | 747        |   | $ | (1,084 | ) | $ | (337 | ) |
| Investment securities             |       | 171                                            |       | 130 |   | 301 |   |
| Federal funds sold                |       | 7                                              |       | (11 | ) | (4 | ) |
| Interest-earning deposits         |       | 1                                              |       | (1 | ) | 0 |   |
| **Total interest income**         | ** ** | **$**                                          | **926**    | ** ** | **$** | **(966** | **)** | **$** | **(40** | **)** |
|                              |       |                                           |       |   |   |   |   |
| **Interest expense:**             |       |                                           |       |   |   |   |   |
| Money market deposits             |       | 161                                            |       | (512 | ) | (351 | ) |
| NOW deposits                      |       | 0                                              |       | (20 | ) | (20 | ) |
| Savings deposits                  |       | (15                                            | )          | (58 | ) | (73 | ) |
| Time CD $100K or more             |       | (62                                            | )          | (177 | ) | (239 | ) |
| Other time deposits               |       | 86                                             |       | (235 | ) | (149 | ) |
| Other borrowings                  |       | 231                                            |       | (371 | ) | (140 | ) |
| **Total interest expense**        | ** ** | **$**                                          | **401**    | ** ** | **$** | **(1,373** | **)** | **$** | **(972** | **)** |
| ** **                        | ** ** | ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Change in net interest income** | ** ** | **$**                                          | **525**    | ** ** | **$** | **407** | ** ** | **$** | **932** | ** ** |

 

----

*(1) * Loan fees have been included in thecalculation of interest income. Loan fees were approximately $60,000 and$276,000 for the three months ended March 31, 2009 and 2008, respectively.

 

The table above reflectsthe market interest rate decline has impacted liabilities slightly more thanassets as indicated by the increase of $407,000 in net interest income due tothe rate change.  The increased loan volume and the overall change in mixof deposit balances contributed an increase of $525,000 to net interest income.

 

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**Non-Interest Income**

 

Non-interest incomerepresents service charges on deposit accounts and other non-interest relatedcharges and fees, including fees from the sale of loans.  For the threemonth period ended March 31, 2009, non-interest income was $598,309, adecrease of $15,274 or 2.5% from the same period in 2008.

 

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

 

***Non-Interest Income***

***(In thousands)***

 
| ** **                                          | ** ** | **For the Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **2009**                                                               | ** ** | **2008** | ** ** | **$ change** | ** ** | **% change** | ** ** |
| Service charges  on deposits                        |       | $                                                                      | 282        |   | $ | 303 |   | $ | (21 | ) | (6.8 | )% |
| Earnings on cash  surrender value of life insurance |       | 101                                                                    |       | 81 |   | 20 |   | 24.3 | % |
| Mortgage  commissions                               |       | 43                                                                     |       | 50 |   | (7 | ) | (14.5 | )% |
| Other                                               |       | 172                                                                    |       | 180 |   | (8 | ) | (4.1 | )% |
|                                                |       | $                                                                      | 598        |   | $ | 614 |   | $ | (16 | ) | (2.5 | )% |

 

Service charges ondeposits decreased by $20,542 or 6.8% in the three month period ended March 31,2009, as compared to the same periods in 2008, which is primarily due todecreased NSF fee income.  The Bankcontinues to expand its offerings to the consumer and business depositor. Offsetting the decrease to service charges on deposits, was an increase of$19,781 in earnings on cash surrender of life insurance as a result of the$4.74 million invested in additional life insurance policies on certainofficers and directors during the first quarter of 2008.

