Table ofContents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-K**

 

**ANNUALREPORT PURSUANT TO SECTION 13 OR 15(D)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the fiscal year ended December 31, 2009**

 

**Commission File Number 0-51678**

 

**COMMUNITYVALLEY BANCORP**

(Exact name of registrant as specified in its charter)

 

| **California**                         | ** ** | **68-0479553**                        |
|----------------------------------------|------------|---------------------------------------|
| State of incorporation                 |       | I.R.S. Employer Identification Number |
|                                   |       |                                  |
| **1360 E. Lassen Avenue**              | ** ** | ** **                            |
| **Chico, California**                  | ** ** | **95973**                             |
| Address of principal executive offices |       | Zip Code                              |

 

**(530) 899-2344**

Registrant’s telephone number, including area code

 

Securitiesregistered pursuant to Section 12(b) of the Act: **Common Stock, No Par Value**

 

Securitiesregistered pursuant to Section 12(g) of the Act: **None**

 

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

 

Indicateby check mark if the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Exchange Act.  Yes  o  No  x

 

Indicateby check mark whether the Registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.  Yes  x  No o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter)during the preceding 12 months (or for such shorter period that the registrantwas required to submit and post such files).  Yes  o  No o

 

Checkif disclosure of delinquent filers pursuant to Item 405 of Regulation S-K isnot contained herein, and will not be contained, to the best of Registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this form10-K.  o

 

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

 

| Large accelerated filer  o |   | Accelerated filer  o         |
|--------------------------------------|--------|----------------------------------------|
|                                 |   |                                   |
| Non-accelerated filer  o   |   | Smaller Reporting Company  x |

 

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

 

Asof June 30, 2009, the aggregate market value of the voting stock held bynon-affiliates of the Registrant was approximately $6.7 million, based on thesales price reported to the Registrant on that date of $3.10 per share.

 

Sharesof Common Stock held by each officer and director and each person owning morethan five percent of the outstanding Common Stock have been excluded in thatsuch persons may be deemed to be affiliates. This determination of theaffiliate status is not necessarily a conclusive determination for otherpurposes.

 

Thenumber of shares of Common Stock of the registrant outstanding as of April 12,2010 was 6,699,603.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Portionsof the Proxy Statement relating to the Annual Meeting of Shareholders to beheld on June 3, 2010, are incorporated by reference into Part III ofthis Report.

 

 

 

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**TABLE OF CONTENTS**

 
| PART I   |     |                                                                                                             |   | 3      |
|---------------|----------|------------------------------------------------------------------------------------------------------------------|--------|--------|
|          |     |                                                                                                             |   |   |
|          | Item 1.  |  Business                                                                                                   |   | 3      |
|          |     |                                                                                                             |   |   |
|          | Item 1a. | Risk Factors                                                                                                     |   | 20     |
|          |     |                                                                                                             |   |   |
|          | Item 1b. | Unresolved Staff  Comments                                                                                       |   | 24     |
|          |     |                                                                                                             |   |   |
|          | Item 2.  | Properties                                                                                                       |   | 24     |
|          |     |                                                                                                             |   |   |
|          | Item 3.  | Legal Proceedings                                                                                                |   | 26     |
|          |     |                                                                                                             |   |   |
|          | Item 4.  | Not Applicable                                                                                                   |   |   |
|          |     |                                                                                                             |   |   |
| PART II  |     |                                                                                                             |   | 26     |
|          |     |                                                                                                             |   |   |
|          | Item 5.  | Market for Registrants  Common Equity and Related Shareholder Matters and Issuer Purchases of Equity  Securities |   | 26     |
|          |     |                                                                                                             |   |   |
|          | Item 6.  | Selected Financial  Data                                                                                         |   | 29     |
|          |     |                                                                                                             |   |   |
|          | Item 7.  | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                      |   | 30     |
|          |     |                                                                                                             |   |   |
|          | Item 7a. | Quantitative  and Qualitative Disclosures About Market Risk                                                      |   | 55     |
|          |     |                                                                                                             |   |   |
|          | Item 8.  | Financial  Statements and Supplementary Data                                                                     |   | 55     |
|          |     |                                                                                                             |   |   |
|          | Item 9.  | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure                            |   | 55     |
|          |     |                                                                                                             |   |   |
|          | Item 9a. | Controls and  Procedures                                                                                         |   | 55     |
|          |     |                                                                                                             |   |   |
|          | Item 9b. | Other Information                                                                                                |   | 57     |
|          |     |                                                                                                             |   |   |
| PART III |     |                                                                                                             |   | 57     |
|          |     |                                                                                                             |   |   |
|          | Item 10. | Directors and  Executive Officers and Corporate Governance                                                       |   | 57     |
|          |     |                                                                                                             |   |   |
|          | Item 11. | Executive  Compensation                                                                                          |   | 57     |
|          |     |                                                                                                             |   |   |
|          | Item 12. | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                 |   | 57     |
|          |     |                                                                                                             |   |   |
|          | Item 13. | Certain  Relationships and Related Transactions and Director Independence                                        |   | 57     |
|          |     |                                                                                                             |   |   |
|          | Item 14. | Principal  Accountant Fees and Services                                                                          |   | 57     |
|          |     |                                                                                                             |   |   |
| PART IV  |     |                                                                                                             |   | 58     |
|          |     |                                                                                                             |   |   |
|          | Item 15. | Exhibits,  Financial Statement Schedules, and Reports on Form 8-K                                           |   | 58     |
|          |     |                                                                                                             |   |   |
| SIGNATURES    |     |                                                                                                             |   | 62     |

 

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**PART I**

 

**Item 1.  Business**

 

**ForwardLooking Statements**

 

Certainstatements contained in this Annual Report on Form 10-K that are notstatements of historical fact constitute forward-looking statements within themeaning of the Private Securities Litigation Reform Act of 1995 (the “Act”),notwithstanding that such statements are not specifically identified. These statements are based on management’sbeliefs and assumptions, and on information available to management as of thedate of this document. Forward-looking statements include the informationconcerning possible or assumed future results of operations of the Company setforth under the heading “Management’s Discussion and Analysis of FinancialCondition and Results of Operations.” Forward-looking statements also includestatements in which words such as “expect,” “anticipate,” “intend,” “plan,” “believe,”“estimate,” “consider” or similar expressions are used. Forward-lookingstatements are not guarantees of future performance. They involve risks,uncertainties and assumptions, including the risks discussed under the heading “RiskFactors” and elsewhere in this report. The Company’s actual future results andshareholder values may differ materially from those anticipated and expressedin these forward-looking statements. Many of the factors that will determinethese results and values, including those discussed under the heading “RiskFactors,” are beyond the Company’s ability to control or predict. Investors arecautioned not to put undue reliance on any forward-looking statements. Inaddition, the Company does not have any intention or and assumes no obligationto update forward-looking statements after the date of the filing of thisreport, even if new information, future events or other circumstances have madesuch statements incorrect or misleading. Except as specifically noted hereinall referenced to the “Company” refer to Community Valley Bancorp, a Californiacorporation, and its consolidated subsidiaries.

 

**RecentDevelopments**

 

On March 31, 2009,Butte Community Bank finalized the sale of its merchant processing portfolioto Elavon (formerly known as NOVA Information Systems).  Inconsideration for the merchant business through the purchase of allinterest in the Bank’s principal assets used in its merchant credit card anddebit card processing business, the Bank realized a one time pre tax gain of$2,640,000. The Bank will continue to offer merchant processing businessto our customers through our marketing alliance with Elavon.

 

OnSeptember 18, 2009, the Company gave formal written notice to the NASDAQStock Market of its intention to voluntarily delist its common stock from theNASDAQ Capital Market. The decision to delist was part of the overall strategyto conserve resources and improve cost effectiveness as the benefits ofmaintaining a NASDAQ listing have not materialized. Considering the limitedtrading volume and low trading prices on NASDAQ, the Company concluded alisting on NASDAQ does not justify the expense and administrative burdenassociated with maintaining such listing.

 

Asa result of the Company’s 2009 strategic cost reduction plan, in March of2009 the Gridley Loan Production Office (LPO) was consolidated with the fullservice Yuba City Office. In December 2009, the Redding Offices were consolidatedinto one location on Hilltop Drive. These offices were less than two milesapart and streamlining banking operations is part of the Company’s strategicplan to decrease expenses and increase efficiencies. In February 2010, theCitrus Heights Loan Production Office was consolidated with the Yuba CityOffice. With the slowdown in the real estate market, the consolidation of bothLPOs into the Yuba City Office will allow the Company to continue to serviceits customers and provide opportunities for its lenders to gain exposure to allareas of lending.

