**UNITED STATES****SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20006**

 

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**FORM 10-K**

 

**ANNUAL REPORT PURSUANT TO SECTION13 OR 15(D)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thefiscal year ended December 31, 2005**

 

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**COMMUNITY VALLEY BANCORP**

(Exactname of registrant as specified in its charter)

** **

| **California**                            | ** ** | **68-0479553**                         |
|-------------------------------------------|------------|----------------------------------------|
| State  of incorporation                   |       | I.R.S.  Employer Identification Number |
|                                      |       |                                   |
| **2041 Forest Avenue  Chico, California** | ** ** | **95928**                              |
| Address  of principal executive offices   |       | Zip  Code                              |

 

**(530)899-2344**Registrant’s telephone number, including area code

 

Securities registeredpursuant to Section 12(b) of the Act:  **None**

 

Securities registeredpursuant to Section 12(g) of the Act:  **Common Stock, No Par Value**

 

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Indicateby check mark if the registrant is a well-known seasoned issuer, as defined inRule 405 of the Securities Act. Yes  o    No  ý

 

Indicate by check mark if theregistrant is not required to file reports pursuant to Section 13 or Section15(d) of the Exchange Act.

Yes  o    No  ý

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

 

Yes  ý    No  o

 

Check if disclosure ofdelinquent filers pursuant to Item 405 of Regulation S-K is not containedherein, and will not be contained, to the best of Registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in PartIII of this Form 10-K or any amendment to this form 10-K.  ý

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act)
| Large  accelerated filer  o |   | Accelerated  filer  o |   | Non-accelerated  filer  ý |
|---------------------------------------|--------|---------------------------------|--------|------------------------------------------|

 

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

 

As of June 30, 2005, theaggregate market value of the voting stock held by non-affiliates of theRegistrant was approximately $73.1 million, based on the sales price reportedto the Registrant on that date of $15.40 per share.

 

Shares of Common Stock heldby each officer and director and each person owning more than five percent ofthe outstanding Common Stock have been excluded in that such persons may bedeemed to be affiliates. This determination of the affiliate status is notnecessarily a conclusive determination for other purposes.

 

The number of shares ofCommon Stock of the registrant outstanding as of March 1, 2006 was 7,439,877.

 

Documents incorporated byreference

 

 

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**TABLE OF CONTENTS**

 
| ** ** | **ITEM**                                                                                                  | ** ** |
|------------|-----------------------------------------------------------------------------------------------------------|------------|
|       |                                                                                                      |       |
| PART I     |                                                                                                      |       |
|       |                                                                                                      |       |
|       | Item 1. Business                                                                                          |       |
|       |                                                                                                      |       |
|       | Item 2.  Properties                                                                                       |       |
|       |                                                                                                      |       |
|       | Item 3.  Legal Proceedings                                                                                |       |
|       |                                                                                                      |       |
|       | Item  4. Submission of Matters to a Vote of Security Holders                                              |       |
|       |                                                                                                      |       |
| PART II    |                                                                                                      |       |
|       |                                                                                                      |       |
|       | Item  5. Market for Common Equity and Related Shareholder Matters                                         |       |
|       |                                                                                                      |       |
|       | Item  6. Selected Financial Data                                                                          |       |
|       |                                                                                                      |       |
|       | Item  7. Management’s Discussion and Analysis of Financial Condition and Results of  Operations      |       |
|       |                                                                                                      |       |
|       | Item 7a.  Quantitative and Qualitative Disclosures About Market Risk.                                     |       |
|       |                                                                                                      |       |
|       | Item 8.  Consolidated Financial Statements and Supplementary Data                                         |       |
|       |                                                                                                      |       |
|       | Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial  Disclosure            |       |
|       |                                                                                                      |       |
|       | Item 9a. Controls  and Procedures                                                                         |       |
|       |                                                                                                      |       |
| PART III   |                                                                                                      |
|       |                                                                                                      |
|       | Item 10.  Directors and Executive Officers of the Registrant                                              |       |
|       |                                                                                                      |       |
|       | Item 11.  Executive Compensation                                                                          |       |
|       |                                                                                                      |       |
|       | Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related  Stockholder Matters |       |
|       |                                                                                                      |       |
|       | Item 13.  Certain Relationships and Related Transactions                                                  |       |
|       |                                                                                                      |       |
|       | Item 14.  Principal Accountant Fees and Services                                                          |       |
|       |                                                                                                      |       |
| PART IV    |                                                                                                      |
|       |                                                                                                      |       |
|       | Item 15.  Exhibits, Financial Statement Schedules, and Reports on Form 8-K                                |       |
|       |                                                                                                      |       |
| SIGNATURES |                                                                                                      |

 

1

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**PART I**

 

**Item 1.    Business**

 

**ForwardLooking Statements**

 

Certain statements contained in this Annual Report on Form 10-Kthat are not statements of historical fact constitute forward-lookingstatements within the meaning of the Private Securities Litigation Reform Actof 1995 (the “Act”), notwithstanding that such statements are not specificallyidentified. These statements are basedon management’s beliefs and assumptions, and on information available to managementas of the date of this document. Forward-looking statements include theinformation concerning possible or assumed future results of operations of theCompany set forth under the heading “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.” Forward-looking statements alsoinclude statements in which words such as “expect,” “anticipate,” “intend,” “plan,”“believe,” “estimate,” “consider” or similar expressions are used.Forward-looking statements are not guarantees of future performance. Theyinvolve risks, uncertainties and assumptions, including the risks discussedunder the heading “Risk Factors” and elsewhere in this report. The Company’sactual future results and shareholder values may differ materially from thoseanticipated and expressed in these forward-looking statements. Many of thefactors that will determine these results and values, including those discussedunder the heading “Risk Factors That May Affect Results,” are beyond theCompany’s ability to control or predict. Investors are cautioned not to putundue reliance on any forward-looking statements. In addition, the Company doesnot have any intention or and assumes no obligation to update forward-lookingstatements after the date of the filing of this report, even if newinformation, future events or other circumstances have made such statementsincorrect or misleading. Except as specifically noted herein all referenced tothe “Company” refer to Community Valley Bancorp, a California corporation, andits consolidated subsidiaries.

 

**General**

 

**The Company**

 

Community Valley Bancorp (the “Company”) is a California corporationregistered as a financial holding company under the Financial  Holding Company Act of 1956, as amended (the “BHCAct”), and is headquartered in Chico, California. The Company was incorporatedin July, 2001 and acquired all of the outstanding shares of Butte CommunityBank (the “Bank”) in May, 2002. The Company’s principal subsidiary is the Bank.The Company also has a subsidiary in the name of Community Valley Bancorp TrustI, which was formed in December, 2002 solely to facilitate the issuance ofcapital trust pass-through securities. The Company also has an insurancesubsidiary in the name of Community Valley Bancorp Insurance Agency, LLC whichwas formed in December 2004 to provide a full service insurance agency offeringall lines of coverage. The Company exists primarily for the purpose of holdingthe stock of the Bank and of such other subsidiaries as it may acquire orestablish.

 

The Company’s principal source of income is currently dividends fromthe Bank, but the Company intends to explore additional supplemental sources ofincome in the future. The expenditures of the Company, including (but notlimited to) the payment of dividends to shareholders, if and when declared bythe Board of Directors, and the cost of servicing debt will generally be paidfrom such payments made to the Company by the Bank.

 

At December 31, 2005, the Company had consolidated assets of $494.8million, deposits of $434.0 million and shareholders’ equity of $41.6 million.

 

The Company’s Administrative Offices are located at 2041 Forest Avenue,Chico, California and its telephone number is(530) 899-2344. References herein to the “Company” include the Company and theBank, unless the context indicates otherwise.

 

The Company filesannual, quarterly and other reports under the Securities Exchange Act of 1934with the Securities and Exchange Commission. These reports are posted and areavailable at no cost on the Company’s website, www.communityvalleybancorp.comthrough the reports link, as soon as reasonably practicable after the Companyfiles such documents with the SEC. The Company’s filings are also availablethrough the SEC’s website at www.sec.gov.

 

**The Bank**

 

Butte Community Bank was incorporated under the laws of the State ofCalifornia on May 11, 1990 and commenced operations as a Californiastate-chartered commercial bank on December 14, 1990. The Bank’s AdministrativeOffice is located at 2041 Forest Avenue, Chico, California. The Bank is aninsured bank under the Federal Deposit Insurance Act up to the maximum limitsthereof. The Bank is not a member of the Federal Reserve System. At December31, 2005, the Bank had approximately $495.2 million in assets, $408.1 millionin loans and $439.2 million in deposits.

 

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We operate seven full-service branch offices in four Butte Countycommunities, one full-service branch office in Sutter County, two full-servicebranches in Tehama County, one full-service branch in Yuba County, onefull-service branch in Colusa County, one full-service branch in Shasta County,one Loan Production office in Sacramento County, and one Loan Production officein Butte County. We offer a full range of banking services to individuals andvarious-sized businesses in the communities we serve. The locations of thoseoffices are:

 
| Chico:         |   | Main Office                                     |   | Paradise  |   | South Paradise Branch  |
|----------------|--------|-------------------------------------------------|--------|-----------|--------|------------------------|
|           |   | 2041 Forest Avenue                              |   |      |   | 672 Pearson Road       |
|           |   |                                            |   |      |   |                   |
|           |   | Administrative Headquarters  2041 Forest Avenue |   |      |   | North Paradise Branch  |
|           |   | 2041 Forest Avenue                              |   |      |   | 6653 Clark Road        |
|           |   |                                            |   |      |   |                   |
|           |   | North Chico Branch                              |   | Oroville  |   | Oroville Branch        |
|           |   | 237 West East Avenue                            |   |      |   | 2227 Myers Street      |
|           |   |                                            |   |      |   |                   |
|           |   | Central Chico Branch                            |   | Magalia   |   | Magalia Branch         |
|           |   | 900 Mangrove Avenue                             |   |      |   | 14001 Lakeridge Circle |
|           |   |                                            |   |      |   |                   |
| Citrus Heights |   | Citrus Heights Loan Office                      |   | Yuba City |   | Yuba City Branch       |
|           |   | 5959 Greenback Lane #450                        |   |      |   | 1600 Butte House Road  |
|           |   |                                            |   |      |   |                   |
| Redding        |   | Redding Branch                                  |   | Red Bluff |   | Red Bluff Branch       |
|           |   | 100 East Cypress Ave.                           |   |      |   | 84 Belle Mill Road     |
|           |   | Suite # 150                                     |   |      |   |                   |
|           |   |                                            |   |      |   |                   |
| Marysville     |   | Marysville Branch                               |   | Colusa    |   | Colusa Branch          |
|           |   | 812 B Street                                    |   |      |   | 1017 Bridge Street     |
|           |   |                                            |   |      |   |                   |
| Gridley        |   | Gridley Loan Office                             |   | Corning   |   | Corning Branch         |
|           |   | 1010 Spruce Street                              |   |      |   | 908 Hwy 99W            |

 

In addition, our Real Estate Loan Center, Data Processing, Call Center,Central Note Department and Bank Card Center are located at 1390 RidgewoodDrive, Chico. We also have specialized credit centers for agricultural lendingand construction and real estate lending within a number of these branchoffices. These facilities are located in the cities of Chico, Paradise, andOroville in Butte County, the city of Yuba City in Sutter County, The cities ofRed Bluff and Corning in Tehama County, the city of Marysville in Yuba County,the city of Colusa in Colusa County, the city of Citrus Heights in SacramentoCounty, and the city of Redding in Shasta County.

 

Throughout the history of Butte Community Bank, our growth has beenexclusively by establishing de novo full-service branch offices and creditcenters in various locations in California’s Northern Sacramento Valley andfoothill region.

 

With a predominant focus on personal service, Butte Community Bank haspositioned itself as a multi-community independent bank serving the financialneeds of individuals and businesses, including agricultural and real estatecustomers in Butte and other surrounding counties. Our principal retail lendingservices include home equity and consumer loans. In addition, we have two othersignificant dimensions which surround this core of retail communitybanking:  Agricultural lending, and realestate financing (both construction and long term).

 

The Agricultural Credit Centers located in Yuba City, Chico, and RedBluff provide a complete line of credit services in support of the agriculturalactivities which are key to the continued economic development of thecommunities we serve. “Ag lending” clients include a full range of individualfarming customers and small business farming organizations.

 

3

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The Bank Card Center, headquartered in Chico, provides a range ofcredit, debit and ATM card services, which are made available to each of thecustomers served by the branch banking offices. In addition, we staff ourChico, Paradise, Oroville, Red Bluff and Yuba City offices with real estatelending specialists. These officers are responsible for a complete line of landacquisition and development loans, construction loans for residential andcommercial development, and the origination of multifamily credit facilities. Secondarymarket services are provided though the Bank’s affiliations with Fannie Mae andvarious non-governmental programs. The Bank services these real estate loanssold on the secondary market, and as of year end the portfolio was in excess of$157 million. We also have an orientation toward Small Business Administrationlending and have been designated as a Preferred Lender since 1998. The Bank’sSBA program generated approximately $7.9 million in loans during the past year.It is anticipated that loans under this program will be an increasing segmentof our loan portfolio over the next few years. The Bank was also recognized asthe number two USDA Business and Industry Lender in California and number ninein the nation during 2005. The Bank originated $10.8 million in loans throughthis program during 2005.

 

As of December 31, 2005, the principal areas in which we directedour lending activities, and the percentage of our total loan portfolio forwhich each of these areas was responsible, were as follows: (i) agriculturalloans (6%); (ii) commercial and industrial (including SBA) loans (15%); (iii)real estate loans (mortgage and construction) (70%); (iv) consumer loans (9%).

 

In addition to the lending activities noted above, we offer a widerange of deposit products for the retail banking market including checking,interest bearing transaction, savings, time certificates of deposit andretirement accounts, as well as telephone banking and internet banking withbill pay options. As of December 31, 2005, we had 30,097 deposit accountswith balances totaling approximately $434 million, compared to 26,242 depositaccounts with balances totaling approximately $399 million at December 31, 2004.Butte Community Bank attracts deposits through its customer-oriented productmix, competitive pricing, convenient locations, extended hours and drive-upbanking, all provided with the highest level of customer service.

 

We also offer other products and services to our customers, whichcomplement the lending and deposit services previously reviewed. These includecashier’s checks, traveler’s checks, bank-by-mail, ATM, night depository, safedeposit boxes, direct deposit, automated payroll services and other customarybanking services. Shared ATM and Point of Sale (POS) networks allow customersaccess to the national and international funds transfer networks. During thepast few years we have substantially enhanced our ATM locations to includeoff-site areas not previously served by cash or deposit facilities. We now havea total of five such remote ATM’s at five different locations, including twohospitals, two convenience stores, and an entertainment center. These locationsfacilitate cash advances which would not otherwise be available to consumers atnon-branch locations, thereby increasing consumer convenience. In addition tosuch specifically oriented customer applications, we provide safe deposit, wiretransfer capabilities and a convenient customer service group in our CallCenter to answer questions and assure a high level of customer satisfactionwith the level of services and products we provide.

 

Most of the Bank’s deposits are attracted from individuals,business-related sources and smaller municipal entities. This results in arelatively modest average deposit balance of approximately $14,000 atDecember 31, 2005, but makes the Bank less subject to adverse effects fromthe loss of a substantial depositor who may be seeking higher yields in othermarkets or who may have need of money otherwise on deposit with the Bank,especially during periods of inflation or conservative monetary policies. TheBank has had a relationship with a local title company for many years. Theyhave kept substantial deposit balances which have increased consistently withnew home purchases and refinancing activity. Management believes thisrelationship to be very secure and does not anticipate this business leavingthe Bank.

 

For non-deposit services, we have a strategic alliance with LinscoPrivate Ledger Financial Services. Through this arrangement, our registered andlicensed representatives provide Bank customers with convenient access toannuities, insurance products, mutual funds, and a full range of investmentproducts which are not FDIC insured. They conduct business from all of our fullservice offices.

 

We do not believe there is a significant demand for additional trustservices in our service areas, and we do not operate or have any presentintention to seek authority to operate a Trust Department. We believe that thecost of establishing and operating such a department would not be justified bythe potential income to be gained there from.

 

The officers and employees of the Bank are continually engaged inmarketing activities, including the evaluation and development of new productsand services, which enable the Bank to retain and improve its competitiveposition in its service area. All of these developments are meant to increasepublic convenience and enhance public access to the electronic payments system.The cost to the Bank for these development, implementation, and marketingactivities cannot expressly be calculated with any degree of certainty.

 

The Bank holds no patents or licenses (other than licenses required byappropriate bank regulatory agencies), franchises, or concessions. The Bank isnot dependent on a single customer or group of related customers for a materialportion of its deposits, nor is a material portion of the Bank’s loans concentratedwithin a single industry or group of related industries. There has been nomaterial effect upon the Bank’s capital expenditures, earnings, or competitiveposition as a result of Federal, state, or local environmental regulation.

 

4

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**Recent Developments**

 

On September 29, 2004 the Company filed forFinancial Holding Company status with the Federal Reserve Bank of San Franciscowith subsequent approval granted on October 29, 2004. On October 15, 2004 theCompany filed with the California Department of Insurance for permission tooperate a subsidiary of Community Valley Bancorp called CVB Insurance AgencyLLC which was formed in December 2004 with a capital investment of $1 milliondown streamed from the Company.

 

On October 28, 2004 the Company filed applications with the CaliforniaDepartment of Financial Institutions and the Federal Deposit InsuranceCorporation for permission to establish a branch office in the city of Colusa. Thisbranch was subsequently opened on December 20, 2004.

 

On February 2, 2005 the Company filed applications with the CaliforniaDepartment of Financial Institutions and the Federal Deposit InsuranceCorporation for permission to establish a branch office in the city of Corningand was subsequently approved on February 25, 2005. This branch subsequentlyopened for business on March 7, 2005.

 

On June 10, 2005 the Company filed applications with the CaliforniaDepartment of Financial Institutions and the Federal Deposit Insurance Corporationfor permission to discontinue our Loan Production Office and establish a branchoffice in the city of Redding. These applications were subsequently approved onJune 13, 2005. This branch opened for business on September 6, 2005.

 

On June 15, 2005 the Company filed applications with the CaliforniaDepartment of Financial Institutions to establish a Loan Production Officeplace of business at 1010 Spruce Street in the city of Gridley. This LoanProduction Office was subsequently approved on June 16, 2005 and opened forbusiness on July 18, 2005.

 

**Competition**

 

The banking business in California generally, and specifically in ourmarket areas, is highly competitive with respect to virtually all products andservices and has become increasingly more so in recent years. The industrycontinues to consolidate and strong, unregulated competitors have enteredbanking markets with focused products targeted at highly profitable customersegments. Many largely unregulated competitors are able to compete across geographicboundaries and provide customers increasing access to meaningful alternativesto banking services in nearly all significant products. These competitivetrends are likely to continue.

 

With respect to commercial bank competitors, the business is largelydominated by a relatively small number of major banks with many officesoperating over a wide geographical area, which banks have, among otheradvantages, the ability to finance wide-ranging and effective advertisingcampaigns and to allocate their investment resources to regions of highestyield and demand. Many of the major banks operating in the area offer certainservices which we do not offer directly but may offer indirectly throughcorrespondent institutions. By virtue of their greater total capitalization,such banks also have substantially higher lending limits than we do.

 

In addition to other banks, competitors include savings institutions,credit unions, and numerous non-banking institutions such as finance companies,leasing companies, insurance companies, brokerage firms, and investment bankingfirms. In recent years, increased competition has also developed fromspecialized finance and non-finance companies that offer wholesale finance,credit card, and other consumer finance services, including on-line bankingservices and personal finance software. Strong competition for deposit and loanproducts affects the rates of those products as well as the terms on which theyare offered to customers. Mergers between financial institutions have placedadditional pressure on banks within the industry to streamline theiroperations, reduce expenses, and increase revenues to remain competitive.Competition has also intensified due to recently enacted federal and stateinterstate banking laws, which permit banking organizations to expandgeographically, and the California market has been particularly attractive toout-of-state institutions. The Financial Modernization Act, which, effectiveMarch 11, 2000, has made it possible for full affiliations to occur betweenbanks and securities firms, insurance companies, and other financial companies,is also expected to intensify competitive conditions.

 

Technological innovation has also resulted in increased competition infinancial services markets. Such innovation has, for example, made it possiblefor non-depository institutions to offer customers automated transfer paymentservices that previously have been considered traditional banking products. Inaddition, many customers now expect a choice of several delivery systems andchannels, including telephone, mail, home computer, ATMs, self  service branches, and/or in-store branches.In addition to other banks, the sources of competition for such productsinclude savings associations, credit unions, brokerage firms, money market andother mutual funds, asset management groups, finance and insurance companies,internet-only financial intermediaries, and mortgage banking firms.

 

For many years, we have countered this increasing competition byproviding our own style of community-oriented, personalized service. We relyupon local promotional activity, personal contacts by our officers, directors,employees, and shareholders, automated 24-hour banking, and the individualizedservice which we can provide through our flexible policies. In addition, tomeet the needs of customers with electronic access requirements, the Companyhas embraced the electronic age and installed telephone banking and personalcomputer and internet banking with bill payment capabilities. This high techand high touch approach allows the individual to customize the Bank’s contactmethodologies to their particular preference. Moreover, for customers whoseloan demands exceed our legal lending limit, we attempt to arrange for suchloans on a participation basis with correspondent banks. We also assist ourcustomers in obtaining from our correspondent banks other services that theBank may not offer.

 

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Our credit card business is subject to an even higher level ofcompetitive pressure than our general banking business. There are a number ofmajor banks and credit card issuers that are able to finance often highlysuccessful advertising campaigns with which community banks generally do nothave the resources to compete. As a result, our credit card balancesoutstanding are much more likely to increase at a slower rate than that whichmight be seen in nationwide issuers’ year-end statistics. Additionalcompetition comes from many non-financial institutions, such as providers ofvarious retail products, which offer many types of credit cards.

 

**Employees**

 

As of December 31, 2005 the Company had 161 full-time and 114 part-timeemployees. On a full time equivalent basis, the Company’s staff level was 241at December 31, 2005, as compared to 204 at December 31, 2004. None of ouremployees is concurrently represented by a union or covered by a collectivebargaining agreement. Management of the Company believes its employee relationsare satisfactory.

 

**Regulation and Supervision**

 

The Company and the Bank are subject to significant regulation byfederal and state regulatory agencies. The following discussion of statutes andregulations is only a brief summary and does not purport to be complete. Thisdiscussion is qualified in its entirety by reference to such statutes andregulations. No assurance can be given that such statutes or regulations willnot change in the future.

 

**The Company**

 

The Company is a financial holding company within the meaning of theFinancial Holding Company Act of 1956 and is registered as such with the Boardof Governors of the Federal Reserve System (the “Federal Reserve Board”). Afinancial holding company is required to file with the Federal Reserve Boardannual reports and other information regarding its business operations andthose of its subsidiaries. It is also subject to examination by the FederalReserve Board and is required to obtain Federal Reserve Board approval beforeacquiring, directly or indirectly, ownership or control of any voting shares ofany bank if, after such acquisition, it would directly or indirectly own orcontrol more than 5% of the voting stock of that bank, unless it already owns amajority of the voting stock of that bank.

 

The Federal Reserve Board has by regulation determined certainactivities in which a financial holding company may or may not conduct business.A financial holding company must engage, with certain exceptions, in thebusiness of banking or managing or controlling banks or furnishing services toor performing services for its subsidiary banks. The permissible activities andaffiliations of certain bank holding companies have recently been expanded. (See“Financial Modernization Act” below.)

 

**The Bank**

 

As a California state-chartered bank whose accounts are insured by theFDIC up to a maximum of $100,000 per depositor, the Bank is subject toregulation, supervision and regular examination by the Department of FinancialInstitutions (the “DFI”) and the FDIC. In addition, while the Bank is not a memberof the Federal Reserve System, it is subject to certain regulations of theFederal Reserve Board. The regulations of these agencies govern most aspects ofthe Bank’s business, including the making of periodic reports by the Bank, andthe Bank’s activities relating to dividends, investments, loans, borrowings,capital requirements, certain check-clearing activities, branching, mergers andacquisitions, reserves against deposits and numerous other areas. Supervision,legal action and examination of the Bank by the FDIC are generally intended toprotect depositors and are not intended for the protection of shareholders.

 

The earnings and growth of the Bank are largely dependent on itsability to maintain a favorable differential or “spread” between the yield onits interest-earning assets and the rate paid on its deposits and otherinterest-bearing liabilities. As a result, the Bank’s performance is influencedby general economic conditions, both domestic and foreign, the monetary andfiscal policies of the federal government, and the policies of the regulatoryagencies, particularly the Federal Reserve Board. The Federal Reserve Boardimplements national monetary policies (such as seeking to curb inflation andcombat recession) by its open-market operations in United States Governmentsecurities, by adjusting the required level of reserves for financialinstitutions subject to its reserve requirements and by varying the discountrate applicable to borrowings by banks which are members of the Federal ReserveSystem. The actions of the Federal Reserve Board in these areas influence thegrowth of bank loans, investments and deposits and also affect interest ratescharged on loans and deposits. The nature and impact of any future changes inmonetary policies cannot be predicted.

 

6

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**Capital Adequacy Requirements**

 

The Company and the Bank are subject to the regulations of the FederalReserve Board and the FDIC, respectively, governing capital adequacy. Thoseregulations incorporate both risk-based and leverage capital requirements. Eachof the federal regulators has established risk-based and leverage capitalguidelines for the banks or bank holding companies it regulates, which settotal capital requirements and define capital in terms of “core capitalelements,” or Tier 1 capital; and “supplemental capital elements,” or Tier 2capital. Tier 1 capital is generally defined as the sum of the core capitalelements less goodwill and certain other deductions, notably the unrealized netgains or losses (after tax adjustments) on available for sale investmentsecurities carried at fair market value. The following items are defined ascore capital elements: (i) common shareholders’ equity; (ii) trust preferredsecurities are a form of long-term borrowing that currently qualifies as Tier 1capital not to exceed 25% of pro-forma Tier 1 capital; (iii) qualifyingnon-cumulative perpetual preferred stock and related surplus (not to exceed 25%of pro-forma Tier 1 capital); and (iv) minority interests in the equityaccounts of consolidated subsidiaries. Supplementary capital elementsinclude:  (i) allowance for loan andlease losses (but not more than 1.25% of an institution’s risk-weightedassets); (ii) perpetual preferred stock and related surplus not qualifying ascore capital; (iii) hybrid capital instruments, perpetual debt and mandatoryconvertible debt instruments; and (iv) term subordinated debt andintermediate-term preferred stock and related surplus. The maximum amount ofsupplemental capital elements which qualifies as Tier 2 capital is limited to100% of Tier 1 capital, net of goodwill.

 

The minimum required ratio of qualifying total capital to totalrisk-weighted assets is 8.0% (“Total Risk-Based Capital Ratio”), at least onehalf of which must be in the form of Tier 1 capital, and the minimum requiredratio of Tier 1 capital to total risk-weighted assets is 4.0% (“Tier 1Risk-Based Capital Ratio”). Risk-based capital ratios are calculated to providea measure of capital that reflects the degree of risk associated with a bankingorganization’s operations for both transactions reported on the balance sheetas assets, and transactions, such as letters of credit and recoursearrangements, which are recorded as off-balance sheet items. Under therisk-based capital guidelines, the nominal dollar amounts of assets andcredit-equivalent amounts of off-balance sheet items are multiplied by one ofseveral risk adjustment percentages, which range from 0% for assets with lowcredit risk, such as certain U. S. Treasury securities, to 100% for assets withrelatively high credit risk, such as business loans. As of December 31,2005 and 2004, the Bank’s Total Risk-Based Capital Ratios were 11.3% and 11.3%,respectively and its Tier 1 Risk-Based Capital Ratios were 10.1% and10.2%, respectively. As of December 31, 2005 and 2004, the Company’s TotalRisk-Based Capital was 12.5% and 12.5% respectively, and its Tier 1 Risk-BasedCapital Ratio was 11.4% and 11.3% respectively. The risk-based capitalrequirements also take into account concentrations of credit (i.e., relativelylarge proportions of loans involving one borrower, industry, location,collateral or loan type) and the risks of “non-traditional” activities (thosethat have not customarily been part of the banking business). The regulationsrequire institutions with high or inordinate levels of risk to operate withhigher minimum capital standards, and authorize the regulators to review aninstitution’s management of such risks in assessing an institution’s capitaladequacy.

 

The risk-based capital regulations also include exposure to interestrate risk as a factor that the regulators will consider in evaluating a bank’scapital adequacy. Interest rate risk is the exposure of a bank’s current andfuture earnings and equity capital arising from adverse movements in interestrates. While interest risk is inherent in a bank’s role as financialintermediary, it introduces volatility to bank earnings and to the economicvalue of the bank.

 

The FDIC and the Federal Reserve Board also require the maintenance ofa leverage capital ratio designed to supplement the risk-based capitalguidelines. Banks and bank holding companies that have received the highestrating of the five categories used by regulators to rate banks and are notanticipating or experiencing any significant growth must maintain a ratio ofTier 1 capital (net of all intangibles) to adjusted total assets (“LeverageCapital Ratio”) of at least 3%. All other institutions are required to maintaina leverage ratio of at least 100 to 200 basis points above the 3% minimum, fora minimum of 4% to 5%. Pursuant to federal regulations, banks must maintaincapital levels commensurate with the level of risk to which they are exposed,including the volume and severity of problem loans, and federal regulators may,however, set higher capital requirements when a bank’s particular circumstanceswarrant. As of December 31, 2005 and 2004, the Bank’s Leverage CapitalRatios were 9.5% and 8.6%, respectively. As of December 31, 2005 and 2004, theCompany’s leverage capital ratios were 9.8% and 9.5%, respectively, exceedingregulatory minimums. At December 31, 2005 and 2004 the Company met all of itscapital adequacy guidelines and the Bank was considered “well capitalized”under the prompt corrective action provisions. See Part II, Item 7, Management’sDiscussion and Analysis of Financial Condition and Results of Operation —Liquidity and Market Risk Management.

 

7

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**Prompt Corrective Action Provisions**

 

Federal law requires each federal banking agency to take promptcorrective action to resolve the problems of insured financial institutions,including but not limited to those that fall below one or more prescribed minimumcapital ratios. The federal banking agencies have by regulation defined thefollowing five capital categories: “well capitalized” (Total Risk-Based CapitalRatio of 10%; Tier 1 Risk-Based Capital Ratio of 6%; and Leverage Ratio of 5%);“adequately capitalized” (Total Risk-Based Capital Ratio of 8%; Tier 1Risk-Based Capital Ratio of 4%; and Leverage Ratio of 4%) (or 3% if theinstitution receives the highest rating from its primary regulator); “undercapitalized”(Total Risk-Based Capital Ratio of less than 8%; Tier 1 Risk-Based CapitalRatio of less than 4%; or Leverage Ratio of less than 4%) (or 3% if theinstitution receives the highest rating from its primary regulator); “significantlyundercapitalized” (Total Risk-Based Capital Ratio of less than 6%; Tier 1Risk-Based Capital Ratio of less than 3%; or Leverage Ratio less than 3%); and “criticallyundercapitalized” (tangible equity to total assets less than 2%). A bank may betreated as though it were in the next lower capital category if after noticeand the opportunity for a hearing, the appropriate federal agency finds anunsafe or unsound condition or practice so warrants, but no bank may be treatedas “critically undercapitalized” unless its actual capital ratio warrants suchtreatment.

 

At each successively lower capital category, an insured bank is subjectto increased restrictions on its operations. For example, a bank is generallyprohibited from paying management fees to any controlling persons or frommaking capital distributions if to do so would make the bank “undercapitalized.”  Asset growth and branching restrictions applyto undercapitalized banks, which are required to submit written capitalrestoration plans meeting specified requirements (including a guarantee by theparent holding company, if any). “Significantly undercapitalized” banks aresubject to broad regulatory authority, including among other things, capitaldirectives, forced mergers, restrictions on the rates of interest they may payon deposits, restrictions on asset growth and activities, and prohibitions onpaying certain bonuses without FDIC approval. Even more severe restrictionsapply to critically undercapitalized banks. Most importantly, except underlimited circumstances, not later than 90 days after an insured bank becomescritically undercapitalized, the appropriate federal banking agency is requiredto appoint a conservator or receiver for the bank.

 

In addition to measures taken under the prompt corrective actionprovisions, insured banks may be subject to potential actions by the federalregulators for unsafe or unsound practices in conducting their businesses orfor violations of any law, rule, regulation or any condition imposed in writingby the agency or any written agreement with the agency. Enforcement actions mayinclude the issuance of cease and desist orders, termination of insurance ofdeposits (in the case of a bank), the imposition of civil money penalties, theissuance of directives to increase capital, formal and informal agreements, orremoval and prohibition orders against “institution-affiliated” parties.

 

**Safety and Soundness Standards**

 

The federal banking agencies have also adopted guidelines establishingsafety and soundness standards for all insured depository institutions. Thoseguidelines relate to internal controls, information systems, internal auditsystems, loan underwriting and documentation, compensation and interest rateexposure. In general, the standards are designed to assist the federal bankingagencies in identifying and addressing problems at insured depositoryinstitutions before capital becomes impaired. If an institution fails to meetthese standards, the appropriate federal banking agency may require theinstitution to submit a compliance plan and institute enforcement proceedingsif an acceptable compliance plan is not submitted.

 

**Premiums for Deposit Insurance**

 

The FDIC regulations also implement a risk-based premium system,whereby insured depository institutions are required to pay insurance premiumsdepending on their risk classification. Under this system, institutions such asthe Bank which are insured by the Bank Insurance Fund (“BIF”) are categorizedinto one of three capital categories (well capitalized, adequately capitalized,and undercapitalized) and one of three supervisory categories based on federalregulatory evaluations. The three supervisory categories are: financially soundwith only a few minor weaknesses (Group A), demonstrates weaknesses that couldresult in significant deterioration (Group B), and poses a substantialprobability of loss (Group C). The capital ratios used by the FDIC to definewell capitalized, adequately capitalized and undercapitalized are the same inthe FDIC’s prompt corrective action regulations. The current BIF baseassessment rates (expressed as cents per $100 of deposits) are summarized asfollows:

 
| ** **              | ** ** | **Group A** | ** ** | **Group B** | ** ** | **Group C** | ** ** |
|-------------------------|------------|------------------|------------|------------------|------------|------------------|------------|
|                    |       |             |       |             |       |             |       |
| Well Capitalized        |       | 0                |       | 3                |       | 17               |       |
| Adequately  Capitalized |       | 3                |       | 10               |       | 24               |       |
| Undercapitalized        |       | 10               |       | 24               |       | 27               |       |

 

In addition, BIF member banks (such as the Bank) must pay an amountwhich fluctuates but is currently 1.34 basis points, or cents per $100 ofinsured deposits, toward the retirement of the Financing Corporation bondsissued in the 1980’s to assist in the recovery of the savings and loanindustry.

 

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**Dividends**

 

The Company is entitled to receive dividends, when and as declared byits subsidiary banks’ Boards of Directors. Those dividends may come from fundslegally available for those dividends, as specified and limited by theCalifornia Financial Code and the U.S. Code. Under the California FinancialCode, funds available for cash dividends by a California-chartered bank arerestricted to the lesser of:(i) the bank’s retained earnings; or (ii) the bank’snet income for its last three fiscal years (less any distributions toshareholders made during such period). With the prior approval of theCalifornia Department of Financial Institutions (“DFI”) , cash dividends mayalso be paid out of the greater of: (i) the bank’s retained earnings; (ii) netincome for the bank’s last preceding fiscal year; or (iii) net income for thebank’s current fiscal year. If the DFI determines that the shareholders’ equityof the bank paying the dividend is not adequate or that the payment of thedividend would be unsafe or unsound for the bank, the DFI may order the banknot to pay the dividend.

 

It is also possible, depending upon its financial condition and otherfactors, that a regulatory agency could assert that the payment of dividends orother payments might, under some circumstances, constitute an unsafe or unsoundpractice and thereby prohibit such payments.

 

California Corporations Code Section 500 allows the Company to pay adividend to its shareholders only to the extent that it has retained earningsand, after the dividend, its:

 

•                  assets(exclusive of goodwill and other intangible assets) would be 1.25 times itsliabilities (exclusive of deferred taxes, deferred income and other deferredcredits); and

 

•                  currentassets would be at least equal to current liabilities.

 

Additionally, the FRB’s policy regarding dividends provides that a bankholding company should not pay cash dividends exceeding its net income or whichcan only be funded in ways that weaken the bank holding company’s financialhealth, such as by borrowing. The FRB also possesses enforcement powers overbank holding companies and their non-bank subsidiaries to prevent or remedyactions that represent unsafe or unsound practices or violations of applicablestatutes and regulations.

 

**Transactions With Affiliates**

 

The Company and any of its subsidiaries and certain related interestsare deemed to be affiliates of its subsidiary banks within the meaning ofSections 23A and 23B of the Federal Reserve Act. Under those terms, loans by asubsidiary bank to affiliates, investments by them in affiliates’ stock, andtaking affiliates’ stock as collateral for loans to any borrower is limited to10% of the particular banking subsidiary’s capital, in the case of any one affiliate,and is limited to 20% of the banking subsidiary’s capital, in the case of allaffiliates. In addition, such transactions must be on terms and conditions thatare consistent with safe and sound banking practices; in particular, a bank andits subsidiaries generally may not purchase from an affiliate a low-qualityasset, as defined in the Federal Reserve Act. These restrictions also prevent abank holding company and its other affiliates from borrowing from a bankingsubsidiary of the bank holding company unless the loans are secured bymarketable collateral of designated amounts. The Company and its subsidiarybanks are also subject to certain restrictions with respect to engaging in theunderwriting, public sale and distribution of securities.

 

**Recent Legislation**

 

From time to time legislation is enacted which has the effect ofincreasing the cost of doing business and changing the competitive balancebetween banks and other financial and non-financial institutions. Variousfederal laws enacted over the past several years have provided, among otherthings, for:

 

•                  themaintenance of mandatory reserves with the Federal Reserve Bank on deposits bydepository institutions;

 

•                  thephasing-out of the restrictions on the amount of interest which financial institutionsmay pay on certain types of accounts; and

 

•                  theauthorization of various types of new deposit accounts, such as “NOW” accounts,“Money Market Deposit” accounts and “Super NOW” accounts, designed to becompetitive with money market mutual funds and other types of accounts andservices offered by various financial and non-financial institutions.

 

The lending authority and permissible activities of certainnon-bank financial institutions such as savings and loan associations andcredit unions have been expanded, and federal regulators have been givenincreased enforcement authority. These laws have generally had the effect ofaltering competitive relationships existing among financial institutions,reducing the historical distinctions between the services offered by banks,savings and loan associations and other financial institutions, and increasingthe cost of funds to banks and other depository institutions.

 

9

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*Amendments to Regulation H and Y for TrustPreferred Securities**.***The Federal Reserve Board issued a final rule on March 1, 2005 that amendsRegulation H and Regulation Y to limit restricted core capital elements(including trust preferred securities) which count as Tier 1 capital to 25percent of all core capital elements, net of goodwill less any associateddeferred tax liability. Internationally active bank holding companies, will besubject to a 15 percent limit, but they may include qualifying mandatoryconvertible preferred securities up to the generally applicable 25 percentlimit. Amounts of restricted core capital elements in excess of these limitsgenerally may be included in Tier 2 capital. The final rule provides afive-year transition period, ending March 31, 2009, for application of thequantitative limits.

 

**Community Reinvestment Act**

 

The Bank is subject to certain requirements and reporting obligationsinvolving Community Reinvestment Act (“CRA”) activities. The CRA generallyrequires the federal banking agencies to evaluate the record of a financialinstitution in meeting the credit needs of its local communities, including lowand moderate income neighborhoods. The CRA further requires the agencies totake a financial institution’s record of meeting its community credit needsinto account when evaluating applications for, among other things, domesticbranches, consummating mergers or acquisitions, or holding company formations. Inmeasuring a bank’s compliance with its CRA obligations, the regulators utilizea performance-based evaluation system which bases CRA ratings on the bank’sactual lending service and investment performance, rather than on the extent towhich the institution conducts needs assessments, documents community outreachactivities or complies with other procedural requirements. In connection withits assessment of CRA performance, the FDIC assigns a rating of “outstanding,” “satisfactory,”“needs to improve” or “substantial noncompliance.”  The Bank was last examined for CRA compliancein January 2004 and received a “satisfactory” CRA Assessment Rating.

 

###### **Other Consumer ProtectionLaws and Regulations**

###### ** **

The bank regulatory agencies are increasingly focusing attention oncompliance with consumer protection laws and regulations. Examination andenforcement has become intense, and banks have been advised to carefullymonitor compliance with various consumer protection laws and their implementingregulations. The federal Interagency Task Force on Fair Lending issued a policystatement on discrimination in home mortgage lending describing three methodsthat federal agencies will use to prove discrimination: overt evidence ofdiscrimination, evidence of disparate treatment, and evidence of disparateimpact. In addition to CRA and fair lending requirements, the Bank is subject tonumerous other federal consumer protection statutes and regulations. Due toheightened regulatory concern related to compliance with consumer protectionlaws and regulations generally, the Bank may incur additional compliance costsor be required to expend additional funds for investments in the localcommunities it serves.

 

**Interstate Banking and Branching**

 

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994(the “Interstate Banking Act”) regulates the interstate activities of banks andbank holding companies and establishes a framework for nationwide interstatebanking and branching. Since June 1, 1997, a bank in one state has generallybeen permitted to merge with a bank in another state without the need forexplicit state law authorization. However, states were given the ability toprohibit interstate mergers with banks in their own state by “opting-out”(enacting state legislation applying equality to all out-of-state banksprohibiting such mergers) prior to June 1, 1997.

 

Since 1995, adequately capitalized and managed bank holding companieshave been permitted to acquire banks located in any state, subject to twoexceptions: first, any state may still prohibit bank holding companies fromacquiring a bank which is less than five years old; and second, no interstateacquisition can be consummated by a bank holding company if the acquirer wouldcontrol more than 10% of the deposits held by insured depository institutionsnationwide or 30% percent or more of the deposits held by insured depositoryinstitutions in any state in which the target bank has branches.

 

A bank may establish and operate de novo branches in any state in whichthe bank does not maintain a branch if that state has enacted legislation toexpressly permit all out-of-state banks to establish branches in that state.

 

In 1995 California enacted legislation to implement importantprovisions of the Interstate Banking Act discussed above and to repealCalifornia’s previous interstate banking laws, which were largely preempted bythe Interstate Banking Act.

 

The changes effected by Interstate Banking Act and California laws haveincreased competition in the environment in which the Bank operates to theextent that out-of-state financial institutions directly or indirectly enterthe Bank’s market areas. It appears that the Interstate Banking Act hascontributed to the accelerated consolidation of the banking industry. Whilemany large out-of-state banks have already entered the California market as aresult of this legislation, it is not possible to predict the precise impact ofthis legislation on the Bank and the Company and the competitive environment inwhich they operate.

 

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**Financial Modernization Act**

 

Effective March 11, 2000 the Gramm-Leach-Bliley Act eliminated mostbarriers to affiliations among banks and securities firms, insurance companies,and other financial service providers, and enabled full affiliations to occurbetween such entities. This legislation permits bank holding companies tobecome “financial holding companies” and thereby acquire securities firms andinsurance companies and engage in other activities that are financial in nature.A bank holding company may become a financial holding company if each of itssubsidiary banks is well capitalized under the FDICIA prompt corrective actionprovisions, is well managed, and has at least a satisfactory rating under theCRA by filing a declaration that the bank holding company wishes to become afinancial holding company. No regulatory approval will be required for afinancial holding company to acquire a company, other than a bank or savingsassociation, engaged in activities that are financial in nature or incidentalto activities that are financial in nature, as determined by the FederalReserve Board. The Company became a financial holding company in 2004 for thepurpose of establishing the subsidiary CVB Insurance Agency.