 

**Non-InterestExpense**

 

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

 

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

 

***Non-Interest Expense***

***(In thousands)***

 
| ** **                      | ** ** | **For the Three Months Ended March 31,** | ** ** |
|---------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                      | ** ** | **2009**                                                               | ** ** | **2008** | ** ** | **$ change** | ** ** | **% change** | ** ** |
| Salaries and  employee benefits |       | $                                                                      | 2,050      |   | $ | 2,446 |   | $ | (396 | ) | (16.2 | )% |
| Occupancy  expenses             |       | 695                                                                    |       | 670 |   | 25 |   | 3.9 | % |
| Data processing  fees           |       | 218                                                                    |       | 179 |   | 39 |   | 22.4 | % |
| OREO expenses                   |       | 125                                                                    |       | — |   | 125 |   |   |   |
| Other operating  expenses       |       | 850                                                                    |       | 762 |   | 88 |   | 11.5 | % |
|                            |       | $                                                                      | 3,938      |   | $ | 4,057 |   | $ | (119 | ) | (2.9 | )% |

 

Non-interest expensesdecreased by $118,263 or 2.9% for the three months ended March 31, 2009,as compared to the same period of 2008.  Salaries and employee benefitsdecreased $396,543 for the three months ended March 31, 2009, as comparedto the same periods of 2008 as a result of a reduction in full time equivalentemployees in effort to improve operating efficiency and an increase in deferredloan costs.  Data processing fees increased by $39,957 or 22.4% for thefirst quarter 2009 compared to the same period of 2008, as a result of anincreased number of transaction accounts. A primary component of the $87,449 increase in other operating expense,was FDIC assessments which increased by $55,643 for the first quarter 2009compared to first quarter 2008.  OREOexpenses were $125,029 in the first quarter of 2009 compared to no expenses inthe comparable period of 2008.  Theseexpenses resulted from various overhead costs associated with the threeproperties classified as other real estate owned.

 

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

 

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**IncomeTaxes**

 

Provision for incometaxes for the three months ended March 31, 2009, was a net tax benefit of$13,912, a decrease of $459,161 or 103.1% from the same period in 2008. The effective tax rate (income tax expense as a percentage of pre-tax income)for the first quarter of 2009 was (3.3%), compared with 36.5% for the sameperiod in 2008.  The disparity between the effective tax rates in 2009 ascompared to 2008 is primarily due to tax credits from California EnterpriseZones and low income housing projects as well as tax free-income on loanswithin these enterprise zones and municipal securities and loans that comprisea larger proportion of pre-tax income in 2009 as compared to 2008.

 

**AssetQuality**

 

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

 

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

 

Non-accrual loans totaled$10.6 million at March 31, 2009, as compared to $4.7 million at December 31,2008.  The non-accrual loans as of March 31, 2009 are loans made tosix borrowers for purposes of commercial, real estate construction andcommercial real estate.

 

OREO totaled $3.3 millionas of March 31, 2009 and consists of three properties that were acquiredthrough foreclosure including residential land lots and a commercial realestate property.

 

The following tablepresents information about the Company’s non-performing loans, including assetquality ratios as of March 31, 2009 and December 31, 2008:

 

***Non-Performing Assets***

*(inthousands)*

 
| ** **                                               | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                               | ** ** | **2009**           | ** ** | **2008**              | ** ** |
| Loans in  nonaccrual status                              |       | $                  | 10,639     |                  | $          | 4,078 |   |
| Loans past due  90 days or more and accruing             |       | —             |       | 643                   |       |
| Restructured  loans                                      |       | —             |       | —                |       |
| Total  nonperforming loans                               |       | 10,639             |       | 4,721                 |       |
| Other real  estate owned                                 |       | 3,267              |       | 2,746                 |       |
| Total  nonperforming assets                              |       | $                  | 13,906     |                  | $          | 7,467 |   |
|                                                     |       |               |       |                  |       |
| Allowance for  loan losses                               |       | $                  | 6,603      |                  | $          | 5,569 |   |
|                                                     |       |               |       |                  |       |
| Asset quality  ratios:                                   |       |               |       |                  |       |
| Non-performing  assets to total assets                   |       | 2.66               | %          | 1.47                  | %          |
| Non-performing  loans to total loans                     |       | 2.47               | %          | 1.10                  | %          |
| Allowance for  loan losses to total loans                |       | 1.53               | %          | 1.30                  | %          |
| Allowance for  loan losses to total non-performing loans |       | 62.06              | %          | 117.96                | %          |