 

On December 30, 2009, the Company, pursuant to aloan participation and debt conversion agreement (“Agreement”) converted $3.3million in outstanding debt into shareholders’ equity by issuing preferred stock in a privateplacement transaction.  The $3.3 million outstanding debt of the Companywas the net balance of the principal amount of a loan from Pacific CoastBankers’ Bank (“PCBB”) to the Company that was collateralized by all of theoutstanding common stock of the Bank.  As part of the transaction, $1.2million of the $3.3 million loan from PCBB was participated by PCBB to certainaccredited investors, including certain directors of the Company.  Theparticipated debt of $1.2 million was then converted into 240,000 shares of 6%Mandatory Convertible Cumulative Preferred Stock Series A (“PreferredStock Series A”).  The remaining $2.1 million of $3.3 million debtwas converted into 105,647 shares of 8% Cumulative Perpetual Preferred Stock Series B(“Preferred Stock Series B”) that was issued in a private placementtransaction to Pacific Coast Bankers’ Bank. As part of the debt conversion, allof the outstanding shares of common stock of the Bank held as collateral forthe $3.3 million debt was released to the Company.

 

On December 31, 2009,Keith C. Robbins, longtime President and CEO of the Company and CEO of theBank, retired from the daily management of the Company and the Bank.  Mr. Robbinswill continue as a director of the Company and the Bank and also serve as amember of the ALCO committee of the board of directors. John Coger has beennamed to replace Mr. Robbins as the new president and chief executiveofficer of the Company and the Bank. Regulatory approval was received on January 21,2009. In addition to being a board member, Mr. Coger is also the chairmanof the Asset Liability Committee and was the driving force behind the formationof the Bank in 1989.

 

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As a result of aregularly scheduled and recently concluded joint Federal Deposit InsuranceCorporation (FDIC) and California Department of Financial Institutions (DFI) examination, management expects toreceive a formal order (“Order”) from the FDIC and the DFI. The Order isexpected to include provisions to further strengthen and improve asset quality,enhance problem loan identification policies and procedures includingidentification of impaired loans and troubled debt restructured loans, reducethe level of classified assets, maintain certain capital ratios and requestregulatory approval prior to paying any cash dividends. At this time,management does not know what impact the Order will have on the Company’sbusiness strategies. Various strategic options are being evaluated andmanagement continues to act upon both tactical and strategic alternatives toraise capital and restructure the Company’s balance sheet. The Company formed aBoard appointed Capital Augmentation Committee (“Committee”) and has engaged afinancial advisor to explore alternatives to assist the Company in resolvingits capital deficiency issues.

 

The Company incurred anet loss of $(27,508,000) for the year ended December 31, 2009 andreported net income of $2,739,000 and $6,459,000 for the years ended December 31,2008 and 2007, respectively. The 2009 loss was primarily the result ofsignificant increases in the provision for loan losses, increases in costsassociated with foreclosed real estate and continued compression of theinterest margin caused by 2008 interest rate reductions and increased amountsof non-accrual loans.  Furthermore, avaluation allowance provided against our deferred tax assets during the fourthquarter of 2009 also negatively impacted our results. The severe net losscaused the Bank to be under-capitalized. The culmination of net losses inrecent quarters has restricted our operations and has had a negative impact onour operations, liquidity and capital adequacy.

 

**General**

 

**TheCompany**

 

Community Valley Bancorp (the “Company”) is a California corporationregistered as a financial holding company under the Bank Holding Company Act of1956, as amended (the “BHC Act”), and is headquartered in Chico, California.The Company was incorporated in July, 2001 and acquired all of the outstandingshares of Butte Community Bank (the “Bank”) in May, 2002. The Company’sprincipal subsidiary is the Bank. On July 10, 2007 the Company formed awholly-owned subsidiary, Community Valley Bancorp Trust II (the “Trust”), whichis a Delaware statutory business trust, for the purpose of issuing trustpreferred securities. The proceeds from the Trust were used to redeem 100% ofthe trust preferred securities issued by the 2002 Community Valley BancorpTrust I.  After redemption CommunityValley Bancorp Trust I was dissolved (see Note 9 to the Consolidated FinancialStatements in Part II - Item 8). The Company also has an insurance subsidiary in the name of ButteCommunity Insurance Agency, LLC which was formed in December 2004 toprovide a full service insurance agency offering all lines of coverage. TheCompany exists primarily for the purpose of holding the stock of the Bank andof such other subsidiaries as it may acquire or establish.

 

TheCompany’s principal source of income is currently dividends from the Bank, butthe Company intends to explore additional supplemental sources of income in thefuture. The expenditures of the Company, including (but not limited to) thepayment of dividends to shareholders, if and when declared by the Board ofDirectors, and the cost of servicing debt will generally be paid from suchpayments made to the Company by the Bank.

 

AtDecember 31, 2009, the Company had consolidated assets of $538.5 million,deposits of $498.2 million and shareholders’ equity of $16.0 million.

 

TheCompany’s Administrative Offices are located at 1360 East Lassen Avenue, Chico,California and its telephone number is (530) 899-2344. References herein to the“Company” include the Company and its subsidiaries, unless the contextindicates otherwise.

 

The Company files annual,quarterly and other reports under the Securities Exchange Act of 1934 with theSecurities and Exchange Commission. These reports are posted and are availableat no cost on the Company’s website, www.communityvalleybancorp.com through thereports link, as soon as reasonably practicable after the Company files suchdocuments with the SEC. The Company’s filings are also available through theSEC’s website at www.sec.gov.

 

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**TheBank**

 

ButteCommunity Bank was incorporated under the laws of the State of California on May 11,1990 and commenced operations as a California state-chartered commercial bankon December 14, 1990. The Bank’s Administrative Office is located at 1360East Lassen Avenue, Chico, California. The Bank is an insured bank under theFederal Deposit Insurance Act up to the maximum limits thereof and isparticipating in the separate FDIC Transaction Account Guarantee Program.  Under that program, through December 31,2010, all noninterest-bearing transaction accounts are fully guaranteed by theFDIC for the entire amount in the account. The Bank is not a member of the Federal Reserve System. At December 31,2009, the Bank had approximately $532.3 million in assets, $434.1 million inloans and $500.1 million in deposits.

 

Weoperate seven full-service branch offices in four Butte County communities, onefull-service branch office in Sutter County, two full-service branches inTehama County, one full-service branch in Yuba County, one full-service branchin Colusa County, and two full-service branches in Shasta County. During 2009,management evaluated its administrative and retail branch facilities in orderto identify opportunities for greater efficiencies in its operationalstructure. As a result of our expense control initiative, due to the downturnin the economy, a few locations were consolidated. The Gridley LPO moved to theYuba City full service branch and in Redding, the Churn Creek branchconsolidated with the Hilltop branch. In 2010, the Citrus Heights LPO moved tothe Yuba City branch. Management considers these moves as part if its strategicplan to decrease expenses and increase efficiencies to continue to meet theneeds of its customers.   We offer a fullrange of banking services to individuals and various-sized businesses in thecommunities we serve. The locations of those offices are:

 
| Chico:     |   | Main  Office                                           |   | Paradise   |   | South  Paradise Branch                    |
|------------|--------|--------------------------------------------------------|--------|------------|--------|-------------------------------------------|
|       |   | 2041  Forest Avenue                                    |   |       |   | 672  Pearson Road                         |
|       |   |                                                   |   |       |   |                                      |
|       |   | Administrative  Headquarters   1360 East Lassen Avenue |   |       |   | North  Paradise Branch   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                   |
|       |   |                                                   |   |       |   |                                      |
| Colusa     |   | Colusa  Branch

1017  Bridge Street                    |   | Yuba  City |   | Yuba  City Branch   1600 Butte House Road |
|       |   |                                                   |   |       |   |                                      |
| Redding    |   | Hilltop  Branch   1335 Hilltop Drive                   |   | Red  Bluff |   | Red  Bluff Branch   10 Gilmore Rd         |
|       |   |                                                   |   |       |   |                                      |
| Marysville |   | Marysville  Branch   904 B Street                      |   | Anderson   |   | Anderson  Branch   5026 Rhonda Road       |
|       |   |                                                   |   |       |   |                                      |
| Corning    |   | Corning  Branch                                        |   |       |   |                                      |
|       |   | 950  Hwy 99W                                           |   |       |   |                                      |

 

Inaddition, our Data Processing, Call Center and Bank Card Center are located at1390 Ridgewood Drive, Chico. Our Real Estate Loan Center and Central NoteDepartment are located at 1360 East Lassen Avenue, Chico.  We also have specialized credit centers foragricultural lending and construction and real estate lending within a numberof these branch offices. These facilities are located in the cities of Chico,Paradise, and Oroville in Butte County, the city of Yuba City in Sutter County,the cities of Red Bluff and Corning in Tehama County, the city of Marysville inYuba County, the city of Colusa in Colusa County, and the cities of Andersonand Redding in Shasta County. Throughout the history of Butte Community Bank,our growth has been exclusively by establishing de novo full-service branchoffices and credit centers in various locations in California’s NorthernSacramento Valley and foothill 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 County and other surrounding counties. Our principal retaillending services include home equity and consumer loans. In addition, we havethree other significant dimensions which surround this core of retail communitybanking:  Agricultural lending,commercial lending, and real estate financing (both construction and longterm).