 

The Gramm-Leach-Bliley Act defines “financial in nature” to includesecurities underwriting, dealing and market making; sponsoring mutual funds andinvestment companies; insurance underwriting and agency; merchant bankingactivities; and activities that the Board has determined to be closely relatedto banking. A national bank (and therefore, a state bank as well) may alsoengage, subject to limitations on investment, in activities that are financialin nature, other than insurance underwriting, insurance company portfolioinvestment, real estate development and real estate investment, through a financialsubsidiary of the bank, if the bank is well capitalized, well managed and hasat least a satisfactory CRA rating. Subsidiary banks of a financial holdingcompany or national banks with financial subsidiaries must continue to be wellcapitalized and well managed in order to continue to engage in activities thatare financial in nature without regulatory actions or restrictions, which couldinclude divestiture of the financial in nature subsidiary or subsidiaries. Inaddition, a financial holding company or a bank may not acquire a company thatis engaged in activities that are financial in nature unless each of thesubsidiary banks of the financial holding company or the bank has a CRA ratingof satisfactory or better.

 

The Gramm-Leach-Bliley Act also imposes significant new requirements onthe sharing of customer information between financial institutions. The Companyhas responded to these new restrictions.

 

The Company and the Bank must file periodic reports with the variousregulators to keep them informed of their financial condition and operations aswell as their compliance with all the various regulations. Three regulatoryagencies - the Federal Reserve Bank of San Francisco for the Company, and theFDIC and the California Department of Financial Institutions - conduct periodicexaminations of the Company and the Bank to verify their reporting is accurateand to ascertain that they are in compliance with regulations.

 

A banking agency may take action against a financial holding company ora bank should it find the financial institution has failed to maintain adequatecapital. This action has usually taken the form of restrictions on the paymentof dividends to shareholders, requirements to obtain more capital frominvestors, and restrictions on operations. The FDIC may also take actionagainst a bank that is not acting in a safe and sound manner. Given the strongcapital position and performance of the Company and the Bank, Management doesnot expect to be impacted by these types of restrictions in the foreseeablefuture.

 

**Sarbanes-Oxley Act**

 

In 2002, the Sarbanes-Oxley Act was enacted as Federal legislation. Thislegislation imposes a number of new requirements on financial reporting andcorporate governance on all corporations. Passed in response to corporateaccounting and reporting failures, the act requires all public companies todocument their internal controls over financial reporting, evaluate the designand effectiveness of those controls, periodically test all significant controlsto ensure they are functioning, and provide a certification by the ChiefExecutive Officer and Chief Financial Officer of the documentation, evaluation,and testing. Among the new requirements is the inclusion in the Company’sAnnual Report of a report by Management on the Company’s internal controls overfinancial reporting and the safeguarding of assets. The report must beevaluated by the Company’s independent auditors. The Company is not yet subjectto this legislation but is in the process of documenting these internalcontrols, evaluating their effectiveness, and ensuring that adequate testing isperformed to ensure that they are functioning as intended.

 

**Regulatory Capital Treatment of EquityInvestments.**

 

In December of 2001 and January of 2002, the OCC, the FRB and the FDICadopted final rules governing the regulatory capital treatment of equityinvestments in non-financial companies held by banks, bank holding companiesand financial holding companies. The new capital requirements applysymmetrically to equity investments made by banks and their holding companiesin non-financial companies under the legal authorities specified in the finalrules. Among others, these include the merchant banking authority granted bythe Gramm-Leach-Bliley Act and the authority to invest in small businessinvestment companies (“SBICs”) granted by the Small Business Investment Act. Coveredequity investments will be subject to a series of marginal Tier 1 capitalcharges, with the size of the charge increasing as the organization’s level ofconcentration in equity investments increases. The highest marginal chargespecified in the final rules requires a 25 percent deduction from Tier 1capital for covered investments that aggregate more than 25 percent of anorganization’s Tier 1 capital. Equity investments through SBICs will be exemptfrom the new charges to the extent such investments, in the aggregate, do notexceed 15 percent of the banking organization’s Tier 1 capital. Grandfatheredinvestments made by state banks under section 24(f) of the Federal DepositInsurance Act also are exempted from coverage.

 

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**Other Pending and Proposed Legislation**

 

Other legislative and regulatory initiatives which could affect theCompany, the Bank and the banking industry in general are pending, andadditional initiatives may be proposed or introduced before the United StatesCongress, the California legislature and other governmental bodies in thefuture. Such proposals, if enacted, may further alter the structure, regulationand competitive relationship among financial institutions, and may subject theBank to increased regulation, disclosure and reporting requirements. Inaddition, the various banking regulatory agencies often adopt new rules andregulations to implement and enforce existing legislation. It cannot bepredicted whether, or in what form, any such legislation or regulations may beenacted or the extent to which the business of the Company or the Bank would beaffected thereby.

 

**Recent Accounting Pronouncements**

 

### ***Other-Than-Temporary Impairment of Securities***

 

In March 2004, theFinancial Accounting Standards Board (FASB) and Emerging Issues Task Force(EITF) reached consensus on several issues being addressed in EITF Issue No.03-1, *The Meaning of Other-Than-TemporaryImpairment and Its Application to Certain Investments*. The consensusprovides guidance for evaluating whether an investment isother-than-temporarily impaired and was effective for other-than-temporaryimpairment evaluations made in reporting periods beginning after June 15,2004. The disclosure provisions of EITF 03-1 continue to be effective for the Company’s consolidated financialstatements for the year ended December 31, 2005.

 

On November 3, 2005, theFASB issued FASB Staff Position (FSP) Nos. FAS 115-1 and FAS 124-1, *The Meaning of Other-Than-Temporary Impairment andIts Application to Certain Investments*. This FSP addresses thedetermination as to when an investment is considered impaired, whether thatimpairment is other than temporary, and the measurement of an impairment loss. ThisFSP also includes accounting considerations subsequent to the recognition of another-than-temporary impairment and requires certain disclosures aboutunrealized losses that have not been recognized as other-than-temporaryimpairments. This FSP nullifies certain requirements of EITF Issue 03-1, andsupersedes EITF Topic No. D-44, *Recognitionof Other-Than-Temporary Impairment upon the Planned Sale of a Security WhoseCost Exceeds Fair Value*. The guidance in this FSP amends FASBStatement No. 115, Accounting for Certain Investments in Debt and EquitySecurities. The FSP is effective for reporting periods beginning after December15, 2005. The Company does notanticipate any material impact to its financial condition or results ofoperations as a result of the adoption of this guidance.

 

***Share-Based Payments***

** **

In December 2004 the FASBissued Statement No. 123 (revised 2004) (FAS 123 (R)), *Share-Based Payments*. FAS 123 (R) requiresall entities to recognize compensation expense in an amount equal to the fairvalue of share-based payments such as stock options granted to employees. TheCompany may elect to adopt FAS 123 (R) using a modified prospective method ormodified retrospective method. Under the modified retrospective method, theCompany would restate previously issued financial statements, basing theexpense on that previously reported in their pro forma disclosures required byFAS 123. The modified prospective method would require the Company to recordcompensation expense for the unvested portion of previously granted awards thatremain outstanding at the date of adoption as these awards continue to vest. FAS 123 (R)is effective for the first fiscal year beginning after June 15, 2005. Managementhas elected to use the modified prospective method and has completed itsevaluation of the effect that FAS 123 (R) will have, and believes that theeffect of its implementation will be consistent with the pro forma disclosuresincluded in the audited consolidated financial statements in Item 8 of thisAnnual

 

*Accounting Changes and Error Corrections*

 

On June 7, 2005, the FASB issued Statement No. 154 (FAS 154), Accounting Changes and Error Corrections - a replacement of Accounting Principles Board (APB) Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. Under the provisions of FAS 154, voluntary changes in accounting principles are applied retrospectively to prior periods’ financial statements unless it would be impractical to do so. FAS 154 supersedes APB Opinion No. 20, which required that most voluntary changes in accounting principles be recognized by including in the current period’s net income the cumulative effect of the change. FAS 154 also makes a distinction between “retrospective application” of a change in accounting principle and the “restatement” of financial statements to reflect the correction of an error. The provisions of FAS 154 are effective for accounting changes made in fiscal years beginning after December 15, 2005. Management of the Company does not expect the adoption of this standard to have a material impact on its financial position or results of operations.

 

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**RISK FACTORS**

 

This discussion and analysis provides insight into Management’sassessment of the operating trends over the last several years and itsexpectations for 2006. Such expressions of expectations are not historical innature and are “forward-looking statements” within the meaning of the PrivateSecurities Litigation Reform Act of 1995. Forward-looking statements aresubject to risks and uncertainties that may cause actual future results todiffer materially from those expressed in any forward-looking statement. Suchrisks and uncertainties with respect to the Company include:

 

•                  increasedcompetitive pressure among financial services companies;

•                  changes in theinterest rate environment reducing interest margins or increasing interest raterisk;

•                  deterioration ingeneral economic conditions, internationally, nationally or in the State ofCalifornia;

•                  the occurrenceof future events such as the terrorist acts of September 11, 2001;

•                  the availabilityof sources of liquidity at a reasonable cost; and

•                  legislative orregulatory changes adversely affecting the business in which the Companyengages.

 

**Competition**

 

The Company faces competition from other financial institutions andfrom businesses in other industries that have developed financial products. Banksonce had an almost exclusive franchise for deposit products and provided themajority of business financing. With deregulation in the 1980’s, other kinds offinancial institutions began to offer competing products. Also, increasedcompetition in consumer financial products has come from companies nottypically associated with the banking and financial services industry, such asAT &T, General Motors and various software developers. Similar competitionis faced for commercial financial products from insurance companies andinvestment bankers. Community banks, including the Company, attempt to offsetthis trend by developing new products that capitalize on the service qualitythat a local institution can offer. Among these are new loan, deposit, and investmentproducts. The Company’s primary competitors are different for each specificproduct and market area. While this offers special challenges for the marketingof our products, it offers protection from one competitor dominating theCompany in its market areas. Many of these competitors are much larger in totalassets and capitalization, have greater access to capital markets and offer abroader array of financial services than we do, which creates certaincompetitive disadvantages for the Company.

 

**Economic Conditions**

 

Beginning in the summer of 2004 the Fed began raising its target rateand by year end it had increased by 1.25% to 5.25%. Throughout 2005 the Fedcontinued to increase its target rate and by year end it reached 7.25%. Thesechanges impacted the Company as market rates for loans, investments anddeposits respond to the Fed’s actions. From a national perspective, the mostsignificant economic factors impacting the Company in the last three years havebeen the slow growth in 2003 followed by more healthy economic expansion during2004 and 2005. The Federal Reserve expects the economies of 2006 to mirror thatof 2005. Their self assessment of the monetary policy is accommodative; withfinancial conditions generally advantageous to households and firms. We arealso affected by certain industry -specific economic factors. For example, asignificant portion of our total loan portfolio is related to real estateobligations, particularly residential real estate loans. Our local economiescontinue to grow and prosper as people keep moving into our service areas. Thesmaller towns in close proximity to Chico such as Orland and Oroville aregrowing at a much faster than normal pace due to the lower cost of landacquisition for new housing. The areas around Redding such as Cottonwood andAnderson are also experiencing increasing growth.

 

**Risk Management**

 

The Company sees the process of addressing the potential impacts of theexternal factors listed above as part of its management of risk. In addition tocommon business risks such as disasters, theft, and loss of market share, theCompany is subject to special types of risk due to the nature of its business. Newand sophisticated financial products are continually appearing with differenttypes of risk which need to be defined and managed if the Company chooses tooffer them to its customers. Also, the risks associated with existing productsmust be reassessed periodically. The Company cannot operate risk-free and makea profit. Instead, the process of risk definition and assessment allows theCompany to select the appropriate level of risk for the anticipated level ofreward and then decide on the steps necessary to manage this risk. The Company’sRisk Officer and the other members of its Senior Management Team under thedirection and oversight of the Board of Directors lead the risk managementprocess.

 

Some of the risks faced by the Company are those faced by mostenterprises — reputational risk, operational risk, and legal risk. The specialrisks related to financial products are **credit risk** and**interest rate risk.**Credit risk relatesto the possibility that a debtor will not repay according to the terms of thedebt contract. Credit risk is discussed in the sections related to loans. Interestrate risk is discussed in the sections related to Liquidity and Market RiskManagement and relates to the adverse impacts of changes in interest rates. Theeffective management of these and other risks mentioned above is the backboneof the Company’s business strategy.

 

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**Managing Our Growth**

 

Our Company’s(1) total assets increased from $450 million at December31, 2004 to $495 million at December 31, 2005. Management’s intention is toleverage the Company’s current infrastructure to sustain the momentum achievedin 2005, although no assurance can be provided that this strategy will resultin significant growth. Our ability to manage growth will depend primarily onour ability to:

 

•                  monitoroperations;

•                  control funding costsand operating expenses;

•                  maintainpositive customer relations; and

•                  attract,assimilate and retain qualified personnel.

 

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(1) Inasmuch as the Company did not acquire the outstanding shares ofthe Bank until May, 2002, the financial information contained throughout thisAnnual Report for 2001 and earlier is for the Bank only. Information for 2002,2003, 2004, and 2005 is for the Company on a consolidated basis unlessotherwise stated.

 

**The Impact of Changes in Assets and Liabilities toNet Interest Income and Net Interest Margin**

 

The Company earns income from two sources. The primary source is fromthe management of its financial assets and liabilities and the second is fromcharging fees for services provided. The first source involves functioning as a**financial intermediary**, that is, theCompany accepts funds from depositors or obtains funds from other creditors andthen either lends the funds to borrowers or invests those funds in securitiesor other financial instruments. Income is earned as a spread between theinterest earned from the loans or investments and the interest paid on thedeposits and other borrowings. The second source, fee income, is discussed inother sections of this analysis, specifically in “Noninterest Revenue.”

 

**Changes in Net Interest Income and Net InterestMargin**

 

**Net interest income** is thedifference or spread between the interest and fees earned on loans andinvestments (the Company’s **earning assets**)and the interest expense paid on deposits and other liabilities. The amount bywhich interest income will exceed interest expense depends on two factors: (1)the volume or balance of earning assets compared to the volume or balance ofinterest-bearing deposits and liabilities, and (2) the interest rate earned onthose interest earning assets compared with the interest rate paid on thoseinterest-bearing deposits and liabilities.

 

**Net interest margin**is netinterest income expressed as a percentage of average earning assets. It is usedto measure the difference between the average rate of interest earned on assetsand the average rate of interest that must be paid on liabilities used to fundthose assets. To maintain its net interest margin, the Company must manage therelationship between interest earned and paid. A shift in the relative size ofthe major balance sheet categories has an impact on net interest income and netinterest margin. To the extent that funds invested in securities can berepositioned into loans, earnings increase because of the higher rates paid onloans. However, additional credit risk is incurred with loans compared to thevery low risk of loss on securities, and the Company must carefully monitor theunderwriting process to ensure that the benefit of the additional interestearned is not offset by additional credit losses. In general, depositors arewilling to accept a lower rate on their funds than are other providers of fundsbecause of the Federal Deposit Insurance Corporation (“FDIC”) insurancecoverage. To the extent that the Company can fund asset growth by deposits,especially the lower cost transaction accounts, rather than borrowing fundsfrom other financial institutions, the average rates paid on funds will beless, and net interest income more.

 

**The Allowance for Loan Losses May Not Cover ActualLoan Losses.**We attempt to limit the risk that borrowerswill fail to repay loans by carefully underwriting the loans, neverthelesslosses can and do occur. We create an allowance for loan losses in ouraccounting records, based on estimates of the following:

 

•                  industrystandards;

•                  historicalexperience with our loans;

•                  evaluation ofqualitative factors such as loan concentrations and local economic conditions;

•                  regular reviewsof the quality, mix and size of the overall loan portfolio;

•                  regular reviewsof delinquencies; and

•                  the quality ofthe collateral underlying our loans;

•                  loan impairment.

 

14

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We maintain an allowance for loan losses at a level which we believe isadequate to absorb any specifically identified losses as well as any otherlosses inherent in our loan portfolio. However, changes in economic, operatingand other conditions, including changes in interest rates, which are beyond ourcontrol, may cause our actual loan losses to exceed our current allowanceestimates. If the actual loan losses exceed the amount reserved, it will hurtour business. In addition, the FDIC and the Department of FinancialInstitutions, as part of their supervisory functions, periodically review ourallowance for loan losses. Such agencies may require us to increase ourprovision for loan losses or to recognize further loan losses, based on theirjudgments, which may be different from those of our management. Any increase inthe allowance required by the FDIC or the California Department of FinancialInstitutions could also impact our business.

 

**Item 2.    Properties**

 

The following properties (real properties and/or improvements thereon)are owned by the Company(1) and are unencumbered. In the opinion of Management,all properties are adequately covered by insurance.

 

----

(1) As used throughout this Annual Report, the term “Company” includes,where appropriate, both Community Valley Bancorp and its consolidatedsubsidiaries, Butte Community Bank and CVB Insurance Agency LLC.

 

On June 1, 2005, Community Valley Bancorp entered into a short term,unsecured note payable in a principal amount of $800,000 in conjunction withthe purchase of real property. The interest rate on the note at December 31,2005 was 4.5%. The note was paid in full on January 4, 2006. This real propertyis a 14,000 square foot building in Chico that will serve as the corporateadministrative headquarters and also house other service departments. Thisbuilding is currently being remodeled and should be ready for occupancy in thethird quarter of 2006.

 
| **Location**                                               | ** ** | **Use of  Facilities** | ** ** | **Square  Feet of  Office Space** | ** ** | **Land and  Building Cost** | ** ** |
|------------------------------------------------------------|------------|------------------------|------------|-----------------------------------|------------|-----------------------------|------------|
|                                                       |       |                   |       |                              |       |                        |       |
| 672 Pearson Road                                           |       | Branch Office          |       | 4,200                             |       | $                           | 612,261    |   |
| Paradise,  California                                      |       |                   |       |                              |       |                        |       |
| (Opened December  1990)                                    |       |                   |       |                              |       |                        |       |
|                                                       |       |                   |       |                              |       |                        |       |
| 2227 Myers  Street                                         |       | Branch Office          |       | 9,800                             |       | $                           | 1,029,737  |   |
| Oroville,  California                                      |       |                   |       |                              |       |                        |       |
| (Opened December  1990)                                    |       |                   |       |                              |       |                        |       |
|                                                       |       |                   |       |                              |       |                        |       |
| 2041 Forest  Avenue                                        |       | Branch Office          |       | 8,000                             |       | $                           | 1,543,845  |   |
| Chico,  California                                         |       |                   |       |                              |       |                        |       |
| (Opened September,  1996)                                  |       |                   |       |                              |       |                        |       |
|                                                       |       |                   |       |                              |       |                        |       |
| 1390 Ridgewood  Drive                                      |       | Central Services       |       | 8,432                             |       | $                           | 1,098,293  |   |
| Chico,  California                                         |       |                   |       |                              |       |                        |       |
| (Opened May,  1998)                                        |       |                   |       |                              |       |                        |       |
|                                                       |       |                   |       |                              |       |                        |       |
| 1600 Butte House  Road                                     |       | Branch Office          |       | 6,580                             |       | $                           | 1,448,340  |   |
| Yuba City,  California (Opened September, 1997)            |       |                   |       |                              |       |                        |       |
|                                                       |       |                   |       |                              |       |                        |       |
| 237 West East  Ave Chico, California                       |       | Branch Office          |       | 4,771                             |       | $                           | 845,493    |   |
| (Opened June,  1999, moved to this location November 2003) |       |                   |       |                              |       |                        |       |
| Building is  owned, land is leased                         |       |                   |       |                              |       |                        |       |

 

15

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The following facilities are leased by the Company:

 
| **Location**                          | ** ** | **Use of  Facilities** | ** ** | **Square  Feet of  Office Space** | ** ** | **Monthly  Rent  as of 12/31/04** | ** ** | **Term of  Lease** | ** **            |
|---------------------------------------|------------|------------------------|------------|-----------------------------------|------------|-----------------------------------|------------|--------------------|-----------------------|
|                                  |       |                   |       |                              |       |                              |       |               |                  |
| 14001 Lakeridge Circle                |       | Branch Office          |       | 600                               |       | $                                 | 570        |               | 3/31/2008 (1)         |   |
| Magalia, California                   |       |                   |       |                              |       |                              |       |               |                  |
|                                  |       |                   |       |                              |       |                              |       |               |                  |
| 237 West East Ave.                    |       | Branch Office          |       |                              |       | $                                 | 3,958      |               | 10/31/2028 (2)        |   |
| Chico, California                     |       |                   |       |                              |       |                              |       |               |                  |
| land lease only                       |       |                   |       |                              |       |                              |       |               |                  |
|                                  |       |                   |       |                              |       |                              |       |               |                  |
| 900 Mangrove Ave.                     |       | Branch Office          |       | 6,000                             |       | $                                 | 6,623      |               | 9/30/2011 (3)         |   |
| Chico, California                     |       |                   |       |                              |       |                              |       |               |                  |
|                                  |       |                   |       |                              |       |                              |       |               |                  |
| 6653 Clark Road                       |       | Branch Office          |       | 4,640                             |       | $                                 | 5,170      |               | 3/31/2013 (4)         |   |
| Paradise, California                  |       |                   |       |                              |       |                              |       |               |                  |
|                                  |       |                   |       |                              |       |                              |       |               |                  |
| 100 East Cypress #150                 |       | Branch Office          |       | 1,850                             |       | $                                 | 2,334      |               | 4/30/2006 (5)         |   |
| Redding, California                   |       |                   |       |                              |       |                              |       |               |                  |
|                                  |       |                   |       |                              |       |                              |       |               |                  |
| 5959 Greenback #450                   |       | Loan Office            |       | 1,315                             |       | $                                 | 2,038      |               | 7/31/2006 (6)         |   |
| Citrus Heights, California            |       |                   |       |                              |       |                              |       |               |                  |
|                                  |       |                   |       |                              |       |                              |       |               |                  |
| 936 Mangrove Ave.                     |       | General Offices        |       | 6,000                             |       | $                                 | 4,600      |               | 2/28/2013 (7)         |   |
| Chico, California                     |       |                   |       |                              |       |                              |       |               |                  |
|                                  |       |                   |       |                              |       |                              |       |               |                  |
| 84 Belle Mill Rd                      |       | Branch office          |       | 3,825                             |       | $                                 | 4,972      |               | 5/31/2007 (8)         |   |
| Red Bluff CA                          |       |                   |       |                              |       |                              |       |               |                  |
|                                  |       |                   |       |                              |       |                              |       |               |                  |
| 812 B Street                          |       | Branch Office          |       | 1,651                             |       | $                                 | 2,888      |               | 6/30/2006 (9)         |   |
| Marysville, California                |       |                   |       |                              |       |                              |       |               |                  |
| Opened July 2004                      |       |                   |       |                              |       |                              |       |               |                  |
|                                  |       |                   |       |                              |       |                              |       |               |                  |
| 1017 Bridge Street                    |       | Branch Office          |       | 1,500                             |       | $                                 | 1,300      |               | 2/28/2014 (10)        |   |
| Colusa, California                    |       |                   |       |                              |       |                              |       |               |                  |
| Opened December 2004                  |       |                   |       |                              |       |                              |       |               |                  |
|                                  |       |                   |       |                              |       |                              |       |               |                  |
| 1010 Spruce Street                    |       | Loan Office            |       | 960                               |       | $                                 | 900        |               | Month to month        |   |
| Gridley, California  Opened July 2005 |       |                   |       |                              |       |                              |       |               |                  |
|                                  |       |                   |       |                              |       |                              |       |               |                  |
| 908 Hwy. 99W                          |       | Branch Office          |       | 1,556                             |       | $                                 | 3,190      |               | January 31, 2006 (11) |   |
| Corning, California                   |       |                   |       |                              |       |                              |       |               |                  |
| Opened March 2005                     |       |                   |       |                              |       |                              |       |               |                  |

 

Additionally, the Bank has five remote ATM locations. The amount ofmonthly rent at these locations is minimal.

 

16

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----

(1)**    **This is the termination date of the current5-year lease. The Company also has two renewal options for five years each.

(2)     This is the termination date of the current 25-year lease. The Companyalso has three renewal options for five years each.

(3)     This is the termination date of the current10-year lease. The Company also has four renewal options for five years each.

(4)     This is the termination date of the current10-year lease. The Company also has two renewal options for five years each.

(5)     This is the termination date of the current3-year lease. The Company does not have renewal options on this property.

(6)     This is the termination date of the current3-year lease. The Company does not have renewal options on this property.

(7)     This is the termination date of the current10-year lease. The Company also has one renewal option for ten years.

(8)     This is the termination date of the current3-year lease. The Company has one renewal option for three years.

(9)     This is the termination date of the firstoption period. The Company has two renewal options for five years each.

(10)   This is the termination date of the current10-year lease. The Company does not have renewal options on the property.

(11)   This is the termination date of the current1-year lease. The Company will continue to occupy this building on a month to monthbasis pending completion of construction of the new building

 

**Item 3.****    LegalProceedings**

 

From time to time, the Company is a party to claims and legalproceedings arising in the ordinary course of business. After taking into considerationinformation furnished by counsel to the Company as to the current status ofthese claims or proceedings to which the Company is a party, management is ofthe opinion that the ultimate aggregate liability represented thereby, if any,will not have a material adverse affect on the financial condition of theCompany.

 

**Item 4.****    Submission of Matters to a Vote of Security Holders**

 

No matters were submittedto our shareholders’ during the fourth quarter of the fiscal year endedDecember 31, 2005.

 

17

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**PART II**

 

**Item 5.****    Market for Common Equity and Related ShareholderMatters**

 

**(a)****           MarketInformation**

 

Community Valley Bancorp has been listed on the Nasdaq OTC BulletinBoard since June 17, 2002 (the effective date of the holding companyreorganization), and Butte Community Bank was previously also listed on theNasdaq OTC Bulletin Board. Our Common Stock trades under the symbol CVLL andthe CUSIP number for such common stock is #20415P101. Previously the ButteCommunity Bank CUSIP number for the common stock was #12406Q107. Trading in theCompany has not been extensive and such trades cannot be characterized asamounting to an active trading market. Management is aware of the followingsecurities dealers who make a market in the Company’s stock: Hoefer &Arnett, San Francisco, California, Wachovia First Union Securities, GrassValley, California, and Wedbush Morgan Securities, Portland, Oregon (the “SecuritiesDealers”).

 

The following table summarizes trades of the Company setting forth theapproximate high and low sales prices and volume of trading for the periodsindicated, based upon information provided by public sources. The informationin the following table does not include trading activity between dealers. Thestock prices and approximate trading volumes and cash dividends have beenadjusted to give effect to the four-for-three stock split issued in March 2004and the two-for-one stock split issued in May 2005.

 
| **Calendar**           | ** ** | **Sale Price of the  Company’s  Common Stock** | ** ** | **Approximate  Trading Volume** | ** ** |
|------------------------|------------|-------------------------------------------------------------------------|------------|--------------------------------------|------------|
| **Quarter Ended** | ** ** | **High**                                                                | ** ** | **Low**                              | ** ** | **Shares** | ** ** |
| March 31, 2004         |       | 16.61                                                                   |       | 13.39                                |       | 185,172 |   |
| June 30, 2004          |       | 16.86                                                                   |       | 12.93                                |       | 229,268 |   |
| September 30,  2004    |       | 14.21                                                                   |       | 12.22                                |       | 112,006 |   |
| December 31,  2004     |       | 13.87                                                                   |       | 13.02                                |       | 218,190 |   |
| March 31, 2005         |       | 14.59                                                                   |       | 12.85                                |       | 135,200 |   |
| June 30, 2005          |       | 15.27                                                                   |       | 13.26                                |       | 322,700 |   |
| September 30,  2005    |       | 15.41                                                                   |       | 13.92                                |       | 186,500 |   |
| December 31,  2005     |       | 15.00                                                                   |       | 13.21                                |       | 80,600 |   |

 

###### **(b)**           Holders

###### ** **

On March 1, 2006 there were approximately 541 shareholders of record ofthe Company.

 

**(c)**           **Dividends**

 

As a financial holding company which currently has no significantassets other than its equity interest in the Bank and the proceeds from theissuance of the Trust Preferred Securities previously mentioned, the Company’sability to declare dividends depends primarily upon dividends it receives fromthe Bank. The Bank’s dividend practices in turn depend upon the Bank’searnings, financial position, current and anticipated cash requirements andother factors deemed relevant by the Bank’s Board of Directors at that time.

 

The Company paid cash dividends quarterly totaling $1.2 million or$0.16 per share in 2005 and $1.09 million or $0.15 per share in 2004,representing 16% and 19%, respectively of the prior year’s earnings. The Companyanticipates paying dividends in the future consistent with the general dividendpolicy which declares that dividends must meet applicable legal requirementswhile maintaining the minimum capital ratios established by the Company.

 

The policy is to declare and pay dividends of no more than 40% of itsprevious years net income to shareholders. However, no assurance can be giventhat the Bank’s and the Company’s future earnings and/or growth expectations inany given year will justify the payment of such a dividend.

 

The ability of the Bank’s Board of Directors to declare cash dividendsis also limited by statutory and regulatory restrictions which restrict theamount available for cash dividends depending upon the earnings, financialcondition and cash needs of the Bank, as well as general business conditions. Adetailed discussion is located in Item 1 above.

 

18

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**(d)****           StockRepurchase Plan**

 

The Board of Directors approved a plan to repurchase up to $3,000,000of the outstanding common stock of the Company in 2003. Stock repurchases maybe made from time to time on the open market or through privately negotiatedtransactions. The timing of purchases and the exact number of shares to bepurchased will depend on market conditions. The share repurchase program doesnot include specific price targets or timetables and may be suspended at anytime. No shares were repurchased under this program in 2005. During 2004,38,470 shares of the Company’s common stock were repurchased for $502,200. Noshares were repurchased under this program in 2003.

 

**(e)****          ****Equity Compensation Plan Information**

 

The following chart setsforth information for the fiscal year ended December 31, 2005, regarding equitybased compensation plans of the Company.

 
|                                                            |       | **Number  of securities to be****Issued upon exercise of  outstanding options,****warrants and rights** |       | **Weighted  average exercise****price of outstanding****options, warrants and****rights** |       | **Number  of securities  remaining available for****future issuance under****equity compensation plans****(excluding securities****reflected in column (a)).** |       |
|-----------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Plan  category**                                              | ** ** | **(a)**                                                                                                 | ** ** | **(b)**                                                                                   | ** ** | **(c)**                                                                                                                                                        | ** ** |
| Equity  compensation  plans approved  by security  holders      |       | 841,942                                                                                                 |       | $                                                                                         | 6.51       |                                                                                                                                                           | 74,677     |   |
|                                                            |       |                                                                                                    |       |                                                                                      |       |                                                                                                                                                           |       |
| Equity  compensation  plans not  approved by  security  holders |       | None                                                                                                    |       | None                                                                                      |       | None                                                                                                                                                           |       |
|                                                            |       |                                                                                                    |       |                                                                                      |       |                                                                                                                                                           |       |
| Total                                                           |       | 841,942                                                                                                 |       | $                                                                                         | 6.51       |                                                                                                                                                           | 74,677     |   |

 

During 2005, the Companydid not conduct any unregistered offerings or sales of its securities. TheCompany did not repurchase any shares of its outstanding securities.

 

**(f)****            RecentSales of Unregistered Securities**

 

On December 19, 2002, the Company issued an aggregate of $8,248,000 inprincipal amount of its Floating Rate Junior Subordinated Deferrable InterestDebentures due 2032 (the “Subordinated Debt Securities”). All of theSubordinated Debt Securities were issued to Community Valley Trust I, aDelaware statutory business trust and a wholly-owned but unconsolidatedsubsidiary of the Company (the “Trust”). The Subordinated Debt Securities werenot registered under the Securities Act in reliance on the exemption set forthin Section 4(2) thereof. The Subordinated Debt Securities were issued to theTrust in consideration for the receipt of the net proceeds (approximately $7.75million) raised by the Trust from the sale of $8,000,000 in principal amount ofthe Trust’s Floating Rate Capital Trust Pass-through Securities (the “TrustPreferred Securities”). Bear Stearns & Co. Inc. acted as the placementagent in connection with the offering of the Trust Preferred Securities foraggregate commissions of $240,000 payable by the Trust. The sale of the TrustPreferred Securities was part of a larger transaction arranged by Bear Stearns& Co. pursuant to which the Trust Preferred Securities were deposited intoa special purpose vehicle along with similar securities issued by a number ofother banks and the special purpose vehicle then issued its securities to thepublic (the “Pooled Trust Preferred Securities”). The Pooled Trust PreferredSecurities were sold by Bear Stearns & Co. Inc. only (i) to those entitiesBear Stearns & Co. Inc. reasonably believed were qualifiedinstitutional  buyers (as defined in Rule144A under the Securities Act), (ii) to “accredited investors” (as defined inRule 501(a)(1), (2), (3) or (7) or Regulation D promulgated under theSecurities Act) or (iii) in offshore transactions in compliance with Rule 903of Regulation S under the Securities Act. The Trust Preferred Securities werenot registered under the Securities Act in reliance on exemptions set forth inRule 144A, Regulation D and Regulation S, as applicable.

 

19

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**Item 6.****    Selected Financial Data**

 

The “selected financial data” for 2005 which follows is derived fromthe audited Consolidated Financial Statements of the Company and other datafrom our internal accounting system. The selected financial data should be readin conjunction with the audited Consolidated Financial Statements and Notesthereto, and Management’s Discussion and Analysis of Financial Condition andResults of Operations in Item 7 below. Statistical information below isgenerally based on average daily amounts.

 

**Selected Financial Data**

 
| ** **                                             | ** ** | **As of December 31,**                                           | ** ** |
|--------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                                             | ** ** | **(Dollars in thousands, except per share data)** | ** ** |
| ** **                                             | ** ** | **2005**                                                                        | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| **Income Statement Summary**                 |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Interest income                                        |       | $                                                                               | 32,438     |   | $ | 24,980 |   | $ | 21,517 |   | $ | 18,977 |   | $ | 19,756 |   |
| Interest expense                                       |       | $                                                                               | 5,331      |   | $ | 4,056 |   | $ | 4,396 |   | $ | 4,774 |   | $ | 7,344 |   |
| Net interest  income before provision for              |       |                                                                            |       |   |   |   |   |   |   |   |   |
| loan losses                                            |       | $                                                                               | 27,107     |   | $ | 20,924 |   | $ | 17,121 |   | $ | 14,203 |   | $ | 12,411 |   |
| Provision for  loan losses                             |       | $                                                                               | 724        |   | $ | 734 |   | $ | 586 |   | $ | 603 |   | $ | 500 |   |
| Non-interest  income                                   |       | $                                                                               | 6,711      |   | $ | 6,019 |   | $ | 5,950 |   | $ | 6,164 |   | $ | 3,659 |   |
| Non-interest  expense                                  |       | $                                                                               | 20,925     |   | $ | 16,795 |   | $ | 13,877 |   | $ | 12,539 |   | $ | 9,335 |   |
| Income before  provision for income taxes              |       | $                                                                               | 12,169     |   | $ | 9,413 |   | $ | 8,598 |   | $ | 7,225 |   | $ | 6,235 |   |
| Provision for  income taxes                            |       | $                                                                               | 4,971      |   | $ | 3,803 |   | $ | 3,329 |   | $ | 2,375 |   | $ | 2,424 |   |
| Net Income                                             |       | $                                                                               | 7,198      |   | $ | 5,610 |   | $ | 5,269 |   | $ | 4,850 |   | $ | 3,811 |   |
|                                                   |       |                                                                            |       |   |   |   |   |   |   |   |   |
| **Balance  Sheet Summary**                             |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Total loans, net                                       |       | $                                                                               | 401,221    |   | $ | 339,174 |   | $ | 270,231 |   | $ | 229,699 |   | $ | 197,875 |   |
| Allowance for  loan losses                             |       | $                                                                               | (4,716     | ) | $ | (4,381 | ) | $ | (3,587 | ) | $ | (3,007 | ) | $ | (2,397 | ) |
| Investment  securities held to maturity                |       | $                                                                               | 2,332      |   | $ | 2,582 |   | $ | 3,823 |   | $ | 2,873 |   | $ | 2,507 |   |
| Investment  securities available for sale              |       | $                                                                               | 4,344      |   | $ | 4,379 |   | $ | 502 |   | $ | 514 |   | $ | 500 |   |
| Interest-bearing  deposits in banks                    |       | $                                                                               | 6,636      |   | $ | 8,715 |   | $ | 7,925 |   | $ | 4,061 |   | $ | 694 |   |
| Cash and due  from banks                               |       | $                                                                               | 18,988     |   | $ | 21,778 |   | $ | 26,205 |   | $ | 15,621 |   | $ | 12,402 |   |
| Federal funds  sold                                    |       | $                                                                               | 29,015     |   | $ | 46,440 |   | $ | 50,605 |   | $ | 57,410 |   | $ | 37,270 |   |
| Other real  estate                                     |       |                                                                            |       |   |   | $ | — |   | $ | — |   | $ | 12 |   |
| Premises and  equipment, net                           |       | $                                                                               | 11,221     |   | $ | 9,027 |   | $ | 8,554 |   | $ | 6,653 |   | $ | 5,642 |   |
| Total  interest-earning assets                         |       | $                                                                               | 443,548    |   | $ | 401,290 |   | $ | 333,086 |   | $ | 294,557 |   | $ | 238,846 |   |
| Total assets                                           |       | $                                                                               | 494,777    |   | $ | 449,675 |   | $ | 386,723 |   | $ | 337,483 |   | $ | 272,464 |   |
| Total  interest-bearing deposits                       |       | $                                                                               | 350,682    |   | $ | 318,266 |   | $ | 274,048 |   | $ | 243,092 |   | $ | 201,434 |   |
| Total deposits                                         |       | $                                                                               | 434,018    |   | $ | 399,059 |   | $ | 342,511 |   | $ | 297,981 |   | $ | 246,420 |   |
| Total  liabilities                                     |       | $                                                                               | 453,222    |   | $ | 415,144 |   | $ | 356,774 |   | $ | 312,103 |   | $ | 251,644 |   |
| Total  shareholders’ equity                       |       | $                                                                               | 41,555     |   | $ | 34,531 |   | $ | 29,949 |   | $ | 25,380 |   | $ | 20,820 |   |
| **Per  Share Data  (1)**                          |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Net Income                                             |       | $                                                                               | 1.00       |   | $ | 0.79 |   | $ | 0.75 |   | $ | 0.70 |   | $ | 0.57 |   |
| Book value per  weighted average share                 |       | $                                                                               | 5.76       |   | $ | 4.86 |   | $ | 4.26 |   | $ | 3.67 |   | $ | 3.13 |   |
| Cash Dividends                                         |       | $                                                                               | 0.16       |   | $ | 0.15 |   | $ | 0.15 |   | $ | 0.11 |   | $ | 0.09 |   |
| Weighted Average  Common Shares Outstanding, Basic     |       | 7,166,258                                                                       |       | 7,112,386 |   | 7,025,290 |   | 6,922,230 |   | 6,646,858 |   |
| Weighted Average  Common Shares Outstanding, Diluted   |       | 7,611,704                                                                       |       | 7,601,092 |   | 7,430,516 |   | 7,279,858 |   | 7,147,480 |   |
|                                                   |       |                                                                            |       |   |   |   |   |   |   |   |   |
| **Key  Operating Ratios:**                             |       |                                                                            |       |   |   |   |   |   |   |   |   |
| **Performance  Ratios:**                               |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Return on  Average Equity  (2)                    |       | 18.82                                                                           | %     | 17.20 | % | 19.07 | % | 20.82 | % | 19.73 | % |
| Return on  Average Assets (3)                          |       | 1.51                                                                            | %          | 1.34 | % | 1.44 | % | 1.69 | % | 1.54 | % |
| Net Interest  Margin (4)                               |       | 6.32                                                                            | %          | 5.70 | % | 5.32 | % | 5.52 | % | 5.49 | % |
| Dividend Payout  Ratio (5)                             |       | 16.04                                                                           | %          | 20.28 | % | 20.67 | % | 17.84 | % | 14.83 | % |
| Equity to Assets  Ratio (6)                            |       | 8.02                                                                            | %          | 7.82 | % | 7.54 | % | 8.12 | % | 7.85 | % |
| Net Loans to  Total Deposits at Period End             |       | 92.44                                                                           | %          | 84.99 | % | 78.90 | % | 77.09 | % | 80.30 | % |
| **Asset  Quality Ratios:**                             |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Non Performing  Loans to Total Loans                   |       | 0.00                                                                            | %          | 0.03 | % | 0.02 | % | 0.25 | % | 0.88 | % |
| Nonperforming  Assets to Total Loans and               |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Other Real  Estate                                     |       | 0.00                                                                            | %          | 0.03 | % | 0.02 | % | 0.22 | % | 0.88 | % |
| Net Charge-offs  to Average Loans                      |       | 0.00                                                                            | %          | 0.00 | % | 0.03 | % | 0.00 | % | 0.05 | % |
| Allowance for  Loan Losses to Net Loans  at Period End |       | 1.16                                                                            | %          | 1.16 | % | 1.19 | % | 1.16 | % | 1.07 | % |
| **Capital  Ratios:**                                   |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Tier 1 Capital  to Adjusted Total Assets               |       | 9.8                                                                             | %          | 9.5 | % | 9.9 | % | 10.4 | % | 7.7 | % |
| Tier 1 Capital  to Total Risk-Weighted Assets          |       | 11.4                                                                            | %          | 11.3 | % | 12.2 | % | 12.8 | % | 10.4 | % |
| Total Capital to  Total Risk-Weighted Assets           |       | 12.5                                                                            | %          | 12.5 | % | 13.3 | % | 14.0 | % | 11.6 | % |

 

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(1)   All per share data and the average number ofshares outstanding have been retroactively restated on a split-adjusted basis.

(2)   Net income divided by average shareholders’equity.

(3)   Net income divided by average total assets.

(4)   Net interest income divided by average earningassets.

(5)   Dividends declared per share divided by netincome per share.

(6)   Average equity divided by average totalassets.

 

20

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**Item 7.****    Management’s Discussion and Analysis of FinancialCondition and Results of Operations**

 

This discussion presents Management’s analysis of the financialcondition as of December 31, 2005 and 2004 and results of operations of theCompany for each of the years in the three-year period ended December 31, 2005.(1)The discussion should be read in conjunction with the Consolidated FinancialStatements of the Company and the Notes related thereto presented elsewhere inthis Form 10-K Annual Report (see Item 8).

 

Statements contained in this report that are not purely historical areforward looking statements within the meaning of Section 21E of the SecuritiesExchange Act of 1934 as amended, including the Company’s expectations,intentions, beliefs, or strategies regarding the future. All forward-lookingstatements concerning economic conditions, rates of growth, rates of income orvalues as may be included in this document are based on information availableto the Company on the date noted, and the Company assumes no obligation toupdate any such forward-looking statements. It is important to note that theCompany’s actual results could materially differ from those in suchforward-looking statements. Factors that could cause actual results to differmaterially from those in such forward-looking statements are fluctuations ininterest rates, inflation, government regulations, economic conditions,customer disintermediation and competitive product and pricing pressures in thegeographic and business areas in which the Company conducts its operations.