 

**Allowancefor Loan and Lease Losses**

 

In anticipation of creditrisk inherent in our lending business, we set aside allowances through chargesto earnings. Such charges were not only made for the outstanding loanportfolio, but also for off-balance sheet items, such as commitments to extendcredits or letters of credit. The charges made for the outstanding loanportfolio were credited to the allowance for loan losses, whereas charges foroff-balance sheet items were credited to the reserve for off-balance sheetitems, which is presented as a component of other liabilities.  The Bankrecorded loan loss provisions of $1,900,000 for the three month period in 2009,a $1,755,000 increase from the provisions recorded in the same period of 2008.

 

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The allowance for loanlosses increased by 18.6%, or $1.03 million, to $6.60 million at March 31,2009, as compared with $5.57 million at December 31, 2008.  TheBank recognized the increase in the allowance for loan losses during thequarter due to the loan loss provision of $1.9 million which was partiallyoffset by loan charge-offs.  The weak business climate adversely impactedthe financial conditions of certain clients and increased net loan charge-offsto $866,000 for the first three months of 2009, compared to $416,000 for thefirst three months of 2008. The increase to the allowance for loan lossesoutpaced the growth of our loan portfolio which increased the allowance forloan losses as a percentage of total loans to 1.53% at March 31, 2009 ascompared to 1.30% at December 31, 2008.

 

Management reviews theseconditions with our senior credit officers. To the extent that any of theseconditions is evidenced by a specifically identifiable problem credit orportfolio segment as of the evaluation date, management’s estimate of theeffect of such condition may be reflected as a specific allowance applicable tosuch credit or portfolio segment. Where any of these conditions is notevidenced by a specific, identifiable problem credit or portfolio segment as ofthe evaluation date, management’s evaluation of the inherent loss related tosuch condition is reflected in the unallocated allowance. Although managementhas allocated a portion of the allowance to specific loan categories, theadequacy of the allowance is considered in its entirety.

 

The following tableprovides an analysis of the changes in the ALLL for the three-month periodsended March 31, 2009 and 2008:

 

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

*(dollarsin thousands)*

 
| ** **                                                            | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                            | ** ** | **March 31,**               | ** ** |
| ** **                                                            | ** ** | **2009**                         | ** ** | **2008** | ** ** |
| Balance at beginning of period                                        |       | $                                | 5,569      |   | $ | 4,507 |   |
| Provision for loan losses                                             |       | 1,900                            |       | 145 |   |
| Loans charged off                                                     |       | (867                             | )          | (417 | ) |
| Recoveries of previous charge-offs                                    |       | 1                                |       | 1 |   |
| Net charge-offs                                                       |       | (866                             | )          | (416 | ) |
| Reclassification  of reserve related to off-balance-sheet commitments |       | —                           |       | (11 | ) |
| Balance at end of period                                              |       | $                                | 6,603      |   | $ | 4,225 |   |
|                                                                  |       |                             |       |   |   |
| Allowance for loan losses to total loans                              |       | 1.53                             | %          | 1.09 | % |
| Net charge-offs to average loans (annualized)                         |       | 0.82                             | %          | 0.43 | % |
| Provision for loan losses to average loans (annualized)               |       | 1.79                             | %          | 0.15 | % |

 

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

 

Although managementbelieves the allowance at March 31, 2009 was adequate to absorb probablelosses from any known and inherent risks in the portfolio, no assurance can begiven that economic conditions which adversely affect our service areas orother variables will not result in increased losses in the loan portfolio inthe future.