 

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TheAgricultural Credit Centers located in Yuba City, Chico, and Red Bluff providea complete line of credit services in support of the agricultural activitieswhich are key to the continued economic development of the communities weserve. “Ag lending” clients include a full range of individual farmingcustomers and small business farming organizations.

 

The Bank Card Center,headquartered in Chico, provides a range of credit, debit and ATM cardservices, which are made available to each of the customers served by thebranch banking offices. In addition, we staff our Chico, Paradise, Oroville,Red Bluff, Yuba City and Redding offices with real estate lending specialists.These officers are responsible for a complete line of land acquisition anddevelopment loans, construction loans for residential and commercialdevelopment, and the origination of multifamily credit facilities. The Bank services real estate loans soldon the secondary market, and as of year end 2009 the portfolio serviced realestate loans was in excess of $70.4 million.  We also have an orientation toward SmallBusiness Administration lending and have been designated as a Preferred Lendersince 1998. It is anticipated that loans under this program will be anincreasing segment of our loan portfolio over the next few years.  The Bank has historically been one of themost active lenders in the state of California and the Nation.  In addition, the Bank services loans totaling$128.3 million originated under the USDA B&I program. The primary purposesof the program are to stimulate the local economy, create additionalemployment, attract additional commercial investment capital and supportpotential growth in tax revenue, which will improve the quality of life forrural residents.

 

Asof December 31, 2009, the principal areas in which we directed our lendingactivities, and the percentage of our total loan portfolio for which each ofthese areas was responsible, were as follows: (i) agricultural loans (9%);(ii) commercial and industrial (including SBA and B&I) loans (19%); (iii) realestate loans (commercial and construction) (58%); and (iv) consumer loans(14%).

 

Inaddition to the lending activities noted above, we offer a wide range ofdeposit products for the retail banking market including checking, interestbearing transaction, savings, time certificates of deposit, retirementaccounts, and business sweep, as well as telephone banking, mobile banking, andinternet banking with bill pay options. Butte Community Bank attracts depositsthrough its customer-oriented product mix, competitive pricing, convenientlocations, extended hours drive-up and on-line banking, all provided with thehighest level of customer service.

 

Wealso offer other products and services to our customers which complement thelending and deposit services previously reviewed. These include cashier’schecks, traveler’s checks, bank-by-mail, ATM, night depository, safe depositboxes, direct deposit, automated payroll services, cash management, lockbox,remote deposit capture and other customary banking services. Shared ATM andPoint of Sale (POS) networks allow customers access to the national andinternational funds transfer networks. We have two remote ATMs which arelocated in a hospital and the Company’s administrative building, and fivescript machines located in four different movie theaters and one restaurant.These locations facilitate cash advances which would not otherwise be availableto consumers at non-branch locations, thereby increasing consumer convenience.In addition to such specifically oriented customer applications, we providewire transfer 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 attractedfrom individuals, business-related sources and smaller municipal entities. Thisresults in a relatively modest average deposit balance of approximately $11,100at December 31, 2009, but makes the Bank less subject to adverse effectsfrom the loss of a substantial depositor who may be seeking higher yields inother markets or who may have need of money otherwise on deposit with the Bank,especially during periods of inflation or conservative monetary policies.

 

Fornon-deposit services, we have a strategic alliance with Linsco Private LedgerFinancial Services. Through this arrangement, our registered and licensedrepresentatives provide Bank customers with convenient access to annuities,insurance products, mutual funds, and a full range of investment products whichare not FDIC insured. They conduct business from all of our full serviceoffices.

 

Wedo not believe there is a significant demand for additional trust services inour service areas, and we do not operate or have any present intention to seekauthority to operate a Trust Department. We believe that the cost ofestablishing and operating such a department would not be justified by thepotential income to be gained there from.

 

Theofficers and employees of the Bank are continually engaged in marketingactivities, including the evaluation and development of new products andservices, which enable the Bank to retain and improve its competitive positionin its service areas. All of these developments are meant to increase publicconvenience and enhance public access to the electronic payments system. Thecost to the Bank for these development, implementation, and marketingactivities cannot expressly be calculated with any degree of certainty.

 

TheBank holds no patents or licenses (other than licenses required by appropriatebank regulatory agencies), franchises, or concessions. The Bank is notdependent on a single customer or group of related customers for a materialportion of its deposits. There has been no material effect upon the Bank’scapital expenditures, earnings, or competitive position as a result of Federal,state, or local environmental regulation.

 

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**Competition**

 

Thebanking business in California generally, and specifically in our market areas,is highly competitive with respect to virtually all products and services andhas become increasingly more so in recent years. The industry continues toconsolidate and strong, unregulated competitors have entered banking marketswith focused products targeted at highly profitable customer segments. Manylargely 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.

 

Withrespect to commercial bank competitors, the business is largely dominated by arelatively small number of major banks with many offices operating over a widegeographical area.  These banks have,among other advantages, the ability to finance wide-ranging and effectiveadvertising campaigns and to allocate their investment resources to regions ofhighest yield and demand. Many of the major banks operating in the area offercertain services which we do not offer directly but may offer indirectlythrough correspondent institutions. By virtue of their greater totalcapitalization, such banks also have substantially higher lending limits thanwe do.

 

Inaddition to other banks, competitors include savings institutions, creditunions, 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, creditcard, and other consumer finance services, including on-line banking servicesand personal finance software. Strong competition for deposit and loan productsaffects the rates of those products as well as the terms on which they areoffered 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, effective March 11,2000, made it possible for full affiliations to occur between banks andsecurities firms, insurance companies, and other financial companies and hasintensified competitive conditions.

 

Technologicalinnovation has also resulted in increased competition in financial servicesmarkets. Such innovation has, for example, made it possible for non-depositoryinstitutions to offer customers automated transfer payment services thatpreviously have been considered traditional banking products. In addition, manycustomers now expect a choice of several delivery systems and channels,including telephone, mail, home computer, mobile, remote deposit capture, ATMs,self service branches, and/or in-store branches. In addition to other banks,the sources of competition for such products include savings associations,credit unions, brokerage firms, money market and other mutual funds, assetmanagement groups, finance and insurance companies, internet-only financialintermediaries, and mortgage banking firms.

 

Formany years, we have countered this increasing competition by providing our ownstyle of community-oriented, personalized service. We rely upon localpromotional activity, personal contacts by our officers, directors, employees,and shareholders, automated 24-hour banking, and the individualized servicewhich we can provide through our flexible policies. In addition, to meet theneeds of customers with electronic access requirements, the Company hasembraced the electronic age and installed telephone banking, internet banking withbill payment capabilities, and mobile banking. This high tech and high touchapproach allows the individual to customize the Bank’s contact methodologies totheir particular preference. Moreover, for customers whose loan demands exceedour legal lending limit, we attempt to arrange for such loans on aparticipation basis with correspondent banks. We also assist our customers inobtaining from our correspondent banks other services that the Bank may notoffer.

 

Ourcredit card business is subject to an even higher level of competitive pressurethan our general banking business. There are a number of major banks and creditcard issuers that are able to finance often highly successful advertisingcampaigns with which community banks generally do not have the resources tocompete. As a result, our credit card balances outstanding are much more likelyto increase at a slower rate than that which might be seen in nationwideissuers’ year-end statistics. Additional competition comes from manynon-financial institutions, such as providers of various retail products, whichoffer many types of credit cards.

 

**Employees**

 

Asof December 31, 2009 the Company had 139 full-time and 116part-time employees. On a full time equivalent basis, the Company’s staff levelwas 227 at December 31, 2009, as compared to 248 at December 31,2008. None of our employees is concurrently represented by a union or coveredby a collective bargaining agreement. Management of the Company believes itsemployee relations are satisfactory.

 

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**Supervision and Regulation**

 

**The Company**

 

TheCompany is a financial holding company within the meaning of the FinancialHolding Company Act of 1956 and is registered as such with the Board ofGovernors 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.