 

(1) As the holding company reorganization pursuant to which the Companybecame the sole shareholder of the Bank was effective during  June 2002, all financial information as ofand for the years ended December 31, 2001 and any earlier years or periodsrelates to the Bank rather than the Company. Information as of and for theyears ending December 31, 2002 and beyond is provided for the Bank and theCompany on a consolidated basis.

 

**CriticalAccounting Policies**

 

*General*

 

The Company’s significantaccounting principles are described in Note 1 of the consolidated financialstatements and are essential to understanding Management’s Discussion andAnalysis of Results of Operations and Financial Condition. Community ValleyBancorp’s consolidated financial statements are prepared in accordance withaccounting principles generally accepted in the United States of America(GAAP). The financial information contained within our statements is, to asignificant extent, financial information that is based on measures of thefinancial effects of transactions and events that have already occurred. Someof the Company’s accounting principles require significant judgment to estimatevalues of assets or liabilities. In addition, certain accounting principlesrequire significant judgment in applying the complex accounting principles totransactions to determine the most appropriate treatment. The following is asummary of the more judgmental and complex accounting estimates and principles.

 

*Allowancefor Loan Losses (ALL)*

 

Theallowance for loan losses is management’s best estimate of the probable lossesthat may be sustained in our loan portfolio. The allowance is based on twobasic principles of accounting: (1) SFAS No.5 which requires that losses be accrued when they areprobable of occurring and estimable and (2) SFAS No. 114, which requiresthat losses be accrued on impaired loans based on the differences between thevalue of collateral, present value of future cash flows or values that areobservable in the secondary market and the loan balance. The Company performsperiodic and systematic detailed evaluations of its lending portfolio toidentify and estimate the inherent risks and assess the overall collectibility.These evaluations include general conditions such as the portfolio composition,size and maturities of various segmented portions of the portfolio such assecured, unsecured, construction, and Small Business Administration (“SBA”).

 

21

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Additional factorsinclude concentrations of borrowers, industries, geographical sectors, loanproduct, loan classes and collateral types, volume and trends of loandelinquencies and non-accrual, criticized and classified assets and trends inthe aggregate in significant credits identified as watch list items. There areseveral components to the determination of the adequacy of the ALL. Each ofthese components is determined based upon estimates that can and do change whenthe actual events occur. The Company estimates the SFAS No. 5 portion ofthe ALL based on the segmentation of its portfolio. For those segments thatrequire an ALL, the Company estimates loan losses on a monthly basis based uponits ongoing loan review process and analysis of loan performance. The Companyfollows a systematic and consistently applied approach to select the mostappropriate loss measurement methods and support its conclusions and rationalewith written documentation. One method of estimating loan losses for groups ofloans is through the application of loss rates to the groups’ aggregate loanbalances. Such rates typically reflect historical loss experience for eachgroup of loans, adjusted for relevant economic factors over a defined period oftime. The Company evaluates and modifies its loss estimation model as needed toensure that the resulting loss estimate is consistent with GAAP.

 

For individually impaired loans, SFAS No. 114 provides guidance onthe acceptable methods to measure impairment. Specifically, SFAS No. 114states that when a loan is impaired, the Company should measure impairmentbased on the present value of expected future principal and interest cash flowsdiscounted at the loan’s effective interest rate, except that as a practicalexpedient, a creditor may measure impairment based on a loan’s observablemarket price or the fair value of collateral, if the loan is collateraldependent. When developing the estimate of future cash flows for a loan, theCompany considers all available information reflecting past events and currentconditions, including the effect of existing environmental factors.

 

*LoanSales and Servicing*

 

TheCompany originates government guaranteed loans and mortgage loans that may besold in the secondary market. The amounts of gains recorded on sales of loansand the initial recording of servicing assets and interest only (I/O) strips isbased on the estimated fair values of the respective components. In recordingthe initial value of the servicing assets and the fair value of the I/O stripsreceivable, the Company uses estimates which are made based on management’sexpectations of future prepayment and discount rates. Servicing assets areamortized over the estimated life of the related loan. I/O strips are notsignificant at December 31, 2005. These prepayment and discount rates werebased on current market conditions and historical performance of the variouspools of serviced loans. If actual prepayments with respect to sold loans occurmore quickly than projected the carrying value of the servicing assets may haveto be adjusted through a charge to earnings.

 

*Stock-BasedCompensation*

 

The Company uses theintrinsic value based method for measuring compensation cost related to stockoptions. Under the intrinsic value based method, compensation cost is theexcess, if any, of the quoted market price of the stock at grant date over theamount an employee must pay to acquire the stock. This cost is amortized on astraight-line basis over the vesting period of the options granted. The Companyapplies Accounting Principles Board Opinion (“APB”) No. 25 *Accounting for Stock Issued to Employees*andrelated interpretations in accounting for stock options. No compensation costhas been recorded in the accompanying financial statements because all optionshave been granted at an exercise price of no less than the fair market value atdate of grant.

 

*RevenueRecognition*

 

The Company’s primarysource of revenue is interest income, which is the difference between theinterest income it receives on interest-earning assets and the interest expenseit pays on interest-bearing liabilities, and (ii) fee income, whichincludes fees earned on deposit services, income from SBA lending,electronic-based cash management services, mortgage brokerage fee income andmerchant credit card processing services. Interest income is recorded on anaccrual basis. Note 1 to the Consolidated Financial Statements offers anexplanation of the process for determining when the accrual of interest incomeis discontinued on an impaired loan.

 

*IncomeTaxes*

 

The Company accounts forincome taxes under the asset and liability method. Under the asset andliability method, deferred tax assets and liabilities are recognized for thefuture tax consequences attributable to differences between the financialstatement carrying amounts of existing assets and liabilities and theirrespective tax bases. Deferred tax assets and liabilities are measured usingcurrently enacted tax rates applied to such taxable income in the years inwhich those temporary differences are expected to be recovered or settled. Theeffect on deferred tax assets and liabilities of a change in tax rates isrecognized in income in the period that includes the enactment date. If futureincome should prove non-existent or less than the amount of deferred tax assetswithin the tax years to which they may be applied, the asset may not berealized and our net income will be reduced.

 

22

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###### **Summary of Performance**

###### ** **

For 2005, net income was $7.20 million, compared to the $5.61 millionearned in 2004 and net income of $5.27 million in 2003. Net income per dilutedshare was $.95 for 2005, as compared to $.74 during 2004 and $.71 in 2003. TheCompany’s Return on Average Assets (“ROAA”) was 1.51% and Return on AverageEquity (“ROAE”) was 18.82% in 2005, as compared to 1.34% and 17.20%,respectively, in 2004 and 1.44% and 19.07%, respectively, for 2003.

 

Beginning in June of 2004 the Federal Reserve Board  began increasing its target rate and by yearend the rate had increased by 1.25% to 5.25%. During 2005 this trend continuedwith the target rate reaching 7.25% by year end. This upward movement in rateshelped the Company achieve a better net interest margin throughout the year. Netinterest income, generated by a higher level of average earning assets andfavorable changes in the Company’s deposit mix, increased by $6.2 million from2004 to 2005. Moreover, the relatively stable long-term market rates allowedthe Company to maintain a steady volume of mortgage loans, which we were ableto sell at substantial gains. The Company was also able to sell several USDABusiness and Industry guaranteed loans and SBA loans for substantial gains.

 

###### **Results of Operations**

###### ** **

###### **Net Interest Income andNet Interest Margin**

###### ** **

The Company earns income from two primary sources. The first is netinterest income brought about by income from the successful deployment ofearning assets less the costs of interest-bearing liabilities. The second isnon-interest income, which generally comes from customer service charges andfees, but can also result from non-customer sources such as gains on loan sales.The majority of the Company’s expenses are operating costs which relate toproviding a full range of banking services to our customers.

 

Net interest income, which is simply total interest income (includingfees) less total interest expense, was $27.1 million in 2005 compared to $20.9million and $17.1 million in 2004 and 2003, respectively. This represents anincrease of 29.7% in 2005 over 2004 and an increase of 22.2% in 2004 over 2003.The amount by which interest income exceeds interest expense depends on severalfactors. Among those factors are yields on earning assets, the cost ofinterest-bearing liabilities, the relative volume of total earning assets andtotal interest-bearing liabilities, and the mix of products which comprise theCompany’s earning assets, deposits, and other interest-bearing liabilities. Changein the amount and mix of interest-earning assets and interest-bearingliabilities is referred to as “volume change.” Change in interest rates earned on assets and rates paid on deposits andother borrowed funds is referred to as “rate change.”

 

The Volume and Rate Variances table which follows sets forth the dollaramount of changes in interest earned and paid for each major category ofinterest-earning assets and interest-bearing liabilities and the amount ofchange attributable to changes in average balances (volume) or changes inaverage interest rate. The calculation is as follows: the change due to increase or decrease in volume isequal to the increase or decrease in the average balance times the prior period’srate. The change due to an increase or decrease in the rate is equal to theincrease or decrease in the average rate times the current period’s balance.The variances attributable to both the volume and rate changes have beenallocated to the change in rate.

 

23

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| ** **                          | ** ** | **Years  Ended December 31,**  | ** ** |
|-------------------------------------|------------|--------------------------------|------------|
| ** **                          | ** ** | **2005 over  2004**            | ** ** | **2004  over 2003** | ** ** |
| ** **                          | ** ** | **Increase(decrease)  due to** | ** ** | **Increase(decrease)  due to** | ** ** |
| **Volume & Rate Variances**     | ** ** | **Volume**                     | ** ** | **Rate** | ** ** | **Net** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Net** | ** ** |
| **(dollars in thousands)**          | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                          | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Earning  Assets:**                |       |                           |       |   |   |   |   |   |   |   |   |   |   |
| Loans                               |       | $                              | 5,201      |   | $ | 1,701 |   | $ | 6,902 |   | $ | 4,795 |   | $ | (1,280 | ) | $ | 3,515 |   |
| Federal funds  sold                 |       | $                              | (111       | ) | $ | 566 |   | $ | 455 |   | $ | (207 | ) | $ | 61 |   | $ | (146 | ) |
| Investment  Securities:             |       |                           |       |   |   | $ | — |   |   |   |   |   | $ | — |   |
| Taxable                             |       | $                              | 40         |   | $ | 9 |   | $ | 49 |   | $ | 102 |   | $ | (55 | ) | $ | 47 |   |
| Non-taxable(1)                      |       | $                              | 65         |   | $ | (8 | ) | $ | 57 |   | $ | 7 |   | $ | (2 | ) | $ | 5 |   |
| Deposits in  banks                  |       | $                              | (26        | ) | $ | 21 |   | $ | (5 | ) | $ | 79 |   | $ | (37 | ) | $ | 42 |   |
| Total earning  assets               |       | $                              | 5,169      |   | $ | 2,289 |   | $ | 7,458 |   | $ | 4,776 |   | $ | (1,313 | ) | $ | 3,463 |   |
|                                |       |                           |       |   |   |   |   |   |   |   |   |   |   |
| **Interest-Bearing  Liabilities**   |       |                           |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  deposits:         |       |                           |       |   |   |   |   |   |   |   |   |   |   |
|                                |       |                           |       |   |   |   |   |   |   |   |   |   |   |
| Demand -  interest bearing          |       | $                              | 69         |   | $ | 138 |   | $ | 207 |   | $ | 233 |   | $ | (544 | ) | $ | (311 | ) |
| Savings Accounts                    |       | $                              | 36         |   | $ | (1 | ) | $ | 35 |   | $ | 38 |   | $ | (14 | ) | $ | 24 |   |
| Certificates of  Deposit            |       | $                              | 502        |   | $ | 339 |   | $ | 841 |   | $ | 118 |   | $ | (170 | ) | $ | (52 | ) |
| Total interest  bearing deposits    |       | $                              | 607        |   | $ | 476 |   | $ | 1,083 |   | $ | 389 |   | $ | (728 | ) | $ | (339 | ) |
| Borrowed funds:                     |       |                           |       |   |   | $ | — |   |   |   |   |   | $ | — |   |
| Other Borrowings                    |       | $                              | 8          |   | $ | 184 |   | $ | (1 | ) | $ | (5 | ) | $ | 4 |   | $ | (1 | ) |
| Total Borrowed  Funds               |       | $                              | 8          |   | $ | 184 |   | $ | 192 |   | $ | (5 | ) | $ | 4 |   | $ | (1 | ) |
| Total Interest  Bearing Liabilities |       | $                              | 615        |   | $ | 660 |   | $ | 1,275 |   | $ | 384 |   | $ | (724 | ) | $ | (340 | ) |
| **Net  Interest Margin/Income**     |       | $                              | 4,554      |   | $ | 1,629 |   | $ | 6,183 |   | $ | 4,392 |   | $ | (589 | ) | $ | 3,803 |   |

 

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(1)   Yields on tax exempt income have not beencomputed on a tax equivalent basis.

 

The Company’s net interest margin is its net interest income expressedas a percentage of average earning assets. The Company’s net interest marginfor 2005 was 6.32% an increase of 62 basis points from the 5.70% reported in2004. For the year 2003, this margin was 5.32%. The following Distribution,Rate and Yield table shows, for each of the past three years, the rates earnedon each component of the Company’s investment and loan portfolio and the ratespaid on each segment of the Company’s interest bearing liabilities. That sametable also shows the Company’s average daily balances for each principalcategory of assets, liabilities and shareholders’ equity, the amount ofinterest income or interest expense, and the average yield or rate for eachcategory of interest-earning asset and interest-bearing liability along withthe net interest margin for each of the reported periods.

 

24

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**Distribution,Rate & Yield**

 
| ** **                                           | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                           | ** ** | **2005(a)**                                | ** ** | **2004(a)** | ** ** | **2003(a)** | ** ** |
| **(dollars in thousands)**                 | ** ** | **Average  Balance**                       | ** ** | **Income/  Expense** | ** ** | **Average  Rate** | ** ** | **Average  Balance** | ** ** | **Income/  Expense** | ** ** | **Average  Rate** | ** ** | **Average  Balance** | ** ** | **Income/  Expense** | ** ** | **Average  Rate** | ** ** |
| **Assets**                                           |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Investments:                                         |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Federal Funds  Sold                                  |       | $                                          | 30,066     |   | $ | 943 |   | 3.14 | % | $ | 38,945 |   | $ | 488 |   | 1.25 | % | $ | 57,811 |   | $ | 634 |   | 1.10 | % |
| Taxable                                              |       | $                                          | 5,793      |   | $ | 199 |   | 3.45 | % | $ | 4,575 |   | $ | 151 |   | 3.30 | % | $ | 2,308 |   | $ | 104 |   | 4.51 | % |
| Non-taxable(1)                                       |       | $                                          | 2,289      |   | $ | 111 |   | 4.85 | % | $ | 1,039 |   | $ | 54 |   | 5.20 | % | $ | 902 |   | $ | 49 |   | 5.43 | % |
| Deposits in Banks                                    |       | $                                          | 7,918      |   | $ | 239 |   | 3.02 | % | $ | 8,862 |   | $ | 244 |   | 2.75 | % | $ | 6,371 |   | $ | 201 |   | 3.15 | % |
| Total Investments                                    |       | $                                          | 46,066     |   | $ | 1,492 |   | 3.24 | % | $ | 53,421 |   | $ | 937 |   | 1.75 | % | $ | 67,392 |   | $ | 988 |   | 1.47 | % |
| Loans:                                               |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Agricultural                                         |       | $                                          | 25,388     |   | $ | 2,032 |   | 8.00 | % | $ | 26,287 |   | $ | 1,909 |   | 7.26 | % | $ | 22,573 |   | $ | 1,671 |   | 7.40 | % |
| Commercial                                           |       | $                                          | 63,051     |   | $ | 5,827 |   | 9.24 | % | $ | 60,261 |   | $ | 4,996 |   | 8.29 | % | $ | 55,694 |   | $ | 4,605 |   | 8.27 | % |
| Real Estate                                          |       | $                                          | 263,141    |   | $ | 20,967 |   | 7.97 | % | $ | 203,675 |   | $ | 15,579 |   | 7.65 | % | $ | 156,452 |   | $ | 12,866 |   | 8.22 | % |
| Consumer                                             |       | $                                          | 31,079     |   | $ | 2,120 |   | 6.82 | % | $ | 23,689 |   | $ | 1,559 |   | 6.58 | % | $ | 19,963 |   | $ | 1,386 |   | 6.94 | % |
| Total Loans                                          |       | $                                          | 382,659    |   | $ | 30,946 |   | 8.09 | % | $ | 313,912 |   | $ | 24,043 |   | 7.66 | % | $ | 254,682 |   | $ | 20,528 |   | 8.06 | % |
| Total Earning  Assets(2)                             |       | $                                          | 428,725    |   | $ | 32,438 |   | 7.57 | % | $ | 367,333 |   | $ | 24,980 |   | 6.80 | % | $ | 322,074 |   | $ | 21,516 |   | 6.68 | % |
| Non-Earning  Assets                                  |       | $                                          | 48,167     |   |   |   |   |   | $ | 49,825 |   |   |   |   |   | $ | 44,259 |   |   |   |   |   |
| **Total  Assets**                                    |       | $                                          | 476,892    |   |   |   |   |   | $ | 417,158 |   |   |   |   |   | $ | 366,333 |   |   |   |   |   |
| **Liabilities  and Shareholders’ Equity**       |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-Bearing  Deposits:                          |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| NOW                                                  |       | $                                          | 143,250    |   | $ | 934 |   | 0.65 | % | $ | 136,612 |   | $ | 811 |   | 0.59 | % | $ | 121,289 |   | $ | 1,050 |   | 0.87 | % |
| Savings                                              |       | $                                          | 36,759     |   | $ | 181 |   | 0.49 | % | $ | 29,463 |   | $ | 145 |   | 0.49 | % | $ | 22,409 |   | $ | 121 |   | 0.54 | % |
| Money Market                                         |       | $                                          | 41,795     |   | $ | 368 |   | 0.88 | % | $ | 37,820 |   | $ | 284 |   | 0.75 | % | $ | 29,494 |   | $ | 356 |   | 1.21 | % |
| TDOA’s, and IRA’s                          |       | $                                          | 6,434      |   | $ | 183 |   | 2.84 | % | $ | 6,895 |   | $ | 177 |   | 2.57 | % | $ | 7,117 |   | $ | 201 |   | 2.82 | % |
| Certificates of  Deposit < $100,000               |       | $                                          | 54,005     |   | $ | 1,510 |   | 2.80 | % | $ | 45,681 |   | $ | 1,032 |   | 2.26 | % | $ | 50,744 |   | $ | 1,343 |   | 2.65 | % |
| Certificates of  Deposit > $100,000               |       | $                                          | 47,417     |   | $ | 1,492 |   | 3.15 | % | $ | 36,854 |   | $ | 1,136 |   | 3.08 | % | $ | 28,300 |   | $ | 853 |   | 3.01 | % |
| Total  Interest-Bearing Deposits                     |       | $                                          | 329,660    |   | $ | 4,668 |   | 1.42 | % | $ | 293,325 |   | $ | 3,585 |   | 1.22 | % | $ | 259,353 |   | $ | 3,924 |   | 1.51 | % |
| Borrowed Funds:                                      |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other Borrowings                                     |       | $                                          | 9,095      |   | $ | 663 |   | 7.29 | % | $ | 8,935 |   | $ | 471 |   | 5.27 | % | $ | 9,038 |   | $ | 472 |   | 5.22 | % |
| Total Borrowed  Funds                                |       | $                                          | 9,095      |   | $ | 663 |   | 7.29 | % | $ | 8,935 |   | $ | 471 |   | 5.27 | % | $ | 9,038 |   | $ | 472 |   | 5.22 | % |
| Total Interest  Bearing Liabilities                  |       | $                                          | 338,755    |   | $ | 5,331 |   | 1.57 | % | $ | 302,260 |   | $ | 4,056 |   | 1.34 | % | $ | 268,391 |   | $ | 4,396 |   | 1.64 | % |
| Demand Deposits                                      |       | $                                          | 89,325     |   |   |   |   |   | $ | 77,225 |   |   |   |   |   | $ | 66,347 |   |   |   |   |   |
| Other Liabilities                                    |       | $                                          | 10,560     |   |   |   |   |   | $ | 5,066 |   |   |   |   |   | $ | 3,961 |   |   |   |   |   |
| Shareholders’  Equity                           |       | $                                          | 38,252     |   |   |   |   |   | $ | 32,607 |   |   |   |   |   | $ | 27,634 |   |   |   |   |   |
| **Total  Liabilities and Shareholders’ Equity** |       | $                                          | 476,892    |   |   |   |   |   | $ | 417,158 |   |   |   |   |   | $ | 366,333 |   |   |   |   |   |
|                                                 |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest Income/Earning  Assets                      |       |                                       |       |   |   | 7.57 | % |   |   |   |   | 6.80 | % |   |   |   |   | 6.68 | % |
| Interest  Expense/Earning Assets                     |       |                                       |       |   |   | 1.24 | % |   |   |   |   | 1.10 | % |   |   |   |   | 1.36 | % |
| **Net  Interest Margin(3)**                          |       |                                       |       | $ | 27,107 |   | 6.32 | % |   |   | $ | 20,924 |   | 5.70 | % |   |   | $ | 17,120 |   | 5.32 | % |

 

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(a)   Average balances are obtained from the bestavailable daily or monthly data.

(1)   Yields on tax exempt income have not beencomputed on a tax equivalent basis.

(2)   Non-accrual loans have been included in totalloans for purposes of total earning assets.

(3)   Represents net interest income as a percentageof average interest-earning assets.

(4)   Yields and amounts earned on loans includeloan fees of $2,453,000, $2,303,000 and $1,954,000 for the years ended December31, 2005, 2004 and 2003 respectively.

 

During 2005, the Company’s net interest margin improved primarily as aresult of the growth in and change in the mix of earning assets bothinvestments and loans that contributed to an overall increase in net interestmargin. On an average basis, the rates on loans increased by 43 basis pointsresulting in an increase in interest income of $1.7 million. This increase inrates was augmented by the increase in the average volume of loans of $69million that generated an additional $5.2 million in loan related interestincome. Overall interest income on earning assets increased by $7.5 million.

 

25

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A large portion of the Bank’s loans carry variable rates and re-priceimmediately, versus a large base of core deposits which are generally slower tore-price. Due to the favorable changes in the Company’s mix of deposits fromthe growth in average balances of NOW, savings and money market accounts, theCompany was able to increase the overall level of deposits while controllinginterest expense. The average rates paid on interest bearing deposits for 2005was 1.42% compared to 1.22% in 2004 and 1.51% in 2003. The changes in rates in2005 compared to 2004 were primarily due to the changes in interest ratebrought on by Fed actions as discussed previously. The average rates that arepaid on deposits generally trail behind these money market rate changes forthree reasons: (1) financial institutions do not try to change deposit rateswith each small increase or decrease in short-term rates; (2) in the low interestrate environment of 2002 through 2004, banks were not able to decrease depositrates as much as the Fed decreased its Federal funds target rates; and (3) withtime deposit accounts, even when new offering rates are established, theaverage rates paid during the year are a blend of the rate paid on individualaccounts. Only new accounts and those that mature and are renewed will bear thenew rate. On an average basis, NOW account deposits were up $6.6 million,savings account deposits were up $7.3 million, money market account depositswere up $4.0 million and certificate of deposit balances were up $18.8 million.Average non interest bearing demand deposits balances also increased by $12.1million or 15.7%, from 2004 to 2005.

 

From 2004 to 2005, the Company’s average loan portfolio grew byapproximately $69 million, or 23.3%, building on the growth of $59 million, or23.3% from 2003 to 2004. The earnings on that growth, net of associated fundingcosts, are a significant contributor to net interest income. Additionally, loanbalances, which are the highest yielding component of the Company’s earningassets, increased during 2005 as a portion of the Company’s average asset base.During 2005, the loan portfolio averaged 80.2% of total assets, while for 2004and 2003 such balances represented 75.3% and 69.5%, respectively, of averageassets.

 

Based on these indications and current economic conditions, the Companyexpects moderate increases in the rates paid on interest-bearing liabilitiesand rates earned on both the investment and loan portfolio during 2006. Inorder to fund the loan portfolio growth anticipated in 2006, it is anticipatedthat the Company’s net interest margin will experience some compression as wewill have to pay higher rates on deposits to attract the funds necessary forthat growth. Net interest income should increase if loans grow as planned evenif the loan growth is funded by higher priced deposits. However, no assurancecan be given that this will, in fact, occur.

 

###### **Non-interest Income andNon-interest Expense**

 

For the year 2005, non-interest income increased by $693,000 or (11.5%)to $6,711,000 as compared to $6,019,000 for 2004. Non interest income in 2003was $5,950,000. The primary traditional sources of non-interest income for theCompany are service charges on deposit accounts, gains on the sale of loans,loan servicing income, alternative investment fees earned on the sales ofnon-deposit investment products and merchant credit card fees. Service chargeson deposit accounts and loan sales income in 2005 accounted for 35.0% and27.8%, respectively, of total non-interest income, as compared to 34.7% and30.3%, respectively, for 2004 and 23.5% and 46.8%, respectively, for 2003. Loanservicing income, alternative investment fees and merchant credit card fees for2005 were 6.3%, 7.7% and 5.8% respectively, of total non-interest income, ascompared to 6.4%, 7.1% and 5.1%, respectively, for 2004 and 6.4%, 3.7% and5.8%, respectively, for 2003.

 

The primary source of non-interest income during 2005 was from servicecharges on deposit accounts followed closely by the gain recognized on the saleof loans. The increase in service charges on deposit accounts was primarily aresult of the fees charged on additional deposit accounts opened during theyear, an overall increase in the fee structure charged for services and theoverdraft privilege deposit product which on a year over year basis increased$361,000. Loan sales income increased $169,000 from $1,637,000 in 2004 to$1,806,000 in 2005. This was a result of the higher volume of mortgage loansand government guaranteed loans originated and sold during 2005. Mortgage loanactivity was still vigorous in 2005 and fees derived from the sale of theseloans increased. We anticipate sales of existing homes continuing throughout2006 as mortgage rates remain attractive and the construction of new homescontinues. The loan portfolio also includes loans which are 75% to 90%guaranteed by the Small Business Administration (SBA), U.S. Department ofAgriculture, Rural Business-Cooperative Service (RBS) and Farm Services Agency(FSA). The guaranteed portion of these loans may be sold to a third party, withthe Company retaining the unguaranteed portion. The Company generally receivesa premium in excess of the adjusted carrying value of the loan at the time ofsale.

 

The portfolio of real estate loans being serviced by the Companydeclined by 3% from 2004 to 2005. The portfolio of SBA, RBS and FSA governmentguaranteed loans being serviced by the Company declined by 8% from 2004 to 2005.These reductions resulted in a decrease in loan servicing income of $90,000from $571,000 in 2004 to $481,000 in 2005.

 

Alternative investment fees earned on the sales of non-depositinvestment products increased by $92,000 in 2005 compared to 2004 primarily asa result of aggressive sales techniques and excellent referrals from the branchnetwork.

 

26

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Merchant credit card fees increased by $53,000 from 2004 to 2005, butwere approximately the same percentage of average earning assets. Through moreaggressive marketing efforts of this product, management expects income fromthis area to increase somewhat in 2006.

 

The Company is increasingly focused on enhancing its fee income. Based onthe Company’s efficiency ratio of 61.6% for 2005, 62.1% for 2004, and 60% for2003 as compared to the 55% and lower ratios of certain major financialinstitutions, it is expected that this activity will continue for theforeseeable future.

 

The Company’s total non-interest expense increased to $20.9 million in2005, as compared to $16.8 million in 2004, and $13.9 million in 2003.

 

The largest dollar increase in non-interest expense was in salaries andemployee benefits, which increased by $2,290,000, or 22.9% from 2004 to 2005. Thisincrease resulted from normal cost of living raises, salaries paid to employeesfor a full year in 2005 at the three branch offices opened during 2004 in RedBluff, Marysville and Colusa as well as the branch office in Corning opened inMarch, 2005 and the branch office opened in Redding in September, 2005. We alsoopened a Loan Production Office in the city of Gridley in July, 2005. Commissionspaid to Butte Community Bank’s Real Estate Loan agents and staffing additionsmade during the year as the Company continued to grow also contributed to theincrease. The increase in salaries and benefits in 2004 compared to 2003 was$1,829,000 or 22.4%. Full time equivalent employees increased to 240 atDecember 31, 2005 from 204 at December 31, 2004 and 177 at December 31, 2003.Benefit costs and employer taxes increased commensurate with the salaries. Itis management’s opinion that the Company can achieve significant growth inloans and deposits with the staff as it exists. Additional increases in staffwill take place during 2006 as the Company moves its branches in Red Bluff,Marysville, and Corning to new larger locations and with the opening of anadditional full service branch in Redding during the third quarter.

 

Occupancy and equipment expenses were $2,969,000, an increase of$444,000 or 18% when compared to the 2004 total of $2,525,000. Much of theincrease in occupancy expense was related to furniture, fixtures and equipmentfor the new Red Bluff, Marysville, Colusa opened during 2004, and the Corningand Redding branch offices opened in 2005. The lease agreements and remodelingcosts associated with these offices, also added to the year over year increase.The increase in occupancy expenses in 2004 compared to 2003 was $488,000 or24%.

 

The majority of the increase in professional services costs of $402,000from 2004 to 2005 relates to outsourcing audit work and the application processfor the Company to join the NASDAQ exchange. The increase in 2004 compared to2003 was due to outsourcing of audit work. We anticipate these costs may go upsubstantially in 2006 as we go through the process of implementingSarbanes-Oxley 404 compliance. Advertising and marketing expenses increased by36% in 2005 from 2004 after a slight increase in 2004 from 2003 as we promotedthe Bank within the areas we expanded to.

 

Expenses representing telephone and data communications, postage andmail, stationery and supplies, director fees and retirement accruals,advertising and promotion, and other expenses totaled $4,651,000 for 2005compared to $3,657,000 in 2004 and $3,162,000 in 2003, an increase of 27.2% and15.7% on a year over year basis. Management considers this increase in expensescommensurate with the growth of the Company.

 

27

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**NonInterest Income/Expense**

(dollars in thousands, unaudited)

 

| ** **                                                       | ** ** | **2005** | ** ** | **% of Total** | ** ** | **2004** | ** ** | **% of Total** | ** ** | **2003** | ** ** | **% of Total** | ** ** |
|------------------------------------------------------------------|------------|----------|------------|--------------------------|------------|----------|------------|--------------------------|------------|----------|------------|--------------------------|------------|
| OTHER OPERATING INCOME:                                |       |     |       |                     |       |     |       |                     |       |     |       |                     |       |
| Service charges  on deposit accounts                             |       | $        | 2,351      |                     | 35.03      | %        | $          | 2,086                    |       | 34.66    | %          | $                        | 1,397      |   | 23.48 | % |
| Gain on sale of  loans                                           |       | $        | 1,806      |                     | 26.91      | %        | $          | 1,637                    |       | 27.20    | %          | $                        | 1,978      |   | 33.24 | % |
| Loan servicing  income                                           |       | $        | 481        |                     | 7.17       | %        | $          | 571                      |       | 9.49     | %          | $                        | 1,185      |   | 19.92 | % |
| Alternative  investment fees                                     |       | $        | 520        |                     | 7.75       | %        | $          | 428                      |       | 7.11     | %          | $                        | 218        |   | 3.66 | % |
| Merchant card  processing fees                                   |       | $        | 390        |                     | 5.81       | %        | $          | 337                      |       | 5.60     | %          | $                        | 343        |   | 5.76 | % |
| Earnings from  cash surrender value of bank owned life insurance |       | $        | 294        |                     | 4.38       | %        | $          | 284                      |       | 4.72     | %          | $                        | 380        |   | 6.39 | % |
| Other                                                            |       | $        | 869        |                     | 12.95      | %        | $          | 675                      |       | 11.22    | %          | $                        | 449        |   | 7.55 | % |
| Total non-interest  income                                       |       | $        | 6,711      |                     | 100.00     | %        | $          | 6,018                    |       | 100.00   | %          | $                        | 5,950      |   | 100.00 | % |
| As a percentage  of average earning assets                       |       |     |       | 1.57                     | %          |     |       | 1.64                     | %          |     |       | 1.85                     | %          |
|                                                             |       |     |       |                     |       |     |       |                     |       |     |       |                     |       |
| OTHER OPERATING  EXPENSES:                                       |       |     |       |                     |       |     |       |                     |       |     |       |                     |       |
| Salaries and  employee benefits                                  |       | $        | 12,270     |                     | 58.64      | %        | $          | 9,980                    |       | 59.42    | %          | $                        | 8,151      |   | 58.70 | % |
| Occupancy and  equipment                                         |       | $        | 2,969      |                     | 14.19      | %        | $          | 2,525                    |       | 15.03    | %          | $                        | 2,037      |   | 14.67 | % |
| Professional fees                                                |       | $        | 1,035      |                     | 4.95       | %        | $          | 633                      |       | 3.77     | %          | $                        | 537        |   | 3.87 | % |
| Telephone and  postage                                           |       | $        | 580        |                     | 2.77       | %        | $          | 511                      |       | 3.04     | %          | $                        | 498        |   | 3.59 | % |
| Stationery &  supply costs                                   |       | $        | 545        |                     | 2.60       | %        | $          | 521                      |       | 3.10     | %          | $                        | 549        |   | 3.95 | % |
| Director fees and  retirement accrual                            |       | $        | 469        |                     | 2.24       | %        | $          | 408                      |       | 2.43     | %          | $                        | 357        |   | 2.57 | % |
| Advertising and  promotion                                       |       | $        | 412        |                     | 1.97       | %        | $          | 302                      |       | 1.80     | %          | $                        | 277        |   | 1.99 | % |
| Other                                                            |       | $        | 2,645      |                     | 12.64      | %        | $          | 1,915                    |       | 11.40    | %          | $                        | 1,481      |   | 10.66 | % |
| Total  non-interest expense                                      |       | $        | 20,925     |                     | 100.00     | %        | $          | 16,795                   |       | 100.00   | %          | $                        | 13,887     |   | 100.00 | % |
| As a % of average  earning assets                                |       |     |       | 5.70                     | %          |     |       | 4.57                     | %          |     |       | 4.31                     | %          |

 

###### **Provision for Loan Losses**

###### ** **

Credit risk is inherent in the business of making loans. The Companysets aside an allowance for loan losses through charges to earnings. Thecharges are shown in the income statements as provisions for loan losses, andspecifically identifiable and quantifiable losses are immediately charged offagainst the allowance.

 

The Company’s provisions for loan losses and undisbursed commitments in2005, 2004, and 2003 were $825,000, $790,000, and $655,000 respectively. Theloan loss provision is determined by conducting a monthly evaluation of theadequacy of the Company’s allowance for loan losses, and charging theshortfall, if any, to the current month’s expense. This has the effect ofcreating variability in the amount and frequency of charges to the Company’searnings. The procedures for monitoring the adequacy of the allowance, as wellas detailed information concerning the allowance itself, are included belowunder “Allowance for Loan Losses.”

 

###### **Income Taxes**

 

As indicated in Note 13 in the Notes to the Consolidated FinancialStatements, the provision for income taxes is the sum of two components, theprovision for current taxes and deferred taxes. The provision for current taxesresults from applying the current tax rate to taxable income, and is in essencethe actual current income tax liability. Some items of income and expense arerecognized in different years for tax purposes than when applying accountingprinciples generally accepted in the United States of America, however, leadingto differences between the Company’s actual tax liability and the amountaccrued for this liability based on book income. These temporary timingdifferences comprise the deferred portion of the Company’s tax provision.

 

Most of the Company’s temporary differences involve recognizing moreexpenses in its financial statements than it has been allowed to deduct for taxpurposes, and therefore the Company normally carries a net deferred tax asseton its books. At December 31, 2005, the Company’s $4.2 million net deferred taxasset was primarily due to temporary differences in the reported allowance forloan losses, deferred compensation, and future benefit of state tax deductionoffset by the temporary differences related to certain deferred taxliabilities.

 

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###### **Financial Condition**

 

The following discussion of the financial condition of the Company isgrouped into earning assets, comprised of loans and investments; non-earningassets, comprised of cash and due from banks, premises and equipment and otherassets; liabilities, consisting of deposits and other borrowings; capitalresources; and liquidity and market risk. Each section provides details whereapplicable on volume, rates of change, and significance relative to the overallactivities of the Company.

 

A comparison between the summary year-end balance sheets for 2005through 2001 was presented previously in the table of Selected Financial Data(see Item 6 above). As indicated in that table, the Company’s total assets,loans, deposits, and shareholders’ equity have grown each year for the pastfour years, with asset growth, in terms of total dollars, most pronounced in2002 when the Company grew by $65 million, or 23.8%. Growth in the Company’stotal assets over the past year approximated $45 million, or 10.0%, as comparedto growth in 2004 of $63 million or 16.3%.

 

On the liability side, the deposit mix remained relatively unchanged in2005. The average rates paid only increased 23 basis points as the re-pricingof time sensitive deposits lagged the increases in the interest rateenvironment. This resulted in a positive impact on the Company’s net interestmargin. Throughout 2005 deposit growth was achieved in our newer markets in RedBluff and Corning and in our more seasoned Yuba City and Chico branches. In ourParadise market we realized a decline in deposits which is being addressedduring 2006 with campaigns to recapture the lost market share. The Orovillemarket share remained stable during 2005.

 

###### **Loan Portfolio**

 

The Company offers a wide variety of loan types and terms to customersalong with very competitive pricing and quick delivery of the credit decision. TheCompany’s loan portfolio represents the single largest portion of investedassets, substantially greater than the investment portfolio or any other assetcategory. At December 31, 2005, gross loans represented 82.3% of totalassets, as compared to 76.4% and 70.8% at December 31, 2004 and 2003,respectively. The quality and diversification of the Company’s loan portfolioare important considerations when reviewing the Company’s results ofoperations.

 

The Selected Financial Data table in Item 6 reflects the net amount ofloans outstanding at December 31st for each year between 2001 and2005. The Loan Distribution table which follows sets forth the amount of theCompany’s total loans outstanding in each category at the dates indicated.

 

###### **LoanPortfolio Composition**

 

The following table sets forth the composition of the Company’s loanportfolio by type as of the dates indicated:

 

**Loan Distribution**

(dollars in thousands)

 
| ** **                          | ** ** | **As of December 31,** | ** ** |
|-------------------------------------|------------|------------------------|------------|
|                                | ** ** | **2005**               | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| Agricultural                        |       | $                      | 24,803     |   | $ | 22,177 |   | $ | 20,820 |   | $ | 18,935 |   | $ | 19,407 |   |
| Commercial                          |       | $                      | 61,162     |   | $ | 58,662 |   | $ | 57,739 |   | $ | 48,661 |   | $ | 42,517 |   |
| Real estate - mortgage              |       | $                      | 173,449    |   | $ | 146,876 |   | $ | 111,249 |   | $ | 82,057 |   | $ | 52,315 |   |
| Real estate - construction          |       | $                      | 111,130    |   | $ | 90,643 |   | $ | 63,345 |   | $ | 64,565 |   | $ | 68,943 |   |
| Installment                         |       | $                      | 36,501     |   | $ | 26,219 |   | $ | 21,698 |   | $ | 19,325 |   | $ | 17,764 |   |
|                                |       | $                      | 407,045    |   | $ | 344,577 |   | $ | 274,851 |   | $ | 233,543 |   | $ | 200,946 |   |
|                                |       |                   |       |   |   |   |   |   |   |   |   |
| Deferred loan origination fees, net |       | $                      | (1,108     | ) | $ | (1,022 | ) | $ | (1,033 | ) | $ | (837 | ) | $ | (674 | ) |
| Allowance for loan losses           |       | $                      | (4,716     | ) | $ | (4,000 | ) | $ | (3,262 | ) | $ | (3,007 | ) | $ | (2,397 | ) |
|                                |       | $                      | 401,221    |   | $ | 339,555 |   | $ | 270,556 |   | $ | 229,699 |   | $ | 197,875 |   |
|                                |       |                   |       |   |   |   |   |   |   |   |   |
| **Percentage of Total Loans**       |       |                   |       |   |   |   |   |   |   |   |   |
| Agricultural                        |       | 6.09                   | %          | 6.44 | % | 7.58 | % | 8.11 | % | 9.66 | % |
| Commercial                          |       | 15.03                  | %          | 17.02 | % | 21.01 | % | 20.84 | % | 21.16 | % |
| Real Estate - mortgage              |       | 42.61                  | %          | 42.63 | % | 40.48 | % | 35.13 | % | 26.03 | % |
| Real Estate - construction          |       | 27.30                  | %          | 26.31 | % | 23.05 | % | 27.65 | % | 34.31 | % |
| Installment                         |       | 8.97                   | %          | 7.60 | % | 7.88 | % | 8.27 | % | 8.84 | % |
|                                |       | 100.00                 | %          | 100.00 | % | 100.00 | % | 100.00 | % | 100.00 | % |

 

29

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As reflected in the Loan Distribution table, aggregate loan balanceshave increased $203 million, or 103%, over the last four years. The largestpercentage growth during 2005 came in installment loans while real estatemortgages showed the largest dollar volume increase.

 

Loan growth in the Company’s immediate market has been oriented towardloans secured by real estate, commercial loans, including Small BusinessAdministration loans, as well as consumer loans. As a result, these areas havecomprised the major portion of the Company’s loan growth over the past fewyears. Loans secured by real estate grew by $47 million, or 20%, and commercialloans grew by $2.5 million, or 4.3%, during 2005. Loans secured by real estateand commercial loans comprised 69.9% and 15%, respectively, of the Bank’s totalloan portfolio at the end of 2005.

 

The Company’s commercial loans are centered in locally orientedcommercial activities in the markets where the Company has a presence. Additionally,the Company has a Government Lending Division dedicated to its SBA product andits Business and Industry (B&I) Guaranteed Loan Program. For the fiscalyear ended September 30, 2004, the Company was named the number two USDABusiness and Industry lender in California and the number nine lender for theentire United States by originating over $10.8 million in loans. The Company isalso designated as an SBA Preferred Lender, which means it has the authority tounderwrite and approve SBA loans locally. This recognition lends credence tothe Company’s success in meeting the needs of smaller business owners in thecommunities in which the Company conducts its banking activities.

 

The most significant shift in the loan portfolio mix over the past fiveyears has been in loans secured by real estate mortgages, which increased from26.0% of total loans at the end of 2001 to 42.6% of total loans at the end of2005. Real estate lending is an important part of the Company’s focus, and islikely to remain so for the immediate future. Commercial loans, however,declined to just 15.0% of total loan balances by the end of 2005 from 21.2% atthe end of 2001, and agricultural loans dropped during the same period to 6.1%of the Company’s total loan balances from 9.7%. The decline in the percentageof agricultural loans to total loans over the last few years has been due tothe growth in the other lending areas outpacing the growth in the agriculturallending. We continue to have the same borrowing relationships year after yearand have not substantially expanded this part of our business.

 

Another important aspect of the Company’s loan business has been thatof residential real estate loans which were generated internally by the realestate mortgage loan department and then sold in the secondary market togovernment sponsored enterprises or other long-term lenders. The Company hasconsistently been among the largest real estate mortgage lenders in ButteCounty for the past several years. During 2005, the Company originated and soldaggregate balances of approximately $78 million of such loans, a $9 millionincrease from the $69 million originated and sold in 2004. The Company servicesthe mortgage loans sold to the Federal National Mortgage Association (FNMA). Asof December 31, 2005, aggregate balances of $157 million were being serviced ascompared to $162 million at the end of 2004.