 

**InvestmentActivities**

 

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

 

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

 

The Bank holds federalfunds sold, unpledged available-for-sale securities and salable governmentguaranteed loans to help meet liquidity requirements and provide temporaryholdings until the funds can be otherwise deployed or invested. As of March 31,2009, and December 31, 2008, we had $11.1 million and $9.8 million,respectively, in cash and cash equivalents.

 

*InvestmentSecurities*

 

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

 

Management has evaluatedthe investment securities portfolio to determine if the impairment of anysecurity in an unrealized loss position is temporary or other thantemporary.  Management has determined that no investment security is otherthan temporarily impaired.  The unrealized losses are due solely tointerest rate changes.

 

**Deposits**

 

Total deposits at March 31,2009 were $410.1 million, a $31.8 million or 8.4% increase from the deposittotal of $378.2 million at December 31, 2008.  Average depositsincreased $21.1 million to $385.8 million for the three month period ended March 31,2009 as compared to the same period in 2008.

 

**Deposits**

**(inthousands)**

 
| ** **      | ** ** | **March 31,** | ** **  | **December 31,** | ** ** | **Three month change** | ** ** |
|-----------------|------------|--------------------|-------------|-----------------------|------------|------------------------|------------|
| ** **      | ** ** | **2009**           | ** **  | **2008**              | ** ** | **$**                  | ** ** | **%** | ** ** |
|            |       |               |        |                  |       |                   |       |   |   |
| Demand          |       | $                  | 60,446      |                  | $          | 64,277                 |       | $ | (3,831 | ) | (6.0 | )% |
| NOW             |       | 56,882             |        | 53,485                |       | 3,397                  |       | 6.4 | % |
| MMDA            |       | 169,693            |        | 157,351               |       | 12,342                 |       | 7.8 | % |
| Savings         |       | 15,700             |        | 12,532                |       | 3,168                  |       | 25.3 | % |
| Time < 100K  |       | 47,203             |        | 46,563                |       | 640                    |       | 1.4 | % |
| Time > $100K |       | 60,165             |        | 44,040                |       | 16,125                 |       | 36.6 | % |
| ** **      | ** ** | **$**              | **410,089** | ** **            | **$**      | **378,248**            | ** ** | **$** | **31,841** | ** ** | **8.4** | **%** |

 

Because our client baseis comprised primarily of commercial and industrial accounts, individualaccount balances are generally higher than those of consumer-oriented banks.Three of our clients carry deposit balances of more than 1% of our totaldeposits, one of which had a deposit balance of more than 3% of total depositsat March 31, 2009.

 

Since our deposit growthstrategy emphasizes core deposit growth we have avoided relying on brokereddeposits as a consistent source of funds.  The only brokered deposits theBank holds are from CDARS, a certificate of deposit program that exchangesfunds with other network banks to offer full FDIC insurance coverage to thecustomer.  The Bank had $9.7 million in brokered deposits as of March 31,2009 as compared to $10.5 million at December 31, 2008.

 

**Borrowings**

 

Although deposits are theprimary source of funds for our lending and investment activities and forgeneral business purposes, we may obtain advances from the Federal Home LoanBank of San Francisco (“FHLB”) as an alternative to retail deposit funds. Ouroutstanding FHLB advances decreased by $17 million at March 31, 2009to  $52.0 million, compared to $69.0 million at December 31, 2008 dueto the increase in deposits. See “Liquidity Management” below for the detailson the FHLB borrowings program.

 

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**CapitalRatios**

 

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

 

The following table showsthe Oak Valley Community Bank’s and Oak Valley Bancorp’s capital ratios, ascalculated under regulatory guidelines, compared to the regulatory minimumcapital ratios and the regulatory minimum capital ratios needed to qualify as a“well-capitalized” institution at March 31, 2009 and December 31,2008:

 