 

We and our subsidiary are prohibited from engaging incertain tie-in arrangements in connection with any extension of credit, sale orlease of property or provision of services. For example, with certainexceptions, the bank may not condition an extension of credit on a customerobtaining other services provided by us, the bank or any other subsidiary ofours, or on a promise by the customer not to obtain other services from acompetitor. In addition, federal law imposes certain restrictions ontransactions between the bank and its affiliates. As affiliates, the bank andwe are subject, with certain exceptions, to the provisions of federal lawimposing limitations on and requiring collateral for extensions of credit bythe bank to any affiliate.

 

**The Bank**

 

Asa California state-chartered bank whose accounts are insured by the FDIC up toapplicable limits per depositor, the Bank is subject to regulation, supervisionand regular examination by the DFI and the FDIC. In addition, while the Bank isnot a member of the Federal Reserve System, it is subject to certainregulations of the Federal Reserve Board. The regulations of these agenciesgovern most aspects of the Bank’s business, including the making of periodicreports by the Bank, and the Bank’s activities relating to dividends, investments,loans, borrowings, capital requirements, certain check-clearing activities,branching, mergers and acquisitions, reserves against deposits and numerousother areas. Supervision, legal action and examination of the Bank by the FDICare generally intended to protect depositors and are not intended for theprotection of shareholders.

 

Theearnings and growth of the Bank are largely dependent on its ability tomaintain a favorable differential or “spread” between the yield on itsinterest-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. Californialaw presently permits a bank to locate a branch office in any locality in thestate.  Additionally, California lawexempts banks from California usury laws. The nature and impact of anyfuture changes in monetary policies cannot be predicted.

 

**Capital Standards**

 

The FRB has risk-based capital adequacy guidelinesintended to provide a measure of capital adequacy that reflects the degree ofrisk associated with a banking organization’s operations for both transactionsreported on the balance sheet as assets, and transactions, such as letters ofcredit and recourse arrangements, which are reported as off-balance-sheetitems.  Under these guidelines, nominaldollar amounts of assets and credit equivalent amounts of off-balance-sheetitems are multiplied by one of several risk adjustment percentages, which rangefrom 0% for assets with low credit risk, such as certain U.S. governmentsecurities, to 100% for assets with relatively higher credit risk, such asbusiness loans.

 

A banking organization’s risk-based capital ratios areobtained by dividing its qualifying capital by its total risk-adjusted assetsand off-balance-sheet items.  Theregulators measure risk-adjusted assets and off-balance-sheet items againstboth total qualifying capital (the sum of Tier 1 capital and limited amounts ofTier 2 capital) and Tier 1 capital.  Tier1 capital consists of common stock, retained earnings, noncumulative perpetualpreferred stock and minority interests in certain subsidiaries, less most otherintangible assets.  Tier 2 capital mayconsist of a limited amount of the allowance for loan and lease losses andcertain other instruments with some characteristics of equity.  The inclusion of elements of Tier 2 capitalis subject to certain other requirements and limitations of the federal bankingagencies.  Since December 31, 1992,the FRB and the FDIC have required a minimum ratio of qualifying total capitalto risk-adjusted assets and off-balance-sheet items of 8%, and a minimum ratioof Tier 1 capital to risk-adjusted assets and off-balance-sheet items of 4%.

 

In addition to the risk-based guidelines, the FRBrequires banking organizations to maintain a minimum amount of Tier 1 capitalto average total assets, referred to as the leverage ratio.  For a banking organization rated in thehighest of the five categories used by regulators to rate bankingorganizations, the minimum leverage ratio of Tier 1 capital to total assets is3%.  It is improbable; however, that aninstitution with a 3% leverage ratio would receive the highest rating by theregulators since a strong capital position is a significant part of theregulators’ ratings.  For all bankingorganizations not rated in the highest category, the minimum leverage ratio 

 

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is at least 100 to 200 basis points above the 3%minimum.  Thus, the effective minimumleverage ratio, for all practical purposes, is at least 4% or 5%.  In addition to these uniform risk-basedcapital guidelines and leverage ratios that apply across the industry, the FRBand FDIC have the discretion to set individual minimum capital requirements forspecific institutions at rates significantly above the minimum guidelines andratios.

 

A bank that does notachieve and maintain the required capital levels may be issued a capitaldirective by the FDIC to ensure the maintenance of required capitallevels.  As discussed above, the Companyis required to maintain certain levels of capital, as is the Bank.  The Company and the Bank were bothunder-capitalized at December 31, 2009. In addition, subsequent to aregulatory examination in 2009, the Bank is required to maintain a Tier 1leverage ratio of 10%. See page 54, Capital Resources and Note 12 to theConsolidated Financial Statements for more comprehensive discussions on theCompany’s regulatory capital requirements. The regulatory capital guidelines aswell as the actual capitalization for the Bank and Company as of December 31,2009 follow:

 
| ** **                       | ** ** | **Requirement for the********Bank to be:** | ** ** | ** **            | ** ** | ** ** |
|----------------------------------|------------|--------------------------------------------|------------|-----------------------|------------|------------|
| ** **                       | ** ** | **Adequately  Capitalized**                | ** ** | **Well  Capitalized** | ** ** | **Bank**   | ** ** | **Company** |
| Tier  1 leverage capital ratio   |       | 4.0%                                       |       | 5.0%                  |       | 4.1%       |   | 3.0% |
| Tier  1 risk-based capital ratio |       | 4.0%                                       |       | 6.0%                  |       | 4.8%       |   | 3.5% |
| Total  risk-based capital ratio  |       | 8.0%                                       |       | 10.0%                 |       | 6.0%       |   | 6.2% |

 

**Prompt Corrective Action**

 

Federal banking agencies possess broad powers to takecorrective and other supervisory action to resolve the problems of insureddepository institutions, including those institutions that fall below one ormore prescribed minimum capital ratios described above.  An institution that, based upon its capitallevels, is classified as well capitalized, adequately capitalized, orundercapitalized may be treated as though it were in the next lower capitalcategory if the appropriate federal banking agency, after notice andopportunity for hearing, determines that an unsafe or unsound condition or anunsafe or unsound practice warrants such treatment.  At each successive lower capital category, aninsured depository institution is subject to more restrictions.

 

In addition to measures taken under the promptcorrective action provisions, commercial banking organizations may be subjectto potential enforcement actions by the federal regulators for unsafe orunsound practices in conducting their businesses or for violations of any law,rule, regulation, or any condition imposed in writing by the agency or anywritten agreement with the agency. Enforcement actions may include the imposition of a conservator orreceiver, the issuance of a consent order that can be judicially enforced, thetermination of insurance of deposits (in the case of a depository institution),the imposition of civil money penalties, the issuance of directives to increasecapital, the issuance of formal and informal agreements, the issuance ofremoval and prohibition orders against institution-affiliated parties and theenforcement of such actions through injunctions or restraining orders basedupon a judicial determination that the agency would be harmed if such equitablerelief was not granted.  Additionally, aholding company’s inability to serve as a source of strength to its subsidiarybanking organizations could serve as an additional basis for a regulatoryaction against the holding company.

 

**Premiums for Deposit Insurance**

 

The deposit insurance fund of the FDIC insures ourcustomer deposits up to prescribed limits for each depositor.  The Federal Deposit Insurance Reform Act of2005 and the Federal Deposit Insurance Reform Conforming Amendments Act of 2005amended the insurance of deposits by the FDIC and collection of assessmentsfrom insured depository institutions for deposit insurance.  The FDIC approved a final rule in 2006and amended the rule in February 2009 that sets an insured depositoryinstitution’s assessment rate on different factors that pose a risk of loss tothe Deposit Insurance Fund, including the institution’s recent financial ratiosand supervisory ratings, and level of reliance on a significant amount ofsecured liabilities or significant amount of brokered deposits (except that thefactor of brokered deposits will not be considered for well capitalizedinstitutions that are not accompanied by rapid growth).  The FDIC also in February 2009 set theassessment base rates to range between $0.12 to $0.16 per $100 of insureddeposits on an annual basis.  In May 2009,the FDIC imposed a special assessment of 5 basis points on each insureddepository institution’s assets less its Tier 1 capital payable on September 30,2009 with a ceiling of 10 basis points of an institution’s domesticdeposits.  In November 2009, theFDIC approved a final rule to requireall insured depository institutions including the Bankto prepay three years of FDIC assessments in the fourth quarter of 2009, exceptin the event such prepayment is waived by the FDIC.  The amount of this prepaid assessment was $3.9 million which the Bank paid on December 31, 2009.  While the prepaid assessments are not chargedagainst income for 2009 but rather expensed quarterly based on the FDIC’squarterly assessment calculation over three years beginning in 2010, the amountpaid will reduce the cash and liquidity of the Bank at year end 2009 andsubsequent periods.  Due to 

 

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the significant losses at failed banks and expectedlosses for banks that will fail, it is likely that FDIC insurance fundassessments on the Bank will increase and such assessments could have amaterial adverse effect on our business, financial condition, results ofoperations or cash flows, depending on the amount of the increase.  Furthermore, the FDIC is authorized to raiseinsurance premiums under certain circumstances.