 

In the normal course of business, the Company makes commitments toextend credit as long as there are no violations of any condition establishedin the contractual arrangement. Total unused commitments to extend credit were$201 million at December 31, 2005 as compared to $148 million at December 31,2004. These commitments represented 49% of outstanding gross loans atDecember 31, 2005 and 44% at December 31, 2004, respectively. The Company’sstand-by letters of credit at December 31, 2005 and 2004 were $4.9 millionand $4.6 million, respectively, which represented approximately 2.4% and 3.1%of total commitments outstanding at the end of 2005 and 2004 respectively. Itis not anticipated that all of these stand-by letters of credit will fund.

 

Approximately one half of the loans held by the Company have floatingrates of interest tied to the Company’s base lending rate or to another marketrate indicator so that they may be re-priced as interest rates change. The sameinterest rate and liquidity risks that apply to securities are also applicableto lending activity. Fixed-rate loans are subject to market risk:  they decline in value as interest rates rise.The Company’s loans that have fixed rates generally have relatively shortmaturities or amortize monthly, which effectively lessens the market risk. Thetable in Note 16 to the consolidated financial statements shows that atDecember 31, 2005, the difference in the carrying amount of loans, i.e., theirface value, is about $ 6.4 million or 1.6 % less than their fair value. At theend of 2004, the fair value of loans was about $4.3 million or 1.3% less thanthe carrying amount.

 

Because the Company is not involved with chemicals or toxins that mighthave an adverse effect on the environment, its primary exposure toenvironmental legislation is through its lending activities. The Company’slending procedures include steps to identify and monitor this exposure to avoidany significant loss or liability related to environmental regulations.

 

30

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**Loan Maturities**

 

The following Loan Maturity table shows the amounts of total loansoutstanding as of December 31, 2005, which, based on remaining scheduledrepayments of principal, are due within one year, after one year but less thanfive years, and in more than five years. (Non-accrual loans are intermixedwithin each category.)

 

**Loan Maturity**

(dollars in thousands)

 
| ** **               | ** ** | ** **  | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | **Floating**  | ** ** | **Fixed**     | ** ** |
|--------------------------|------------|-------------|------------|-------------|------------|------------|------------|------------|------------|---------------|------------|---------------|------------|
| ** **               | ** ** | **One**     | ** ** | **One**     | ** ** | **Over**   | ** ** | ** ** | ** ** | **rate:**     | ** ** | **rate:**     | ** ** |
| ** **               | ** ** | **year or** | ** ** | **to five** | ** ** | **five**   | ** ** | ** ** | ** ** | **due after** | ** ** | **due after** | ** ** |
| ** **               | ** ** | **less**    | ** ** | **years**   | ** ** | **years**  | ** ** | **Total**  | ** ** | **one year**  | ** ** | **one year**  | ** ** |
| Agricultural             |       | $           | 15,560     |        | $          | 8,566      |       | $          | 677        |          | $          | 24,803        |       | $ | — |   | $ | 9,243 |   |
| Commercial               |       | $           | 22,945     |        | $          | 16,716     |       | $          | 21,501     |          | $          | 61,162        |       | $ | 727 |   | $ | 37,490 |   |
| Real Estate Mortgage     |       | $           | 76,222     |        | $          | 87,058     |       | $          | 10,169     |          | $          | 173,449       |       | $ | 1,306 |   | $ | 95,921 |   |
| Real Estate Construction |       | $           | 102,987    |        | $          | 8,143      |       | $          | —     |          | $          | 111,130       |       | $ | — |   | $ | 8,143 |   |
| Installment              |       | $           | 4,124      |        | $          | 30,552     |       | $          | 1,825      |          | $          | 36,501        |       | $ | — |   | $ | 32,377 |   |
|                     |       |        |       |        |       |       |       |       |       |          |       |          |       |
| TOTAL                    |       | $           | 221,838    |        | $          | 151,035    |       | $          | 34,172     |          | $          | 407,045       |       | $ | 2,033 |   | $ | 183,174 |   |

 

This schedule, which aggregates contractual principal repayments bytime period, can be used in combination with the Investment Maturities table inthe Investment Securities section and the Deposit Maturities table in theDeposits section to identify time periods with potential liquidity exposure. Thereferenced maturity schedules do not convey a complete picture of the Company’sre-pricing exposure or interest rate risk, however. For details on there-pricing characteristics of the Company’s balance sheet and a morecomprehensive discussion of the Company’s sensitivity to changes in interestrates, see the “Liquidity and Market Risk” section.

 

###### **Non-performing Assets**

 

Banks have generally suffered their most severe earnings declines as aresult of customers’ inability to generate sufficient cash flow to servicetheir debts, or as a result of the downturns in national and regional economieswhich have brought about declines in overall property values. In addition, certaininvestments which the Company may purchase have the potential of becoming lessvaluable as the conditions change in the obligor’s financial capacity to repay,based on regional economies or industry downturns. As a result of these typesof failures, an institution may suffer asset quality risk, and may lose theability to obtain full repayment of an obligation to the Company. Since loansare the most significant assets of the Company and generate the largest portionof revenues, the Company’s management of asset quality risk is focusedprimarily on loan quality.

 

The Company achieves a certain level of loan quality by establishing asound credit plan, which includes defining goals and objectives and devisingand documenting credit policies and procedures. These policies and proceduresidentify certain markets, set goals for portfolio growth or contraction, andestablish limits on industry and geographic concentrations. In addition, thesepolicies establish the Company’s underwriting standards and the methods ofmonitoring ongoing credit quality. Unfortunately, however, the Company’sasset-quality risk may be affected by external factors such as the level ofinterest rates, employment, general economic conditions, real estate values andtrends in particular industries or certain geographic markets. The Company’sinternal factors for controlling risk are centered in underwriting practices,credit granting procedures, training, risk management techniques, andfamiliarity with our loan customers as well as the relative diversity andgeographic concentration of our loan portfolio.

 

As a multi-community, independent bank headquartered in and servingButte County (with a smaller presence in each of Colusa, Sutter, Sacramento,Shasta, Tehama, and Yuba counties); the Company has mitigated its risk to anyone segment of these Northern Sacramento Valley markets. The Company’s assetquality continues to be excellent with delinquency ratios at very low levels. TheCompany is optimistic that the local and regional economy will continue toperform, but no assurance can be given that this performance will in factcontinue.

 

From time to time, Management has reason to believe that certainborrowers may not be able to repay their loans within the parameters of thepresent repayment term, even though, in some cases, the loans are current atthe time. These loans are regarded as potential problem loans, and a portion ofthe allowance is assigned and/or allocated, as discussed below, to cover theCompany’s exposure to loss would the borrowers indeed fail to perform accordingto the terms of the notes. This class of loans does not include loans in anonaccrual status or 90 days or more delinquent but still accruing, which areshown in the table below.

 

31

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Non-performing assets are comprised of loans on non-accrual status,loans 90 days or more past due and still accruing interest, loans restructuredwhere the terms of repayment have been renegotiated resulting in a deferral ofinterest or principal and other real estate (“ORE”). Loans are generally placedon non-accrual status when they become 90 days past due as to principal orinterest. Loans may be restructured by management when a borrower hasexperienced some change in financial status causing an inability to meet theoriginal repayment terms and where the Company believes the borrower willeventually overcome those circumstances and repay the loan in full. OREconsists of properties acquired by foreclosure or similar means that managementintends to offer for sale.

 

Management’s classification of a loan as non-accrual is an indicationthat there is reasonable doubt as to the full collectibility of principal orinterest on the loan; at that point, the Company stops recognizing income fromthe interest on the loan and reverses any uncollected interest that had beenaccrued but unpaid. These loans may or may not be collateralized, butcollection efforts are continuously pursued.

 

The following table provides information with respect to components ofthe Company’s non-performing assets at the date indicated. The Company has nothad any loans 90 days past due and still accruing interest in any periodspresented.

 

**Non-performingAssets**

(dollars in thousands)

 
| ** **                                        | ** ** | **As of December 31,** | ** ** |
|---------------------------------------------------|------------|------------------------|------------|
| ** **                                        | ** ** | **2005**               | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| **Nonaccrual Loans:**                             | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Agricultural                                      |       | $                      | —     |   | $ | 17 |   | $ | — |   | $ | — |   | $ | — |   |
| Commercial and Industrial                         |       | $                      | —     |   |   |   | $ | 46 |   | $ | 134 |   | $ | 1,554 |   |
| Real Estate                                       |       |                   |       |   |   |   |   |   |   |   |   |
| Secured by Commercial/Professional Office         |       | $                      | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Properties Including Construction and Development |       | $                      | —     |   | $ | — |   | $ | — |   |   |   | $ | 221 |   |
| Secured by Residential Properties                 |       | $                      | —     |   | $ | 84 |   | $ | — |   | $ | — |   | $ | — |   |
| Secured by Farmland                               |       | $                      | —     |   | $ | — |   |   |   | $ | 460 |   | $ | — |   |
| Consumer Loans                                    |       | $                      | 9          |   |   |   | $ | 8 |   | $ | — |   | $ | — |   |
| **SUBTOTAL**                                      |       | $                      | 9          |   | $ | 101 |   | $ | 54 |   | $ | 594 |   | $ | 1,765 |   |
|                                              |       |                   |       |   |   |   |   |   |   |   |   |
| Other Real Estate (ORE)                           |       | $                      | —     |   | $ | — |   | $ | — |   |   |   | $ | 13 |   |
| Total non-performing Assets                       |       | $                      | 9          |   | $ | 101 |   | $ | 54 |   | $ | 594 |   | $ | 1,778 |   |
| Restructured Loans                                |       | N/A                    |       | N/A |   | N/A |   | N/A |   | N/A |   |
| Non-performing loans as % of total gross loans    |       | 0.00                   | %          | 0.03 | % | 0.02 | % | 0.25 | % | 0.88 | % |
| Non-performing assets as a % of total gross       |       |                   |       |   |   |   |   |   |   |   |   |
| loans and other real estate                       |       | 0.00                   | %          | 0.03 | % | 0.02 | % | 0.22 | % | 0.88 | % |

 

Total non-performing balances stood at $9,000 at the end of 2005, whichwas an automobile loan. This vehicle had been recovered through repossessionand was expected to be sold in the first quarter of 2006. There was no OREoutstanding at December 31, 2005, 2004 or 2003. Other than the loans includedas non-performing assets at December 31, 2005, the company has not identifiedany potential problem loans that would result in any loan being included as anon-performing asset at a future date.

 

###### **Allowance for Loan Losses**

###### ** **

The allowance for loan losses is established through a provision forloan losses based on management’s evaluation of known and inherit risk in ourloan portfolio. The allowance is increased by provisions charged againstcurrent earnings and reduced by net charge-offs. Loans are charged off whenthey are deemed to be uncollectible; recoveries are generally recorded onlywhen cash payments are received subsequent to the charge off. The followingtable summarizes the activity in the allowance for loan losses for the pastfive years.

 

32

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**Allowance For Loan Losses**

(dollars in thousands)

 
| ** **                                                          | ** ** | **As of December 31,** | ** **  |
|---------------------------------------------------------------------|------------|------------------------|-------------|
| ** **                                                          | ** ** | **2005**               | ** **  | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| **Balances:**                                                       | ** ** | ** **             | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Average gross loans outstanding during period                       |       | $                      | 382,659     |   | $ | 313,912 |   | $ | 254,682 |   | $ | 216,953 |   | $ | 194,448 |   |
| Gross loans outstanding at end of period                            |       | $                      | 407,045     |   | $ | 344,577 |   | $ | 274,851 |   | $ | 233,542 |   | $ | 200,946 |   |
|                                                                |       |                   |        |   |   |   |   |   |   |   |   |
| **Allowance for Loan Losses:**                                      |       |                   |        |   |   |   |   |   |   |   |   |
| Balance at beginning of period                                      |       | $                      |  4,000 |   | $ |  3,587 |   | $ |  3,007 |   | $ |  2,397 |   | $ |  2,000 |   |
| Adjustments                                                         |       |                   |        |   |   |   |   |   |   |   |   |
| Provision Charged to Expense                                        |       | $                      | 825         |   | $ | 790 |   | $ | 655 |   | $ | 603 |   | $ | 500 |   |
|                                                                |       |                   |        |   |   |   |   |   |   |   |   |
| Loan Charge-offs                                                    |       |                   |        |   |   |   |   |   |   |   |   |
| Agricultural                                                        |       |                   |        |   |   |   |   |   |   |   |   |
| Commercial &  Industrial Loans                                  |       | $                      | —      |   | $ | 11 |   | $ | 77 |   | $ | — |   | $ | 29 |   |
| Real Estate  Loans                                                  |       |                   |        |   |   | $ | — |   | $ | 4 |   | $ | — |   |
| Consumer Loans                                                      |       | $                      | 9           |   | $ | 12 |   | $ | 4 |   | $ | 3 |   | $ | 95 |   |
| Credit Card  Loans                                                  |       |                   |        |   |   | $ | — |   | $ | — |   | $ | 9 |   |
| Total                                                               |       | $                      | 9           |   | $ | 23 |   | $ | 81 |   | $ | 7 |   | $ | 133 |   |
|                                                                |       |                   |        |   |   |   |   |   |   |   |   |
| Recoveries                                                          |       |                   |        |   |   |   |   |   |   |   |   |
| Agricultural                                                        |       |                   |        |   |   | $ | — |   | $ | — |   | $ | — |   |
| Commercial &  Industrial Loans                                  |       | $                      | 1           |   | $ | 15 |   | $ | — |   | $ | 14 |   | $ | 16 |   |
| Real Estate  Loans                                                  |       |                   |        |   |   | $ | — |   | $ | — |   | $ | — |   |
| Consumer Loans                                                      |       | $                      | —      |   | $ | 12 |   | $ | 6 |   | $ | — |   | $ | 10 |   |
| Credit Card  Loans                                                  |       |                   |        |   |   | $ | — |   | $ | — |   | $ | 4 |   |
| Total                                                               |       | $                      | 1           |   | $ | 27 |   | $ | 6 |   | $ | 14 |   | $ | 30 |   |
| Net Loan Charge-offs                                                |       | $                      | 8           |   | $ | (4 | ) | $ | 75 |   | $ | (7 | ) | $ | 103 |   |
| Reserve for unfunded commitments                                    |       | $                      | (100        | ) | $ | (381 | ) |   |   |   |   |   |   |
| Balance at end of period                                            |       | $                      | 4,717       |   | $ | 4,000 |   | $ | 3,587 |   | $ | 3,007 |   | $ | 2,397 |   |
|                                                                |       |                   |        |   |   |   |   |   |   |   |   |
| **Ratios:**                                                         |       |                   |        |   |   |   |   |   |   |   |   |
| Net Loan Charge-offs to Average Loans                               |       | 0.00                   | %           | 0.00 | % | 0.03 | % | 0.05 | % | 0.13 | % |
| Allowance for  Loan Losses to Gross Loans at End of Period          |       | 1.16                   | %           | 1.16 | % | 1.31 | % | 1.29 | % | 1.19 | % |
| Allowance for  Loan Losses to Non-Performing Loans                  |       | 52411.11               | %           | 3960.40 | % | 6642.59 | % | 506.23 | % | 134.81 | % |
| Net Loan  Charge-offs to Allowance for Loan Losses at End of Period |       | 0.17                   | %           | -0.10 | % | 2.09 | % | -0.23 | % | 4.30 | % |
| Net Loan  Charge-offs to Provision Charged to Operating Expense     |       | 0.97                   | %           | -0.51 | % | 11.45 | % | -1.16 | % | 20.60 | % |

 

We employ a systematic methodology for determining the allowance forloan losses that includes a monthly review process and monthly adjustment ofthe allowance. Our process includes a periodic review of individual loans thathave been specifically identified as problem loans or have characteristicswhich could lead to impairment, as well as detailed reviews of other loans(either individually or in pools). While this methodology utilizes historicaland other objective information, the establishment of the allowance for loanlosses and the classification of loans are, to some extent, based on management’sjudgment and experience.

 

Our methodology incorporates a variety of risk considerations, bothquantitative and qualitative, in establishing an allowance for loan losses thatmanagement believes is appropriate at each reporting date. Quantitative factorsinclude our historical loss experience, delinquency and charge-off trends,collateral values, changes in non-performing loans, and other factors. Quantitativefactors also incorporate known information about individual loans, includingborrowers’ sensitivity to interest rate movements and borrowers’ sensitivity toquantifiable external factors including commodity prices as well as acts ofnature (freezes, earthquakes, fires, etc.) that occur in a particular period.

 

33

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Qualitative factors include the general economic environment in ourmarkets and, in particular, the state of the agriculture industry and other keyindustries in the Northern Sacramento Valley. The way a particular loan mightbe structured, the extent and nature of waivers of existing loan policies, loanconcentrations and the rate of portfolio growth are other qualitative factorsthat are considered.

 

Our methodology is, and has been, consistently followed. However, as weadd new products, increase in complexity, and expand our geographic coverage,we expect to enhance our methodology to keep pace with the size and complexityof the loan portfolio. On an ongoing basis we engage outside firms toindependently assess our methodology, and to perform independent credit reviewsof our loan portfolio. The FDIC and the California Department of FinancialInstitutions review the allowance for loan losses as an integral part of theexamination processes. Management believes that our current methodology isappropriate given our size and level of complexity. Further, managementbelieves that the allowance for loan losses is adequate as of December 31, 2005to cover known and inherent risks in the loan portfolio. However, fluctuationsin credit quality, or changes in economic conditions or other factors couldcause management to increase or decrease the allowance for loan losses asnecessary.

 

The following table provides a summary of the allocation of theallowance for loan losses for specific loan categories at the dates indicated.The allocation presented should not be interpreted as an indication thatcharges to the allowance for loan losses will be incurred in these amounts orproportions, or that the portion of the allowance allocated to each loancategory represents the total amounts available for charge-offs that may occurwithin these categories. The unallocated portion of the allowance for loanlosses and the total allowance is applicable to the entire loan portfolio.

 

**Allocation of Loan Loss Allowance**

(dollars in thousands)

 
| ** **                        | ** ** | **As of  December 31,** | ** ** |
|-----------------------------------|------------|-------------------------|------------|
| ** **                        | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                        | ** ** | ** **              | ** ** | **% Total  (1)** | ** ** | ** ** | ** ** | **% Total  (1)** | ** ** | ** ** | ** ** | **% Total  (1)** | ** ** | ** ** | ** ** | **% Total  (1)** | ** ** | ** ** | ** ** | **% Total  (1)** | ** ** |
| ** **                        | ** ** | **Amount**              | ** ** | **Loans** | ** ** | **Amount** | ** ** | **Loans** | ** ** | **Amount** | ** ** | **Loans** | ** ** | **Amount** | ** ** | **Loans** | ** ** | **Amount** | ** ** | **Loans** | ** ** |
| Agricultural                      |       | $                       | 200        |   | 6.09 | % | $ | 244 |   | 6.44 | % | $ | 179 |   | 7.58 | % | $ | 146 |   | 8.11 | % | $ | 142 |   | 9.66 | % |
| Commercial                        |       | $                       | 1,123      |   | 15.03 | % | $ | 690 |   | 17.02 | % | $ | 1,258 |   | 21.01 | % | $ | 735 |   | 20.84 | % | $ | 494 |   | 21.16 | % |
| Real Estate                       |       | $                       | 3,488      |   | 69.91 | % | $ | 3,027 |   | 68.93 | % | $ | 1,815 |   | 63.52 | % | $ | 1,379 |   | 62.78 | % | $ | 1,201 |   | 60.34 | % |
| Installment Loans                 |       | $                       | 386        |   | 8.97 | % | $ | 420 |   | 7.61 | % | $ | 335 |   | 7.89 | % | $ | 747 |   | 8.27 | % | $ | 560 |   | 8.84 | % |
| Reserve for  Unfunded Commitments |       | $                       | (481       | ) |   |   | $ | (381 | ) |   |   | $ | (325 | ) |   |   | $ | (256 | ) |   |   | $ | (205 | ) |   |   |
| **TOTAL**                         |       | $                       | 4,716      |   | 100.00 | % | $ | 4,000 |   | 100.00 | % | $ | 3,262 |   | 100.00 | % | $ | 2,751 |   | 100.00 | % | $ | 2,192 |   | 100.00 | % |

 

----

(1) Represents percentage of loans in category to total loans.

 

At December 31,2005, the Company’s allowance for loan losses was $4.7 million. The loan lossand undisbursed commitment provisions in 2005, 2004, and 2003 totaled $825,000,$790,000, and $655,000, respectively. Over the past five years, net charge-offshave averaged $35,000. Through the diligent efforts of our loan officers andcollection personnel, the Company ended 2005 with net loan losses of $8,000,compared to net recoveries of $4,000 during 2004.

 

**Other Loan Portfolio Information**

 

Loan Concentrations:  The concentration profile of the Company’sloans is discussed in Note 10 to the accompanying Consolidated FinancialStatements.

 

Loan Sales and Mortgage Servicing Rights:  The Company sells or brokers some of thefixed-rate single family mortgage loans it originates as well as other selectedportfolio loans. Some are sold “servicing released” and the purchaser takesover the collection of the payments. However, most are sold with “servicingretained” and the Company continues to receive the payments from the borrowerand forwards the funds to the purchaser. The Company earns a fee for this service.The sales are made without recourse, that is, the purchaser cannot look to theCompany in the event the borrower does not perform according to the terms ofthe note. The Company recognizes the rights to service mortgage loans forothers as separate assets. For loans originated for sale, a portion of theinvestment in the loan is attributed to the right to receive this fee forservicing and this value is recorded as a separate asset. Mortgage servicingassets are carried at their amortized cost, which approximates fair value. AtDecember 31, 2005 and 2004, the amortized cost of these assets was $1,073,000and $1,348,000 respectively.

 

34

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###### **Investment Portfolio**

 

The investment securities portfolio had a carrying value of $6.7million at December 31, 2005. The Company classified its investments into twoportfolios: “held-to-maturity”, and “available-for-sale”. The Company does nothave any investments classified as trading. The held-to-maturity portfolioshould consist only of investments that the Company has both the intention andability to hold until maturity, to be sold only in the event of concerns withan issuer’s creditworthiness, a change in tax law that eliminates their taxexempt status or other infrequent situations as permitted under GAAP. Given thesmall and non complex nature of the portfolio, management does not rely heavilyon these investments as a source of funds for growth in the loan portfolio.

 

Securities pledged as collateral on repurchase agreements, publicdeposits and for other purposes as required or permitted by law were $3,357,000and $2,304,000, for December 31, 2005 and 2004, respectively.

 

The total investment portfolio decreased in size in 2005 to $6.7million at the end of the year from its starting balance of $6.9 million. TheCompany’s investment portfolio is composed primarily of:  (1) U.S. Treasury and Agency issues forliquidity and pledging; and (2) state, county and municipal obligations whichprovide tax free income and pledging potential. The relative distribution ofthese groups within the overall portfolio changed in 2005, with most of thesecurities purchased being classified as available-for-sale. The U.S. Treasuryand Agency issues continue to be the largest portion of the total portfolio at80%, up from 79% at the end of 2004. Municipal issues comprised 20% of totalinvestments at the end of 2005, down slightly from 21% at the end of 2004.

 

The following Investment Portfolio table reflects the amortized costand fair market values for the total portfolio for each of the categories ofinvestments for the past three years.

 

**InvestmentPortfolio**

(dollars in thousands)

 
| ** **                                    | ** ** | **As of December 31,** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|
| ** **                                    | ** ** | **2005**               | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                    | ** ** | **Amortized**          | ** ** | **Fair Market** | ** ** | **Amortized** | ** ** | **Fair Market** | ** ** | **Amortized** | ** ** | **Fair Market** | ** ** |
| ** **                                    | ** ** | **Cost**               | ** ** | **Value** | ** ** | **Cost** | ** ** | **Value** | ** ** | **Cost** | ** ** | **Value** | ** ** |
| **Held to maturity**                          | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| US Government  Agencies & Corporations    |       | 2,317                  |       | 2,332 |   | 2,481 |   | 2,482 |   | 3,277 |   | 3,270 |   |
| State &  political subdivisions           |       |                   |       |   |   | 101 |   | 101 |   | 545 |   | 554 |   |
| Total held to maturity                        |       | $                      | 2,317      |   | $ | 2,332 |   | $ | 2,582 |   | $ | 2,583 |   | $ | 3,822 |   | $ | 3,824 |   |
| **Available for sale**                        |       |                   |       |   |   |   |   |   |   |   |   |   |   |
| **US  Government**Agencies & Corporations |       | 3,009                  |       | 2,964 |   | 3,004 |   | 3,002 |   | 300 |   | 302 |   |
| State &  political subdivisions           |       | 1,356                  |       | 1,380 |   | 1,356 |   | 1,377 |   | 200 |   | 200 |   |
| Total available for sale                      |       | $                      | 4,365      |   | $ | 4,344 |   | $ | 4,360 |   | $ | 4,379 |   | $ | 500 |   | $ | 502 |   |
| **Total Investment Securities**               |       | $                      | 6,682      |   | $ | 6,676 |   | $ | 6,942 |   | $ | 6,962 |   | $ | 4,322 |   | $ | 4,326 |   |
|                                          |       |                   |       |   |   |   |   |   |   |   |   |   |   |
|                                               |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The investment maturities table below summarizes the maturity of theCompany’s investment securities and their weighted average yields at December31, 2005. Expected remaining maturities may differ from remaining contractualmaturities because obligors may have the right to repay certain obligationswith or without penalties.

 

**Investment Maturities**

(dollars in thousands)

 
| ** **                                 | ** ** | **As of  December 31, 2005** | ** ** |
|--------------------------------------------|------------|------------------------------|------------|
| ** **                                 | ** ** | **Within  One  Year**        | ** ** | ** After One  But Within Five Years** | ** ** | **After  Five Years But  Within Ten Years** | ** ** | **After  Ten  Years** | ** ** | **Total** | ** ** |
| ** **                                 | ** ** | **Amount**                   | ** ** | **Yield** | ** ** | **Amount** | ** ** | **Yield** | ** ** | **Amount** | ** ** | **Yield** | ** ** | **Amount** | ** ** | **Yield** | ** ** | **Amount** | ** ** | **Yield** | ** ** |
| **Held to maturity**                       | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| US Government  agencies & corporations |       |                         |       | — |   | 1,000 |   | 3.50 | % | 1,212 |   | 5.01 | % | 120 |   | 5.88 | % | 2,332 |   | 4.41 | % |
| State &  political subdivisions        |       |                         |       | — |   |   |   |   |   | — |   | — |   | — |   | — |   | — |   |   |   |
| **Total  held to maturity**                |       | $                            | —     |   | — |   | $ | 1,000 |   | 3.50 | % | 1,212 |   |   |   | $ | 120 |   | 5.88 | % | $ | 2,332 |   | 4.41 | % |
| **Available for sale**                     |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| US Government  agencies & corporations |       | 993                          |       | 3.01 | % | 984 |   | 3.22 | % | 987 |   | 4.94 | % | — |   | — |   | 2,964 |   | 3.72 | % |
| State &  political subdivisions        |       | —                       |       | — |   | — |   |   |   | — |   | — |   | 1,380 |   | 4.75 | % | 1,380 |   | 4.75 | % |
| **Total  available for sale**              |       | $                            | 993        |   | 3.01 | % | $ | 984 |   | 3.22 | % | $ | 987 |   | 4.94 | % | $ | 1,380 |   | 4.75 | % | $ | 4,344 |   | 4.05 | % |
| **Total investment securities**            |       | $                            | 993        |   | 3.01 | % | $ | 1,984 |   | 3.36 | % | $ | 2,199 |   | 4.98 | % | $ | 1,500 |   | 4.84 | % | $ | 6,676 |   | 4.17 | % |

 

35

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###### **Cash and Due From Banks**

 

Cash on hand and balances due from correspondent banks represent themajor portion of the Company’s non-earning assets. At December 31, 2005 theseareas comprised 3.8% of total assets, as compared to 4.8% of total assets atDecember 31, 2004. The Company strives to maintain vault cash at a levelconsistent with the withdrawal needs of the customers. The vault cash amountfor December 31, 2005 was $3.6 million.

 

The Company’s operating branches lie within the Federal Reserve Bank(FRB) of San Francisco’s responsibility area of check clearing activities,while the Company’s item processing activities are performed in Chico. As aresult of the Federal Reserve Banks’ new Check 21 services the Company couldtake advantage of quicker clearing times to offset time zone and geographychallenges and improve availability. With traditional paper check clearing, allnon-local and country items in the 12th District receive availabilitythat is at least one day deferred. Under the new programs becoming availablefrom the Federal Reserve Banks, many of these items will receive immediateavailability if received by the 1:00 a.m. Pacific time deadline. With filedeposit deadlines starting as early as 5:00 p.m. Pacific through 9:00 a.m.Pacific time, image cash letters enable institutions on the West Coast toreduce the clearing time of many high value East Coast items by at least onebusiness day, thereby increasing funds available for investment and reducingrisk.

 

###### **Premises and Equipment**

###### ** **

Premises and equipment are stated at cost less accumulated depreciationand amortization. Depreciation is charged to income over the estimated usefullives of the assets and leasehold improvements are amortized over the terms ofthe related lease, or the estimated useful lives of the improvements, whicheveris shorter. Depreciation expense was $1,574,000 for the year ended December 31,2005 as compared to $1,313,000 during 2004 and $934,000 during 2003. Thefollowing premises and equipment table reflects the balances by major categoryof fixed assets:

 

**Premises& Equipment**

(dollars in thousands)

 
| ** **               | ** ** | **As of December 31,** | ** ** |
|--------------------------|------------|------------------------|------------|
| ** **               | ** ** | **2005**               | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **               | ** ** | **Cost**               | ** ** | **Accumulated  Depreciation** | ** ** | **Net Book  Value** | ** ** | **Cost** | ** ** | **Accumulated  Depreciation** | ** ** | **Net Book  Value** | ** ** | **Cost** | ** ** | **Accumulated  Depreciation** | ** ** | **Net   Book  Value** | ** ** |
| Land                     |       | $                      | 2,176      |   | $ | — |   | $ | 2,176 |   | $ | 1,519 |   | $ | — |   | $ | 1,519 |   | $ | 1,193 |   | $ | — |   | $ | 1,193 |   |
| Buildings                |       | $                      | 6,908      |   | $ | 1,425 |   | $ | 5,483 |   | $ | 5,761 |   | $ | 1,172 |   | $ | 4,589 |   | $ | 5,667 |   | $ | 946 |   | $ | 4,721 |   |
| Leasehold Improvements   |       | $                      | 994        |   | $ | 386 |   | $ | 608 |   | $ | 841 |   | $ | 248 |   | $ | 593 |   | $ | 690 |   | $ | 168 |   | $ | 522 |   |
| Construction in progress |       | $                      | 622        |   | $ | — |   | $ | 622 |   | $ | 75 |   | $ | — |   | $ | 75 |   | $ | 138 |   | $ | — |   | $ | 138 |   |
| Furniture and Equipment  |       | $                      | 7,384      |   | $ | 5,052 |   | $ | 2,332 |   | $ | 6,242 |   | $ | 3,991 |   | $ | 2,251 |   | $ | 5,106 |   | $ | 3,126 |   | $ | 1,980 |   |
| **Total**                |       | $                      | 18,084     |   | $ | 6,863 |   | $ | 11,221 |   | $ | 14,438 |   | $ | 5,411 |   | $ | 9,027 |   | $ | 12,794 |   | $ | 4,240 |   | $ | 8,554 |   |

 

The net book value of the Company’s premises and equipment increased by$2,193,000 in 2005, primarily due to the opening of the new branches in Corningand Redding , and the Loan Office in Gridley. The Company also purchased a14,000 square foot building in Chico that will serve as the corporateadministrative headquarters and also house other service departments. Thisbuilding is currently being remodeled and should be ready for occupancy in thethird quarter of 2006. As a percentage of total assets, the Company’s premisesand equipment was 2.3%, at the end of 2005, 2.0% at the end of 2004 and 2.2% atthe end of 2003.

 

###### **Deposits**

###### ** **

The composition and cost of the Company’s deposit base are importantcomponents in analyzing the Company’s net interest margin and balance sheetliquidity characteristics, both of which are discussed in greater detail inother sections herein. Net interest margin is improved to the extent thatgrowth in deposits can be concentrated in historically lower-cost coredeposits, namely non-interest-bearing demand, NOW accounts, savings accountsand money market deposit accounts. Liquidity is impacted by the volatility ofdeposits or other funding instruments, or in other words their propensity toleave the institution for rate-related or other reasons. Potentially, the mostvolatile deposits in a financial institution are large certificates of deposit,which generally mean time deposits with balances exceeding $100,000. Becausethese deposits (particularly when considered together with a customer’s otherspecific deposits) may exceed FDIC insurance limits, depositors may selectshorter maturities to offset perceived risk elements associated with depositsover $100,000. The Company’s community-oriented deposit gathering activities inButte, Colusa, Shasta, Sutter, Tehama, and Yuba counties, however, haveengendered a less volatile than usual base of depositor certificates over$100,000.

 

36

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The Company’s total deposit volume increased to $434 million at the endof 2005, as compared to $399 million at the end of 2004. Deposit growth of $35million was achieved during 2005, both as a result of the newer branchesopening and the growth of the other more established branches within the system.The mix of the deposits changed very little from 2004 to 2005. Lower cost coredeposit accounts (demand deposits, NOW accounts, money market, and savings)increased by 6 % or $18 million while the higher cost certificates of depositbalances increased by 16% or $17 million. We expect increasing deposit ratesand pressure from competition will impact the Company’s cost of funds and netinterest margin in 2006.

 

As deposit rates continued to rise in 2005 from their extremely lowlevels in 2003, depositors gradually moved their funds out of liquidtransaction accounts back into certificates of deposit. The average rates thatare paid on deposits generally trail behind money market rates becausefinancial institutions do not try to change deposit rates with each smallincrease or decrease in short-term rates. This trailing characteristic isstronger with time deposits, such as certificates of deposit that pay a fixedrate for some specified term, than with deposit types that have administeredrates. With time deposits accounts, even when new offering rates areestablished, the average rates paid during the year are a blend of the ratespaid on individual accounts. Only new accounts and those that mature and arerenewed will bear the new rate.

 

The scheduled maturity distribution of the Company’s time deposits,including IRA accounts as of December 31, 2005 was as follows:

 

**DepositMaturity Distribution**

(dollars in thousands)

 
| ** **                                  | ** ** | **As of December 31, 2005** | ** ** |
|---------------------------------------------|------------|-----------------------------|------------|
| ** **                                  | ** ** | **Three**                   | ** ** | **Three** | ** ** | **One** | ** ** | **Over** | ** ** | ** ** | ** ** |
| ** **                                  | ** ** | **months**                  | ** ** | **to twelve** | ** ** | **to three** | ** ** | **three** | ** ** | ** ** | ** ** |
| ** **                                  | ** ** | **or less**                 | ** ** | **months** | ** ** | **years** | ** ** | **Years** | ** ** | **Total** | ** ** |
| Time Certificates of Deposits < $100,000 |       | $                           | 12,398     |   | $ | 33,988 |   | $ | 13,645 |   | $ | 1,131 |   | $ | 61,162 |   |
| Other Time Deposits > $100,000           |       | $                           | 7,097      |   | $ | 24,670 |   | $ | 27,283 |   | $ | 450 |   | $ | 59,500 |   |
|                                        |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| TOTAL                                       |       | $                           | 19,495     |   | $ | 58,658 |   | $ | 40,928 |   | $ | 1,581 |   | $ | 120,662 |   |
|                                             |            |                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Notes Payable and Other Borrowings**

 

The Company has $15 million in unsecured borrowing arrangements withtwo of its correspondent banks to meet short-term liquidity needs. There wereno borrowings outstanding under these arrangements at December 31, 2005 and2004.

 

The following summarizes the note payable to the Company’s subsidiarygrantor trust at December 31, 2005:

 
| ** **                                                                                                                                                                                                                                                            | ** ** | **(Dollars in thousands)** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|
| Subordinated  debentures due to Community Valley Bancorp Trust I With interest adjusted and  payable quarterly based on 3-month Libor plus 3.30% to a maximum of 12.5%  (7.45% at December 31, 2005), redeemable beginning December 31, 2007, due  December 31, 2032. |       | $                          | 8,248      |   |
|                                                                                                                                                                                                                                                                       |            |                            |            |  |

 

The Company has guaranteed, on a subordinated basis, distributions andother payments due on the trust preferred securities issued by the subsidiarygrantor trust. Interest expense recognized by the Company for the years endedDecember 31, 2005, 2004 and 2003 related to the junior subordinated debentureswas $592,000, $438,000 and $439,000, respectively. These junior subordinateddebentures currently qualify as Tier 1 capital when determining regulatoryrisk-based capital ratios.

 

The ESOP obtained financing through a $1.2 million unsecured line ofcredit from another financial institution with the Company acting as theguarantor. The note has a variable interest rate, based on an independentindex, and a maturity date of November 12, 2012. At December 31, 2005, theinterest rate was 7.00%. Advances on the line of credit totaled $981,000,$835,000 at December 31, 2005 and 2004, respectively. A summary of the activityin this line of credit follows.

 
| **ESOP  Note Payable**                      | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **(dollars in thousands)**                  |       |     |       |     |       |     |       |
| Balance at December 31                      |       | $        | 981        |     | $          | 835      |       | $ | 832 |   |
|                                        |       |     |       |     |       |     |       |
| Average amount outstanding                  |       | $        | 865        |     | $          | 778      |       | $ | 786 |   |
|                                        |       |     |       |     |       |     |       |
| Maximum amount outstanding at any month end |       | $        | 1,080      |     | $          | 848      |       | $ | 843 |   |
|                                        |       |     |       |     |       |     |       |
| Average interest rate for the year          |       | 6.13     | %          | 4.31     | %          | 4.15     | %          |

 

On June 1, 2005, Community Valley Bancorpentered into a short term, unsecured note payable in a principal amount of $800,000in conjunction with the purchase of real property. The interest rate on thenote at December 31, 2005 was 4.5%. The note was paid in full on January 4,2006.

 

37

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###### **Capital Resources**

 

At December 31, 2005, the Company had total shareholders equity of$41.6 million, comprised of $7.7 million in common stock, and $33.9 million inretained earnings. Total shareholders equity at the end of 2004 was $34.5million. Net income has provided $18.1 million in capital over the last threeyears, of which $3 million or approximately 17% was distributed in dividends. Theretention of earnings has been the Company’s main source of capital since 1990,however the Company issued $8.2 million in Subordinated Debentures in 2002, theproceeds of which are considered Tier 1 capital for regulatory purposes butlong-term debt in accordance with GAAP.

 

The Company paid quarterly cash dividends totaling $1,092,000 or $.16per share in 2005 and $1,091,000 or $.153 per share in 2004, representing 15.8%and 19.5%, respectively of the prior year’s earnings. (As the holding companyreorganization became effective on May 23, 2002, all of the dividends paidprior to that date were paid by the Bank, rather than the Company.)  Since the second quarter of 2001, the Bank(or the Company, as applicable) has adhered to a policy of paying quarterlycash dividends totaling about 17% of the prior year’s net earnings to theextent consistent with general considerations of safety and soundness, providedthat such payments do not adversely affect the Bank’s or the Company’sfinancial condition and are not overly restrictive to its growth capacity. TheCompany anticipates paying dividends in the future consistent with the generaldividend policy as described above. However, no assurance can be given that theBank’s and the Company’s future earnings and/or growth expectations in anygiven year will justify the payment of such a dividend.

 

The Company uses a variety of measures to evaluate capital adequacy. Managementreviews various capital measurements on a monthly basis and takes appropriateaction to ensure that such measurements are within established internal andexternal guidelines. The external guidelines, which are issued by the FDIC,establish a risk-adjusted ratio relating capital to different categories ofassets and off balance sheet exposures. There are two categories of capitalunder the FDIC guidelines: Tier 1 and Tier 2 Capital. Tier 1 Capital includescommon shareholders’ equity and the proceeds from the issuance oftrust-preferred securities (subject to the limitations previously discussed),less goodwill and certain other deductions, notably the unrealized net gains orlosses (after tax adjustments) on securities available for sale, which arecarried at fair market value. Tier 2 Capital includes preferred stock andcertain types of debt equity, which the Company does not hold, as well as theallowance for loan losses, subject to certain limitations. (For a more detaileddefinition, see “Item 1, Business-Supervision and Regulation — Capital AdequacyRequirements” herein.)

 

At December 31, 2005, the Company had a Tier 1 risk based capital ratioof 11.4%, a total capital to risk-weighted assets ratio of 12.6%, and aleverage ratio of 9.8%. The Company had a Tier 1 risk-based capital ratio of11.3%, a total risk-based capital ratio of 12.5%, and a leverage ratio of 9.5%at December 31, 2004. Note 11 of the Notes to Consolidated Financial Statementsprovides more detailed information concerning the Company’s capital amounts andratios as of December 31, 2005 and 2004.

 

At the current time, the Bank is considered “well capitalized” underthe Prompt Corrective Action standards. With the accumulation of retainedearnings and the addition of regulatory capital via the issuance of TrustPreferred Securities in 2002, the Company’s regulatory capital ratios improvedsubstantially. It is anticipated that the current level of capital will allowthe Company to grow substantially and remain well capitalized, although noassurance can be given that this will be the case.

 

****Off-Balance Sheet Items and Contractual Obligations****

 

The Company has certainongoing commitments under operating leases. See Note 10 to the consolidatedfinancial statements at Item 8 of this report for the terms. These commitmentsdo not significantly impact operating results. As of December 31, 2005commitments to extend credit were the Company’s only financial instruments withoff-balance sheet risk. Loan commitments increased to $201 million from $148million at December 31, 2004. The commitments represent 49% of the total loansoutstanding at year-end 2005 versus 44% at December 31, 2004.

 

38

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The following chart summarizes certain contractual obligations of the Company as of December 31, 2005:

 
| ** **                        | ** ** | **Less than** | ** ** | ** **    | ** ** | ** **    | ** ** | **More than** | ** ** | ** ** | ** ** |
|-----------------------------------|------------|---------------|------------|---------------|------------|---------------|------------|---------------|------------|------------|------------|
| ** **                        | ** ** | **1 year**    | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **5 years**   | ** ** | **Total**  | ** ** |
|                              |       |          |       |          |       |          |       |          |       |       |       |
| Subordinated debentures           |       | —        |       | —        |       | —        |       | 8,248         |       | 8,248      |       |
| Operating lease obligations       |       | 630           |       | 1,351         |       | 1,330         |       | 5,612         |       | 8,923      |       |
| Deferred compensation (1)         |       | —        |       | —        |       | —        |       | 3,037         |       | 3,037      |       |
| Supplemental retirement plans (1) |       | 116           |       | 242           |       | 390           |       | 1,412         |       | 2,160      |       |
| Notes payable                     |       | 800           |       |          |       |          |       | 981           |       | 1781       |       |
| Total contractual obligations     |       | $             | 1,546      |          | $          | 1,593         |       | $             | 1,720      |       | $          | 19,290 |   | $ | 24,149 |   |
|                                   |            |               |            |               |            |               |            |               |            |            |            |  |  |  |  |  |

 

----

(1)  These amounts represent the accrued liabilities as ofDecember 31, 2005 under the Company’s deferred compensation and supplementalretirement plans. See Note 15 to the consolidated financial statements at Item8 of this report for additional information related to the Company’s deferredcompensation and supplemental retirement plan liabilities.