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

***(dollars in thousands)***

 
| ** **                                           | ** ** | ** ** | ** ** | ** **           | ** ** | **Amount of Capital Required** |       |
|------------------------------------------------------|------------|------------|------------|----------------------|------------|-----------------------------------------------|------------|
| ** **                                           | ** ** | ** ** | ** ** | ** **           | ** ** | **To Be**                                | ** ** | **To Be Adequately** |   |
| ** **                                           | ** ** | **Actual** | ** ** | **Well-Capitalized** |       | **Capitalized**                               |       |
| ** **                                           | ** ** | **Amount** | ** ** | **Ratio**            | ** ** | **Amount**                                    | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **As of  March 31, 2009:**                      |       |       |       |                 |       |                                          |       |   |   |   |   |   |   |
| Total Capital  (to Risk-Weighted Assets)             |       | $          | 63,707     |                 | 13.2       | %                                             | $          | 48,239 |   | 10 | % | $ | 38,591 |   | 8 | % |
| Tier 1 Capital  (to Risk-Weighted Assets)            |       | $          | 57,668     |                 | 12.0       | %                                             | $          | 28,943 |   | 6 | % | $ | 19,296 |   | 4 | % |
| Tier 1 Capital  (to Average Assets)                  |       | $          | 57,668     |                 | 11.2       | %                                             | $          | 25,871 |   | 5 | % | $ | 20,697 |   | 4 | % |
|                                                 |       |       |       |                 |       |                                          |       |   |   |   |   |   |   |
| **As of  December 31, 2008:**                   |       |       |       |                 |       |                                          |       |   |   |   |   |   |   |
| Total Capital  (to Risk-Weighted Assets)             |       | $          | 63,379     |                 | 13.3       | %                                             | $          | 47,758 |   | 10 | % | $ | 38,206 |   | 8 | % |
| Tier 1 Capital  (to Risk-Weighted Assets)            |       | $          | 57,635     |                 | 12.1       | %                                             | $          | 28,655 |   | 6 | % | $ | 19,103 |   | 4 | % |
| Tier 1 Capital  (to Average Assets)                  |       | $          | 57,635     |                 | 11.8       | %                                             | $          | 24,492 |   | 5 | % | $ | 19,593 |   | 4 | % |
|                                                 |       |       |       |                 |       |                                          |       |   |   |   |   |   |   |   |   |   |
| ***Oak Valley  Bancorp Capital Ratios —*** |
| ***(dollars in  thousands)***                        |       |
|                                                 |       |       |       |                 |       |                                          |       |   |   |   |   |   |   |   |   |   |
| ** **                                           | ** ** | ** ** | ** ** | ** **           | ** ** | **Amount of Capital Required** | ** ** |
| ** **                                           | ** ** | ** ** | ** ** | ** **           | ** ** | **To Be**                                | ** ** | **To Be Adequately** | ** ** |
| ** **                                           | ** ** | **Actual** | ** ** | **Well-Capitalized** | ** ** | **Capitalized**                               | ** ** |
| ** **                                           | ** ** | **Amount** | ** ** | **Ratio**            | ** ** | **Amount**                                    | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **As of  March 31, 2009:**                      |       |       |       |                 |       |                                          |       |   |   |   |   |   |   |
| Total Capital  (to Risk-Weighted Assets)             |       | $          | 63,868     |                 | 13.2       | %                                             | N/A        |   | N/A |   | $ | 38,602 |   | 8 | % |
| Tier 1 Capital  (to Risk-Weighted Assets)            |       | $          | 57,827     |                 | 12.0       | %                                             | N/A        |   | N/A |   | $ | 19,301 |   | 4 | % |
| Tier 1 Capital  (to Average Assets)                  |       | $          | 57,827     |                 | 11.2       | %                                             | N/A        |   | N/A |   | $ | 20,701 |   | 4 | % |
|                                                 |       |       |       |                 |       |                                          |       |   |   |   |   |   |   |
| **As of  December 31, 2008:**                   |       |       |       |                 |       |                                          |       |   |   |   |   |   |   |
| Total Capital  (to Risk-Weighted Assets)             |       | $          | 63,440     |                 | 13.3       | %                                             | N/A        |   | N/A |   | $ | 38,211 |   | 8 | % |
| Tier 1 Capital  (to Risk-Weighted Assets)            |       | $          | 57,696     |                 | 12.1       | %                                             | N/A        |   | N/A |   | $ | 19,106 |   | 4 | % |
| Tier 1 Capital  (to Average Assets)                  |       | $          | 57,696     |                 | 11.8       | %                                             | N/A        |   | N/A |   | $ | 19,594 |   | 4 | % |
|                                                      |            |            |            |                      |            |                                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**LiquidityManagement**