 

The FDIC is authorized to terminate a depositoryinstitution’s deposit insurance upon a finding by the FDIC that the institution’sfinancial condition is unsafe or unsound or that the institution has engaged inunsafe or unsound practices or has violated any applicable rule, regulation,order or condition enacted or imposed by the institution’s regulatoryagency.  The termination of depositinsurance for the Bank would have a material adverse effect on our business,financial condition, results of operations and/or cash flows.

 

**Federal Reserve System. **The FRB requires all depository institutions tomaintain non-interest bearing reserves at specified levels against theirtransaction accounts and non-personal time deposits.  At December 31, 2009, we were incompliance with these requirements.

 

**Impact of Monetary Policies. **The earnings and growth of the Company are subject tothe influence of domestic and foreign economic conditions, including inflation,recession and unemployment.  The earningsof the Company are affected not only by general economic conditions but also bythe monetary and fiscal policies of the United States and federal agencies,particularly the FRB.  The FRB can anddoes implement national monetary policy, such as seeking to curb inflation andcombat recession, by its open market operations in United States Governmentsecurities and by its control of the discount rates applicable to borrowings bybanks from the FRB.  The actions of the FRBin these areas influence the growth of bank loans and leases, investments anddeposits and affect the interest rates charged on loans and leases and paid ondeposits.  The FRB’s policies have had asignificant effect on the operating results of commercial banks and areexpected to continue to do so in the future. The nature and timing of any future changes in monetary policies are notpredictable.

 

**Extensions of Credit to Insiders andTransactions with Affiliates. **The *Federal Reserve Act*and FRB *Regulation O* place limitations andconditions on loans or extensions of credit to:

 

·                  a bank’s or bank holding company’sexecutive officers, directors and principal shareholders (*i.e.*, in most cases, those persons whoown, control or have power to vote more than 10% of any class of votingsecurities),

·                  any company controlled by any such executiveofficer, director or shareholder, or

·                  any political or campaign committeecontrolled by such executive officer, director or principal shareholder.

 

Loans and leases extended to any of the above personsmust comply with loan-to-one-borrower limits, require prior full board approvalwhen aggregate extensions of credit to the person exceed specified amounts,must be made on substantially the same terms (including interest rates andcollateral) as, and follow credit-underwriting procedures that are not lessstringent than, those prevailing at the time for comparable transactions withnon-insiders, and must not involve more than the normal risk of repayment orpresent other unfavorable features.  Inaddition, Regulation O provides that the aggregate limit on extensions ofcredit to all insiders of a bank as a group cannot exceed the bank’s unimpairedcapital and unimpaired surplus. Regulation O also prohibits a bank from paying an overdraft on anaccount of an executive officer or director, except pursuant to a writtenpre-authorized interest-bearing extension of credit plan that specifies amethod of repayment or a written pre-authorized transfer of funds from anotheraccount of the officer or director at the bank.

 

**Consumer Protection Laws and Regulations. **The banking regulatory agencies are focusing greaterattention on compliance with consumer protection laws and their implementingregulations.  Examination and enforcementhave become more intense in nature, and insured institutions have been advisedto monitor carefully compliance with such laws and regulations.  The Company is subject to many federal andstate consumer protection and privacy statutes and regulations, some of whichare discussed below.

 

The*Community ReinvestmentAct* (the “CRA”) is intended to encourage insured depositoryinstitutions, while operating safely and soundly, to help meet the credit needsof their communities.  The CRAspecifically directs the federal regulatory agencies, in examining insureddepository institutions, to assess a bank’s record of helping meet the creditneeds of its entire community, including low-and moderate-income neighborhoods,consistent with safe and sound banking practices.  The CRA further requires the agencies to takea financial institution’s record of meeting its community credit needs intoaccount when evaluating applications for, among other things, domesticbranches, mergers or acquisitions, or holding company formations**. **The agencies usethe CRA assessment factors in order to provide a rating to the financialinstitution.  The ratings range from ahigh of “outstanding” to a low of “substantial noncompliance.”  In its last examination for CRA compliance,as of February 2007, the Bank was rated “satisfactory.”

 

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The*Equal Credit OpportunityAct* (the “ECOA”) generally prohibits discrimination in any credittransaction, whether for consumer or business purposes, on the basis of race,color, religion, national origin, sex, marital status, age (except in limitedcircumstances), receipt of income from public assistance programs, or goodfaith exercise of any rights under the Consumer Credit Protection Act.

 

The*Truth in Lending Act*(the “TILA”) is designed to ensure that credit terms are disclosed in ameaningful way so that consumers may compare credit terms more readily andknowledgeably.  As a result of the TILA,all creditors must use the same credit terminology to express rates andpayments, including the annual percentage rate, the finance charge, the amountfinanced, the total of payments and the payment schedule, among other things.

 

The*Fair Housing Act*(the “FH Act”) regulates many practices, including making it unlawful for anylender to discriminate in its housing-related lending activities against anyperson because of race, color, religion, national origin, sex, handicap orfamilial status.  A number of lendingpractices have been found by the courts to be, or may be considered, illegalunder the FH Act, including some that are not specifically mentioned in the FHAct itself.

 

The*Home Mortgage DisclosureAct* (the “HMDA”), in response to public concern over creditshortages in certain urban neighborhoods, requires public disclosure ofinformation that shows whether financial institutions are serving the housingcredit needs of the neighborhoods and communities in which they arelocated.  The HMDA also includes a “fairlending” aspect that requires the collection and disclosure of data aboutapplicant and borrower characteristics as a way of identifying possiblediscriminatory lending patterns and enforcing anti-discrimination statutes.

 

The *Right to Financial PrivacyAct* (the “RFPA”) imposes a new requirement for financialinstitutions to provide new privacy protections to consumers.  Financial institutions must providedisclosures to consumers of its privacy policy, and state the rights ofconsumers to direct their financial institution not to share their nonpublicpersonal information with third parties.

 

Finally, the *Real Estate SettlementProcedures Act* (the “RESPA”) requires lenders to providenoncommercial borrowers with disclosures regarding the nature and cost of realestate settlements.  Also, RESPAprohibits certain abusive practices, such as kickbacks, and places limitationson the amount of escrow accounts.

 

Penalties for noncompliance or violations under theabove laws may include fines, reimbursement and other penalties.  Due to heightened regulatory concern relatedto compliance with CRA, ECOA, TILA, FH Act, HMDA, RFPA and RESPA generally, theCompany may incur additional compliance costs or be required to expendadditional funds for investments in its local communities.

 

**Recent Legislation and OtherChanges. **Federal and state laws affecting banking are enactedfrom time to time, and similarly federal and state regulations affectingbanking are also adopted from time to time. The following include some of the recent laws and regulations affectingbanking.

 

In May 2009 the Helping Families Save Their HomesAct of 2009 was enacted to help consumers avoid mortgage foreclosures on theirhomes through certain loss mitigation actions including special forbearance,loan modification, pre-foreclosure sale, deed in lieu of foreclosure, supportfor borrower housing counseling, subordinate lien resolution, and borrowerrelocation.  The new law permits theSecretary of Housing and Urban Development (HUD), for mortgages either indefault or facing imminent default, to: (1) authorize the modification of suchmortgages; and (2) establish a program for payment of a partial claim to amortgagee who agrees to apply the claim amount to payment of a mortgage on a1-4family residence.  In implementing thelaw, the Secretary of HUD is authorized to (1) provide compensation to themortgagee for lost income on monthly mortgage payments due to interest ratereduction; (2) reimburse the mortgagee from a guaranty fund in connection withactivities that the mortgagee is required to undertake concerning repayment bythe mortgagor of the amount owed to HUD; (3) make payments to themortgagee on behalf of the borrower, under terms defined by HUD; and (4) makemortgage modification with terms extended up to 40 years from the modificationdate.  The new law also authorizes theSecretary of HUD to: (1) reassign the mortgage to the mortgagee; (2) actas a Government National Mortgage Association (GNMA, or Ginnie Mae) issuer, orcontract with an entity for such purpose, in order to pool the mortgage into aGinnie Mae security; or (3) resell the mortgage in accordance with anyprogram established for purchase by the federal government of insuredmortgages.  The new law also amends theForeclosure Prevention Act of 2008, with respect to emergency assistance forthe redevelopment of abandoned and foreclosed homes (neighborhoodstabilization), to authorize each state that has received certain minimumallocations and has fulfilled certain requirements, to distribute any remainingamounts to areas with homeowners at risk of foreclosure or in foreclosurewithout regard to the percentage of home foreclosures in such areas.