 

###### **Liquidity and Market RiskManagement**

###### ** **

The Company must address on a daily basis the various and sundryfactors which impact its continuing operations. Three of these factors, theeconomic climate which encompasses our business environment, the regulatoryframework which governs our practices and procedures, and credit risk have beenpreviously discussed. There are other risks specific to the operation of afinancial institution which also need to be managed, and this section willaddress liquidity risk and market risk.

 

Liquidity refers to the Company’s ability to maintain a cash flowadequate to fund operations, and to meet obligations and other commitments in atimely and cost-effective fashion. At various times the Company requires fundsto meet short-term cash requirements brought about by loan growth or depositoutflows, the purchase of assets, or liability repayments. To manage liquidityneeds properly, cash inflows must be timed to coincide with anticipatedoutflows, or sufficient liquidity resources must be available to meet varyingdemands. The Company manages its own liquidity in such a fashion as to be ableto meet unexpected sudden changes in levels of its assets or depositliabilities, without maintaining excessive amounts of on-balance sheetliquidity. Excess balance sheet liquidity can negatively impact the interestmargin.

 

An integral part of the Company’s ability to manage its liquidity positionappropriately is provided by the Company’s large base of core deposits, whichwere generated by offering traditional banking services in the communities inits service area and which have, historically, been a very stable source offunds.

 

Additionally, the Company maintains $15 million in unsecured borrowingarrangements with two of its correspondent banks. The Company also has theability to raise deposits through various deposit brokers, sell investmentsecurities, or sell loans if required for liquidity purposes

 

Market risk arises from changes in interest rates, exchange rates,commodity prices and equity prices. The Company’s market risk exposure isprimarily that of interest rate risk, and it has risk management policies tomonitor and limit earnings and balance sheet exposure to changes in interestrates. The Company does not engage in the trading of financial instruments.

 

The principal objective of interest rate risk management (oftenreferred to as “asset/liability management”) is to manage the financialcomponents of the Company in a manner that will optimize the risk/rewardequation for earnings and capital in relation to changing interest rates. Inorder to identify areas of potential exposure to rate changes, the Companycalculates its re-pricing gap on a monthly basis. It also performs an earningssimulation analysis and a market value of portfolio equity calculation on amonthly basis to identify more dynamic interest rate risk exposures than thoseapparent in the standard re-pricing gap analysis.

 

39

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Modeling software is used by the Company for asset/liability managementin order to simulate the effects of potential interest rate changes on theCompany’s net interest margin. These simulations can also provide both staticand dynamic information on the projected fair market values of the Company’sfinancial instruments under differing interest rate assumptions. The simulationprogram utilizes specific individual loan and deposit maturities, embeddedoptions, rates and re-pricing characteristics to determine the effects of agiven interest rate change on the Company’s interest income and interestexpense. Rate scenarios consisting of key rate and yield curve projections arerun against the Company’s investment, loan, deposit and borrowed fundsportfolios. These rate projections can be shocked (an immediate and sustainedchange in rates, up or down), ramped (an incremental increase or decrease inrates over a specified time period), economic (based on current trends andeconometric models) or stable (unchanged from current actual levels). TheCompany typically uses seven standard interest rate scenarios in conducting thesimulation, namely stable, an upward shock of 100, 200, and 300 basis points,and a downward shock of 100, 200, and 300 basis points.

 

The Company’s policy is to limit the change in the Company’s netinterest margin and economic value to plus or minus 5%, 15%, and 25% uponapplication of interest rate shocks of 100 bp, 200 bp, and 300 bp as comparedto a base rate scenario. As of December 31, 2005, the Company had the followingestimated net interest margin sensitivity profile:

 
| ** **             | ** ** | **Immediate Change in Rate** | ** ** | **Immediate Change in Rate** | ** ** | **Immediate Change in Rate** | ** ** |
|------------------------|------------|------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **             | ** ** | **+100 bp**                  | ** ** | **-100 bp**                  | ** ** | **+200 bp**                  | ** ** | **-200 bp** | ** ** | **+300 bp** | ** ** | **-300 bp** | ** ** |
| Net Int. Income Change |       | $                            | 864,000    |                         | $          | -901,000                     |       | $ | 1,732,000 |   | $ | -2,380,000 |   | $ | 2,604,000 |   | $ | -2,659,000 |   |
|                        |            |                              |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

The above profile illustrates that if there were an immediate increaseof 200 basis points in interest rates, the Company’s annual net interest incomewould likely increase by about $1,732,000, or approximately 6.04%. Likewise, ifthere were an immediate downward adjustment of 200 basis points in interestrates, the Company’s net interest income would likely decrease by approximately$2,380,000, or 8.29%, over the next year.

 

The results for the Company’s December 31, 2005, balances indicate thatthe Company’s net interest income at risk over a one-year period and neteconomic value at risk from 2% shocks are within normal expectations for suchsudden changes.

 

The amount of change is based on the profiles of each loan and depositclass, which include the rate, the likelihood of prepayment or repayment,whether its rate is fixed or floating, the maturity of the instrument and theparticular circumstances of the customer. The quantification of the change ineconomic value is somewhat apparent in Note 16, Fair Value of FinancialInstruments, in the consolidated financial statements; however such valueschange over time based on certain assumptions about interest rates and likelychanges in the yield curve.

 

**SelectedQuarterly Financial Data**

 

(Dollars in thousands, except per share data)

 
| **2005 Quarter**                                    | ** ** | **1st** | ** ** | **2nd** | ** ** | **3rd** | ** ** | **4th** | ** ** |
|-----------------------------------------------------|------------|---------|------------|---------|------------|---------|------------|---------|------------|
|                                                |       |    |       |    |       |    |       |    |       |
| Interest income                                     |       | $       | 7,054      |    | $          | 7,675   |       | $       | 8,583      |   | $ | 9,126 |   |
| Net Interest income                                 |       | $       | 5,907      |    | $          | 6,506   |       | $       | 7,177      |   | $ | 7,514 |   |
| Net interest income after provision for loan losses |       | $       | 5,682      |    | $          | 6,281   |       | $       | 6,952      |   | $ | 7,367 |   |
|                                                |       |    |       |    |       |    |       |    |       |
| Net income                                          |       | $       | 1,454      |    | $          | 1,730   |       | $       | 2,159      |   | $ | 1,855 |   |
|                                                |       |    |       |    |       |    |       |    |       |
| Net income per share, basic                         |       | $       | 0.20       |    | $          | 0.24    |       | $       | 0.30       |   | $ | 0.26 |   |
|                                                |       |    |       |    |       |    |       |    |       |
| Net income per share, diluted                       |       | $       | 0.19       |    | $          | 0.23    |       | $       | 0.29       |   | $ | 0.24 |   |
|                                                |       |    |       |    |       |    |       |    |       |
| Dividends declared                                  |       | $       | 0.040      |    | $          | 0.040   |       | $       | 0.040      |   | $ | 0.040 |   |

 

40

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| **2004 Quarter**                                    | ** ** | **1st** | ** ** | **2nd** | ** ** | **3rd** | ** ** | **4th** | ** ** |
|-----------------------------------------------------|------------|---------|------------|---------|------------|---------|------------|---------|------------|
|                                                |       |    |       |    |       |    |       |    |       |
| Interest income                                     |       | $       | 5,575      |    | $          | 5,840   |       | $       | 6,306      |   | $ | 7,259 |   |
| Net Interest income                                 |       | $       | 4,587      |    | $          | 4,881   |       | $       | 5,521      |   | $ | 5,935 |   |
| Net interest income after provision for loan losses |       | $       | 4,362      |    | $          | 4,691   |       | $       | 5,296      |   | $ | 5,785 |   |
|                                                |       |    |       |    |       |    |       |    |       |
| Net Income                                          |       | $       | 1,088      |    | $          | 1,465   |       | $       | 1,594      |   | $ | 1,463 |   |
|                                                |       |    |       |    |       |    |       |    |       |
| Net income per share, basic                         |       | $       | 0.15       |    | $          | 0.20    |       | $       | 0.23       |   | $ | 0.20 |   |
|                                                |       |    |       |    |       |    |       |    |       |
| Net income per share, diluted                       |       | $       | 0.15       |    | $          | 0.19    |       | $       | 0.21       |   | $ | 0.19 |   |
|                                                |       |    |       |    |       |    |       |    |       |
| Dividends Declared                                  |       | $       | 0.0375     |    | $          | 0.0375  |       | $       | 0.0375     |   | $ | 0.0375 |   |

 

**Item 7a. Quantitative andQualitative Disclosures About Market Risk**

 

The information require by Item 7a of Form 10-K is contained in theLiquidity and Market Risk Management section of Item 7 – Managements Discussionand Analysis of Financial Condition and Results of Operations.

 

**Item 8.****    Financial Statements and Supplementary Data**

 

The financial statements begin on page 57 of this report.

 

**Item 9.****    Changes in and Disagreements with Accountants onAccounting and Financial Disclosure**

 

There were no changes or disagreements with Accountants for the year2005.

 

# **Item 9a.**  Controlsand Procedures

 

As of the end of the period covered by this report, we conducted anevaluation, under the supervision and with the participation of our ChiefExecutive Officer and Chief Financial Officer, of our disclosure controls andprocedures (as defined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934).  Based on this evaluation, our ChiefExecutive Officer and Chief Financial Officer concluded that our disclosurecontrols and procedures are effective to ensure that information required to bedisclosed by us in reports that we file or submit under the Exchange Act is recorded,processed, summarized and reported within the time periods specified inSecurities and Exchange Commission rules and forms.  There was no changein our internal control over financial reporting during our most recentlycompleted fiscal quarter that has materially affected, or is reasonably likelyto materially affect, our internal control over financial reporting.

 

41

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**PART III**

 

**Item 10.Directors and Executive Officers of the Registrant**

 

The following table sets forth, as of February 15, 2006, the names of,and certain information regarding, the directors of Community Valley Bancorp.

 
| ** **                               | ** ** | ** ** | ** ** | **Year First** | ** ** | **Principal Occupation**                                                                                                                |
|------------------------------------------|------------|------------|------------|----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------|
| **Name and Title**                       | ** ** | ** ** | ** ** | **Appointed**  | ** ** | **During the**                                                                                                                          |
| **Other than Director**                  | ** ** | **Age**    | ** ** | **Director**   | ** ** | **Past Five Years**                                                                                                                     |
|                                     |       |       |       |           |       |                                                                                                                                    |
| M. Robert Ching, M.D.                    |       | 60         |       | 2002           |       | Orthopedic surgeon.                                                                                                                     |
|                                     |       |       |       |           |       |                                                                                                                                    |
| John F. Coger  Executive V.P. CFO/COO    |       | 56         |       | 2004           |       | Executive Vice President Chief Financial Officer and  Chief Operating Officer of the Bank.                                              |
|                                     |       |       |       |           |       |                                                                                                                                    |
| Eugene B. Even                           |       | 78         |       | 2002           |       | Retired.                                                                                                                                |
|                                     |       |       |       |           |       |                                                                                                                                    |
| John D. Lanam                            |       | 71         |       | 2002           |       | Retired. Former attorney and senior partner of  McKernan, Lanam, Bakke, Benson & Bodney, a law firm.                                |
|                                     |       |       |       |           |       |                                                                                                                                    |
| Donald W. Leforce  Chairman of the Board |       | 58         |       | 2002           |       | Retired. Past President and Secretary/Treasurer of  Compass Equipment, Inc., a distributor of mining and heavy construction  equipment. |
|                                     |       |       |       |           |       |                                                                                                                                    |
| Charles J. Mathews                       |       | 68         |       | 2003           |       | Owner of Mathews Farms and Partner in Mathews Rice  Dryer.                                                                              |
|                                     |       |       |       |           |       |                                                                                                                                    |
| Ellis L. Matthews                        |       | 72         |       | 2002           |       | Retired.                                                                                                                                |
|                                     |       |       |       |           |       |                                                                                                                                    |
| Robert L. Morgan, M.D.                   |       | 78         |       | 2002           |       | Retired.                                                                                                                                |
|                                     |       |       |       |           |       |                                                                                                                                    |
| Luther McLaughlin                        |       | 61         |       | 2005           |       | President and managing director of Matson and Isom  an accountancy firm.                                                                |
|                                     |       |       |       |           |       |                                                                                                                                    |
| James S. Rickards  Secretary             |       | 55         |       | 2002           |       | Real estate broker associated with Century 21 Select  since April, 2000.                                                                |
|                                     |       |       |       |           |       |                                                                                                                                    |
| Keith C. Robbins  President/CEO          |       | 64         |       | 2002           |       | President and Chief Executive Officer of the Bank.                                                                                      |
|                                     |       |       |       |           |       |                                                                                                                                    |
| Gary B. Strauss, M.D.  Vice Chairman     |       | 75         |       | 2002           |       | Retired.                                                                                                                                |
|                                     |       |       |       |           |       |                                                                                                                                    |
| Jack Schmelke                            |       | 83         |       | 2005           |       | Retired.                                                                                                                                |
|                                     |       |       |       |           |       |                                                                                                                                    |
| Hubert I. Townshend                      |       | 69         |       | 2002           |       | Retired. Formerly involved in general engineering,  contracting and equipment rental.                                                   |

 

42

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None of the directors were selected pursuant to any arrangement orunderstanding other than with the directors and executive officers (1) ofCommunity Valley Bancorp acting within their capacities as such. There are nofamily relationships between any of the directors of Community Valley Bancorp. Nodirector of Community Valley Bancorp serves as a director of any company whichhas a class of securities registered under, or which is subject to the periodicreporting requirements of the Securities Exchange Act of 1934, or of anycompany registered as an investment company under the Investment Company Act of1940.

 

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(1)  As used inthis statement, the term “executive officer” of Community Valley Bancorpincludes the President/Chief Executive Officer and the Executive VicePresident/Chief Financial Officer-Chief Operating Officer.

 

**Compensation of Directors**

 

During 2005, directors, other than Mr. Robbins and Mr.Coger, received a base fee of $900.00 per month for serving as directors(provided the director attends 75% of the meetings) and received additionalfees for chairing meetings and attending meetings. Mr. Robbins and Mr.Coger (appointed to the Board of Directors in September 2004) also received abase fee of $900.00 per month for serving as a director. Community ValleyBancorp’s Chairman of the Board also received an additional $500 per month forserving as the Chairman. Any director, other than Mr. Robbins and Mr. Coger,who chaired a Board of Directors or committee meeting, which met during themonth, received an additional $50.00 per month for serving as the chairman. Inaddition, directors, other than Mr. Robbins and Mr. Coger, but includingthe chairman, who attended any Board meeting, also received an additional$365.00 per Board of Directors meeting attended. Directors, other than Mr.Robbins and Mr. Coger, but including the chairman of any committee, whoattended any committee meeting held at the same gathering as a Board ofDirector’s meeting (other than one committee meeting held concurrently with theBoard meeting) also received an additional $50.00 per committee meetingattended. Directors, other than Mr. Robbins and Mr. Coger, but including thechairman of any committee, who attended any other committee meeting received$350 per committee meeting attended. In addition, if any Board of Directors orcommittee meeting extended beyond three hours, directors, other than Mr.Robbins and Mr. Coger, received an additional $105.00 per hour for each hourthe meeting extended over three hours, subject to a maximum additional $210.00per meeting. Directors, other than Mr. Robbins and Mr. Coger, who traveled to aBoard of Directors or committee meeting held outside the town of the director’sresidence received an additional $15.00 travel fee per meeting and all othertravel in connection with the Board of Director’s or Community Valley Bancorp’sactivities was compensated at the Internal Revenue Service’s rate per mile.

 

During 2006, the compensation to directors will remainthe same as above except Community Valley Bancorp’s Chairman of the Board ofDirectors will receive $800.00 for serving as the Chairman.

 

In May, 1997, each director of Community ValleyBancorp received a stock option under Community Valley Bancorp’s 1997 StockOption Plan to acquire 26,394 shares of common stock, giving effect to allstock dividends and splits. The exercise price for these shares is $2.30 pershare, giving effect to all stock dividends and splits. The options are for aterm of ten years expiring in May, 2007 and are 100% vested.

 

In addition, in May, 2000, each director of CommunityValley Bancorp, received a stock option under Community Valley Bancorp’s 2000Stock Option Plan to acquire 26,666 shares of common stock, giving effect toall stock dividends and splits after May 2000. The exercise price for theseshares is $4.71 per share. The options are for a term of ten years expiring inMay, 2010. The vesting of the director options is 20% of the total optionamount per year with the first 20% amount having vested in May, 2001. InOctober 2003, Director Charles Mathews received a stock option under CommunityValley Bancorp’s 2000 stock option plan to acquire 5,332 shares of commonstock, giving effect to all stock dividends and splits after October, 2003. Theexercise price for these shares is $7.24 per share. The options are for a termof ten years expiring in October, 2013. The vesting of the director options is20% of the total option amount per year with the first 20% amount having vestedin October, 2004. In March 2005, Director Luther McLaughlin received a stockoption under Community Valley Bancorp’s 2000 stock option plan to acquire 4,000shares of common stock, giving effect to all stock dividends and splits afterMarch, 2005. The exercise price for these shares is $13.25 per share. Theoptions are for a term of ten years expiring in March, 2015. The vesting of thedirector options is 20% of the total option amount per year with the first 20%amount vesting in March, 2006.

 

**DirectorRetirement Agreements**

 

In April, 1998, each director of Community ValleyBancorp, other than Mr. Robbins and subsequently Mr. Coger, entered into aDirector Retirement Agreement which provides for the payment of a monthlyretirement benefit for a period of sixty months based upon an individualizedvesting schedule which takes into account the years of service as a directorand each director’s individual retirement age. The agreement also pays in theevent of a change in control of Community Valley Bancorp or disability or deathof the director. The vesting schedule provides for a maximum payment of $500per month.

 

43

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**DirectorDeferred Fee Agreements**

 

Directors of Community Valley Bancorp have the optionof participating in Community Valley Bancorp’s Director Deferred Fee Program. Pursuantto the Director Deferred Fee Program, directors make an initial deferralelection by filing with Community Valley Bancorp a signed election form whichsets forth the amount of the director’s fees to be deferred. Community ValleyBancorp then establishes a Deferral Account on its books for the director andcredits to the Deferral Account the fees deferred by the director and intereston the account balance at a rate equal to Community Valley Bancorp’s primelending rate as of December 31 of the previous year plus one-half percentcompounded each December 31 and assuming all deferrals have been made as ofJanuary 1 of such year. The Deferral Account is not a trust fund of any kindand the director is a general unsecured creditor of Community Valley Bancorpfor the payment of the benefits. Benefits under the Director Deferred FeeProgram are payable upon the director’s termination of service. The amount ofbenefit payable is the Deferral Account balance at the date of termination ofservice. This amount shall be paid to the director in 120 monthly installmentscommencing on the first day of the month following the director’s terminationof service. Dr. Ching and Mr. Leforce have each entered into Director DeferredFee Agreements with Community Valley Bancorp.

 

**DirectorEmeritus Plan**

 

During 2001, Community Valley Bancorp also establisheda Directors Emeritus Plan. Those directors who have served ten or moreconsecutive years as an outside director and any outside directors who haveserved five or more consecutive years as an outside director and immediatelyprior thereto served five or more years as an inside director, are eligible toparticipate in the Directors Emeritus Plan. Each Director Emeritus will be afive year position or until a Director Emeritus shall sell a majority of his orher ownership in Community Valley Bancorp. Directors Emeritus will receive amonthly fee equal to a percent of the base director fee they were receiving forserving as a director at the time they became Director Emeritus. For the firstyear, they shall receive 90%, for the second year, they shall receive 80%, forthe third year, they shall receive 60%, for the fourth year, they shall receive50%, and for the fifth year, they shall receive 40%. In the event of anymerger, consolidation of acquisition where Community Valley Bancorp is not thesurviving entity, the Director Emeritus Plan shall remain in full force andeffect; provided, however, the resulting corporation may elect to pay theDirector Emeritus a lump sum amount in cash equal to 50% of the remainingbenefits due the Director Emeritus.

 

**Executive Officers**

 

The following table sets forth information, as ofFebruary 15, 2006, concerning executive officers of Community Valley Bancorp:

 
| **Name**         | ** ** | **Age** | ** ** | **Position and Principal Occupation For the Past Five Years**                                              | ** ** |
|------------------|------------|---------|------------|-----------------------------------------------------------------------------------------------------------------|------------|
| Keith C. Robbins |       | 64      |       | President and Chief  Executive Officer of Community Valley Bancorp                                              |       |
|             |       |    |       |                                                                                                            |       |
| John F. Coger    |       | 56      |       | Executive Vice  President and Chief Financial Officer and Chief Operating Officer of  Community Valley Bancorp. |       |

 

44

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**Item 11.Executive Compensation**

 

The persons serving as the executive officers of Community ValleyBancorp received during 2005, and are expected to continue to receive in 2006,cash compensation in their capacities as executive officers of Community ValleyBancorp

 

The following Summary Compensation Table indicates the compensation ofCommunity Valley Bancorp’s executive officers.

 

**2005**

 

**SummaryCompensation Table**

 
| **Annual Compensation**                                | ** ** | **Long Term Compensation** | ** ** | ** **      | ** ** |
|--------------------------------------------------------|------------|----------------------------|------------|-----------------|------------|
| ** **                                             | ** ** | ** **                 | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** | **Awards** | ** ** | **Payouts** | ** ** | ** ** | ** ** |
| **(a)**                                                | ** ** | **(b)**                    | ** ** | **(c)**         | ** ** | **(d)** | ** ** | **(e)** | ** ** | **(f)** | ** ** | **(g)** | ** ** | **(h)** | ** ** | **(i)** | ** ** |
| **Name and  Principal Position**                       | ** ** | **Year**                   | ** ** | **Salary  ($)** | ** ** | **Bonus  ($)** | ** ** | **Other  Annual  Compensation  ($)** | ** ** | **Restricted  Stock  Award(s)  ($)** | ** ** | **Options/  SARS** | ** ** | **LTIP  Payouts  ($)** | ** ** | **All Other  Compensation  ($)(4)(5)** | ** ** |
| Keith C Robbins                                        |       | 2005                       |       | $               | 255,918    | (1) | $ | 250,592 |   | 0 |   | 0 |   | 0 |   | 0 |   | $ | 17,464 |   |
| President and Chief                                    |       | 2004                       |       | $               | 234,108    | (2) | $ | 249,605 |   | 0 |   | 0 |   | 0 |   | 0 |   | $ | 20,998 |   |
| Executive Officer                                      |       | 2003                       |       | $               | 234,108    | (2) | $ | 237,527 |   | 0 |   | 0 |   | 0 |   | 0 |   | $ | 19,129 |   |
| John F Coger                                           |       | 2005                       |       | $               | 160,293    | (1) | $ | 191,645 |   | 0 |   | 0 |   | 0 |   | 0 |   | $ | 14,445 |   |
| Executive Vice President, Chief Financial Officer  and |       | 2004                       |       | $               | 147,540    | (3) | $ | 190,891 |   | 0 |   | 0 |   | 0 |   | 0 |   | $ | 13,460 |   |
| Chief Operating Officer                                |       | 2003                       |       | $               | 145,140    |   | $ | 181,654 |   | 0 |   | 0 |   | 0 |   | 0 |   | $ | 10,948 |   |

 

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(1) Includes$10,800 in directors fees

(2) Includes $9,600 in directors fees

(3) Includes $2,400 in directors fees

(4) This amount represents Butte Community Bank’scontribution under Butte Community Bank’s Employee Stock Ownership Plan, andthe cost of premiums for excess medical, dental and life insurance

(5) This amount does not include Butte CommunityBank’s contribution under Butte Community Bank’s Employee Stock Ownership Planas such amount has not yet been determined.

 

45

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**2005**

 

**Option/SARExercises and Year-End Value Table**

 

**AggregatedOption/SAR Exercises in Last Fiscal Year and Year-End Option/SAR Value**

 
| **(a)**         | ** ** | **(b)**                              | ** ** | **(c)**                 | ** ** | **(d)**                                                                                | ** ** | **(e)**                                                                                              | ** ** |
|-----------------|------------|--------------------------------------|------------|-------------------------|------------|----------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------|------------|
| **Name**        | ** ** | **Shares Acquired on  Exercise (#)** | ** ** | **Value Realized  ($)** | ** ** | **Number of  Unexercised  Options/SARs at  Year-End (#)  Exercisable/  Unexercisable** | ** ** | **Value of  Unexercised In-  the-Money  Options/SARs at  Year-End ($)  Exercisable/  Unexercisable** | ** ** |
| Keith C Robbins |       | -0-                                  |       | -0-                     |       | Options Only  50,610/0                                                                 |       | Options Only  $540,668/$0                                                                            |       |
|            |       |                                 |       |                    |       |                                                                                   |       |                                                                                                 |       |
| John F Coger    |       | -0-                                  |       | -0-                     |       | Options Only  441/0                                                                    |       | Options Only  $4,207/$0                                                                              |       |

 

46

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Mr. Robbins has a three year employment contract withCommunity Valley Bancorp beginning April 27, 1995 and which currently expiresApril 27, 2007. In addition, unless the employment contract is otherwiseterminated, the term of the employment contract shall automatically extend inannual increments of one year so as to always remain a three year employmentcontract. Mr. Robbins’ annual salary is currently fixed at $255,918 and may berenegotiated. Under the terms of the employment contract, Mr. Robbins isentitled to incentive compensation provided that Community Valley Bancorpattains a minimum 10% return on equity each year, as well as other criteria. Inthe event Community Valley Bancorp attains the minimum 10% return on equity, aswell as meeting other requirements, a bonus pool will be established in anamount equal to 22.5% of the amount in excess of the 10% return on equity. Mr.Robbins will be entitled to incentive compensation in the amount of 36.75% ofthe bonus pool. Mr. Robbins’ employment contract provides that in theevent he becomes disabled, he shall be entitled to 100% of his salary forninety days. In addition, if Community Valley Bancorp is merged, sold oracquired and the merging, purchasing or acquiring entity elects not to employMr. Robbins in a like position, he shall paid an amount equal to theremaining term of the employment contract.

 

Mr. Robbins has a salary continuation agreement withCommunity Valley Bancorp which provides that Community Valley Bancorp will payhim $150,000 plus a 3% cost of living adjustment per year for 20 yearsfollowing his retirement from Community Valley Bancorp at age 65 (“RetirementAge”), or until the death of the Employee whichever event last occurs. In theevent of disability while Mr. Robbins is actively employed prior toRetirement Age, he will have the option to take the $150,000 plus a 3% cost ofliving adjustment per year for 20 years beginning at the earlier of the timewhen he reaches age 65 or the date on which he is no longer entitled todisability benefits under his principal disability insurance policy. Iftermination of service occurs due to a change in control of Community ValleyBancorp, Mr. Robbins shall be entitled to receive $150,000 plus a 3% cost ofliving adjustment per year for 20 years payable on the first day of each monthcommencing within six months of the date of his termination of employment. Inthe event Mr. Robbins dies while actively employed by Community Valley Bancorpprior to Retirement Age, his beneficiary will receive from Community ValleyBancorp $150,000 plus a 3% cost of living adjustment per year for 20 yearsbeginning one month after his death. In the event of termination without cause,early retirement, or voluntary termination, Mr. Robbins shall receive $150,000plus a 3% cost of living adjustment per year for 20 years beginning with themonth following the month in which Mr. Robbins terminates employment andattains age 65. In the event Mr. Robbins is terminated for cause he willforfeit any benefits from the salary continuation agreement.

 

Mr. Robbins has an Executive Supplemental RetirementPlan Agreement that provides him with the option of deferring a portion of hissalary. Mr. Robbins has elected to defer $20,000 per year. Community ValleyBancorp has established a Deferral Account on its books for Mr. Robbinsand credits to the Deferral Account the fees deferred by Mr. Robbins andinterest on the account balance at a rate equal to Community Valley Bancorp’sprime lending rate as of December 31 of the previous year plus one-half percentcompounded each December 31 and assuming all deferrals have been made as ofJanuary 1 of such year. In addition, Community Valley Bancorp has purchased anannuity for protection of the benefits. All earnings received above CommunityValley Bancorp’s normal anticipated after tax return earnings on the annuityand the cost of an insurance policy related to this benefit are also creditedto Mr. Robbins’ Deferral Account. The Deferral Account is not a trust fund ofany kind and Mr. Robbins is a general unsecured creditor of Community ValleyBancorp for the payment of the benefits. Benefits under the SupplementalRetirement Plan Agreement are payable upon Mr. Robbins’ termination of service.Upon Mr. Robbins’ retirement at age 65, he will be entitled to the DeferralAccount balance in two hundred forty (240) monthly installments beginning onthe first day of the month following his retirement, unless Mr. Robbinselects one year prior to receiving any benefits to take benefits in a lump sumor otherwise. If Mr. Robbins retires or terminates service prior to the age of65, the amount of benefit payable is also the Deferral Account balance at thedate of termination of service in two hundred forty (240) monthly installmentsbeginning on the first day of month following his attaining age 65, unlessMr. Robbins elects one year prior to receiving any benefits to takebenefits in a lump sum or otherwise.

 

47

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If termination of service occurs due to disability, the amount ofbenefit payable is also the Deferral Account balance at the date of terminationof service in two hundred forty (240) monthly installments beginning on thefirst day of month following his disability, unless Mr. Robbins elects oneyear prior to receiving any benefits to take benefits in a lump sum orotherwise. If termination of service occurs due to a change in control ofCommunity Valley Bancorp, Community Valley Bancorp shall credit Mr. Robbins’Deferral Account with the entire amount that Mr. Robbins would have deferredfor the entire deferral period, and the amount of benefit shall be paid to Mr.Robbins within 30 days of the change in control. If Mr. Robbins suffershardship, Community Valley Bancorp may distribute to him all or a portion ofthe Deferral Account balance as necessary to relieve the financial hardship.

 

 Finally, iftermination of service occurs due to Mr. Robbins’ death, Community ValleyBancorp shall credit Mr. Robbins’ Deferral Account with the entire amount thatMr. Robbins would have deferred for the entire deferral period utilizing theproceeds from the insurance policy which Community Valley Bancorp purchased inconnection with this agreement. The amount shall be paid in two hundred forty(240) monthly installments beginning on the first day of the month followinghis death. Interest accrues on all amounts deferred until final payment.

 

Mr. Coger has a three year employment contract withCommunity Valley Bancorp beginning April 27, 1995 and which currently expiresApril 27, 2007. In addition, unless the employment contract is otherwiseterminated, the term of the employment contract shall automatically extend inannual increments of one year so as to always remain a three year employmentcontract. Mr. Coger’s annual salary is currently fixed at $169,263 and maybe renegotiated. Under the terms of the employment contract, Mr. Coger isentitled to incentive compensation provided that Community Valley Bancorpattains a minimum 10% return on equity each year, as well as other criteria. Inthe event Community Valley Bancorp attains the minimum 10% return on equity, aswell as meeting other requirements, a bonus pool will be established in anamount equal to 22.5% of the amount in excess of the 10% return on equity. Mr.Coger will be entitled to incentive compensation in the amount of 28.10% of thebonus pool. Mr. Coger’s employment contract provides that in the event hebecomes disabled, he shall be entitled to 100% of his salary for ninety days. Inaddition, if Community Valley Bancorp is merged, sold or acquired and themerging, purchasing or acquiring entity elects not to employ Mr. Coger ina like position, he shall paid an amount equal to the remaining term of theemployment contract.

 

Mr. Coger has a salary continuation agreement withCommunity Valley Bancorp which provides that Community Valley Bancorp will payhim $125,000 plus a 3% cost of living adjustment per year for 20 yearsfollowing his retirement from Community Valley Bancorp at age 65 (“RetirementAge”), or until the death of the Employee whichever event last occurs. In theevent of disability while Mr. Coger is actively employed prior toRetirement Age, he will have the option to take the $125,000 plus a 3% cost ofliving adjustment per year for 20 years beginning at the earlier of the timewhen he reaches age 65 or the date on which he is no longer entitled todisability benefits under his principal disability insurance policy. Iftermination of service occurs due to a change in control of Community ValleyBancorp, Mr. Coger shall be entitled to receive $125,000 plus a 3% cost ofliving adjustment per year for 20 years payable on the first day of each monthcommencing within six months of the date of his termination of employment. Inthe event Mr. Coger dies while actively employed by Community ValleyBancorp prior to Retirement Age, his beneficiary will receive from CommunityValley Bancorp $125,000 plus a 3% cost of living adjustment per year for 20years beginning one month after his death. In the event of termination withoutcause, early retirement, or voluntary termination, Mr. Coger shall receive$125,000 plus a 3% cost of living adjustment per year for 20 years beginningwith the month following the month in which Mr. Coger terminates employment andattains age 65. In the event Mr. Coger is terminated for cause he will forfeitany benefits from the salary continuation agreement.

 

Mr. Coger has an Executive Supplemental Retirement Plan Agreement thatprovides him with the option of deferring a portion of his salary. Mr. Cogerhas elected to defer $10,000 per year. Community Valley Bancorp has establisheda Deferral Account on its books for Mr. Coger and credits to the DeferralAccount the fees deferred by Mr. Coger and interest on the account balance at arate equal to Community Valley Bancorp’s prime lending rate as of December 31of the previous year plus one-half percent compounded each December 31 andassuming all deferrals have been made as of January 1 of such year. Inaddition, Community Valley Bancorp has purchased an annuity for protection ofthe benefits.

 

48

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All earnings received above Community Valley Bancorp’s normalanticipated after tax return earnings on the annuity and the cost of aninsurance policy related to this benefit are also credited to Mr. Coger’sDeferral Account. The Deferral Account is not a trust fund of any kind and Mr.Coger is a general unsecured creditor of Community Valley Bancorp for thepayment of the benefits. Benefits under the Supplemental Retirement PlanAgreement are payable upon Mr. Coger’s termination of service. Upon Mr. Coger’sretirement at age 65, he will be entitled to the Deferral Account balance intwo hundred forty (240) monthly installments beginning on the first day of themonth following his retirement, unless Mr. Coger elects one year prior toreceiving any benefits to take benefits in a lump sum or otherwise. IfMr. Coger retires or terminates service prior to the age of 65, the amountof benefit payable is also the Deferral Account balance at the date oftermination of service in two hundred forty (240) monthly installmentsbeginning on the first day of month following his attaining age 65, unlessMr. Coger elects one year prior to receiving any benefits to take benefitsin a lump sum or otherwise. If termination of service occurs due to disability,the amount of benefit payable is also the Deferral Account balance at the dateof termination of service in two hundred forty (240) monthly installmentsbeginning on the first day of month following his disability, unlessMr. Coger elects one year prior to receiving any benefits to take benefitsin a lump sum or otherwise.

 

If termination of service occurs due to a change in control ofCommunity Valley Bancorp, Community Valley Bancorp shall credit Mr. Coger’sDeferral Account with the entire amount that Mr. Coger would have deferredfor the entire deferral period, and the amount of benefit shall be paid to Mr.Coger within 30 days of the change in control. If Mr. Coger suffershardship, Community Valley Bancorp may distribute to him all or a portion ofthe Deferral Account balance as necessary to relieve the financial hardship. Finally,if termination of service occurs due to Mr. Coger’s death, CommunityValley Bancorp shall credit Mr. Coger’s Deferral Account with the entire amountthat Mr. Coger would have deferred for the entire deferral period utilizing theproceeds from the insurance policy which Community Valley Bancorp purchased inconnection with this agreement. The amount shall be paid in two hundred forty(240) monthly installments beginning on the first day of the month followinghis death. Interest accrues on all amounts deferred until final payment.

 

**Item 12.Security Ownership of Certain Beneficial Owners and Management**

 

Management of Community Valley Bancorp knows of no person who owns,beneficially or of record, either individually or together with associates, 5percent or more of the outstanding shares of common stock, except as set forthin the table below. The following table sets forth, as of February 15, 2006,the number and percentage of shares of outstanding common stock beneficiallyowned, directly or indirectly, by each of Community Valley Bancorp’s directorsand principal shareholders and by the directors and officers of CommunityValley Bancorp as a group. The shares “beneficially owned” are determined underSecurities and Exchange Commission Rules, and do not necessarily indicateownership for any other purpose. In general, beneficial ownership includesshares over which the director, principal shareholder or officer has sole orshared voting or investment power and shares which such person has the right toacquire within 60 days of February 15, 2006. Unless otherwise indicated, thepersons listed below have sole voting and investment powers of the sharesbeneficially owned. Management is not aware of any arrangements which may, at asubsequent date, result in a change of control of Community Valley Bancorp.

 

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| **Amount and Nature of   Beneficial Owner**       | ** ** | **Beneficial Ownership** | ** ** | **Percent of Class(1)** | ** ** |
|---------------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
|                                              |       |                     |       |                    |       |
| Directors and Named Officers:                     |       |                     |       |                    |       |
| M. Robert Ching, M.D.                             |       | 193,972                  | (2)        | 2.59                    |       |
| John F. Coger                                     |       | 170,660                  | (3)        | 2.30                    |       |
| Eugene B. Even                                    |       | 118,796                  | (4)        | 1.59                    |       |
| John D. Lanam                                     |       | 176,574                  | (5)        | 2.36                    |       |
| Donald W. Leforce                                 |       | 208,464                  | (6)        | 2.79                    |       |
| Charles J. Mathews                                |       | 5,862                    | (7)        | 0.08                    |       |
| Ellis L. Matthews                                 |       | 98,348                   | (8)        | 1.32                    |       |
| Luther W. McLaughlin                              |       | 6,804                    | (9)        | 0.09                    |       |
| Robert L. Morgan, M.D                             |       | 277,916                  | (10)       | 3.72                    |       |
| James S. Rickards                                 |       | 159,462                  | (11)       | 2.14                    |       |
| Keith C. Robbins                                  |       | 195,948                  | (12)       | 2.62                    |       |
| Jack B. Schmelke                                  |       | 400,354                  | (13)       | 5.38                    |       |
| Gary B. Strauss, M.D.                             |       | 310,964                  | (14)       | 4.16                    |       |
| Hubert I. Townshend                               |       | 236,914                  | (15)       | 3.18                    |       |
|                                              |       |                     |       |                    |       |
| Principal Shareholder                             |       |                     |       |                    |       |
| Community Valley Bancorp ESOP                     |       | 423,863                  | (15)       | 5.70                    |       |
|                                              |       |                     |       |                    |       |
| All Directors and Officers as a Group (14 in all) |       | 2,561,038                |       | 32.81                   |       |

 

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(1)           Includesshares subject to options held by each director and the directors and officersas a group that are exercisable within 60 days of February 15, 2006. These aretreated as issued and outstanding for the purpose of computing the percentageof each director and the directors and officers as a group but not for thepurpose of computing the percentage of class of any other person.

 

(2)           Dr.Ching has shared voting and investment powers as to 25,332 these shares and has53,060 acquirable by exercise of stock options.

 

(3)           Mr.Coger has shared voting and investment powers as to 125,612 of these shares andhas 411 shares acquirable by exercise of stock options.

 

(4)           Mr.Even has 26,666 shares acquirable by exercise of stock options.

 

(5)           Mr.Lanam has shared voting and investment powers as to 117,252 shares and has31,890 shares acquirable by exercise of stock options.

 

(6)           Mr.Leforce has shared voting and investment powers as to 166,130 shares and has35,740shares acquirable by exercise of stock options.

 

(7)           Mr.C. Mathews has shared voting and investment powers as to 3,730 shares and has2,132 shares acquirable by exercise of stock options.

 

(8)           Mr.E. Matthews has 33,230 shares acquirable by exercise of stock options.

 

(9)           Mr.McLaughlin has shared voting and investment powers as to 6,004 shares and has800 shares acquirable by exercise of stock options.

 

(10)         Dr.Morgan has shared voting and investment powers as to 244,053 shares and has33,863 shares acquirable by exercise of stock options.

 

50

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(11)         Mr.Rickards has shared voting and investment powers as to 127,272 shares and has32,190 shares acquirable by exercise of stock options.

 

(12)         Mr.Robbins has shared voting and investment powers as to 40,094 shares and has50,610 shares acquirable by exercise of stock options.

 

(13)         Mr.Schmelke has shared voting and investment powers as to 400,354 shares.

 

(14)         Dr.Strauss has shared voting and investment powers as to 207,982 shares and has43,060 shares acquirable by exercise of stock options.

 

(15)         Mr.Townshend has shared voting and investment powers as to 16,112 shares and26,666 shares acquirable by exercise of stock options.

 

(16)         CommunityValley Bancorp ESOP’s address is c/o Community Valley Bancorp, 2041 ForestAvenue, Chico, California 95928.

 

**Item 13.****         CertainRelationships and Related Transactions**

 

Some of the directors and officers of Community Valley Bancorp and thecompanies with which they are associated are customers of, or have had bankingtransactions with, Community Valley Bancorp in the ordinary course of CommunityValley Bancorp’s business, and Community Valley Bancorp expects to have bankingtransactions with such persons in the future. In the opinion of CommunityValley Bancorp’s management, all loans and commitments to lend in suchtransactions were made in compliance with applicable laws and on substantiallythe same terms, including interest rates and collateral, as those prevailingfor comparable transactions with other persons of similar creditworthiness anddid not involve more than a normal risk of collectibility or present otherunfavorable features.

 

**Item 14.****         PrincipalAccountant Fees and Services**

 

The information required by this item can be found in the Company’sDefinitive Proxy Statement pursuant to Regulation 14A under the Securities andExchange Act of 1934 and is by this reference incorporated herein.

 

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**PART IV**

 

**Item 15.****         Exhibits,Financial Statement Schedules, and Reports on Form 8-K**.

 

(a)           **List ofdocuments filed as part of this report**

 

(1)           **Financial Statements**

 

The following financial statements and independentauditor’s reports are included in this Annual Report on Form 10-K immediatelyfollowing.

 
|   | I.   | Report of  Independent Registered Public Accounting Firm                                                             |
|--------|------|----------------------------------------------------------------------------------------------------------------------|
|   | II.  | Consolidated Balance  Sheet - December 31, 2005 and 2004                                                             |
|   | III. | Consolidated  Statement of Income - Years Ended December 31, 2005, 2004 and 2003                                |
|   | IV.  | Consolidated  Statement of Changes in Shareholders’ Equity - Years Ended December 31,  2005, 2004 and 2003 |
|   | V.   | Consolidated  Statement of Cash Flows - Years Ended December 31, 2005, 2004 and 2003                                 |
|   | VI.  | Notes to the  Consolidated Financial Statements                                                                      |

 

(2)           **Financial Statement Schedules**

 

Schedules to the financial statements are omittedbecause the required information is not applicable or because the requiredinformation is presented in the Company’s Consolidated Financial Statements orrelated notes.