 

Maintenance of adequateliquidity requires that sufficient resources be available at all time to meetour cash flow requirements. Liquidity in a banking institution is requiredprimarily to provide for deposit withdrawals and the credit needs of itscustomers and to take advantage of investment opportunities as they arise.Liquidity management involves our ability to convert assets into cash or cashequivalents without incurring significant loss, and to raise cash or maintainfunds without incurring excessive additional cost. For this purpose, wemaintain a portion of our funds in cash and cash equivalents, salablegovernment guaranteed loans and securities available for sale. Our liquidassets at March 31, 2009 were $74.9 million compared to $60.9 million at December 31,2008.  Our liquidity level measured as the percentage of liquid assets tototal assets was 14.7% and 12.0% at March 31, 2009 and December 31,2008, respectively.

 

As a secondary source ofliquidity, we rely on advances from the FHLB to supplement our supply oflendable funds and to meet deposit withdrawal requirements. Advances from theFHLB are typically secured by a portion of our loan portfolio. The FHLBdetermines limitations on the amount of advances by assigning a percentage toeach eligible loan category that will count towards the borrowing capacity. Asof March 31, 2009, our borrowing capacity from the FHLB was approximately$118 million and the outstanding balance was $52 million, orapproximately 44% of our borrowing capacity. We also maintain 2 lines of creditwith correspondent banks to purchase up to $20 million in federal funds,for which there were no advances as of March 31, 2009.

 

**Off-Balance-SheetArrangements**

 

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

 

As of March 31, 2009and December 31, 2008, we had commitments to extend credit of $58.2million and $63.1 million, respectively, which includes obligations underletters of credit of $3.4 million and $3.5 million, respectively,

 

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

 

**Effectsof Inflation and Economic Issues**

 

Inflation primarilyimpacts us by its effect on interest rates. Our primary source of income is netinterest income, which is affected by changes in interest rates. We attempt tolimit the impact of inflation on our net interest margin through management ofrate-sensitive assets and liabilities and the analysis of interest ratesensitivity. The effect of inflation on premises and equipment as well asnon-interest expenses has not been significant for the periods covered in thisreport. Our business is generally not seasonal.

 

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

 

Not applicable.

 

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

 

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

 

There were no significantchanges in our internal controls or in other factors that could significantlyaffect our internal controls subsequent to the Evaluation Date, nor anysignificant deficiencies or material weaknesses in such controls requiringcorrective actions.

 

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**PART II - OTHER INFORMATION**

 

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

 

There are no materiallegal proceedings to which the Company is a party or to which any of itsproperty is subject.

 

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

 

Not applicable.

 

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

 

None

 

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

 

None.

 

**Item 4.****                                                          ****Submission of Matters toa Vote of Security Holders**

 

None.

 

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

 

None.

 

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

 
| **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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**SIGNATURES**

 

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

 
|                    | **Oak  Valley Bancorp** |
|-------------------------|-------------------------|
| Date: May 14, 2009 | By:                     | /s/    RICHARD  A. MCCARTY |
|                    | ** **              | **Richard  A. McCarty** |
|                    | ** **              | **Executive  Vice President and Chief Financial Officer** |
|                    | ** **              | **(Principal  Financial Officer and duly authorized****signatory)** |

 

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**EXHIBITINDEX**

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

 

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