 

Also in May 2009, the Credit Card Act of 2009 wasenacted to help consumers and ban certain practices of credit card issuers.  The new law allows interest rate hikes onexisting balances only under limited conditions, such as when a promotionalrate ends, there is a variable rate or if the cardholder makes a late payment.  Interest rates on new transactions canincrease only after the first year. Significant changes in terms on accounts cannot occur without 45 days’advance notice of the change.  The newlaw bans raising interest rates on customers based on their payment recordswith other unrelated credit issuers (such as utility companies and other 

 

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creditors) for existing credit card balances, thoughcard issuers would still be allowed to use universal default on future creditcard balances if they give at least 45 days’ advance notice of the change.  The new law allows consumers to opt out ofcertain significant changes in terms on their accounts.  Opting out means cardholders agree to closetheir accounts and pay off the balance under the old terms.  They have at least five years to pay thebalance.  Credit card issuers will bebanned from issuing credit cards to anyone under 21, unless they have adultco-signers on the accounts or can show proof they have enough income to repaythe card debt.  Credit card companiesmust stay at least 1,000 feet from college campuses if they are offering freepizza or other gifts to entice students to apply for credit cards.

 

The new act requires cardissuers to give card account holders “a reasonable amount of time” to makepayments on monthly bills.  That meanspayments would be due at least 21 days after they are mailed or delivered.  Credit card issuers would no longer be ableto set early morning or other arbitrary deadlines for payments.  When consumers have accounts that carrydifferent interest rates for different types of purchases payments in excess ofthe minimum amount due must go to balances with higher interest ratesfirst.  Consumers must “opt in” toover-limit fees. Those who opt out would have their transactions rejected ifthey exceed their credit limits, thus avoiding over-limit fees. Fees chargedfor going over the limit must be reasonable. Finance charges on outstanding credit card balances would be computedbased on purchases made in the current cycle rather than going back to theprevious billing cycle to calculate interest charges.  Fees on credit cards cannot exceed 25 percentof the available credit limit in the first year of the card.  Credit card issuers must disclose tocardholders the consequences of making only minimum payments each month, namelyhow long it would take to pay off the entire balance if users only made theminimum monthly payment.  Issuers mustalso provide information on how much users must pay each month if they want topay off their balances in 36 months, including the amount of interest.

 

On February 17,2009, the American Recovery and Reinvestment Act of 2009 (“ARRA”) was enactedto provide stimulus to the struggling US economy.  ARRA authorizes spending of $787 billion,including about $288 billion for tax relief, $144 billion for state and localrelief aid, and $111 billion for infrastructure and science.  In addition, ARRA includes additional executivecompensation restrictions for recipients of funds from the US Treasury underthe Troubled Assets Relief Program of the Emergency Economic Stimulus Act of2008 (“EESA”).  The provisions of EESAamended by the ARRA include (i) expanding the coverage of the executivecompensation limits to as many as the 25 most highly compensated employees of aTARP funds recipient and its affiliates for certain aspects of executivecompensation limits and (ii) specifically limiting incentive compensationof covered executives to one-third of their annual compensation which isrequired to be paid in restricted stock that does not vest until all of theTARP funds are no longer outstanding (note that if TARP warrants remainoutstanding and no other TARP instruments are outstanding, then such warrantswould not be considered outstanding for purposes of this incentive compensationrestriction).  In addition, the board ofdirectors of any TARP recipient is required under EESA, as amended to have acompany-wide policy regarding excessive or luxury expenditures, as identifiedby the Treasury, which may include excessive expenditures on entertainment orevents; office and facility renovations; aviation or other transportationservices; or other activities or events that are not reasonable expendituresfor staff development, reasonable performance incentives, or other similarmeasures conducted in the normal course of the business operations of the TARPrecipient.

 

EESA, as amended by ARRA,provides for a new incentive compensation restriction for financialinstitutions receiving TARP funds.  Thenumber of executives and employees covered by this new incentive compensationrestriction depends on the amount of TARP funds received by such entity.  For community banks that have or will receiveless than $25 million, the new incentive compensation restriction applies onlyto the highest paid employee. This new incentive compensation restrictionprohibits a TARP recipient from paying or accruing any bonus, retention award,or incentive compensation during the period in which any TARP obligationremains outstanding, except that such prohibition shall not apply to thepayment of long-term restricted stock by such TARP recipient, provided thatsuch long-term restricted stock (i) does not fully vest during the periodin which any TARP obligation remains outstanding, (ii) has a value in anamount that is not greater than 1/3 of the total amount of annual compensationof the employee receiving the stock; and (iii) is subject to such otherterms and conditions as the Secretary of the Treasury may determine is in thepublic interest.  In addition, thisprohibition does not prohibit any bonus payment required to be paid pursuant toa written employment contract executed on or before February 11, 2009, assuch valid employment contracts are determined by the Treasury.

 

EESA was amended by ARRAto also provide additional corporate governance provisions with respect toexecutive compensation including the following:

 

·                  ESTABLISHMENT OF STANDARDS - During theperiod in which any TARP obligation remains outstanding, each TARP recipientshall be subject to the standards in the regulations issued by the Treasurywith respect to executive compensation limitations for TARP recipients, and theprovisions of section 162(m)(5) of the Internal Revenue Code of 1986, asapplicable (nondeductibility of executive compensation in excess of $500,000).

 

·                  COMPLIANCE WITH STANDARDS - The Treasuryis required to see that each TARP recipient meet the required standards forexecutive compensation and corporate governance.

 

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·                  SPECIFIC REQUIREMENTS FOR THE REQUIREDSTANDARDS -

 

·                  Limits on compensation that excludeincentives for senior executive officers of the TARP recipient to takeunnecessary and excessive risks that threaten the value of the financialinstitution during the period in which any TARP obligation remains outstanding.

 

·                  A clawback requirement by such TARPrecipient of any bonus, retention award, or incentive compensation paid to asenior executive officer and any of the next 20 most highly-compensatedemployees of the TARP recipient based on statements of earnings, revenues,gains, or other criteria that are later found to be materially inaccurate.

 

·                  A prohibition on such TARP recipientmaking any golden parachute payment to a senior executive officer or any of thenext 5 most highly-compensated employees of the TARP recipient during theperiod in which any TARP obligation remains outstanding.

 

·                  A prohibition on any compensation planthat would encourage manipulation of the reported earnings of such TARPrecipient to enhance the compensation of any of its employees.

 

·                  A requirement for the establishment of anindependent Compensation Committee that meets at least twice a year to discussand evaluate employee compensation plans in light of an assessment of any riskposed to the TARP recipient from such plans. For a non SEC company that is a TARP recipient that has received$25,000,000 or less of TARP assistance, the duties of the compensationcommittee may be carried out by the board of directors of such TARP recipient.

 

In addition, EESA asamended by ARRA provides that for any TARP recipient, its annual meetingmaterials shall include a nonbinding shareholder approval proposal of executivecompensation for shareholders to vote. The SEC is to establish regulations to implement this provision.  While nonpublic companies are required toinclude this proposal, it is not known what the regulations will provide as toexecutive compensation disclosure requirements of such TARP recipients, andwhether they will be as extensive as the existing SEC executive compensationrequirements.  In addition, shareholdersare allowed to present other nonbinding proposals with respect to executivecompensation.

 

ARRA also provides $730million to the SBA and makes changes to the agency’s lending and investmentprograms so that they can reach more small businesses that need help. Thefunding includes:

 

·                  $375 million for temporarily eliminatingfees on SBA-backed loans and raising SBA’s guarantee percentage on some loansto 90 percent.

·                  $255 million for a new loan program tohelp small businesses meet existing debt payments

·                  $30 million for expanding SBA’s Microloanprogram, enough to finance up to $50 million in new lending and $24 million intechnical assistance grants to microlenders.

 

On February 10,2009, the U. S. Treasury, the Federal Reserve Board, the FDIC, the Office ofthe Comptroller of the Currency, and the Office of Thrift Supervision allannounced a comprehensive set of measures to restore confidence in the strengthof U.S. financial institutions and restart the critical flow of credit tohouseholds and businesses.  This programis intended to restore the flows of credit necessary to support recovery.