 

(3)           **Exhibits**

 
| **Exhibit** | ** ** | ** **               |
|-------------|------------|--------------------------|
| **Number**  | ** ** | **Document Description** |
|        |       |                     |
|        | (3.1)      |                     | Articles of Incorporation incorporated by reference  from the Company’s Registration Statement Form S-4EF,  file #333-85950. |
|        |       |                     |   |
|        | (3.2)      |                     | Bylaws incorporated by reference from the Company’s  Registration Statement Form S-4EF, file #333-85950. |
|        |       |                     |   |
|        | (4)        |                     | Specimen of Company’s Common Stock Certificate  incorporated by reference from the Company’s Registration Statement Form  S-4EF, file #333-85950. |
|        |       |                     |   |
|        | (10.1)     |                     | Employment Agreement with Keith C. Robbins dated  April 27, 1995. Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002. |
|        |       |                     |   |
|        | (10.2)     |                     | Salary Continuation Agreement dated April 14, 1998, and  Amendment to Salary Continuation Agreement dated January 10, 2002, for Keith  C. Robbins. Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002. |
|        |       |                     |   |
|        | (10.2)1.   |                     | Amendment to Salary  Continuation Agreement of April 14, 1998 for Keith C Robbins dated January 1,  2004. Incorporated by reference to the Company’s Annual Report on Form 10-K  for the period ended December 31, 2003, filed with the Commission on March  20, 2004. |
|        |       |                     |   |
|        | (10.3)     |                     | Executive Supplemental Retirement Plan dated August  1, 2000, and Amendment to Executive Supplement Retirement Plan dated January  10, 2002, for Keith C. Robbins. Incorporated  by reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002. |
|        |       |                     |   |
|        | (10.4)     |                     | 1997 Stock Option Agreement for Keith C. Robbins  dated May 1, 1997. Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002. |

 

52

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|   | (10.5)   |   | 2000 Stock Option Agreement for Keith C. Robbins  dated March 14, 2000. Incorporated  by reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002.                                                                                         |
|--------|----------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |     |   |                                                                                                                                                                                                                                                                                                                              |
|   | (10.6)   |   | Employment Agreement with John F. Coger dated April  27, 1995. Incorporated by reference  to the Company’s Quarterly Report on Form 10-Q for the period ended June 30,  2002, filed with the Commission on August 14, 2002.                                                                                                  |
|   |     |   |                                                                                                                                                                                                                                                                                                                              |
|   | (10.7)   |   | Salary Continuation Agreement dated April 14, 1998,  and Amendment to Salary Continuation Agreement dated January 10, 2002, for  John F. Coger. Incorporated by reference  to the Company’s Quarterly Report on Form 10-Q for the period ended June 30,  2002, filed with the Commission on August 14, 2002.                 |
|   |     |   |                                                                                                                                                                                                                                                                                                                              |
|   | (10.7)1. |   | Amendment to Salary  Continuation Agreement of April 14, 1998 for John F. Coger dated  January 1, 2004. Incorporated by reference to the Company’s Annual Report on  Form 10-K for the period ended December 31, 2003, filed with the Commission  on March 20, 2004.                                                         |
|   |     |   |                                                                                                                                                                                                                                                                                                                              |
|   | (10.8)   |   | Executive Supplemental Retirement Plan dated August  1, 2000, and Amendment to Executive Supplement Retirement Plan dated January  10, 2002, for John F. Coger. Incorporated  by reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002. |
|   |     |   |                                                                                                                                                                                                                                                                                                                              |
|   | (10.9)   |   | 2000 Stock Option Agreement for John F. Coger dated  March 14, 2000 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.                                                                                             |
|   |     |   |                                                                                                                                                                                                                                                                                                                              |
|   | (10.10)  |   | 1997 Stock Option Agreement for M. Robert Ching  dated May 1, 1997 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.                                                                                              |
|   |     |   |                                                                                                                                                                                                                                                                                                                              |
|   | (10.11)  |   | 2000 Stock Option Agreement for M. Robert Ching  dated May 1, 2000. Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.                                                                                             |
|   |     |   |                                                                                                                                                                                                                                                                                                                              |
|   | (10.12)  |   | 1997 Stock Option Agreement for Eugene B. Even dated  May 1, 1997 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.                                                                                               |
|   |     |   |                                                                                                                                                                                                                                                                                                                              |
|   | (10.13)  |   | 2000 Stock Option Agreement for Eugene B. Even dated  May 1, 2000. Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.                                                                                              |
|   |     |   |                                                                                                                                                                                                                                                                                                                              |
|   | (10.14)  |   | 1997 Stock Option Agreement for John D. Lanam dated  May 1, 1997. Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.                                                                                               |
|   |     |   |                                                                                                                                                                                                                                                                                                                              |
|   | (10.15)  |   | 2000 Stock Option Agreement for John D. Lanam dated  May 1, 2000. Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.                                                                                               |
|   |     |   |                                                                                                                                                                                                                                                                                                                              |
|   | (10.16)  |   | 1997 Stock Option Agreement for Donald W. Leforce  dated May 1, 1997. Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.                                                                                           |
|   |     |   |                                                                                                                                                                                                                                                                                                                              |
|   | (10.17)  |   | 2000 Stock Option Agreement for Donald W. Leforce  dated May 1, 2000 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.                                                                                            |
|   |     |   |                                                                                                                                                                                                                                                                                                                              |
|   | (10.18)  |   | 1997 Stock Option Agreement for Ellis L. Matthews  dated May 1, 1997 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.                                                                                            |
|   |     |   |                                                                                                                                                                                                                                                                                                                              |
|   | (10.19)  |   | 2000 Stock Option Agreement for Ellis L. Matthews  dated May 1, 2000 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.                                                                                            |
|   |     |   |                                                                                                                                                                                                                                                                                                                              |
|   | (10.20)  |   | 1997 Stock Option Agreement for Robert L. Morgan  dated May 1, 1997 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.                                                                                             |

 

53

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|   | (10.21) |   | 2000 Stock Option Agreement for Robert L. Morgan  dated May 1, 2000 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.          |
|--------|---------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |    |   |                                                                                                                                                                                                                                           |
|   | (10.22) |   | 1997 Stock Option Agreement for James S. Rickards  dated May 1, 1997. Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.        |
|   |    |   |                                                                                                                                                                                                                                           |
|   | (10.23) |   | 2000 Stock Option Agreement for James S. Rickards  dated May 1, 2000 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.         |
|   |    |   |                                                                                                                                                                                                                                           |
|   | (10.24) |   | 1997 Stock Option Agreement for Gary B. Strauss  dated May 1, 1997 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.           |
|   |    |   |                                                                                                                                                                                                                                           |
|   | (10.25) |   | 2000 Stock Option Agreement for Gary B. Strauss  dated May 1, 2000. Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.          |
|   |    |   |                                                                                                                                                                                                                                           |
|   | (10.26) |   | 1997 Stock Option Agreement for Hubert I. Townshend  dated May 1, 1997 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.       |
|   |    |   |                                                                                                                                                                                                                                           |
|   | (10.27) |   | 2000 Stock Option Agreement for Hubert I. Townshend  dated May 1, 2000 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.       |
|   |    |   |                                                                                                                                                                                                                                           |
|   | (10.28) |   | Director Deferred Fee Agreement for M. Robert Ching  dated April 8, 1998 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.     |
|   |    |   |                                                                                                                                                                                                                                           |
|   | (10.29) |   | Director Retirement Agreement for M. Robert Ching  dated April 14, 1998 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.      |
|   |    |   |                                                                                                                                                                                                                                           |
|   | (10.30) |   | Director Retirement Agreement for Eugene B. Even  dated April 14, 1998 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.       |
|   |    |   |                                                                                                                                                                                                                                           |
|   | (10.31) |   | Director Retirement Agreement for John D. Lanam  dated April 14, 1998. Incorporated  by reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002.       |
|   |    |   |                                                                                                                                                                                                                                           |
|   | (10.32) |   | Director Deferred Fee Agreement for Donald W.  Leforce dated April 14, 1998  Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the period ended June 30, 2002, filed with the Commission on August 14, 2002   |
|   |    |   |                                                                                                                                                                                                                                           |
|   | (10.33) |   | Director Retirement Agreement for Donald W. Leforce  dated April 14, 1998 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.    |
|   |    |   |                                                                                                                                                                                                                                           |
|   | (10.34) |   | Director Retirement Agreement for Ellis L. Matthews  dated April 14, 1998. Incorporated  by reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002.   |
|   |    |   |                                                                                                                                                                                                                                           |
|   | (10.35) |   | Director Retirement Agreement for Robert L. Morgan  dated April 14, 1998 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.     |
|   |    |   |                                                                                                                                                                                                                                           |
|   | (10.36) |   | Director Retirement Agreement James S. Rickards  dated April 14, 1998 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period ended  June 30, 2002, filed with the Commission on August 14, 2002.        |
|   |    |   |                                                                                                                                                                                                                                           |
|   | (10.37) |   | Director Retirement Agreement for Gary B. Strauss  dated April 14, 1998. Incorporated  by reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002.     |
|   |    |   |                                                                                                                                                                                                                                           |
|   | (10.38) |   | Director Retirement Agreement for Hubert I.  Townshend dated April 14, 1998.  Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for  the period ended June 30, 2002, filed with the Commission on August 14, 2002. |

 

54

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|   | (10.39) |   | Lease agreement between Butte Community Bank and  Anna Laura Schilling Trust dated March 20, 2001, related to 900 Mangrove  Ave., Chico, California. Incorporated  by reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002. |
|--------|---------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |    |   |                                                                                                                                                                                                                                                                                                                   |
|   | (10.40) |   | 2000 Stock Option Agreement for Charles J. Mathews  dated October 21, 2003 filed herewith.                                                                                                                                                                                                                             |
|   |    |   |                                                                                                                                                                                                                                                                                                                   |
|   | (10.41) |   | 2000 Stock Option Agreement for Luther W. McLaughlin  dated March 10, 2005 filed herewith.                                                                                                                                                                                                                             |
|   |    |   |                                                                                                                                                                                                                                                                                                                   |
|   | (11)    |   | See Item 6. Selected Financial Data Note 1 for  Statement re computation of earnings per share                                                                                                                                                                                                                         |
|   |    |   |                                                                                                                                                                                                                                                                                                                   |
|   | (12)    |   | See Item 6. Selected Financial Data Notes 2 through  6 for Statements re computation of ratios                                                                                                                                                                                                                         |
|   |    |   |                                                                                                                                                                                                                                                                                                                   |
|   | (23.1)  |   | Consent of Indpendent Registered Public Accounting  Firm                                                                                                                                                                                                                                                               |
|   |    |   |                                                                                                                                                                                                                                                                                                                   |
|   | (31.1)  |   | Rule 13a-14(a)/15d-14(a) certification of Chief  Executive Officer                                                                                                                                                                                                                                                     |
|   |    |   |                                                                                                                                                                                                                                                                                                                   |
|   | (31.2)  |   | Rule 13a-14(a)/15d-14(a) certification of Chief  Financial Officer                                                                                                                                                                                                                                                     |
|   |    |   |                                                                                                                                                                                                                                                                                                                   |
|   | (32.1)  |   | Section 1350 certification of Chief Executive  Officer                                                                                                                                                                                                                                                                 |
|   |    |   |                                                                                                                                                                                                                                                                                                                   |
|   | (32.2)  |   | Section 1350 certification of Chief Financial  Officer                                                                                                                                                                                                                                                                 |
|   |    |   |                                                                                                                                                                                                                                                                                                                   |
|   | (99.1)  |   | 1997 Stock Option Plan is incorporated by reference  from the Company’s Registration Statement Form S-8, filed August 14, 2002.                                                                                                                                                                                   |
|   |    |   |                                                                                                                                                                                                                                                                                                                   |
|   | (99.2)  |   | 2000 Stock Option Plan is incorporated by reference  from the Company’s Registration Statement Form S-8, filed August 14, 2002.                                                                                                                                                                                   |
|   |    |   |                                                                                                                                                                                                                                                                                                                   |
|   | (99.3)  |   | Director Emeritus Plan dated March 20, 2001. Incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the period ended June 30, 2002, filed with  the Commission on August 14, 2002.                                                                                                         |

 

(b) Reports on Form 8-K

 

OnMarch 16, 2005 the company issued a press release announcing the payment of aseven and one-half cent dividend to shareholders of record as of March 31, 2005.The payment date for the dividend was April 22, 2005.

 

OnApril 13, 2005 the Company issued a press release announcing a two-for-onestock split to shareholders of record as of May 2, 2005.

 

OnApril 19, 2005 the Company issued a press release announcing first quarter 2005earnings.

 

OnApril 28, 2005 the Company issued a press release announcing its plans to applyfor listing on the NASDAQ Small Cap Market.

 

OnJuly 1, 2005 the Company issued a press release announcing the appointment ofJack Schmelke to it’s Board of Directors effective June 22, 2005.

 

OnJuly 1, 2005 the Company issued a press release announcing the payment of afour cent dividend to shareholders of record as of July 8, 2005. The paymentdate for the dividend was July 29, 2005.

 

OnJuly 21, 2005 the Company issued a press release announcing second quarter 2005earnings.

 

OnSeptember 26, 2005 the Company issued a press release announcing the payment ofa four cent dividend to shareholders of record as of September 30, 2005. Thepayment date for the dividend was October 28, 2005.

 

OnOctober 18, 2005 the Company issued a press release announcing third quarter2005 earnings.

 

OnDecember 23, 2005 the Company issued a press release announcing the payment ofa four cent dividend to shareholders of record as of December 30, 2005. Thepayment date for the dividend was January 27, 2005.

 

OnJanuary 20, 2006 the Company issued a press release announcing fourth quarter2005 earnings.

 

55

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**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities and Exchange Act of 1934, the Registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 

 
| Dated:  March  16, 2006 | **COMMUNITY VALLEY BANCORP** |
|------------------------------|------------------------------|
|                         | a California corporation     |
|                         |                         |
|                         | By:                          | */s/ Keith C. Robbins* |   |
|                         |                         | Keith C. Robbins |
|                         |                         | President and  Chief Executive Officer |
|                         |                         |   |
|                         | By:                          | */s/ John F. Coger* |   |
|                         |                         | John F. Coger |
|                         |                         | Executive Vice  President  and Chief Financial Officer |

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this report has been signed below by the followingpersons on behalf of the registrant and in the capacities and on the datesindicated.

 
| **Signature**           | ** ** | **Title** | ** **                        | **Date** |
|-------------------------|------------|-----------|-----------------------------------|----------|
|                    |       |      |                              |     |
| */s/ M. Robert Ching*   |       |      | Director                          |     | March 16, 2006 |
| M. Robert Ching         |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ John F. Coger*     | * *   | * *  | Executive Vice President, CFO/COO |     | March 16, 2006 |
| John F. Coger           |       |      | and Director                      |     |   |
|                    |       |      |                              |     |   |
| */s/Eugene B. Even*     |       |      | Director                          |     | March 16, 2006 |
| Eugene B. Even          |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ John D. Lanam*     |       |      | Director                          |     | March 16, 2006 |
| John D. Lanam           |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ Donald W. Leforce* |       |      | Chairman of the Board             |     | March 16, 2006 |
| Donald W. Leforce       |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ Charles Mathews*   |       |      | Director                          |     | March 16, 2006 |
| Charles Mathews         |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ Ellis L. Matthews* |       |      | Director                          |     | March 16, 2006 |
| Ellis L. Matthews       |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ Luther McLaughlin* |       |      | Director                          |     | March 16, 2006 |
| Luther McLaughlin       |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ Robert L. Morgan*  |       |      | Director                          |     | March 16, 2006 |
| Robert L. Morgan        |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ Keith C. Robbins*  | * *   | * *  | President, Chief Executive        |     | March 16, 2006 |
| Keith C. Robbins        |       |      | Officer and Director              |     |   |
|                    |       |      |                              |     |   |
| */s/ James S. Rickards* |       |      | Director and                      |     | March 16, 2006 |
| James S. Rickards       |       |      | Corporate Secretary               |     |   |
|                    |       |      |                              |     |   |
| */s/ Gary B. Strauss*   |       |      | Director                          |     | March 16, 2006 |
| Gary B. Strauss         |       |      | Vice Chairman                     |     |   |
|                    |       |      |                              |     |   |
| */s/ Jack B. Schmelke*  |       |      | Director                          |     | March 16, 2006 |
| Jack B. Schmelke        |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ Hubert Townshend*  | * *   | * *  | Director                          |     | March 16, 2006 |
| Hubert Townshend        |       |      |                              |     |   |

 

56

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** **

**COMMUNITYVALLEY BANCORP AND SUBSIDIARIES**

 

**CONSOLIDATEDFINANCIAL STATEMENTS**

 

**AS OF DECEMBER 31,2005 AND 2004**

 

**AND FORTHE YEARS ENDED**

 

**DECEMBER 31,2005, 2004 AND 2003**

 

**AND**

 

**REPORT OFINDEPENDENT REGISTERED**

 

**PUBLICACCOUNTING FIRM**

 

 

57

----

 

# ***REPORT OF INDEPENDENTREGISTERED PUBLIC ACCOUNTING FIRM***

 

The Board of Directorsand Shareholders

Community Valley Bancorp

 

We have audited theaccompanying consolidated balance sheet of Community Valley Bancorp and subsidiariesas of December 31, 2005 and 2004, and the related consolidated statementsof income, changes in shareholders’ equity and cash flows for each of the yearsin the three-year period ended December 31, 2005. These consolidatedfinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these consolidated financialstatements based on our audits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudits to obtain reasonable assurance about whether the consolidated financialstatements are free of material misstatement. An audit includes examining, on atest basis, evidence supporting the amounts and disclosures in the financialstatements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of Community ValleyBancorp and subsidiaries as of December 31, 2005 and 2004 and theconsolidated results of their operations and their cash flows for each of theyears in the three-year period ended December 31, 2005, in conformity withaccounting principles generally accepted in the United States of America.

 

 
|   | /s/ Perry-Smith LLP |   |
|--------|---------------------|--------|

 

 

Sacramento, California

February 17, 2006

 

58

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**COMMUNITY VALLEY BANCORP AND SUBSIDIARIES**

 

**CONSOLIDATEDBALANCE SHEET**

 

**December 31, 2005 and 2004**

 
| ** **                                                                                                                                   | ** ** | **2005**    | ** **  | **2004**    | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|-------------|-------------|------------|
| **ASSETS**                                                                                                                                   |       |        |        |        |       |
|                                                                                                                                         |       |        |        |        |       |
| Cash  and due from banks                                                                                                                     |       | $           | 18,988,000  |        | $          | 21,778,000 |   |
| Federal  funds sold                                                                                                                          |       | 29,015,000  |        | 46,440,000  |       |
|                                                                                                                                         |       |        |        |        |       |
| Total  cash and cash equivalents                                                                                                             |       | 48,003,000  |        | 68,218,000  |       |
|                                                                                                                                         |       |        |        |        |       |
| Interest-bearing  deposits in banks                                                                                                          |       | 6,636,000   |        | 8,715,000   |       |
| Loans  held for sale, at lower of cost or market                                                                                             |       | 2,197,000   |        | 1,490,000   |       |
| Investment  securities (Note 2):                                                                                                             |       |        |        |        |       |
| Available-for-sale,  at fair value                                                                                                           |       | 4,344,000   |        | 4,379,000   |       |
| Held-to-maturity,  at cost                                                                                                                   |       | 2,332,000   |        | 2,582,000   |       |
| Loans,  less allowance for loan losses of $4,716,000 in 2005 and $4,000,000 in 2004  (Notes 3, 10 and 14)                                    |       | 401,221,000 |        | 339,555,000 |       |
| Premises  and equipment, net (Note 5)                                                                                                        |       | 11,221,000  |        | 9,027,000   |       |
| Bank  owned life insurance (Note 15)                                                                                                         |       | 8,447,000   |        | 6,703,000   |       |
| Accrued  interest receivable and other assets (Notes 4 and 13)                                                                               |       | 10,376,000  |        | 9,387,000   |       |
|                                                                                                                                         |       |        |        |        |       |
| Total  assets                                                                                                                                |       | $           | 494,777,000 |        | $          | 450,056,000 |   |
|                                                                                                                                         |       |        |        |        |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                               |       |        |        |        |       |
|                                                                                                                                         |       |        |        |        |       |
| Deposits:                                                                                                                                    |       |        |        |        |       |
| Non-interest  bearing                                                                                                                        |       | $           | 83,336,000  |        | $          | 80,793,000 |   |
| Interest  bearing (Note 6)                                                                                                                   |       | 350,682,000 |        | 318,266,000 |       |
|                                                                                                                                         |       |        |        |        |       |
| Total  deposits                                                                                                                              |       | 434,018,000 |        | 399,059,000 |       |
|                                                                                                                                         |       |        |        |        |       |
| Notes  Payable (Notes 8 and 15)                                                                                                              |       | 1,782,000   |        | 833,000     |       |
| Junior  subordinated debentures (Note 9)                                                                                                     |       | 8,248,000   |        | 8,248,000   |       |
| Accrued  interest payable and other liabilities (Note 15)                                                                                    |       | 9,174,000   |        | 7,385,000   |       |
|                                                                                                                                         |       |        |        |        |       |
| Total  liabilities                                                                                                                           |       | 453,222,000 |        | 415,525,000 |       |
|                                                                                                                                         |       |        |        |        |       |
| Commitments  and contingencies (Note 10)                                                                                                     |       |        |        |        |       |
|                                                                                                                                         |       |        |        |        |       |
| Shareholders’  equity (Note 11):                                                                                                        |       |        |        |        |       |
| Common  stock - no par value; authorized – 20,000,000 shares, outstanding – 7,408,047  shares in 2005 and 7,273,582 shares in 2004 |       | 9,051,000   |        | 7,862,000   |       |
| Unallocated  ESOP shares (185,051 shares in 2005 and 179,256 shares in 2004, at cost)  (Note 15)                                             |       | (1,391,000  | )           | (1,144,000  | )          |
| Retained  earnings                                                                                                                           |       | 33,908,000  |        | 27,802,000  |       |
| Accumulated  other comprehensive (loss) income, net of taxes (Note 2)                                                                        |       | (13,000     | )           | 11,000      |       |
|                                                                                                                                         |       |        |        |        |       |
| Total  shareholders’ equity                                                                                                             |       | 41,555,000  |        | 34,531,000  |       |
|                                                                                                                                         |       |        |        |        |       |
| Total  liabilities and shareholders’ equity                                                                                             |       | $           | 494,777,000 |        | $          | 450,056,000 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

59

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**COMMUNITYVALLEY BANCORP AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENT OF INCOME**

 

### **For the Years Ended December 31, 2005, 2004 and2003**

 
| ** **                                                   | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|--------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
|                                                         |       |       |       |       |       |       |       |
| Interest  income:                                            |       |       |       |       |       |       |       |
| Interest  and fees on loans                                  |       | $          | 30,946,000 |       | $          | 24,043,000 |       | $ | 20,528,000 |   |
| Interest  on Federal funds sold                              |       | 943,000    |       | 488,000    |       | 634,000    |       |
| Interest  on deposits in banks                               |       | 239,000    |       | 244,000    |       | 201,000    |       |
| Interest  on investment securities:                          |       |       |       |       |       |       |       |
| Taxable                                                      |       | 199,000    |       | 151,000    |       | 105,000    |       |
| Exempt  from Federal income taxes                            |       | 111,000    |       | 54,000     |       | 49,000     |       |
|                                                         |       |       |       |       |       |       |       |
| Total  interest income                                       |       | 32,438,000 |       | 24,980,000 |       | 21,517,000 |       |
|                                                         |       |       |       |       |       |       |       |
| Interest  expense:                                           |       |       |       |       |       |       |       |
| Interest  expense on deposits (Note 6)                       |       | 4,668,000  |       | 3,585,000  |       | 3,924,000  |       |
| Interest  expense on junior subordinated debentures (Note 9) |       | 592,000    |       | 438,000    |       | 439,000    |       |
| Interest  expense on notes payable (Notes 8 and 15)          |       | 71,000     |       | 33,000     |       | 33,000     |       |
|                                                         |       |       |       |       |       |       |       |
| Total  interest expense                                      |       | 5,331,000  |       | 4,056,000  |       | 4,396,000  |       |
|                                                         |       |       |       |       |       |       |       |
| Net  interest income before provision for loan losses        |       | 27,107,000 |       | 20,924,000 |       | 17,121,000 |       |
|                                                         |       |       |       |       |       |       |       |
| Provision  for loan losses (Note 3)                          |       | 724,000    |       | 734,000    |       | 586,000    |       |
|                                                         |       |       |       |       |       |       |       |
| Net  interest income after provision for loan losses         |       | 26,383,000 |       | 20,190,000 |       | 16,535,000 |       |
|                                                         |       |       |       |       |       |       |       |
| Non-interest  income:                                        |       |       |       |       |       |       |       |
| Service  charges and fees                                    |       | 2,351,000  |       | 2,086,000  |       | 1,397,000  |       |
| Gain  on sale of loans                                       |       | 1,806,000  |       | 1,637,000  |       | 1,978,000  |       |
| Loan  servicing income                                       |       | 481,000    |       | 571,000    |       | 1,185,000  |       |
| Other  (Note 12)                                             |       | 2,073,000  |       | 1,724,000  |       | 1,390,000  |       |
|                                                         |       |       |       |       |       |       |       |
| Total  non-interest income                                   |       | 6,711,000  |       | 6,018,000  |       | 5,950,000  |       |
|                                                         |       |       |       |       |       |       |       |
| Non-interest  expenses:                                      |       |       |       |       |       |       |       |
| Salaries  and employee benefits (Notes 3 and 15)             |       | 12,270,000 |       | 9,980,000  |       | 8,151,000  |       |
| Occupancy  and equipment (Notes 5 and10)                     |       | 2,969,000  |       | 2,525,000  |       | 2,037,000  |       |
| Other  (Note 12)                                             |       | 5,686,000  |       | 4,290,000  |       | 3,699,000  |       |
|                                                         |       |       |       |       |       |       |       |
| Total  non-interest expenses                                 |       | 20,925,000 |       | 16,795,000 |       | 13,887,000 |       |
|                                                         |       |       |       |       |       |       |       |
| Income  before provision for income taxes                    |       | 12,169,000 |       | 9,413,000  |       | 8,598,000  |       |
|                                                         |       |       |       |       |       |       |       |
| Provision  for income taxes (Note 13)                        |       | 4,971,000  |       | 3,803,000  |       | 3,329,000  |       |
|                                                         |       |       |       |       |       |       |       |
| Net  income                                                  |       | $          | 7,198,000  |       | $          | 5,610,000  |       | $ | 5,269,000 |   |
|                                                         |       |       |       |       |       |       |       |
| Basic  earnings per share (Note 11)                          |       | $          | 1.00       |       | $          | .79        |       | $ | .75 |   |
|                                                         |       |       |       |       |       |       |       |
| Diluted  earnings per share (Note 11)                        |       | $          | .95        |       | $          | .74        |       | $ | .71 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

60

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#### **COMMUNITY VALLEY BANCORP AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY**

 

**For theYears Ended December 31, 2005, 2004 and 2003**

 
| ** **                                                                  | ** ** | ** **            | ** ** | ** **      | ** ** | ** **   | ** ** | ** **        | ** ** | **Accumulated**            | ** ** | ** **        | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------|------------|-----------------|------------|--------------|------------|-------------------|------------|----------------------------|------------|-------------------|------------|------------|------------|
| ** **                                                                  | ** ** | ** **            | ** ** | ** **      | ** ** | ** **   | ** ** | ** **        | ** ** | **Other**                  | ** ** | ** **        | ** ** | ** ** | ** ** |
| ** **                                                                  | ** ** | ** **            | ** ** | **Unallocated** | ** ** | ** **   | ** ** | **Comprehensive** | ** ** | **Total**                  | ** ** | **Total**         | ** ** |
| ** **                                                                  | ** ** | **Common Stock** | ** ** | **ESOP**        | ** ** | **Retained** | ** ** | **Income**        | ** ** | **Shareholders’**     | ** ** | **Comprehensive** | ** ** |
| ** **                                                                  | ** ** | **Shares**            | ** ** | **Amount**      | ** ** | **Shares**   | ** ** | **Earnings**      | ** ** | **Net of Taxes** | ** ** | **Equity**        | ** ** | **Income** | ** ** |
|                                                                        |       |                  |       |            |       |         |       |              |       |                       |       |              |       |       |       |
| Balance,  January 1, 2003                                              |       | 7,160,936             |       | $               | 6,660,000  |         | $          | (851,000          | )          | $                          | 19,558,000 |              | $          | 14,000     |       | $ | 25,381,000 |   |   |   |
|                                                                        |       |                  |       |            |       |         |       |              |       |                       |       |              |       |       |       |
| Comprehensive  income:                                                      |       |                  |       |            |       |         |       |              |       |                       |       |              |       |       |       |
| Net  income                                                                 |       |                  |       |            |       |         |       | 5,269,000         |       |                       |       | 5,269,000         |       | $          | 5,269,000  |   |
| Other  comprehensive loss:                                                  |       |                  |       |            |       |         |       |              |       |                       |       |              |       |       |       |
| Net  change in unrealized gains on available-for-sale investment securities |       |                  |       |            |       |         |       |              |       | (12,000                    | )          | (12,000           | )          | (12,000    | )          |
|                                                                        |       |                  |       |            |       |         |       |              |       |                       |       |              |       |       |       |
| Total  comprehensive income                                                 |       |                  |       |            |       |         |       |              |       |                       |       |              |       | $          | 5,257,000  |   |
|                                                                        |       |                  |       |            |       |         |       |              |       |                       |       |              |       |       |       |
| Exercise  of stock options and related tax benefit (Note 11)                |       | 82,712                |       | 462,000         |       |         |       |              |       |                       |       | 462,000           |       |       |       |
| Amortization  of stock compensation - ESOP shares (Note 15)                 |       |                  |       | 150,000         |       | 102,000      |       |              |       |                       |       | 252,000           |       |       |       |
| Shares  acquired or redeemed by ESOP (Note 15)                              |       |                  |       |            |       | (321,000     | )          |              |       |                       |       | (321,000          | )          |       |       |
| Cash  dividends - $0.15 per share                                           |       |                  |       |            |       |         |       | (1,082,000        | )          |                       |       | (1,082,000        | )          |       |       |
|                                                                        |       |                  |       |            |       |         |       |              |       |                       |       |              |       |       |       |
| Balance,  December 31, 2003                                            |       | 7,243,648             |       | 7,272,000       |       | (1,070,000   | )          | 23,745,000        |       | 2,000                      |       | 29,949,000        |       |       |       |
|                                                                        |       |                  |       |            |       |         |       |              |       |                       |       |              |       |       |       |
| Comprehensive  income:                                                      |       |                  |       |            |       |         |       |              |       |                       |       |              |       |       |       |
| Net  income                                                                 |       |                  |       |            |       |         |       | 5,610,000         |       |                       |       | 5,610,000         |       | $          | 5,610,000  |   |
| Other  comprehensive income:                                                |       |                  |       |            |       |         |       |              |       |                       |       |              |       |       |       |
| Net  change in unrealized gains on available-for-sale investment securities |       |                  |       |            |       |         |       |              |       | 9,000                      |       | 9,000             |       | 9,000      |       |
|                                                                        |       |                  |       |            |       |         |       |              |       |                       |       |              |       |       |       |
| Total  comprehensive income                                                 |       |                  |       |            |       |         |       |              |       |                       |       |              |       | $          | 5,619,000  |   |
|                                                                        |       |                  |       |            |       |         |       |              |       |                       |       |              |       |       |       |
| Exercise  of stock options and related tax benefit (Note 11)                |       | 68,404                |       | 532,000         |       |         |       |              |       |                       |       | 532,000           |       |       |       |
| Amortization  of stock compensation - ESOP shares (Note 15)                 |       |                  |       | 104,000         |       | 76,000       |       |              |       |                       |       | 180,000           |       |       |       |
| Shares  acquired or redeemed by ESOP (Note 15)                              |       |                  |       |            |       | (150,000     | )          |              |       |                       |       | (150,000          | )          |       |       |
| Cash  dividends - $0.15 per share                                           |       |                  |       |            |       |         |       | (1,091,000        | )          |                       |       | (1,091,000        | )          |       |       |
| Cash  in lieu of fractional shares in four- for-three stock split (Note 11) |       |                  |       | (6,000          | )          |         |       |              |       |                       |       | (6,000            | )          |       |       |
| Repurchase  and retirement of common stock                                  |       | (38,470               | )          | (40,000         | )          |         |       | (462,000          | )          |                       |       | (502,000          | )          |       |       |
|                                                                        |       |                  |       |            |       |         |       |              |       |                       |       |              |       |       |       |
| Balance,  December 31, 2004                                            |       | 7,273,582             |       | 7,862,000       |       | (1,144,000   | )          | 27,802,000        |       | 11,000                     |       | 34,531,000        |       |       |       |
|                                                                        |       |                  |       |            |       |         |       |              |       |                       |       |              |       |       |       |
| Comprehensive  income:                                                      |       |                  |       |            |       |         |       |              |       |                       |       |              |       |       |       |
| Net  income                                                                 |       |                  |       |            |       |         |       | 7,198,000         |       |                       |       | 7,198,000         |       | $          | 7,198,000  |   |
| Other  comprehensive loss:                                                  |       |                  |       |            |       |         |       |              |       |                       |       |              |       |       |       |
| Net  change in unrealized gains on available-for-sale investment securities |       |                  |       |            |       |         |       |              |       | (24,000                    | )          | (24,000           | )          | (24,000    | )          |
|                                                                        |       |                  |       |            |       |         |       |              |       |                       |       |              |       |       |       |
| Total  comprehensive income                                                 |       |                  |       |            |       |         |       |              |       |                       |       |              |       | $          | 7,174,000  |   |
|                                                                        |       |                  |       |            |       |         |       |              |       |                       |       |              |       |       |       |
| Exercise  of stock options and related tax benefit (Note 11)                |       | 134,465               |       | 1,039,000       |       |         |       |              |       |                       |       | 1,039,000         |       |       |       |
| Amortization  of stock compensation - ESOP shares (Note 15)                 |       |                  |       | 150,000         |       | 101,000      |       |              |       |                       |       | 251,000           |       |       |       |
| Shares  acquired or redeemed by ESOP (Note 15)                              |       |                  |       |            |       | (348,000     | )          |              |       |                       |       | (348,000          | )          |       |       |
| Cash  dividends - $.16 per share                                            |       |                  |       |            |       |         |       | (1,092,000        | )          |                       |       | (1,092,000        | )          |       |       |
|                                                                        |       |                  |       |            |       |         |       |              |       |                       |       |              |       |       |       |
| Balance,  December 31, 2005                                            |       | 7,408,047             |       | $               | 9,051,000  |         | $          | (1,391,000        | )          | $                          | 33,908,000 |              | $          | (13,000    | )          | $ | 41,555,000 |   |   |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

61

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### **COMMUNITY VALLEY BANCORP AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENT OF CASH FLOWS**

 

**For theYears Ended December 31, 2005, 2004 and 2003**

 
| ** **                                                                         | ** ** | **2005**    | ** ** | **2004**    | ** ** | **2003**    | ** ** |
|------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|
|                                                                               |       |        |       |        |       |        |       |
| Cash  flows from operating activities:                                             |       |        |       |        |       |        |       |
| Net  income                                                                        |       | $           | 7,198,000  |        | $          | 5,610,000   |       | $ | 5,269,000 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |        |       |        |       |        |       |
| Provision  for loan losses                                                         |       | 724,000     |       | 734,000     |       | 586,000     |       |
| Increase  (decrease) in loan origination fees, net                                 |       | 86,000      |       | (11,000     | )          | 196,000     |       |
| Depreciation,  amortization and accretion, net                                     |       | 1,556,000   |       | 1,350,000   |       | 973,000     |       |
| Increase  in cash surrender value of bank owned life insurance, net                |       | (294,000    | )          | (284,000    | )          | (380,000    | )          |
| Non-cash  compensation cost associated with the ESOP                               |       | 251,000     |       | 180,000     |       | 252,000     |       |
| (Gain)  loss on disposition of equipment                                           |       | (31,000     | )          |        |       | 8,000       |       |
| (Increase)  decrease in loans held for sale                                        |       | (707,000    | )          | 789,000     |       | 5,633,000   |       |
| Decrease  (increase) in accrued interest receivable and other assets               |       | 871,000     |       | 1,218,000   |       | (1,019,000  | )          |
| Increase  in accrued interest payable and other liabilities                        |       | 1,767,000   |       | 1,876,000   |       | 107,000     |       |
| Provision  for deferred income taxes                                               |       | (1,331,000  | )          | (64,000     | )          | (639,000    | )          |
|                                                                               |       |        |       |        |       |        |       |
| Net  cash provided by operating activities                                         |       | 10,090,000  |       | 11,398,000  |       | 10,986,000  |       |
|                                                                               |       |        |       |        |       |        |       |
| Cash  flows from investing activities:                                             |       |        |       |        |       |        |       |
| Purchases  of held-to-maturity investment securities                               |       | (1,234,000  | )          | (1,013,000  | )          | (4,542,000  | )          |
| Purchases  of available-for-sale investment securities                             |       | (2,008,000  | )          | (4,145,000  | )          |        |       |
| Proceeds  from called available-for-sale investment securities                     |       | 2,027,000   |       | 300,000     |       |        |       |
| Proceeds  from matured or called held-to- maturity investment securities           |       | 1,119,000   |       | 1,870,000   |       | 3,440,000   |       |
| Proceeds  from principal repayments of held-to-maturity investment securities      |       | 358,000     |       | 332,000     |       | 113,000     |       |
| Net  increase (decrease) in interest-bearing deposits in banks                     |       | 2,079,000   |       | (790,000    | )          | (3,864,000  | )          |
| Net  increase in loans                                                             |       | (62,477,000 | )          | (69,722,000 | )          | (41,383,000 | )          |
| Premiums  paid for life insurance policies                                         |       | (1,450,000  | )          | (122,000    | )          | (1,626,000  | )          |
| Purchases  of premises and equipment                                               |       | (3,802,000  | )          | (1,786,000  | )          | (2,870,000  | )          |
| Proceeds  from sale of equipment                                                   |       | 65,000      |       |        |       | 27,000      |       |
|                                                                               |       |        |       |        |       |        |       |
| Net  cash used in investing activities                                             |       | (65,323,000 | )          | (75,076,000 | )          | (50,705,000 | )          |
|                                                                                    |            |             |            |             |            |             |            |  |  |  |

 

62

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| ** **                                                                 | ** ** | **2005**    | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|----------------------------------------------------------------------------|------------|-------------|------------|------------|------------|------------|------------|
|                                                                       |       |        |       |       |       |       |       |
| Cash  flows from financing activities:                                     |       |        |       |       |       |       |       |
| Net  increase in demand, interest-bearing and savings deposits             |       | $           | 17,561,000 |       | $          | 37,110,000 |       | $ | 43,927,000 |   |
| Net  increase in time deposits                                             |       | 17,398,000  |       | 19,438,000 |       | 604,000    |       |
| Proceeds  from note payable                                                |       | 800,000     |       |       |       |       |       |
| Proceeds  from ESOP note payable                                           |       | 348,000     |       | 879,000    |       | 321,000    |       |
| Repayments  of ESOP note payable                                           |       | (199,000    | )          | (878,000   | )          | (221,000   | )          |
| Purchase  of unallocated ESOP shares                                       |       | (348,000    | )          | (150,000   | )          | (321,000   | )          |
| Proceeds  from exercise of stock options                                   |       | 527,000     |       | 284,000    |       | 267,000    |       |
| Cash  paid for fractional shares                                           |       |        |       | (6,000     | )          |       |       |
| Payment  of cash dividends                                                 |       | (1,069,000  | )          | (1,089,000 | )          | (1,079,000 | )          |
| Repurchase  of common stock                                                |       |        |       | (502,000   | )          |       |       |
|                                                                       |       |        |       |       |       |       |       |
| Net  cash provided by financing activities                                 |       | 35,018,000  |       | 55,086,000 |       | 43,498,000 |       |
|                                                                       |       |        |       |       |       |       |       |
| (Decrease)  increase in cash and cash equivalents                          |       | (20,215,000 | )          | (8,592,000 | )          | 3,779,000  |       |
|                                                                       |       |        |       |       |       |       |       |
| Cash  and cash equivalents at beginning of year                            |       | 68,218,000  |       | 76,810,000 |       | 73,031,000 |       |
|                                                                       |       |        |       |       |       |       |       |
| Cash  and cash equivalents at end of year                                  |       | $           | 48,003,000 |       | $          | 68,218,000 |       | $ | 76,810,000 |   |
|                                                                       |       |        |       |       |       |       |       |
| Supplemental  disclosure of cash flow information:                         |       |        |       |       |       |       |       |
|                                                                       |       |        |       |       |       |       |       |
| Cash  paid during the year for:                                            |       |        |       |       |       |       |       |
| Interest                                                                   |       | $           | 5,158,000  |       | $          | 4,084,000  |       | $ | 4,396,000 |   |
| Income  taxes                                                              |       | $           | 5,780,000  |       | $          | 2,830,000  |       | $ | 4,350,000 |   |
|                                                                       |       |        |       |       |       |       |       |
| Non-cash  investing activities:                                            |       |        |       |       |       |       |       |
| Net  change in unrealized loss on available-for-sale investment securities |       | $           | (24,000    | )          | $          | 9,000      |       | $ | (12,000 | ) |
|                                                                       |       |        |       |       |       |       |       |
| Non-cash  financing activities:                                            |       |        |       |       |       |       |       |
| Release  of unallocated ESOP shares                                        |       | $           | 101,000    |       | $          | 76,000     |       | $ | 102,000 |   |
| Accrual  of cash dividend declared                                         |       | $           | 296,000    |       | $          | 273,000    |       | $ | 271,000 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

63

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##### **COMMUNITYVALLEY BANCORP AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**1.****                                      SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

 

###### General

 

In May 2002,Community Valley Bancorp (“Community Valley”) was incorporated as a bankholding company for the purpose of acquiring Butte Community Bank (the “Bank”)in a one bank holding company reorganization. In 2004, Community Valley changedit’s status to a Financial Holding Company for the purpose of establishing CVBInsurance Agency LLC (“CVBIA”). The new corporate structure gives CommunityValley, the Bank and CVBIA greater flexibility in terms of operation, expansionand diversification.

 

Founded in 1990,the Bank is a state-chartered financial institution with thirteen branches in tencities including Chico, Magalia, Oroville, Paradise, Redding, Red Bluff, Colusa,Corning, Marysville, and Yuba City and loan production offices in CitrusHeights and Gridley. The Bank provides traditional deposit and lending servicesincluding commercial and construction loans, government guaranteed loans suchas those available from the USDA and SBA, merchant services and investmentservices.

 

On December 19,2002, Community Valley formed a wholly-owned subsidiary, Community ValleyBancorp Trust I (the “Trust”), a Delaware statutory business trust, for thepurpose of issuing trust preferred securities (see Note 9).

 

On December 1,2004, Community Valley formed a wholly-owned subsidiary, CVB Insurance AgencyLLC for the purpose of providing insurance related services.

 

The accounting andreporting policies of Community Valley Bancorp and its subsidiaries(collectively, the “Company”) conform with accounting principles generallyaccepted in the United States of America and prevailing practice within thebanking industry. The more significant of these policies applied in thepreparation of the accompanying consolidated financial statements are discussedbelow.

 

SegmentInformation

 

Management hasdetermined that since all of the banking products and services offered by theCompany are available in each branch of the Bank, all branches are located withinthe same economic environment and management does not allocate resources basedon the performance of different lending or transaction activities, it isappropriate to aggregate the Bank branches and report them as a singleoperating segment. No customer accounts for more than 10 percent of revenuesfor the Company or the Bank.

 

###### Principles ofConsolidation

 

The accompanyingconsolidated financial statements include the accounts of Community Valley andits wholly-owned subsidiaries, Butte Community Bank and CVB Insurance AgencyLLC. Significant intercompany transactions and balances have been eliminated inconsolidation.

 

For financialreporting purposes, the Company’s investment in the Trust of $248,000 (see Note9) is accounted for under the equity method and is included in accrued interestreceivable and other assets on the consolidated balance sheet. The juniorsubordinated debentures issued and guaranteed by the Company and held by theTrust are reflected as debt in the Company’s consolidated balance sheet.