 

The core program elementsinclude:

 

·                  A new Capital Assistance Program to helpensure that our banking institutions have sufficient capital to withstand thechallenges ahead, paired with a supervisory process to produce a moreconsistent and forward-looking assessment of the risks on banks’ balance sheetsand their potential capital needs.

·                  A new Public-Private Investment Fund onan initial scale of up to $500 billion, with the potential to expand up to $1trillion, to catalyze the removal of legacy assets from the balance sheets offinancial institutions. This fund will combine public and private capital withgovernment financing to help free up capital to support new lending.

·                  A new Treasury and Federal Reserveinitiative to dramatically expand — up to $1 trillion — the existing TermAsset-Backed Securities Lending Facility (TALF) in order to reduce creditspreads and restart the securitized credit markets that in recent yearssupported a substantial portion of lending to households, students, smallbusinesses, and others.

·                  An extension of the FDIC’s TemporaryLiquidity Guarantee Program to October 31, 2009. A new framework ofgovernance and oversight to help ensure that banks receiving funds are heldresponsible for appropriate use of those funds through stronger conditions onlending, dividends and executive compensation along with enhanced reporting tothe public.

 

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In October 2008, thePresident signed the Emergency EconomicStabilization Act of 2008 (“EESA”), in response to the globalfinancial crisis of 2008 authorizing the United States Secretary of theTreasury with authority to spend up to $700 billion to purchase distressed assets,especially mortgage-backed securities, under the Troubled Assets Relief Program (“TARP”)and make capital injections into banks under the Capital Purchase Program.  EESA gives the government the unprecedented authority tobuy troubled assets on balance sheets of financial institutions under theTroubled Assets Relief Program and increases the limit on insured deposits from$100,000 to $250,000 through December 31, 2009 then extended the temporaryincrease until December 31, 2013. Some of the other provisions of EESA are as follows:

 

·                  accelerated from 2011 to 2008 the datethat the Federal Reserve Bank could pay interest on deposits of banks held withthe Federal Reserve to meet reserve requirements;

·                  to the extent that the U. S. Treasurypurchases mortgage securities as part of TARP, the Treasury shall implement aplan to minimize foreclosures including using guarantees and creditenhancements to support reasonable loan modifications, and to the extent loansare owned by the government to consent to the reasonable modification of suchloans;

·                  limits executive compensation forexecutives for TARP participating financial institutions including a maximumcorporate tax deduction limit of $500,000 for each of the top five highest paidexecutives of such institution, requiring clawbacks of incentive compensationthat were paid based on inaccurate or false information, limiting goldenparachutes for involuntary and certain voluntary terminations to 2.99x theiraverage annual salary and bonus for the last five years, and prohibiting thepayment of incentive compensation that encourages management to takeunnecessary and excessive risks with respect to the institution;

·                  extends the mortgage debt forgivenessprovision of the Mortgage Forgiveness Debt Relief Act of 2007 by three years(2012) to ease the income tax burden on those involved with certainforeclosures; and

·                  qualifiedfinancial institutions may count losses on FNMA and FHLMC preferred stockagainst ordinary income, rather than capital gain income.

 

On February 10,2009, the Treasury Secretary announced a new comprehensive financial stabilitylegislation (the “Financial Stability Plan”), which earmarked the second $350billion of unused funds originally authorized under the EESA.  The major elements of the Financial StabilityPlan included: (i) a capital assistance program that has invested inconvertible preferred stock of certain qualifying institutions, (ii) aconsumer and business lending initiative to fund new consumer loans, smallbusiness loans and commercial mortgage asset-backed securities issuances, (iii) apublic/private investment fund intended to leverage public and private capitalwith public financing to purchase up to $500 billion to $1 trillion of legacy “toxicassets” from financial institutions, and (iv) assistance for homeowners byproviding up to $75 billion to reduce mortgage payments and interest rates andestablishing loan modification guidelines for government and private programs.

 

On October 22, 2009, the Federal Reserve Boardissued a comprehensive proposal on incentive compensation policies intended toensure that the incentive compensation policies of banking organizations do notundermine the safety and soundness of such organizations by encouragingexcessive risk-taking.  The proposal,which covers all employees that have the ability to materially affect the riskprofile of an organization, either individually or as part of a group, is basedupon the key principles that a banking organization’s incentive compensationarrangements should (i) provide incentives that do not encouragerisk-taking beyond the organization’s ability to effectively identify andmanage risks, (ii) be compatible with effective internal controls and riskmanagement, and (iii) be supported by strong corporate governance,including active and effective oversight by the organization’s board ofdirectors. The proposal also contemplates a detailed review by the FederalReserve Board of the incentive compensation policies and practices of a numberof “large, complex banking organizations.” Any deficiencies in compensationpractices that are identified may be incorporated into the organization’ssupervisory ratings, which can affect its ability to make acquisitions orperform other actions.  In addition, theproposal provides that enforcement actions may be taken against a bankingorganization if its incentive compensation arrangements or relatedrisk-management control or governance processes pose a risk to the organization’ssafety and soundness and the organization is not taking prompt and effectivemeasures to correct the deficiencies. Similarly, on January 12, 2010, the FDIC announced that it wouldseek public comment through advance notice of rule making on whether bankswith compensation plans that encourage risky behavior should be charged athigher deposit assessment rates than such banks would otherwise be charged.  On September 3, 2009, the U.S. Treasuryissued a policy statement entitled “Principles for Reforming the U.S. andInternational Regulatory Capital Framework for Banking Firms.”  The statement was developed in consultationwith the U.S. bank regulatory agencies and sets forth eight “core principles”intended to shapea new international capital accord. Six of the core principles relate directly to bank capital requirements.The statement contemplates changes to the existing regulatory capital regimethat would involve substantial revisions to, if not replacement of, major partsof the Basel I and Basel II and affect all regulated banking organizations andother systemically important institutions. The statement calls for higher and stronger capital requirements forbank and non-bank financial firms that are deemed to pose a risk to financialstability due to their combination of size, leverage, interconnectedness andliquidity risk.  The statement suggestedthat changes to the regulatory capital framework be phased in over a period ofseveral years with a recommended schedule providing for a comprehensiveinternational agreement by December 31, 2010, with the implementation ofreforms by December 31, 2012, although it does remain possible that U.S.bank regulatory agencies could officially 

 

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adopt, or informally implement, new capital standardsat an earlier date.  Following theissuance of the statement, on December 17, 2009, the Basel committeeissued a set of proposals (the “Capital Proposals”) that would significantlyrevise the definitions of Tier 1 capital and Tier 2 capital, with the mostsignificant changes being to Tier 1 capital. Most notably, the Capital Proposals would disqualify certain structuredcapital instruments, such as trust preferred securities, from Tier 1 capitalstatus.  The Capital Proposals would alsore-emphasize that common equity is the predominant component of Tier 1 capitalby adding a minimum common equity to risk-weighted assets ratio and requiringthat goodwill, general intangibles and certain other items that currently mustbe deducted from Tier 1 capital instead be deducted from common equity as acomponent of Tier 1 capital. The Capital Proposals also leave open thepossibility that the Basel committee will recommend changes to the minimum Tier1 capital and total capital ratios of 4.0% and 8.0%, respectively.  Concurrently with the release of the CapitalProposals, the Basel committee also released a set of proposals related toliquidity risk exposure (the “Liquidity Proposals”).  The Liquidity Proposals have three keyelements, including the implementation of (i) a “liquidity coverage ratio”designed to ensure that a bank maintains an adequate level of unencumbered,high-quality assets sufficient to meet the bank’s liquidity needs over a 30-daytime horizon under an acute liquidity stress scenario, (ii) a “net stablefunding ratio” designed to promote more medium and long-term funding of theassets and activities of banks over a one-year time horizon, and (iii) aset of monitoring tools that the Basel committee indicates should be consideredas the minimum types of information that banks should report to supervisors andthat supervisors should use in monitoring the liquidity risk profiles ofsupervised entities.