 

64

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Stock Splits

 

On March 10, 2005,the Board of Directors declared a two-for-one stock split effective May 16,2005, for shareholders of record on May 2, 2005. On February 20,2004, the Board of Directors declared a four-for-three stock split effective March 26,2004 for shareholders of record on March 2, 2004. All share and per sharedata has been retroactively adjusted to reflect these stock splits.

 

###### Reclassifications

 

Certainreclassifications have been made to prior years’ balances to conform toclassifications used in 2005.

 

Use of Estimates

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions. These estimates and assumptions affect the reported amounts ofassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period. Actual resultscould differ from these estimates.

 

###### Cash and CashEquivalents

 

For purposes ofthe consolidated statement of cash flows, cash and cash equivalents includecash and due from banks and Federal funds sold. Federal funds are generallysold for one-day periods.

 

InvestmentSecurities

 

Investmentsecurities are classified into the following categories:

 

•                                          Available-for-salesecurities, reported at fair value, with unrealized gains and losses excludedfrom earnings and reported, net of taxes, as accumulated other comprehensive(loss) income within shareholders’ equity.

 

•                                          Held-to-maturitysecurities, which management has the positive intent and ability to hold,reported at amortized cost, adjusted for the accretion of discounts andamortization of premiums.

 

Managementdetermines the appropriate classification of its investments at the time ofpurchase and may only change the classification in certain limitedcircumstances. All transfers between categories are accounted for at fairvalue. As of December 31, 2005 and 2004 the Company did not have anyinvestment securities classified as trading.

 

65

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Gains or losses onthe sale of investment securities are computed using the specificidentification method. Interest earned on investment securities is reported ininterest income, net of applicable adjustments for accretion of discounts andamortization of premiums.

 

Investment securities areevaluated for impairment on at least a quarterly basis and more frequently wheneconomic or market conditions warrant such an evaluation to determine whether adecline in their value is other than temporary. Management utilizes criteriasuch as the magnitude and duration of the decline and the intent and ability ofthe Company to retain its investment in the issues for a period of timesufficient to allow for an anticipated recovery in fair value, in addition tothe reasons underlying the decline, to determine whether the loss in value isother than temporary. The term “other than temporary” is not intended toindicate that the decline is permanent, but indicates that the prospects for anear-term recovery of value is not necessarily favorable, or that there is alack of evidence to support a realizable value equal to or greater than the carryingvalue of the investment. Once a decline in value is determined to be other thantemporary, the value of the security is reduced and a corresponding charge toearnings is recognized.

 

Loans

 

Loans are stated atprincipal balances outstanding, except for loans transferred from loans heldfor sale which are carried at the lower of principal balance or market value atthe date of transfer, adjusted for accretion of discounts. Interest is accrueddaily based upon outstanding loan balances. However, when, in the opinion ofmanagement, loans are considered to be impaired and the future collectibilityof interest and principal is in serious doubt, loans are placed on nonaccrualstatus and the accrual of interest income is suspended. Any interest accruedbut unpaid is charged against income. Payments received are applied to reduceprincipal to the extent necessary to ensure collection. Subsequent payments onthese loans, or payments received on nonaccrual loans for which the ultimatecollectibility of principal is not in doubt, are applied first to earned butunpaid interest and then to principal.

 

A loan is consideredimpaired when, based on current information and events, it is probable that theCompany will be unable to collect all amounts due (including both principal andinterest) in accordance with the contractual terms of the loan agreement. Animpaired loan is measured based on the present value of expected future cashflows discounted at the loan’s effective interest rate or, as a practicalmatter, at the loan’s observable market price or the fair value of collateralif the loan is collateral dependent. Interest income on impaired loans, ifappropriate, is recognized on a cash basis.

 

Substantially all loanorigination fees, commitment fees, direct loan origination costs and purchasepremiums and discounts on loans are deferred and recognized as an adjustment ofyield, to be amortized to interest income over the contractual term of theloan. The unamortized balance of deferred fees and costs is reported as a componentof net loans.

 

66

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The Company may acquireloans through a business combination or a purchase for which differences may existbetween the contractual cash flows and the cash flows expected to be collecteddue, at least in part, to credit quality. When the Company acquires such loans,the yield that may be accreted (accretable yield) is limited to the excessof the Company’s estimate of undiscounted cash flows expected to be collectedover the Company’s initial investment in the loan. The excess of contractualcash flows over cash flows expected to be collected may not be recognizedas an adjustment to yield, loss, or a valuation allowance. Subsequent increasesin cash flows expected to be collected generally should be recognizedprospectively through adjustment of the loan’s yield over its remaining life. Decreasesin cash flows expected to be collected should be recognized as an impairment. TheCompany may not “carry over” or create a valuation allowance in theinitial accounting for loans acquired under these circumstances. At December 31,2005, there were no such loans being accounted for under this policy.

 

Loans Held forSale, Loan Sales and Servicing Rights

 

The Companyaccounts for the transfer and servicing of financial assets based on thefinancial and servicing assets it controls and liabilities it has incurred,derecognizes financial assets when control has been surrendered, andderecognizes liabilities when extinguished.

 

Servicing rightsacquired through 1) a purchase or 2) the origination of loans which are soldwith servicing rights retained are recognized as separate assets orliabilities. Servicing assets or liabilities are recorded at the differencebetween the contractual servicing fees and adequate compensation for performingthe servicing, and are subsequently amortized in proportion to and over theperiod of the related net servicing income or expense. Servicing assets areperiodically evaluated for impairment. Fair values are estimated usingdiscounted cash flows based on current market interest rates. For purposes ofmeasuring impairment, servicing assets are stratified based on note rate andterm. The amount of impairment recognized, if any, is the amount by which theservicing assets for a stratum exceed their fair value.

 

Any servicingassets in excess of the contractually specified servicing fees have beenreclassified at fair value as an interest-only (IO) strip receivable andtreated like an available-for-sale security. The servicing asset, net of anyrequired valuation allowance, and IO strip receivable are included in accruedinterest and other assets. At December 31, 2005 and 2004, IO strips werenot significant.

 

67

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*Government GuaranteedLoans*

 

Included in theloan portfolio are loans which are 85% to 90% guaranteed by the Small BusinessAdministration (SBA), U.S. Department of Agriculture, Rural Business –Cooperative Service (RBS) and Farm Services Agency (FSA). The guaranteedportion of these loans may be sold to a third party, with the Companyretaining the unguaranteed portion. The Company generally receives a premium inexcess of the adjusted carrying value of the loan at the time of sale. TheCompany may be required to refund a portion of the sales premium if theborrower defaults or the loan prepays within ninety days of the settlementdate.

 

The Company’sinvestment in the loan is allocated between the retained portion of the loan,the servicing asset, the IO strip, and the sold portion of the loan based ontheir relative fair values on the date the loan is sold. The gain on the soldportion of the loan is recognized as income at the time of sale. The carryingvalue of the retained portion of the loan is discounted based on the estimatedvalue of a comparable non-guaranteed loan. The servicing asset and IO strip isrecognized as discussed above. Significant future prepayments of these loanswill result in the recognition of additional amortization of related servicingassets and an adjustment to the carrying value of related IO strips.

 

The Companyserviced SBA, RBS and FSA government guaranteed loans for others totaling $70,894,000and $68,609,000 as of December 31, 2005 and 2004, respectively.

 

*Mortgage Loans*

 

The Company originatesmortgage loans that are either held in the Company’s loan portfolio or sold inthe secondary market. Loans held for sale are carried at the lower of cost ormarket value. Market value is determined by the specific identification methodas of the balance sheet date or the date which the purchasers have committed topurchase the loans. At the time the loan is sold, the related right to servicethe loan is either retained, with the Company recognizing the servicing asset,or released in exchange for a one-time servicing-released premium. Loanssubsequently transferred to the loan portfolio are transferred at the lower ofcost or market value at the date of transfer. Any difference between thecarrying amount of the loan and its outstanding principal balance is recognizedas an adjustment to yield by the interest method.

 

The Companyserviced loans for the Federal National Mortgage Association (FNMA) totaling $157,210,000and $161,832,000 as of December 31, 2005 and 2004, respectively.

 

*ParticipationLoans*

 

The Company alsoserviced loans which it has participated with other financial institutions totaling$1,540,000 and $2,616,000 as of December 31, 2005 and 2004, respectively.

 

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## Allowance for LoanLosses

 

The allowance forloan losses is maintained to provide for losses related to impaired loans andother losses that can be reasonably expected to occur in the normal course ofbusiness. The determination of the allowance for loan losses is based on estimatesmade by management, to include consideration of the character of the loanportfolio, specifically identified problem loans, potential losses inherent inthe portfolio taken as a whole and economic conditions in the Company’s servicearea.

 

Classified loansand loans determined to be impaired are evaluated by management for specificrisk of loss. In addition, a reserve factor is assigned to currently performingloans based on management’s assessment of the following for each identifiedloan type: (1) inherent credit risk, (2) historical losses and, (3) wherethe Company has not experienced losses, the loss experience of peer banks. Theseestimates are particularly susceptible to changes in the economic environmentand market conditions.

 

The Company’s Boardof Directors reviews the adequacy of the allowance for loan losses at leastquarterly, to include consideration of the relative risks in the portfolio andcurrent economic conditions. The allowance for loan losses is adjusted based onthat review if, in the judgment of the Board of Directors and management,changes are warranted.

 

The allowance forloan losses is established through a provision for loan losses which is chargedto expense. Additions to the allowance for loan losses are expected to maintainthe adequacy of the total allowance after loan losses and loan growth. Theallowance for loan losses at December 31, 2005 and 2004 reflectsmanagement’s estimate of possible losses in the portfolio.

 

##### **Allowance for Losses Related to Undisbursed Loan Commitments**

 

The Companymaintains a separate allowance for losses related to undisbursed loancommitments. Management estimates the amount of probable losses by applying theloss factors used in the allowance for loan loss methodology to an estimate ofthe expected usage and applies the factor to the unused portion of undisbursedlines of credit. The allowance totaled $481,000 and $381,000 at December 31,2005 and 2004, respectively, and is included in accrued interest payable andother liabilities on the balance sheet.

 

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###### Premises andEquipment

 

Premises andequipment are carried at cost. Depreciation is determined using thestraight-line method over the estimated useful lives of the related assets. Theuseful lives of premises are estimated to be thirty to thirty-nine years. Leaseholdimprovements are amortized over the life of the improvement or the life of therelated lease, whichever is shorter. The useful lives of furniture, fixturesand equipment are estimated to be three to ten years. When assets are sold orotherwise disposed of, the cost and related accumulated depreciation areremoved from the accounts, and any resulting gain or loss is recognized inincome for the period. The cost of maintenance and repairs is charged toexpense as incurred.

 

The Companyevaluates premises and equipment for financial impairment as events or changesin circumstances indicate that the carrying amount of such assets may notbe fully recoverable.

 

Income Taxes

 

The Company filesits income taxes on a consolidated basis with its subsidiaries. The allocationof income tax expense (benefit) represents each entity’s proportionate share ofthe consolidated provision for income taxes.

 

The Companyaccounts for income taxes using the liability or balance sheet method. Underthis method, deferred tax assets and liabilities are recognized for the taxconsequences of temporary differences between the reported amounts of assetsand liabilities and their tax bases. Deferred tax assets and liabilities areadjusted for the effects of changes in tax laws and rates on the date ofenactment. On the consolidated balance sheet, net deferred tax assets areincluded in accrued interest receivable and other assets.

 

###### Earnings Per Share

 

Basic earnings pershare (EPS), which excludes dilution, is computed by dividing income availableto common shareholders by the weighted-average number of common sharesoutstanding for the period, excluding the effect of unallocated shares of theEmployee Stock Ownership Plan. Diluted EPS reflects the potential dilution thatcould occur if securities or other contracts to issue common stock, such asstock options, result in the issuance of common stock which shares in theearnings of the Company. The treasury stock method has been applied todetermine the dilutive effect of stock options in computing diluted EPS.

 

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###### ComprehensiveIncome

 

Comprehensiveincome is a more inclusive financial reporting methodology that includesdisclosure of other comprehensive income (loss) that historically has not beenrecognized in the calculation of net income. Unrealized gains or losses on theCompany’s available-for-sale investment securities and IO strip are theprinciple source of other comprehensive income or loss. Total comprehensiveincome and the components of accumulated other comprehensive income (loss) arepresented in the consolidated statement of changes in shareholders’ equity.

 

###### Stock-BasedCompensation

 

At December 31,2005, the Company has three stock-based compensation plans, which are describedmore fully in Note 11. The Company accounts for these plans under therecognition and measurement principles of APB Opinion No. 25, *Accounting for Stock Issued to Employees*,and related Interpretations. No stock-based compensation cost is reflected innet income, as all options granted under these plans had an exercise priceequal to the market value of the underlying common stock on the date of grant.

 

The followingtable illustrates the effect on net income and earnings per share if theCompany had applied the fair value recognition provisions of FASB Statement No. 123,*Accounting for Stock-Based Compensation*,to stock-based compensation. Pro forma adjustments to the Company’s consolidatednet earnings and earnings per share are disclosed during the years in which theoptions become vested.

 
| ** **                                                                                                                               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003**  | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|-----------|------------|
|                                                                                                                                     |       |     |       |     |       |      |       |
| Net  income, as reported                                                                                                                 |       | $        | 7,198,000  |     | $          | 5,610,000 |       | $ | 5,269,000 |   |
| Deduct:  Total stock-based compensation expense determined under the fair value based  method for all awards, net of related tax effects |       | 353,000  |       | 311,000  |       | 265,000   |       |
|                                                                                                                                     |       |     |       |     |       |      |       |
| Pro  forma net income                                                                                                                    |       | $        | 6,845,000  |     | $          | 5,299,000 |       | $ | 5,004,000 |   |
|                                                                                                                                     |       |     |       |     |       |      |       |
| Basic  earnings per share -as reported                                                                                                   |       | $        | 1.00       |     | $          | .79       |       | $ | .75 |   |
| Basic  earnings per share - pro forma                                                                                                    |       | $        | .95        |     | $          | .74       |       | $ | .71 |   |
|                                                                                                                                     |       |     |       |     |       |      |       |
| Diluted  earnings per share - as reported                                                                                                |       | $        | .95        |     | $          | .74       |       | $ | .71 |   |
| Diluted  earnings per share - pro forma                                                                                                  |       | $        | .90        |     | $          | .70       |       | $ | .68 |   |

 

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The fair value ofeach option is estimated on the date of grant using an option-pricing modelwith the following assumptions:

 
| ** **                                                      | ** ** | **2005**  | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------------------------------|------------|-----------|------------|----------|------------|----------|------------|
|                                                            |       |      |       |     |       |     |       |
| Expected  volatility                                            |       | 12.38     | %          | 15.21    | %          | 30.09    | %          |
| Risk-free  interest rate                                        |       | 4.0       | %          | 4.02     | %          | 4.52     | %          |
| Expected  option life                                           |       | 7.5 years |       | 10 years |       | 10 years |       |
| Expected  dividend yield                                        |       | 1.11      | %          | 1.36     | %          | 1.72     | %          |
| Weighted  average fair value of options granted during the year |       | $         | 3.25       |     | $          | 3.35     |       | $ | 3.66 |   |
|                                                                 |            |           |            |          |            |          |            |  |  |  |

 

Impact of NewFinancial Accounting Standards

 

### ***Other-Than-Temporary Impairment of Securities***

 

In March 2004, theFinancial Accounting Standards Board (FASB) and Emerging Issues Task Force(EITF) reached consensus on several issues being addressed in EITF Issue No. 03-1,*The Meaning of Other-Than-TemporaryImpairment and Its Application to Certain Investments*. The consensusprovides guidance for evaluating whether an investment isother-than-temporarily impaired and was effective for other-than-temporaryimpairment evaluations made in reporting periods beginning after June 15,2004. The disclosure provisions of EITF 03-1 continue to be effective for the Company’s consolidated financialstatements for the year ended December 31, 2005.

 

On November 3, 2005,the FASB issued FASB Staff Position (FSP) Nos. FAS 115-1 and FAS 124-1, *The Meaning of Other-Than-Temporary Impairment andIts Application to Certain Investments*. This FSP addresses thedetermination as to when an investment is considered impaired, whether thatimpairment is other than temporary, and the measurement of an impairment loss. ThisFSP also includes accounting considerations subsequent to the recognition of another-than-temporary impairment and requires certain disclosures aboutunrealized losses that have not been recognized as other-than-temporaryimpairments. This FSP nullifies certain requirements of EITF Issue 03-1, andsupersedes EITF Topic No. D-44, *Recognitionof Other-Than-Temporary Impairment upon the Planned Sale of a Security WhoseCost Exceeds Fair Value*. The guidance in this FSP amends FASBStatement No. 115, Accounting for Certain Investments in Debt and EquitySecurities. The FSP is effective for reporting periods beginning after December 15,2005. The Company does notanticipate any material impact to its financial condition or results ofoperations as a result of the adoption of this guidance.

 

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***Share-Based Payments***

 

In December 2004the FASB issued Statement No. 123 (revised 2004) (FAS 123 (R)), *Share-Based Payments*. FAS 123 (R) requiresall entities to recognize compensation expense in an amount equal to the fairvalue of share-based payments such as stock options granted to employees. TheCompany may elect to adopt FAS 123 (R) using a modified prospective methodor modified retrospective method. Under the modified retrospective method, theCompany would restate previously issued financial statements, basing theexpense on that previously reported in their pro forma disclosures required byFAS 123. The modified prospective method would require the Company to recordcompensation expense for the unvested portion of previously granted awards thatremain outstanding at the date of adoption as these awards continue to vest. FAS 123 (R)is effective for the first fiscal year beginning after June 15, 2005. Managementhas elected to use the modified prospective method and has completed itsevaluation of the effect that FAS 123 (R) will have and believes that theeffect of its implementation will be consistent with the pro forma disclosuresnoted above.

 

*Accounting Changes and Error Corrections*

 

On June 7,2005, the FASB issued Statement No. 154 (FAS 154), Accounting Changes andError Corrections - a replacement of Accounting Principles Board (APB) Opinion No. 20,Accounting Changes, and SFAS No. 3, Reporting Accounting Changes inInterim Financial Statements. Under the provisions of FAS 154, voluntarychanges in accounting principles are applied retrospectively to prior periods’financial statements unless it would be impractical to do so. FAS 154supersedes APB Opinion No. 20, which required that most voluntary changesin accounting principles be recognized by including in the current period’s netincome the cumulative effect of the change. FAS154 also makes a distinctionbetween “retrospective application” of a change in accounting principle and the“restatement” of financial statements to reflect the correction of an error. Theprovisions of FAS 154 are effective for accounting changes made in fiscal yearsbeginning after December 15, 2005. Management of the Company does not expect the adoptionof this standard to have a material impact on its financial position or resultsof operations.

 

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**2.****                                      INVESTMENTSECURITIES**

 

The amortized costand estimated fair value of investment securities at December 31, 2004 and2005 consisted of the following:

 

Available for Sale

 
| ** **                                        | ** ** | **2005**      | ** ** |
|---------------------------------------------------|------------|---------------|------------|
| ** **                                        | ** ** | ** **    | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                                        | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                                        | ** ** | **Cost**      | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
|                                              |       |          |       |   |   |   |   |   |   |
| Debt  securities:                                 |       |          |       |   |   |   |   |   |   |
| U.S.  Government agencies                         |       | $             | 3,009,000  |   |   |   | $ | (45,000 | ) | $ | 2,964,000 |   |
| Obligations  of states and political subdivisions |       | 1,356,000     |       | $ | 24,000 |   |   |   | 1,380,000 |   |
|                                              |       | $             | 4,365,000  |   | $ | 24,000 |   | $ | (45,000 | ) | $ | 4,344,000 |   |

 
| ** **                                        | ** ** | **2004**      | ** ** |
|---------------------------------------------------|------------|---------------|------------|
| ** **                                        | ** ** | ** **    | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                                        | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                                        | ** ** | **Cost**      | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
|                                              |       |          |       |   |   |   |   |   |   |
| Debt  securities:                                 |       |          |       |   |   |   |   |   |   |
| U.S.  Government agencies                         |       | $             | 2,000,000  |   |   |   | $ | (9,000 | ) | $ | 1,991,000 |   |
| Obligations  of states and political subdivisions |       | 1,356,000     |       | $ | 21,000 |   |   |   | 1,377,000 |   |
| U.S.  Treasuries                                  |       | 1,004,000     |       | 7,000 |   |   |   | 1,011,000 |   |
|                                              |       |          |       |   |   |   |   |   |   |
|                                              |       | $             | 4,360,000  |   | $ | 28,000 |   | $ | (9,000 | ) | $ | 4,379,000 |   |

 

Net unrealized (losses)and gains on available-for-sale investment securities totaling $(21,000) and $19,000were recorded, net of $8,000 and $(8,000) in tax benefits (expenses),respectively, as accumulated other comprehensive (loss) income withinshareholders’ equity at December 31, 2005 and 2004, respectively. Therewere no sales or transfers of available-for-sale investment securities for theyears ended December 31, 2005, 2004 and 2003.

 

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Held to Maturity

 
| ** **                | ** ** | **2005**      | ** ** |
|---------------------------|------------|---------------|------------|
| ** **                | ** ** | ** **    | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                | ** ** | **Cost**      | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
|                      |       |          |       |   |   |   |   |   |   |
| Debt  securities:         |       |          |       |   |   |   |   |   |   |
| U.S.  Government agencies |       | $             | 2,090,000  |   | $ | 6,000 |   | $ | (40,000 | ) | 2,056,000 |   |
| U.S.  Treasuries          |       | 242,000       |       |   |   | (2,000 | ) | 240,000 |   |
|                      |       |          |       |   |   |   |   |   |   |
|                      |       | $             | 2,332,000  |   | $ | 6,000 |   | $ | (42,000 | ) | $ | 2,296,000 |   |
|                           |            |               |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                        | ** ** | **2004**      | ** ** |
|---------------------------------------------------|------------|---------------|------------|
| ** **                                        | ** ** | ** **    | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                                        | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                                        | ** ** | **Cost**      | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
|                                              |       |          |       |   |   |   |   |   |   |
| Debt  securities:                                 |       |          |       |   |   |   |   |   |   |
| U.S.  Government agencies                         |       | $             | 2,481,000  |   | $ | 10,000 |   | $ | (8,000 | ) | $ | 2,483,000 |   |
| Obligations  of states and political subdivisions |       | 101,000       |       |   |   |   |   | 101,000 |   |
|                                              |       |          |       |   |   |   |   |   |   |
|                                              |       | $             | 2,582,000  |   | $ | 10,000 |   | $ | (8,000 | ) | $ | 2,584,000 |   |

 

There were nosales or transfers of held-to-maturity investment securities for the yearsended December 31, 2005, 2004 and 2003.

 

Investmentsecurities with unrealized losses at December 31, 2005 are summarized andclassified according to the duration of the loss period as follows:

 
| ** **                                        | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total** | ** ** |
|---------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|-----------|------------|
| ** **                                        | ** ** | **Fair**                               | ** ** | **Unrealized**                       | ** ** | **Fair**  | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                                        | ** ** | **Value**                              | ** ** | **Losses**                           | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
| Debt  securities:                                 |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| U.S.  Government agencies                         |       | $                                      | 987,000    |                                 | $          | (22,000   | )          | $ | 2,953,000 |   | $ | (47,000 | ) | $ | 3,940,000 |   | $ | (69,000 | ) |
| Obligations  of states and political subdivisions |       |                                   |       |                                 |       | 736,000   |       | (16,000 | ) | 736,000 |   | (16,000 | ) |
| U.S.  Treasuries                                  |       | 240,000                                |       | (2,000                               | )          |      |       |   |   | 240,000 |   | (2,000 | ) |
|                                              |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
|                                              |       | $                                      | 1,227,000  |                                 | $          | (24,000   | )          | $ | 3,689,000 |   | $ | (63,000 | ) | $ | 4,916,000 |   | $ | (87,000 | ) |

 

At December 31,2005, the Company held 11 investment securities of which 2 were in a lossposition for less than twelve months and 4 were in a loss position and had beenin a loss position for twelve months or more.

 

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Managementperiodically evaluates each investment security for other than temporaryimpairment relying primarily on industry analyst reports, observation of marketconditions and interest rate fluctuations. Management believes it will be ableto collect all amounts due according to the contractual terms of the underlyinginvestment securities and that the noted decline in fair value is consideredtemporary and due only to interest rate fluctuations.

 

The amortized costand estimated fair value of investment securities at December 31, 2005, bycontractual maturity, are shown below. Expected maturities will differ fromcontractual maturities because the issuers of securities may have theright to call or prepay obligations with or without prepayment penalties.

 
| ** **                                                | ** ** | **Available for Sale** | ** ** | **Held to Maturity** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                | ** ** | ** **                       | ** ** | **Estimated**                  | ** ** | ** ** | ** ** | **Estimated** | ** ** |
| ** **                                                | ** ** | **Amortized**                    | ** ** | **Fair**                       | ** ** | **Amortized** | ** ** | **Fair** | ** ** |
| ** **                                                | ** ** | **Cost**                         | ** ** | **Value**                      | ** ** | **Cost** | ** ** | **Value** | ** ** |
|                                                      |       |                             |       |                           |       |   |   |   |   |
| Within  one year                                          |       | $                                | 1,000,000  |                           | $          | 993,000 |   |   |   |   |   |
| After  one year through five years                        |       | 1,000,000                        |       | 984,000                        |       | $ | 1,242,000 |   | $ | 1,216,000 |   |
| After  five years through ten years                       |       |                             |       |                           |       |   |   |   |   |
| After  ten years                                          |       | 1,356,000                        |       | 1,380,000                      |       |   |   |   |   |
|                                                      |       |                             |       |                           |       |   |   |   |   |
|                                                      |       | 3,356,000                        |       | 3,357,000                      |       | 1,242,000 |   | 1,216,000 |   |
|                                                      |       |                             |       |                           |       |   |   |   |   |
| Investment  securities not due at a single maturity date: |       |                             |       |                           |       |   |   |   |   |
| SBA  pools                                                |       | 1,009,000                        |       | 987,000                        |       | 1,090,000 |   | 1,080,000 |   |
|                                                      |       |                             |       |                           |       |   |   |   |   |
|                                                      |       | $                                | 4,365,000  |                           | $          | 4,344,000 |   | $ | 2,332,000 |   | $ | 2,296,000 |   |

 

Investmentsecurities with amortized costs totaling $3,357,000 and $2,304,000 and fairvalues totaling $3,349,000 and $2,297,000 were pledged to secure publicdeposits and treasury, tax and loan accounts at December 31, 2005 and 2004,respectively.

 

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**3.****                                      LOANSAND ALLOWANCE FOR LOAN LOSSES**

 

Outstanding loansare summarized as follows:

 
| ** **                           | ** ** | **December 31,** | ** **  |
|--------------------------------------|------------|-----------------------|-------------|
| ** **                           | ** ** | **2005**              | ** **  | **2004** | ** ** |
|                                 |       |                  |        |   |   |
| Real  estate - mortgage              |       | $                     | 173,450,000 |   | $ | 146,876,000 |   |
| Real  estate - construction          |       | 111,130,000           |        | 90,643,000 |   |
| Commercial                           |       | 61,162,000            |        | 58,662,000 |   |
| Agricultural                         |       | 24,803,000            |        | 22,177,000 |   |
| Installment                          |       | 36,500,000            |        | 26,219,000 |   |
|                                 |       |                  |        |   |   |
|                                 |       | 407,045,000           |        | 344,577,000 |   |
|                                 |       |                  |        |   |   |
| Deferred  loan origination fees, net |       | (1,108,000            | )           | (1,022,000 | ) |
| Allowance  for loan losses           |       | (4,716,000            | )           | (4,000,000 | ) |
|                                 |       |                  |        |   |   |
|                                 |       | $                     | 401,221,000 |   | $ | 339,555,000 |   |

 

Changes in theallowance for loan losses were as follows:

 
| ** **                       | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------|------------|--------------------------------------------|------------|
| ** **                       | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
|                             |       |                                       |       |   |   |   |   |
| Balance,  beginning of year      |       | $                                          | 4,000,000  |   | $ | 3,262,000 |   | $ | 2,750,000 |   |
| Provision  charged to operations |       | 724,000                                    |       | 734,000 |   | 586,000 |   |
| Losses  charged to allowance     |       | (9,000                                     | )          | (24,000 | ) | (81,000 | ) |
| Recoveries                       |       | 1,000                                      |       | 28,000 |   | 7,000 |   |
|                             |       |                                       |       |   |   |   |   |
| Balance,  end of year            |       | $                                          | 4,716,000  |   | $ | 4,000,000 |   | $ | 3,262,000 |   |

 

At December 31,2005 and 2004, nonaccrual loans totaled $9,000 and $101,000, which wereconsidered impaired loans. There was no valuation allowance related to theseloans in 2005 and 2004. Interest foregone on nonaccrual loans totaled $1,000 foreach the years ended December 31, 2005, 2004 and 2003. Interest recognizedfor cash payment received on nonaccrual loans was not significant for the yearsended December 31, 2005, 2004 and 2003, respectively.

 

The Company didnot hold any real estate acquired by foreclosure at December 31, 2005 or2004.

 

Salaries andemployee benefits totaling $1,766,000, $1,190,000 and $1,032,000 have beendeferred as loan origination costs for the years ended December 31, 2005,2004 and 2003, respectively.

 

77

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**4.****                                      ACCRUEDINTEREST RECEIVABLE AND OTHER ASSETS**

 

Accrued interestreceivable and other assets consisted of the following:

 
| ** **                          | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **2005**              | ** ** | **2004** | ** ** |
|                                |       |                  |       |   |   |
| Accrued  interest receivable        |       | $                     | 3,424,000  |   | $ | 2,758,000 |   |
| Deferred  tax assets, net (Note 13) |       | 4,190,000             |       | 2,844,000 |   |
| Mortgage  servicing assets          |       | 1,073,000             |       | 1,348,000 |   |
| Prepaid  expenses                   |       | 1,008,000             |       | 1,019,000 |   |
| Other                               |       | 681,000               |       | 1,418,000 |   |
|                                |       |                  |       |   |   |
|                                |       | $                     | 10,376,000 |   | $ | 9,387,000 |   |

 

Originatedmortgage servicing assets totaling $142,000, $515,000 and $1,111,000 wererecognized during the years ended December 31, 2005, 2004 and 2003,respectively. Amortization of mortgage servicing assets totaled $417,000, $381,000and $476,000 for the years ended December 31, 2005, 2004 and 2003,respectively.

 

**5.****                                      PREMISESAND EQUIPMENT**

 

Premises andequipment consisted of the following:

 
| ** **                                      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **2005**              | ** ** | **2004** | ** ** |
|                                            |       |                  |       |   |   |
| Land                                            |       | $                     | 2,176,000  |   | $ | 1,519,000 |   |
| Buildings  and improvements                     |       | 6,908,000             |       | 5,761,000 |   |
| Furniture,  fixtures and equipment              |       | 7,384,000             |       | 6,242,000 |   |
| Leasehold  improvements                         |       | 994,000               |       | 842,000 |   |
| Construction  in progress                       |       | 622,000               |       | 75,000 |   |
|                                            |       |                  |       |   |   |
|                                            |       | 18,084,000            |       | 14,439,000 |   |
| Less  accumulated depreciation and amortization |       | 6,863,000             |       | 5,411,000 |   |
|                                            |       |                  |       |   |   |
|                                            |       | $                     | 11,221,000 |   | $ | 9,027,000 |   |

 

Depreciation andamortization included in occupancy and equipment expense totaled $1,574,000, $1,313,000and $934,000 for the years ended December 31, 2005, 2004 and 2003,respectively.

 

78

----

 

**6.****                                      INTEREST-BEARINGDEPOSITS**

 

Interest-bearingdeposits consisted of the following:

 
| ** **                      | ** ** | **December 31,** | ** **  |
|---------------------------------|------------|-----------------------|-------------|
| ** **                      | ** ** | **2005**              | ** **  | **2004** | ** ** |
|                            |       |                  |        |   |   |
| Savings                         |       | $                     | 36,061,000  |   | $ | 33,824,000 |   |
| Money  market                   |       | 42,029,000            |        | 40,119,000 |   |
| NOW  accounts                   |       | 151,930,000           |        | 140,271,000 |   |
| Individual  retirement accounts |       | 6,030,000             |        | 6,818,000 |   |
| Time,  $100,000 or more         |       | 58,573,000            |        | 46,120,000 |   |
| Other  time                     |       | 56,059,000            |        | 51,114,000 |   |
|                            |       |                  |        |   |   |
|                            |       | $                     | 350,682,000 |   | $ | 318,266,000 |   |

 

Aggregate annualmaturities of time deposits at December 31, 2005 are as follows:

 
| **Year Ending**  | ** ** | ** ** | ** **  |
|-----------------------|------------|------------|-------------|
| **December 31,** | ** ** | ** ** | ** **  |
|                  |       |       |        |
| 2006                  |       | $          | 74,449,000  |   |
| 2007                  |       | 34,070,000 |        |
| 2008                  |       | 5,280,000  |        |
| 2009                  |       | 551,000    |        |
| 2010                  |       | 282,000    |        |
|                  |       |       |        |
|                  |       | $          | 114,632,000 |   |

 

Interest expenserecognized on interest-bearing deposits consisted of the following:

 
| ** **                      | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------|------------|--------------------------------------------|------------|
| ** **                      | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
|                            |       |                                       |       |   |   |   |   |
| Savings                         |       | $                                          | 181,000    |   | $ | 145,000 |   | $ | 121,000 |   |
| Money  market                   |       | 368,000                                    |       | 285,000 |   | 357,000 |   |
| NOW  accounts                   |       | 934,000                                    |       | 811,000 |   | 1,050,000 |   |
| Individual  retirement accounts |       | 183,000                                    |       | 161,000 |   | 185,000 |   |
| Time,  $100,000 or more         |       | 1,492,000                                  |       | 1,136,000 |   | 853,000 |   |
| Other  time                     |       | 1,510,000                                  |       | 1,047,000 |   | 1,358,000 |   |
|                            |       |                                       |       |   |   |   |   |
|                            |       | $                                          | 4,668,000  |   | $ | 3,585,000 |   | $ | 3,924,000 |   |

 

79

----

 

**7.****                                      SHORT-TERMBORROWING ARRANGEMENTS**

 

The Company has $15,000,000in unsecured borrowing arrangements with two of its correspondent banks to meetshort-term liquidity needs. There were no borrowings outstanding under thesearrangements at December 31, 2005 and 2004.

 

**8.****                                      NOTESPAYABLE**

 

Note Payable

 

On June 1, 2005,Community Valley Bancorp entered into a short term, unsecured note payable in aprincipal amount of $800,000 in conjunction with the purchase of real property.The interest rate on the note at December 31, 2005 was 4.5%. The note waspaid in full on January 4, 2006.

 

Employee StockOwnership Plan (ESOP) Note

 

The ESOP obtainedfinancing through a $1,200,000 unsecured line of credit from another financialinstitution with the Company acting as the guarantor (see Note 15). Thenote has a variable interest rate, based on an independent index, and amaturity date of November 12, 2012. At December 31, 2005, theinterest rate was 7.0%. Advances on the line of credit totaled $982,000 and$833,000 at December 31, 2005 and 2004, respectively.

 

**9.**                                      JUNIOR SUBORDINATED DEBENTURES

 

Community Valley BancorpTrust I (CVB Trust I) is a Delaware statutory business trust formed by theCompany for the sole purpose of issuing trust preferred securities fully andunconditionally guaranteed by the Company. Under applicable regulatoryguidance, the amount of trust preferred securities that is eligible as Tier 1capital is limited to twenty-five percent of the Company’s Tier 1 capital on apro forma basis. At December 31, 2005, all of the trust preferredsecurities that have been issued qualify as Tier 1 capital.

 

In December 2002,the Company issued to CVB Trust I Subordinated Debentures due December 31,2032. Simultaneously, CVB Trust I issued 8,000 floating rate trust preferredsecurities, with liquidation values of $1,000 per security, for gross proceedsof $8,000,000. The Subordinated Debentures represent the sole assets of theTrust. The Subordinated Debentures are redeemable by the Company, subject toreceipt by the Company of prior approval from the Federal Reserve Bank (FRB),if then required under applicable capital guidelines or policies of the FRB. TheCompany may redeem the Subordinated Debentures held by CVB Trust I on any December 31ston or after December 31, 2007. The redemption price shall be par plusaccrued and unpaid interest, except in the case of redemption under a specialevent, which is defined in the debenture. The floating rate trust preferredsecurities are subject to mandatory redemption to the extent of any earlyredemption of the Subordinated Debentures and upon maturity of the SubordinatedDebentures on December 31, 2032.

 

80

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Holders of the trust preferred securities are entitledto cumulative cash distributions on the liquidation amount of $1,000 persecurity. Interest rates on the trust preferred securities and Subordinated Debenturesare the same and are computed on a 360-day basis. The stated interest rate isthe three-month London Interbank Offered Rate (LIBOR) plus 3.30% (7.45% at December 31,2005) with a maximum rate of 12.5% annually, adjustable quarterly.

 

Interest expense recognized by the Company for theyears ended December 31, 2005, 2004 and 2003 related to the subordinateddebentures was $592,000, $438,000 and $439,000 respectively. The amount ofdeferred costs at December 31, 2005 and 2004 was $96,000 and $144,000,respectively. The amortization of the deferred costs was $48,000 for the yearsended December 31, 2005, 2004 and 2003.

 

**10.****                               COMMITMENTSAND CONTINGENCIES**

 

###### Leases

 

The Company leasescertain of its branch offices and certain equipment under noncancellableoperating leases. These leases expire on various dates through 2014 and havevarious renewal options ranging from five to fifteen years. Rental paymentsinclude minimum rentals, plus adjustments for changing price indexes. Futureminimum lease payments and sublease rental income are as follows:

 
| ** **            | ** ** | ** **   | ** ** | **Minimum**  | ** ** |
|-----------------------|------------|--------------|------------|--------------|------------|
| ** **            | ** ** | **Minimum**  | ** ** | **Sublease** | ** ** |
| **Year Ending**  | ** ** | **Lease**    | ** ** | **Rental**   | ** ** |
| **December 31,** | ** ** | **Payments** | ** ** | **Income**   | ** ** |
|                  |       |         |       |         |       |
| 2006                  |       | $            | 631,000    |         | $          | 138,000 |   |
| 2007                  |       | 689,000      |       | 142,000      |       |
| 2008                  |       | 662,000      |       | 137,000      |       |
| 2009                  |       | 665,000      |       | 125,000      |       |
| 2010                  |       | 665,000      |       | 120,000      |       |
| Thereafter            |       | 5,611,000    |       | 176,000      |       |
|                  |       |         |       |         |       |
|                  |       | $            | 8,923,000  |         | $          | 838,000 |   |

 

Rental expenseincluded in occupancy and equipment expense totaled $524,000, $458,000 and$391,000 for the years ended December 31, 2005, 2004 and 2003,respectively. Sublease income included in occupancy expense totaled $134,000, $132,000and $91,000 for the years ended December 31, 2005, 2004 and 2003,respectively.

 

81

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FinancialInstruments With Off-Balance-Sheet Risk

 

The Company is aparty to financial instruments with off-balance-sheet risk in the normal courseof business in order to meet the financing needs of its customers. Thesefinancial instruments include commitments to extend credit and standby lettersof credit. These instruments involve, to varying degrees, elements of creditand interest rate risk in excess of the amount recognized on the consolidatedbalance sheet.

 

The Company’sexposure to credit loss in the event of nonperformance by the other party forcommitments to extend credit and standby letters of credit is represented bythe contractual amount of those instruments. The Company uses the same creditpolicies in making commitments and standby letters of credit as it does forloans included on the consolidated balance sheet.

 

The followingfinancial instruments represent off-balance-sheet credit risk:

 
| ** **                    | ** ** | **December 31,** | ** **  |
|-------------------------------|------------|-----------------------|-------------|
| ** **                    | ** ** | **2005**              | ** **  | **2004** | ** ** |
|                          |       |                  |        |   |   |
| Commitments  to extend credit |       | $                     | 200,693,000 |   | $ | 147,751,000 |   |
| Standby  letters of credit    |       | $                     | 4,895,000   |   | $ | 4,649,000 |   |

 

Commitments toextend credit are agreements to lend to a customer as long as there is noviolation of any condition established in the contract. Commitments generallyhave fixed expiration dates or other termination clauses and may requirepayment of a fee. Since some of the commitments are expected to expire withoutbeing drawn upon, the total commitment amounts do not necessarily representfuture cash requirements. Each customer’s creditworthiness is evaluated on acase-by-case basis. The amount of collateral obtained, if deemed necessary uponextension of credit, is based on management’s credit evaluation of theborrower. Collateral held varies, but may include deposit accounts,accounts receivable, inventory, equipment and deeds of trust on residentialreal estate and income-producing commercial properties.

 

Standby letters ofcredit are conditional commitments issued to guarantee the performance of acustomer to a third party. The credit risk involved in issuing standby lettersof credit is essentially the same as that involved in extending loans tocustomers. The fair value of the liability related to these standby letters ofcredit, which represents the fees received for issuing the guarantees, was notsignificant at December 31, 2005 and 2004. The Company recognizes thesefees as revenues over the term of the commitment or when the commitment isused.

 

 

82

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Commercial loancommitments and standby letters of credit represent approximately 12% of totalcommitments and are generally unsecured or secured by collateral other thanreal estate and have variable interest rates. Agricultural loan commitmentsrepresent approximately 6% of total commitments and are generally secured bycrop assignments, accounts receivable and farm equipment and have variableinterest rates. Real estate loan commitments represent approximately 71% oftotal commitments and are generally secured by property with a loan-to-valueratio not to exceed 80%. The majority of real estate commitments also havevariable interest rates. Personal lines of credit and home equity lines of creditrepresent the remaining 11% of total commitments and are generally unsecured orsecured by residential real estate and have both variable and fixed interestrates.

 

Concentrations ofCredit Risk

 

The Company grantsreal estate mortgage, real estate construction, commercial, agricultural andconsumer loans to customers throughout Butte, Sutter, Yuba, Tehama, Shasta,Colusa and Placer Counties.

 

Although theCompany has a diversified loan portfolio, a substantial portion of itsportfolio is secured by commercial and residential real estate. However,personal and business income represent the primary source of repayment for amajority of these loans.

 

In addition, theCompany’s real estate and construction loans represent approximately 70% ofoutstanding loans at December 31, 2005, compared to approximately 69% at December 31,2004. Collateral values associated with this lending concentration can varysignificantly based on the general level of interest rates and both local andregional economic conditions. In management’s opinion, although thisconcentration has no more than the normal risk of collection, a substantialdecline in the performance of the economy in general or a decline in realestate values in the Company’s primary market areas, in particular, could havean adverse impact on the collectibility of these loans.

 

###### CorrespondentBanking Agreements

 

The Companymaintains funds on deposit with other federally insured financial institutionsunder correspondent banking agreements. Uninsured deposits totaled $1,445,000at December 31, 2005.

 

###### Federal ReserveRequirements

 

Banks are requiredto maintain reserves with the Federal Reserve Bank equal to a percentage oftheir reservable deposits less vault cash. The Bank’s vault cash fulfilled itsreserve requirement at December 31, 2005.

 

83

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###### Contingencies

 

The Company issubject to legal proceedings and claims which arise in the ordinary course ofbusiness. In the opinion of management, the amount of ultimate liability withrespect to such actions will not materially affect the consolidated financialposition or consolidated results of operations of the Company.

 

**11.****                               SHAREHOLDERS’EQUITY**

 

Dividends

 

The shareholders of theCompany will be entitled to receive dividends when and as declared by its Boardof Directors, out of funds legally available for the payment of dividends, asprovided in the California General Corporation Law. The California generalcorporation law prohibits the Company from paying dividends on its common stockunless: (i) its retained earnings, immediately prior to the dividendpayment, equals or exceeds the amount of the dividend or (ii) immediatelyafter giving effect to the dividend, the sum of the Company’s assets (exclusiveof goodwill and deferred charges) would be at least equal to 125% of itsliabilities (not including deferred taxes, deferred income and other deferredliabilities) and the current assets of the Company would be at least equal toits current liabilities, or, if the average of its earnings before taxes onincome and before interest expense for the two preceding fiscal years was lessthan the average of its interest expense for the two preceding fiscal yeas, atleast equal to 125% of its current liabilities. In certain circumstances, theCompany may be required to obtain the prior approval of the FederalReserve Board to make capital distributions to shareholders of the Company.

 

The CaliforniaFinancial Code restricts the total dividend payment of any bank in any calendaryear to the lesser of (1) the bank’s retained earnings or (2) thebank’s net income for its last three fiscal years, less distributions made toshareholders during the same three-year period. At December 31, 2005,retained earnings of $13,655,000 were free of such restrictions. In additionthe Company’s ability to pay dividends is subject to certain covenantscontained in the indentures relating to Trust Preferred Securities issued bythe business trust (see Note 9).

 

###### Stock RepurchasePlan

 

The Board ofDirectors approved a plan to repurchase up to $3,000,000 of the outstandingcommon stock of the Company in 2003. Stock repurchases may be made fromtime to time on the open market or through privately negotiated transactions. Thetiming of purchases and the exact number of shares to be purchased will dependon market conditions. The share repurchase program does not include specificprice targets or timetables and may be suspended at any time. During 2005and 2003, no shares of the Company’s common stock were repurchased. During2004, 38,470 shares of the Company’s common stock were repurchased for $502,000.

 

84

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Stock Options

 

The Company hasestablished stock option plans for which shares of common stock have beenreserved for issuance to employees and directors under incentive andnonstatutory agreements. The plans require that the option price may notbe less than the fair market value of the stock at the date the option isgranted, and that the stock must be paid in full at the time the option isexercised. The options expire on a date determined by the Board of Directors,but not later than ten years from the date of grant. The vesting period isdetermined by the Board of Directors and is generally over five years; however,nonstatutory options granted during 1997 vested immediately. Under the 1997 and1991 plans, 293,641 shares of common stock remain reserved for issuance toemployees and directors, and the related options are exercisable until theirexpiration. However, no new options will be granted under these plans. Underthe Company’s 2000 stock option plan, 711,345 shares of common stock remainreserved for issuance to employees and directors, of which 74,677 shares areavailable for future grants.

 
| ** **                              | ** ** | **2005**   | ** ** | **2004**     | ** ** | **2003**   | ** ** |
|-----------------------------------------|------------|------------|------------|--------------|------------|------------|------------|
| ** **                              | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                              | ** ** | ** ** | ** ** | **Average**  | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                              | ** ** | ** ** | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| ** **                              | ** ** | **Shares** | ** ** | **Price**    | ** ** | **Shares** | ** ** | **Price** | ** ** | **Shares** | ** ** | **Price** |   |
|                                    |       |       |       |         |       |       |       |   |   |   |   |   |   |
| Incentive  Options                      |       |       |       |         |       |       |       |   |   |   |   |   |   |
|                                    |       |       |       |         |       |       |       |   |   |   |   |   |   |
| Options  outstanding, beginning of year |       | 551,348    |       | $            | 6.28       |       | 481,070    |   | $ | 4.71 |   | 532,226 |   | $ | 4.42 |   |
|                                    |       |       |       |         |       |       |       |   |   |   |   |   |   |
| Options  granted                        |       | 30,000     |       | $            | 14.48      |       | 107,618    |   | $ | 12.99 |   | 13,334 |   | $ | 9.65 |   |
| Options  exercised                      |       | (69,765    | )          | $            | 5.28       |       | (37,340    | ) | $ | 5.31 |   | (57,378 | ) | $ | 2.97 |   |
| Options  cancelled                      |       | (23,621    | )          | $            | 9.79       |       |       |   |   |   | (7,112 | ) | $ | 6.86 |   |
|                                    |       |       |       |         |       |       |       |   |   |   |   |   |   |
| Options  outstanding, end of year       |       | 487,962    |       | $            | 6.76       |       | 551,348    |   | $ | 6.28 |   | 481,070 |   | $ | 4.70 |   |
|                                    |       |       |       |         |       |       |       |   |   |   |   |   |   |
| Options  exercisable, end of year       |       | 352,016    |       | $            | 4.94       |       | 326,954    |   | $ | 5.15 |   | 321,062 |   | $ | 3.68 |   |
|                                    |       |       |       |         |       |       |       |   |   |   |   |   |   |
| Non-Qualified  Options                  |       |       |       |         |       |       |       |   |   |   |   |   |   |
|                                    |       |       |       |         |       |       |       |   |   |   |   |   |   |
| Options  outstanding, beginning of year |       | 414,680    |       | $            | 3.82       |       | 445,744    |   | $ | 3.75 |   | 465,744 |   | $ | 3.67 |   |
|                                    |       |       |       |         |       |       |       |   |   |   |   |   |   |
| Options  granted                        |       | 4,000      |       | $            | 13.25      |       |       |   |   |   | 5,334 |   | $ | 9.65 |   |
| Options  exercised                      |       | (64,700    | )          | $            | 2.45       |       | (31,064    | ) | $ | 2.79 |   | (25,334 | ) | $ | 3.82 |   |
|                                    |       |       |       |         |       |       |       |   |   |   |   |   |   |
| Options  outstanding, end of year       |       | 353,980    |       | $            | 4.17       |       | 414,680    |   | $ | 3.81 |   | 445,744 |   | $ | 3.74 |   |
|                                    |       |       |       |         |       |       |       |   |   |   |   |   |   |
| Options  exercisable, end of year       |       | 347,892    |       | $            | 4.04       |       | 361,554    |   | $ | 3.82 |   | 170,072 |   | $ | 3.36 |   |

 

85

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A summary ofoptions outstanding at December 31, 2005 follows:

 
| ** **                                  | ** ** | **Number of**    | ** ** | **Weighted**    | ** ** | **Number of**    | ** ** |
|---------------------------------------------|------------|-----------------------|------------|-----------------|------------|-----------------------|------------|
| ** **                                  | ** ** | **Options**           | ** ** | **Average**     | ** ** | **Options**           | ** ** |
| ** **                                  | ** ** | **Outstanding**       | ** ** | **Remaining**   | ** ** | **Exercisable**       | ** ** |
| ** **                                  | ** ** | **December 31,** | ** ** | **Contractual** | ** ** | **December 31,** | ** ** |
| **Range of Exercise Prices** | ** ** | **2005**              | ** ** | **Life**        | ** ** | **2005**              | ** ** |
|                                        |       |                  |       |            |       |                  |       |
| Incentive  Options                          |       |                  |       |            |       |                  |       |
|                                        |       |                  |       |            |       |                  |       |
| $                                           | 2.29       | -                     | $          | 3.80            |       |                  | 177,238    |   | 2.5 years |   | 177,238 |   |
| $                                           | 4.54       | -                     | $          | 5.27            |       |                  | 68,850     |   | 4.1 years |   | 68,850 |   |
| $                                           | 7.13       | -                     | $          | 9.65            |       |                  | 114,210    |   | 6.5 years |   | 70,913 |   |
| $                                           | 12.37      | -                     | $          | 14.75           |       |                  | 127,664    |   | 8.2 years |   | 35,015 |   |
|                                        |       |                  |       |            |       |                  |       |   |   |   |   |   |
|                                        |       |                  |       |            |       |                  | 487,962    |   |   |   | 352,016 |   |
|                                        |       |                  |       |            |       |                  |       |   |   |   |   |   |
| Non-qualified  Options                      |       |                  |       |            |       |                  |       |
|                                        |       |                  |       |            |       |                  |       |   |   |   |   |   |
| $                                           | 2.29       |                  |       |            |       |                  | 104,656    |   | 1.4 years |   | 104,656 |   |
| $                                           | 4.71       |                  |       |            |       |                  | 239,994    |   | 4.3 years |   | 239,994 |   |
| $                                           | 7.24       |                  |       |            |       |                  | 5,330      |   | 7.8 years |   | 2,486 |   |
| $                                           | 13.25      |                  |       |            |       |                  | 4,000      |   | 9.3 years |   | 756 |   |
|                                        |       |                  |       |            |       |                  |       |   |   |   |   |   |
|                                        |       |                  |       |            |       |                  | 353,980    |   |   |   | 347,892 |   |
|                                             |            |                       |            |                 |            |                       |            |  |  |  |  |  |  |

 

###### Earnings Per Share

 

A reconciliationof the numerators and denominators of the basic and diluted earnings per sharecomputations is as follows:

 
| ** **                            | ** ** | ** ** | ** ** | **Weighted**       | ** ** | ** **         | ** ** |
|---------------------------------------|------------|------------|------------|--------------------|------------|--------------------|------------|
| ** **                            | ** ** | ** ** | ** ** | **Average**        | ** ** | ** **         | ** ** |
| ** **                            | ** ** | ** ** | ** ** | **Number of** | ** ** | ** **         | ** ** |
| ** **                            | ** ** | **Net**    | ** ** | **Shares**         | ** ** | **Per Share** | ** ** |
| **For the Year Ended** | ** ** | **Income** | ** ** | **Outstanding**    | ** ** | **Amount**         | ** ** |
|                                  |       |       |       |               |       |               |       |
| December 31,  2005               |       |       |       |               |       |               |       |
|                                  |       |       |       |               |       |               |       |
| Basic  earnings per share             |       | $          | 7,198,000  |               | 7,166,258  |               | $          | 1.00 |   |
|                                  |       |       |       |               |       |               |       |
| Effect  of dilutive stock options     |       |       |       | 445,446            |       |               |       |
|                                  |       |       |       |               |       |               |       |
| Diluted  earnings per share           |       | $          | 7,198,000  |               | 7,611,704  |               | $          | .95 |   |

 

86

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| ** **                            | ** ** | ** ** | ** ** | **Weighted**       | ** ** | ** **         | ** ** |
|---------------------------------------|------------|------------|------------|--------------------|------------|--------------------|------------|
| ** **                            | ** ** | ** ** | ** ** | **Average**        | ** ** | ** **         | ** ** |
| ** **                            | ** ** | ** ** | ** ** | **Number of** | ** ** | ** **         | ** ** |
| ** **                            | ** ** | **Net**    | ** ** | **Shares**         | ** ** | **Per Share** | ** ** |
| **For the Year Ended** | ** ** | **Income** | ** ** | **Outstanding**    | ** ** | **Amount**         | ** ** |
|                                  |       |       |       |               |       |               |       |
| December 31,  2004               |       |       |       |               |       |               |       |
|                                  |       |       |       |               |       |               |       |
| Basic  earnings per share             |       | $          | 5,610,000  |               | 7,112,386  |               | $          | .79 |   |
|                                  |       |       |       |               |       |               |       |
| Effect  of dilutive stock options     |       |       |       | 488,706            |       |               |       |
|                                  |       |       |       |               |       |               |       |
| Diluted  earnings per share           |       | $          | 5,610,000  |               | 7,601,092  |               | $          | .74 |   |
|                                  |       |       |       |               |       |               |       |
| December 31,  2003               |       |       |       |               |       |               |       |
|                                  |       |       |       |               |       |               |       |
| Basic  earnings per share             |       | $          | 5,269,000  |               | 7,025,290  |               | $          | .75 |   |
|                                  |       |       |       |               |       |               |       |
| Effect  of dilutive stock options     |       |       |       | 405,226            |       |               |       |
|                                  |       |       |       |               |       |               |       |
| Diluted  earnings per share           |       | $          | 5,269,000  |               | 7,430,516  |               | $          | .71 |   |

 

During 2005, 14,000 options were excluded from thecomputation of diluted earnings per share as they were anti-dilutive. All otherstock options outstanding were included in the computation of diluted earningsper share for the years ended December 31, 2005, 2004 and 2003 as none ofthose stock options were anti-dilutive.

 

Regulatory Capital

 

The Company andthe Bank are subject to certain regulatory capital requirements administered bythe Board of Governors of the Federal Reserve System and the Federal DepositoryInsurance Corporation (FDIC). Failure to meet these minimum capitalrequirements can initiate certain mandatory, and possibly additionaldiscretionary, actions by regulators that, if undertaken, could have a directmaterial effect on the Company’s consolidated financial statements. Undercapital adequacy guidelines and the regulatory framework for prompt correctiveaction, the Bank must meet specific capital guidelines that involve quantitativemeasures of their assets, liabilities and certain off-balance-sheet items ascalculated under regulatory accounting practices. The Company’s and the Bank’scapital amounts and classifications are also subject to qualitative judgmentsby the regulators about components, risk weightings and other factors.

 

87

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Quantitativemeasures established by regulation to ensure capital adequacy require theCompany and the Bank to maintain minimum amounts and ratios of total and Tier 1capital to risk-weighted assets and of Tier 1 capital to average assets as setforth in the following table. Each of these components is defined in theregulations. Management believes that the Company and the Bank meet all theircapital adequacy requirements as of December 31, 2005 and 2004.

 

In addition, themost recent notification from the FDIC categorized the Bank as well capitalizedunder the regulatory framework for prompt corrective action. To be categorizedas well capitalized, the Bank must maintain minimum total risk-based, Tier 1risk-based and Tier 1 leverage ratios as set forth below. There are noconditions or events since that notification that management believes havechanged the Bank’s category.

 
| ** **                                 | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                            | ** ** | **To Be Well Capitalized** | ** ** |
|--------------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------|------------|---------------------------------------|------------|-------------------------------------------|------------|
| ** **                                 | ** ** | ** ** | ** ** | ** **                 | ** ** | **For Capital**       | ** ** | **Under Prompt Corrective** | ** ** |
| ** **                                 | ** ** | ** ** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| ** **                                 | ** ** | **Actual** | ** ** | **Minimum**                | ** ** | **Minimum**                | ** ** | **Minimum**                           | ** ** | **Minimum**                               | ** ** |
| ** **                                 | ** ** | **Amount** | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio**                             | ** ** | **Amount**                                | ** ** | **Ratio** | ** ** |
|                                       |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
| December 31,  2005                    |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
|                                       |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
| Company:                                   |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
| Total  capital (to risk-weighted assets)   |       | $          | 55,014,000 |                       | 12.5       | %                          | $          | 34,916,000                            |       | 8.0                                       | %          | n/a |   | n/a |   |
| Tier  1 capital (to risk-weighted assets)  |       | $          | 49,568,000 |                       | 11.4       | %                          | $          | 17,458,000                            |       | 4.0                                       | %          | n/a |   | n/a |   |
| Tier  1 capital (to average assets)        |       | $          | 49,568,000 |                       | 9.8        | %                          | $          | 20,216,000                            |       | 4.0                                       | %          | n/a |   | n/a |   |
|                                       |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
| Bank:                                      |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
| Total  capital (to risk-weighted assets)   |       | $          | 49,142,000 |                       | 11.3       | %                          | $          | 34,878,000                            |       | 8.0                                       | %          | $ | 43,597,000 |   | 10.0 | % |
| Tier  1 capital (to risk-weighted assets)  |       | $          | 43,944,000 |                       | 10.1       | %                          | $          | 17,439,000                            |       | 4.0                                       | %          | $ | 26,158,000 |   | 6.0 | % |
| Tier  1 capital (to average assets)        |       | $          | 43,944,000 |                       | 8.8        | %                          | $          | 20,000,000                            |       | 4.0                                       | %          | $ | 25,000,000 |   | 5.0 | % |
|                                       |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
| December 31,  2004                    |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
|                                       |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
| Company:                                   |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
| Total  capital (to risk-weighted assets)   |       | $          | 46,742,000 |                       | 12.5       | %                          | $          | 29,895,000                            |       | 8.0                                       | %          | N/A |   | N/A |   |
| Tier  1 capital (to risk- weighted assets) |       | $          | 42,361,000 |                       | 11.3       | %                          | $          | 14,947,000                            |       | 4.0                                       | %          | N/A |   | N/A |   |
| Tier  1 capital (to average assets)        |       | $          | 42,361,000 |                       | 9.5        | %                          | $          | 17,770,000                            |       | 4.0                                       | %          | N/A |   | N/A |   |
|                                       |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
| Bank:                                      |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
| Total  capital (to risk-weighted assets)   |       | $          | 42,337,000 |                       | 11.3       | %                          | $          | 29,853,000                            |       | 8.0                                       | %          | $ | 37,317,000 |   | 10.0 | % |
| Tier  1 capital (to risk-weighted assets)  |       | $          | 37,956,000 |                       | 10.2       | %                          | $          | 14,927,000                            |       | 4.0                                       | %          | $ | 22,390,000 |   | 6.0 | % |
| Tier  1 capital (to average Assets)        |       | $          | 37,956,000 |                       | 8.6        | %                          | $          | 17,656,000                            |       | 4.0                                       | %          | $ | 22,070,000 |   | 5.0 | % |

 

88

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**12.****                               OTHERNON-INTEREST INCOME AND EXPENSES**

 

Other non-interestincome consisted of the following:

 
| ** **                                                       | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                       | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                             |       |                                       |       |   |   |   |   |
| Alternative  investment fees                                     |       | $                                          | 520,000    |   | $ | 428,000 |   | $ | 218,000 |   |
| Merchant  card processing fees                                   |       | 390,000                                    |       | 337,000 |   | 343,000 |   |
| Earnings  from cash surrender value of bank owned life insurance |       | 294,000                                    |       | 284,000 |   | 380,000 |   |
| Other                                                            |       | 867,000                                    |       | 675,000 |   | 449,000 |   |
|                                                             |       |                                       |       |   |   |   |   |
|                                                             |       | $                                          | 2,071,000  |   | $ | 1,724,000 |   | $ | 1,390,000 |   |

 
| Other  expenses consisted of the following: |   |   |   |   |   |   |   |
|---------------------------------------------|--------|--------|--------|--------|--------|--------|--------|

 
| ** **                            | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------|------------|--------------------------------------------|------------|
| ** **                            | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                  |       |                                       |       |   |   |   |   |
| Professional  fees                    |       | $                                          | 1,035,000  |   | $ | 633,000 |   | $ | 537,000 |   |
| Telephone  and postage                |       | 580,000                                    |       | 511,000 |   | 498,000 |   |
| Stationery  and supplies              |       | 545,000                                    |       | 521,000 |   | 549,000 |   |
| Director  fees and retirement accrual |       | 469,000                                    |       | 408,000 |   | 357,000 |   |
| Advertising  and promotion            |       | 412,000                                    |       | 302,000 |   | 277,000 |   |
| Other                                 |       | 2,645,000                                  |       | 1,915,000 |   | 1,481,000 |   |
|                                  |       |                                       |       |   |   |   |   |
|                                  |       | $                                          | 5,686,000  |   | $ | 4,290,000 |   | $ | 3,699,000 |   |

 

**13.****                               INCOMETAXES**

 

The provision forincome taxes for the years ended December 31, 2005, 2004 and 2003consisted of the following:

 
| ** **                  | ** ** | **Federal** | ** ** | **State** | ** ** | **Total**  | ** ** |
|-----------------------------|------------|-------------|------------|-----------|------------|------------|------------|
| 2005                        |       |        |       |      |       |       |       |
|                        |       |        |       |      |       |       |       |
| Current                     |       | $           | 4,643,000  |      | $          | 1,659,000  |       | $ | 6,302,000 |   |
| Deferred                    |       | (992,000    | )          | (339,000  | )          | (1,331,000 | )          |
|                        |       |        |       |      |       |       |       |
| Provision  for income taxes |       | $           | 3,651,000  |      | $          | 1,320,000  |       | $ | 4,971,000 |   |

 

89

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| 2004                        |   |     |      |     |   |      |   |
|-----------------------------|--------|----------|-----------|----------|--------|-----------|--------|
|                        |   |     |      |     |   |      |   |
| Current                     |   | $        | 2,837,000 |     | $      | 1,030,000 |   | $ | 3,867,000 |   |
| Deferred                    |   | (21,000  | )         | (43,000  | )      | (64,000   | )      |
|                        |   |     |      |     |   |      |   |
| Provision  for income taxes |   | $        | 2,816,000 |     | $      | 987,000   |   | $ | 3,803,000 |   |
|                        |   |     |      |     |   |      |   |
| 2003                        |   |     |      |     |   |      |   |
|                        |   |     |      |     |   |      |   |
| Current                     |   | $        | 2,944,000 |     | $      | 1,024,000 |   | $ | 3,968,000 |   |
| Deferred                    |   | (487,000 | )         | (152,000 | )      | (639,000  | )      |
|                        |   |     |      |     |   |      |   |
| Provision  for income taxes |   | $        | 2,457,000 |     | $      | 872,000   |   | $ | 3,329,000 |   |

 

Deferred taxassets (liabilities) are comprised of the following at December 31, 2005and 2004:

 
| ** **                                                     | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|----------------------------------------------------------------|------------|-----------|------------|-----------|------------|
|                                                           |       |      |       |      |       |
| Deferred  tax assets:                                          |       |      |       |      |       |
| Allowance  for loan losses                                     |       | $         | 2,267,000  |      | $          | 1,800,000 |   |
| Deferred  compensation                                         |       | 2,157,000 |       | 1,644,000 |       |
| Future  benefit of state tax deduction                         |       | 487,000   |       | 391,000   |       |
| Premises  and equipment                                        |       | 60,000    |       |      |       |
| Unrealized  losses on available-for-sale investment securities |       | 8,000     |       |      |       |
| Other                                                          |       | 9,000     |       | 5,000     |       |
|                                                           |       |      |       |      |       |
| Total  deferred tax assets                                     |       | 4,988,000 |       | 3,840,000 |       |
|                                                           |       |      |       |      |       |
| Deferred  tax liabilities:                                     |       |      |       |      |       |
| Future  liability of state deferred tax assets                 |       | (354,000  | )          | (230,000  | )          |
| Premises  and equipment                                        |       |      |       | (182,000  | )          |
| Accrual  to cash - deferred loan costs                         |       | (225,000  | )          | (573,000  | )          |
| Prepaid  expenses                                              |       | (219,000  | )          |      |       |
| Unrealized  gains on available-for-sale investment securities  |       |      |       | (7,000    | )          |
| Other                                                          |       |      |       | (4,000    | )          |
|                                                           |       |      |       |      |       |
| Total  deferred tax liabilities                                |       | (798,000  | )          | (996,000  | )          |
|                                                           |       |      |       |      |       |
| Net  deferred tax assets                                       |       | $         | 4,190,000  |      | $          | 2,844,000 |   |

 

The Companybelieves that it is more likely than not that it will realize the abovedeferred tax assets in future periods; therefore, no valuation allowance hasbeen provided against its deferred tax assets.

 

90

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The provision forincome taxes differs from amounts computed by applying the statutory Federalincome tax rate to operating income before income taxes. The items comprisingthese differences are as follows:

 
| ** **                                      | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                      | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                      | ** ** | **Amount**                                 | ** ** | **Rate %** | ** ** | **Amount** | ** ** | **Rate %** | ** ** | **Amount** | ** ** | **Rate %** | ** ** |
|                                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Federal  income tax expense, at statutory rate  |       | $                                          | 4,261,000  |   | 35.0 |   | $ | 3,200,000 |   | 34.0 |   | $ | 2,923,000 |   | 34.0 |   |
| State  franchise tax, net of Federal tax effect |       | 871,000                                    |       | 7.2 |   | 673,000 |   | 7.1 |   | 589,000 |   | 6.9 |   |
| Tax-exempt  income from life insurance policies |       | (99,000                                    | )          | (.8 | ) | (117,000 | ) | (1.2 | ) | (137,000 | ) | (1.6 | ) |
| Other                                           |       | (62,000                                    | )          | (.6 | ) | 47,000 |   | .5 |   | (46,000 | ) | (.6 | ) |
|                                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
|                                            |       | $                                          | 4,971,000  |   | 40.8 |   | $ | 3,803,000 |   | 40.4 |   | $ | 3,329,000 |   | 38.7 |   |
|                                                 |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**14.****                               RELATEDPARTY TRANSACTIONS**

 

During the normalcourse of business, the Company enters into transactions with related parties,including Directors and executive officers. These transactions includeborrowings with substantially the same terms, including rates and collateral,as loans to unrelated parties. The following is a summary of the aggregateactivity involving related party borrowers during 2005:

 
| Balance, January 1, 2005                             |   | $          |  3,596,000 |   |
|---------------------------------------------------------------------|--------|------------|-----------------|--------|
|                                                                |   |       |            |
| Disbursements                                                       |   | 7,541,000  |            |
| Amounts  repaid                                                     |   | (4,788,000 | )               |
|                                                                |   |       |            |
| Balance,  December 31, 2005                                    |   | $          | 6,349,000       |   |
|                                                                |   |       |            |
| Undisbursed  commitments to related parties, December 31, 2005 |   | $          | 2,533,000       |   |

 

91

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**15.****                               EMPLOYEEBENEFIT PLANS**

 

SalaryContinuation and Retirement Plans

 

Salarycontinuation plans are in place for twelve key executives. In addition, aretirement plan is in place for members of the Board of Directors. Under theseplans, the directors and executives, or designated beneficiaries, will receivemonthly payments for five to twenty years after retirement or death. Thesebenefits are substantially equivalent to those available under insurancepolicies purchased by the Company on the lives of the directors and executives.In addition, the estimated present value of these future benefits is accruedover the period from the effective dates of the plans until their expectedretirement dates. The expense recognized under these plans for the years ended December 31,2005, 2004 and 2003 totaled $741,000, $715,000 and $574,000, respectively.

 

In connection withthese plans, the Company purchased single premium life insurance policies withcash surrender values totaling $8,447,000 and $6,703,000 at December 31,2005 and 2004, respectively. Income earned on these policies, net of expenses,totaled $294,000, $284,000 and $380,000 for the years ended December 31,2005, 2004 and 2003, respectively.

 

###### Savings Plan

 

The ButteCommunity Bank 401(k) Savings Plan commenced January 1, 1993 and isavailable to employees meeting certain service requirements. Under the plan,employees may defer a selected percentage of their annual compensation. TheBank may make a discretionary contribution to the plan which would beallocated as follows:

 

•                                          Amatching contribution to be determined by the Board of Directors each plan yearunder which the Bank will match a percentage of each participant’scontribution.

 

•                                          Abasic contribution that would be allocated in the same ratio as eachparticipant’s contribution bears to total compensation.

 

There were noemployer contributions for the years ended December 31, 2005, 2004 or 2003.

 

92

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Employee StockOwnership Plan

 

Under the ButteCommunity Bank Employee Stock Ownership Plan (“ESOP”), employees who have beencredited with at least 1,000 hours of service during a twelve month period andwho have attained age eighteen are eligible to participate. The ESOP has fundedpurchases of the Bank’s common stock through a line of credit from anotherfinancial institution (see Note 8). The line of credit is repaid fromdiscretionary contributions to the ESOP determined by the Bank’s Board ofDirectors. Annual contributions are limited on a participant-by-participantbasis to the lesser of $30,000 or twenty-five percent of the participant’scompensation for the year. Employee contributions are not permitted.

 

As a leveragedESOP, interest expense is recognized on the line of credit in the Company’sconsolidated financial statements. Shares are allocated on the basis ofeligible compensation, as defined in the ESOP plan document, in the year ofallocation. Benefits generally become 100% vested after seven years of creditedservice. Employees with at least three, but fewer than seven, years of creditedservice receive a partial vesting according to a sliding schedule. However, inthe event of normal retirement, disability, or death, any unvested portion ofbenefits vest immediately.

 

As shares arepurchased by the ESOP with proceeds from the line of credit, the Companyrecords the cost of these unearned ESOP shares as a contra-equity account. Theseamounts are shown as a reduction of shareholders’ equity in the Company’sconsolidated balance sheet. As the debt is repaid, the shares are released fromunallocated ESOP shares in proportion to the debt service paid during the yearand allocated to eligible employees. As shares are released from unallocatedESOP shares, the Company reports compensation expense equal to the currentmarket price of the shares, and the shares are recognized as outstanding forearnings per share computations. Benefits are distributed in the form ofqualifying Company securities. However, the Company will issue a put option toeach participant upon distribution of the securities which, if exercised,requires the Company to purchase the qualifying securities at fair marketvalue.

 

During 2005 and2004, the ESOP purchased 23,637 and 11,320 shares of the Company’s common stockat a cost of $348,000 and $150,000, respectively, using the proceeds from theline of credit to the ESOP. Additionally, during 2003, the ESOP redeemed 12,974shares of the Company’s common stock previously allocated to participants underthe put option described above. The cost of these shares totaled $135,000 andwas funded by the proceeds from the same line of credit. Interest expense of $50,000,$33,000 and $33,000 was recognized in connection with the line of credit duringthe years ended December 31, 2005, 2004 and 2003, respectively.

 

Compensationexpense of $251,000, $180,000 and $252,000 was recognized for the years ended December 31,2005, 2004 and 2003.

 

93

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Allocated andunallocated ESOP shares at December 31, 2005, 2004 and 2003, adjusted forstock splits, were as follows:

 
| ** **                        | ** ** | **2005** | ** ** | **2004** | ** ** | **2003**  | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|-----------|------------|
|                              |       |     |       |     |       |      |       |
| Allocated  shares                 |       | 238,812  |       | 223,020  |       | 210,374   |       |
| Unallocated  shares               |       | 185,051  |       | 179,256  |       | 181,818   |       |
|                              |       |     |       |     |       |      |       |
| Total  ESOP shares                |       | 423,863  |       | 402,276  |       | 392,192   |       |
|                              |       |     |       |     |       |      |       |
| Fair  value of unallocated shares |       | $        | 2,637,000  |     | $          | 2,487,000 |       | $ | 1,841,000 |   |
|                                   |            |          |            |          |            |           |            |  |  |  |

 

**16.****                               DISCLOSURESABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

Estimated fairvalues are disclosed for financial instruments for which it is practicable toestimate fair value. These estimates are made at a specific point in time basedon relevant market data and information about the financial instruments. Theseestimates do not reflect any premium or discount that could result fromoffering the Company’s entire holdings of a particular financial instrument forsale at one time, nor do they attempt to estimate the value of anticipatedfuture business related to the instruments. In addition, the tax ramificationsrelated to the realization of unrealized gains and losses can have asignificant effect on fair value estimates and have not been considered in anyof these estimates.

 

Because no marketexists for a significant portion of the Company’s financial instruments, fairvalue estimates are based on judgments regarding current economic conditions,risk characteristics of various financial instruments and other factors. Theseestimates are subjective in nature and involve uncertainties and matters ofsignificant judgment and therefore cannot be determined with precision. Changesin assumptions could significantly affect the fair values presented.

 

The followingmethods and assumptions were used by the Company to estimate the fair value ofits financial instruments at December 31, 2005 and 2004:

 

Cash and cashequivalents: For cash and cash equivalents, the carryingamount is estimated to be fair value.

 

Interest-bearingdeposits in banks: The fair values of interest-bearingdeposits in banks are estimated by discounting their future cash flows usingrates at each reporting date for instruments with similar remaining maturitiesoffered by comparable financial institutions.

 

Investmentsecurities: For investment securities, fair values are basedon quoted market prices, where available. If quoted market prices are notavailable, fair values are estimated using quoted market prices for similarsecurities and indications of value provided by brokers.

 

94

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Loans:For variable-rate loans that reprice frequently with no significant change incredit risk, fair values are based on carrying values. Fair values of loansheld for sale are estimated using quoted market prices for similar loans or theamount that purchasers have committed to purchase the loans. The fair valuesfor other loans are estimated using discounted cash flow analyses, usinginterest rates offered at each reporting date for loans with similar terms toborrowers of comparable creditworthiness adjusted for the allowance for loanlosses. The carrying amount of accrued interest receivable approximates itsfair value.

 

Other investments:Other investments include non-marketable equity securities. The carrying valueof these investments approximates their fair value.

 

Bank owned lifeinsurance: The fair values of life insurance policies arebased on cash surrender values at each reporting date provided by the insurers.

 

Mortgage servicingrights: The fair value of mortgage servicing rights isestimated using projected cash flows, adjusted for the effects of anticipatedprepayments, using a market discount rate.

 

Deposits:The fair values for demand deposits are, by definition, equal to the amountpayable on demand at each reporting date represented by their carrying amount. Fairvalues for fixed-rate certificates of deposit are estimated using a discountedcash flow analysis using interest rates offered at each reporting date by theBank for certificates with similar remaining maturities. The carrying amount ofaccrued interest payable approximates its fair value.

 

Notes payable:The notes payable reprice based upon an independent index. The carrying amountof the notes payable approximates its fair value.

 

Juniorsubordinated debentures: The fair value of the juniorsubordinated debentures was determined based on the current market forlike-kind instruments of a similar maturity and structure.

 

Commitments toextend credit and standby letters of credit: Commitments toextend credit are primarily for variable rate loans and standby letters ofcredit. For these commitments, there is no difference between the committedamounts and their fair values. The fair value of the commitments at eachreporting date were not significant and not included in the accompanying table.

 

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The estimated fairvalues of the Company’s financial instruments are as follows:

 
| ** **                                       | ** ** | **December 31, 2005** | ** **  | **December 31, 2004** | ** ** |
|--------------------------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|
| ** **                                       | ** ** | **Carrying**                    | ** **  | **Fair**                        | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| ** **                                       | ** ** | **Amount**                      | ** **  | **Value**                       | ** ** | **Amount** | ** ** | **Value** | ** ** |
|                                             |       |                            |        |                            |       |   |   |   |   |
| Financial  assets:                               |       |                            |        |                            |       |   |   |   |   |
| Cash  and due from banks                         |       | $                               | 18,988,000  |                            | $          | 18,988,000 |   | $ | 21,778,000 |   | $ | 21,778,000 |   |
| Federal  funds sold                              |       | 29,015,000                      |        | 29,015,000                      |       | 46,440,000 |   | 46,440,000 |   |
| Interest-bearing  deposits in banks              |       | 6,636,000                       |        | 6,597,000                       |       | 8,715,000 |   | 8,723,000 |   |
| Loans  held for sale                             |       | 2,197,000                       |        | 2,212,000                       |       | 1,490,000 |   | 1,513,000 |   |
| Investment  securities                           |       | 6,676,000                       |        | 6,640,000                       |       | 6,961,000 |   | 6,963,000 |   |
| Loans                                            |       | 401,221,000                     |        | 399,544,000                     |       | 339,174,000 |   | 334,910,000 |   |
| Other  investments                               |       | 118,000                         |        | 118,000                         |       | 118,000 |   | 118,000 |   |
| Accrued  interest receivable                     |       | 3,424,000                       |        | 3,424,000                       |       | 2,578,000 |   | 2,578,000 |   |
| Cash  surrender value of life insurance policies |       | 8,447,000                       |        | 8,447,000                       |       | 6,703,000 |   | 6,703,000 |   |
| Mortgage  servicing assets                       |       | 1,073,000                       |        | 1,073,000                       |       | 1,348,000 |   | 1,348,000 |   |
|                                             |       |                            |        |                            |       |   |   |   |   |
| Financial  liabilities:                          |       |                            |        |                            |       |   |   |   |   |
| Deposits                                         |       | $                               | 434,018,000 |                            | $          | 433,780,000 |   | $ | 399,059,000 |   | $ | 398,950,000 |   |
| Notes  payable                                   |       | 1,782,000                       |        | 1,782,000                       |       | 833,000 |   | 833,000 |   |
| Junior  subordinated debentures                  |       | 8,248,000                       |        | 8,248,000                       |       | 8,248,000 |   | 8,248,000 |   |
| Accrued  interest payable                        |       | 652,000                         |        | 652,000                         |       | 479,000 |   | 479,000 |   |

 

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**17.****                              ****PARENT ONLY CONDENSEDFINANCIAL STATEMENTS**

 

**CONDENSED BALANCE SHEET**

 

**December 31, 2005 and 2004**

 
| ** **                                            | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-------------------------------------------------------|------------|------------|------------|------------|------------|
| * *                                              | * *   | * *   | * *   | * *   | * *   |
| **ASSETS**                                            | * *   | * *   | * *   | * *   | * *   |
| * *                                              | * *   | * *   | * *   | * *   | * *   |
| Cash  and cash equivalents                            |       | $          | 4,358,000  |       | $          | 3,296,000 |   |
| Investment  in bank subsidiary                        |       | 43,931,000 |       | 38,126,000 |       |
| Investment  in non-bank subsidiary                    |       | 865,000    |       | 987,000    |       |
| Other  assets                                         |       | 2,084,000  |       | 1,589,000  |       |
|                                                  |       |       |       |       |       |
| Total  assets                                         |       | $          | 51,238,000 |       | $          | 43,998,000 |   |
|                                                  |       |       |       |       |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**        |       |       |       |       |       |
|                                                  |       |       |       |       |       |
| Liabilities:                                          |       |       |       |       |       |
| ESOP  note payable                                    |       | $          | 982,000    |       | $          | 833,000 |   |
| Junior  subordinated debentures                       |       | 8,248,000  |       | 8,248,000  |       |
| Other  liabilities                                    |       | 453,000    |       | 386,000    |       |
|                                                  |       |       |       |       |       |
| Total  liabilities                                    |       | 9,683,000  |       | 9,467,000  |       |
|                                                  |       |       |       |       |       |
| Shareholders’  equity:                           |       |       |       |       |       |
| Common  stock                                         |       | 9,051,000  |       | 7,862,000  |       |
| Unallocated  ESOP shares                              |       | (1,391,000 | )          | (1,144,000 | )          |
| Retained  earnings                                    |       | 33,908,000 |       | 27,802,000 |       |
| Accumulated  other comprehensive income, net of taxes |       | (13,000    | )          | 11,000     |       |
|                                                  |       |       |       |       |       |
| Total  shareholders’ equity                      |       | 41,555,000 |       | 34,531,000 |       |
|                                                  |       |       |       |       |       |
| Total  liabilities and shareholders’ equity      |       | $          | 51,238,000 |       | $          | 43,998,000 |   |

 

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**17.****                               PARENTONLY CONDENSED FINANCIAL STATEMENTS**

 

**CONDENSED STATEMENT OF INCOME**

 

**For the Years Ended December 31, 2005, 2004 and2003**

 
| ** **                                                    | ** ** | **2005**  | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|---------------------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| * *                                                      | * *   | * *  | * *   | * *  | * *   | * *  | * *   |
| Income:                                                       |       |      |       |      |       |      |       |
| Dividends  declared by bank subsidiary                        |       | $         | 2,258,000  |      | $          | 1,857,000 |       | $ | 2,064,000 |   |
|                                                          |       |      |       |      |       |      |       |
| Expenses:                                                     |       |      |       |      |       |      |       |
| Professional  fees                                            |       | 231,000   |       | 180,000   |       | 147,000   |       |
| Interest  expense                                             |       | 642,000   |       | 439,000   |       | 439,000   |       |
| Other  expenses                                               |       | 374,000   |       | 142,000   |       | 101,000   |       |
|                                                          |       |      |       |      |       |      |       |
| Total  expenses                                               |       | 1,247,000 |       | 761,000   |       | 687,000   |       |
|                                                          |       |      |       |      |       |      |       |
| Income  before equity in undistributed income of subsidiaries |       | 1,011,000 |       | 1,096,000 |       | 1,377,000 |       |
|                                                          |       |      |       |      |       |      |       |
| Equity  in undistributed income of subsidiaries               |       | 5,707,000 |       | 4,235,000 |       | 3,578,000 |       |
|                                                          |       |      |       |      |       |      |       |
| Income  before income tax benefit                             |       | 6,718,000 |       | 5,331,000 |       | 4,955,000 |       |
|                                                          |       |      |       |      |       |      |       |
| Income  tax benefit                                           |       | 480,000   |       | 279,000   |       | 314,000   |       |
|                                                          |       |      |       |      |       |      |       |
| Net  income                                                   |       | $         | 7,198,000  |      | $          | 5,610,000 |       | $ | 5,269,000 |   |

 

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**17.****                               PARENTONLY CONDENSED FINANCIAL STATEMENTS**

 

**CONDENSED STATEMENT OF CASH FLOWS**

 

**Forthe Years Ended December 31, 2005, 2004 and 2003**

 
| ** **                                                                         | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| * *                                                                           | * *   | * *   | * *   | * *   | * *   | * *   | * *   |
| Cash  flows from operating activities:                                             |       |       |       |       |       |       |       |
| Net  income                                                                        |       | $          | 7,198,000  |       | $          | 5,610,000  |       | $ | 5,269,000 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |       |       |       |       |       |       |
| Undistributed  net income of subsidiary                                            |       | (5,707,000 | )          | (4,235,000 | )          | (3,578,000 | )          |
| Increase  in other assets                                                          |       | 268,000    |       | (111,000   | )          | (375,000   | )          |
| Increase  in other liabilities                                                     |       | 44,000     |       | 67,000     |       | 92,000     |       |
|                                                                               |       |       |       |       |       |       |       |
| Net  cash provided by operating activities                                         |       | 1,803,000  |       | 1,331,000  |       | 1,408,000  |       |
|                                                                               |       |       |       |       |       |       |       |
| Cash  flows from investing activities:                                             |       |       |       |       |       |       |       |
| Investment  in Butte Community Bank                                                |       |       |       |       |       | (4,760,000 | )          |
| Investment  in CVB Insurance Agency LLC                                            |       |       |       | (1,000,000 | )          |       |       |
| Investment  in Community Valley Bancorp Trust I                                    |       |       |       |       |       |       |       |
|                                                                               |       |       |       |       |       |       |       |
| Net  cash used in investing activities                                             |       |       |       | (1,000,000 | )          | (4,760,000 | )          |
|                                                                               |       |       |       |       |       |       |       |
| Cash  flows from financing activities:                                             |       |       |       |       |       |       |       |
| Proceed  from ESOP note payable                                                    |       | 348,000    |       | 849,000    |       |       |       |
| Repayments  of ESOP note payable                                                   |       | (199,000   | )          | (16,000    | )          |       |       |
| Purchase  of unallocated ESOP shares                                               |       | (348,000   | )          | (150,000   | )          |       |       |
| Proceeds  from exercise of stock options                                           |       | 527,000    |       | 284,000    |       | 267,000    |       |
| Cash  paid for fractional shares                                                   |       |       |       | (6,000     | )          |       |       |
| Payment  of cash dividends                                                         |       | (1,069,000 | )          | (1,089,000 | )          | (1,079,000 | )          |
| Repurchase  of common stock                                                        |       |       |       | (502,000   | )          |       |       |
|                                                                               |       |       |       |       |       |       |       |
| Net  cash used in financing activities                                             |       | (741,000   | )          | (630,000   | )          | (812,000   | )          |
|                                                                               |       |       |       |       |       |       |       |
| Decrease  in cash and cash equivalents                                             |       | 1,062,000  |       | (299,000   | )          | (4,164,000 | )          |
|                                                                               |       |       |       |       |       |       |       |
| Cash  and cash equivalents at beginning of year                                    |       | 3,296,000  |       | 3,595,000  |       | 7,759,000  |       |
|                                                                               |       |       |       |       |       |       |       |
| Cash  and cash equivalents at end of year                                          |       | $          | 4,358,000  |       | $          | 3,296,000  |       | $ | 3,595,000 |   |

 

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