 

In June 2009, theAdministration proposed a wide range of regulatory reforms that, if enacted,may have significant effects on the financial services industry in the United States.  Significant aspects of the Administration’sproposals included, among other things, proposals (i) that any financialfirm whose combination of size, leverage and interconnectedness could pose athreat to financial stability be subject to certain enhanced regulatoryrequirements, (ii) that federal bank regulators require loan originatorsor sponsors to retain part of the credit risk of securitized exposures, (iii) thatthere be increased regulation of broker-dealers and investment advisers, (iv) forthe creation of a federal consumer financial protection agency that would,among other things, be charged with applying consistent regulations to similarproducts (such as imposing certain notice and consent requirements on consumeroverdraft lines of credit), (v) that there be comprehensive regulation ofOTC derivatives, (vi) that the controls on the ability of bankinginstitutions to engage in transactions with affiliates be tightened, and (vii) thatfinancial holding companies be required to be “well-capitalized” and “well-managed”on a consolidated basis.  The Congress,state lawmaking bodies and federal and state regulatory agencies continue toconsider a number of wide-ranging and comprehensive proposals for altering thestructure, regulation and competitive relationships of the nation’s financialinstitutions, including rules and regulations related to the broad rangeof reform proposals set forth by the Obama administration described above.  Along with amendments to the Administration’sproposal there are separate comprehensive financial reform bills intended toaddress in part or whole or vary in part or in whole from the proposals setforth by the Administration were introduced in both houses of Congress in thesecond half of 2009 and in 2010 and remain under review by both the U.S. Houseof Representatives and the U.S. Senate.

 

The Temporary LiquidityGuarantee Program was implemented by the FDIC on October 14, 2008 tomitigate the lack of liquidity in the financial markets.  The Temporary Liquidity Guarantee Program hastwo primary components: the Debt Guarantee Program, by which the FDIC willguarantee the payment of certain newly-issued senior unsecured debt, and theTransaction Account Guarantee Program, by which the FDIC will guarantee certainnoninterest-bearing and low interest-bearing transaction accounts.  The Debt Guarantee Program provides for anFDIC guarantee as to the payment of all senior unsecured debt (with a term ofmore than 30 days) issued by a qualified participating entity (insureddepository institutions, bank and financial holding companies, and certainsavings and loan holding companies) up to a limit of 125 percent of all seniorunsecured debt outstanding on September 30, 2008, and maturing by June 30,2009.  The FDIC guarantee is until June 30,2012, and the fee for such guarantee depends on the term with a maximum of 100basis points for terms in excess of 365 days. The Transaction Account GuaranteeProgram is the second part of the FDIC’s Temporary Liquidity Guarantee Program.  The FDIC provides for a temporary fullguarantee held at a participating FDIC-insured depository institution ofnoninterest-bearing and low interest-bearing transaction accounts above theexisting deposit insurance limit at the additional cost of 10 basis points perannum.  This coverage became effective onOctober 14, 2008, and continues through December 31, 2010.

 

On July 30, 2008, the Housing and Economic Recovery Act wassigned by the President.  It authorizes the Federal HousingAdministration to guarantee up to $300 billion in new 30-year fixed ratemortgages for subprime borrowers if lenders write-down principal loan balancesto 90 percent of current appraisal value. It is also intended to restore confidence in Fannie Mae and Freddie Macby strengthening regulations and injecting capital into them.  States will be authorized to refinancesubprime loans using mortgage revenue bonds. It also establishes the Federal Housing Finance Agency out of theFederal Housing Finance Board and Office of Federal Housing EnterpriseOversight.

 

In 2008, the Federal Reserve Board, the FDIC, theOffice of the Comptroller of the Currency, and the Office of Thrift Supervisionamended their regulatory capital rules topermit banks, bank holding companies, and savings associations (as to any ofthese a “financial institution”) to reduce the amount of goodwill that abanking organization must deduct from tier 1 capital by the amount of anydeferred tax liability associated with that goodwill.  However, a financial institution that reducesthe amount of goodwill deducted 

 

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from tier 1 capital by the amount of the deferred tax liability is notpermitted to net this deferred tax liability against deferred tax assets whendetermining regulatory capital limitations on deferred tax assets.  For these financial institutions, the amountof goodwill deducted from tier 1 capital will reflect each institution’smaximum exposure to loss in the event that the entire amount of goodwill isimpaired or derecognized, an event which triggers the concurrent derecognitionof the related deferred tax liability for financial reporting purposes.

 

On October 7, 2008 the FDIC adopted a restorationplan that increased the rates banks pay for deposit insurance, and adjusted thesystem that determines what deposit insurance premium rate a bank pays theFDIC.  In 2008, banks paid anywhere fromfive basis points to 43 basis points for deposit insurance. Under the new rule,the assessment rate schedule was raised uniformly by 7 basis points(annualized) beginning on January 1, 2009. Beginning with the secondquarter of 2009, changes were made to the deposit insurance assessment systemto make the increase in assessments fairer by requiring riskier institutions topay a larger share.  Together, thechanges would improve the way the system differentiates risk among insuredinstitutions and help ensure that the reserve ratio returns to at least 1.15percent by the end of 2013. The changes to the assessment system includeassessing higher rates to institutions with a significant reliance on secured liabilities,which generally raises the FDIC’s loss in the event of failure withoutproviding additional assessment revenue. The new rule also would assesshigher rates for institutions with a significant reliance on brokered depositsbut, for well-managed and well-capitalized institutions, only when accompaniedby rapid asset growth. Brokered deposits combined with rapid asset growth haveplayed a role in a number of costly failures, including some recent ones. The rule alsowould provide incentives in the form of a reduction in assessment rates forinstitutions to hold long-term unsecured debt and, for smaller institutions,high levels of Tier 1 capital. The FDIC also voted to maintain the DesignatedReserve Ratio at 1.25 percent as a signal of its long term target for the fund.

 

The Federal Reserve Boardin October 2008 approved final amendments to Regulation C that revise the rules forreporting price information on higher-priced mortgage loans. The changesare intended to improve the accuracy and usefulness of data reported under theHome Mortgage Disclosure Act. Regulation C currently requires lenders tocollect and report the spread between the annual percentage rate (APR) on amortgage loan and the yield on a Treasury security of comparable maturity if thespread is greater than 3.0 percentage points for a first lien loan or greaterthan 5.0 percentage points for a subordinate lien loan. This difference isknown as a rate spread.  Under the finalrule, a lender will report the spread between the loan’s APR and a survey-basedestimate of APRs currently offered on prime mortgages of a comparable type (“averageprime offer rate”) if the spread is equal to or greater than 1.5 percentagepoints for a first lien loan or equal to or greater than 3.5 percentage pointsfor a subordinate-lien loan. The Board will publish average prime offer ratesbased on the Primary Mortgage Market Survey® currently published by FreddieMac.  In setting the rate spread reporting threshold, the Board sought tocover subprime mortgages and generally avoid covering prime mortgages. Thechanges to Regulation C conform the threshold for rate spread reporting to thedefinition of higher-priced mortgage loans adopted by the Board underRegulation Z (Truth in Lending) in July of 2008.

 

The Federal Reserve Board in July 2008 approved a final rule forhome mortgage loans to better protect consumers and facilitate responsiblelending.  The rule prohibits unfair, abusive or deceptive homemortgage lending practices and restricts certain other mortgagepractices.  The final rule also establishes advertising standards andrequires certain mortgage disclosures to be given to consumers earlier in thetransaction.  The final rule, which amends Regulation Z (Truth in Lending)and was adopted under the Home Ownership and Equity Protection Act (HOEPA),largely follows a proposal released by the Board in December 2007, withenhancements that address ensuing public comments, consumer testing, andfurther analysis.

 

The final rule adds four key protections for a newly definedcategory of “higher-priced mortgage loans” secured by a consumer’s principaldwelling.  For loans in this category, these protections will:

 

·                  Prohibit a lender frommaking a loan without regard to borrowers’ ability to repay the loan fromincome and assets other than the home’s value.  A lender complies, inpart, by assessing repayment ability based on the highest scheduled payment inthe first seven years of the loan.  Toshow that a lender violated this prohibition, a borrower does not need todemonstrate that it is part of a “pattern or practice.”

·                  Require creditors toverify the income and assets they rely upon to determine repayment ability.

·                  Ban any prepaymentpenalty if the payment can change in the initial four years.  For otherhigher-priced loans, a prepayment penalty period cannot last for more than twoyears.

·                  Require creditors toestablish escrow accounts for property taxes and homeowner’s insurance for allfirst-lien mortgage loans.

 

In addition to the rules governing higher-priced loans, the rules adoptthe following protections for loans secured by a consumer’s principal dwelling,regardless of whether the loan is higher-priced:

 

·                  Creditors and mortgagebrokers are prohibited from coercing a real estate appraiser to misstate a home’svalue.

 

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·                  Companies that servicemortgage loans are prohibited from engaging in certain practices, such aspyramiding late fees.  In addition, servicers are required to creditconsumers’ loan payments as of the date of receipt and provide a payoffstatement within a reasonable time of request.

·                  Creditors must providea good faith estimate of the loan costs, including a schedule of payments,within three days after a consumer applies for any mortgage loan secured by aconsumer’s principal dwelling, such as a home improvement loan or a loan torefinance an existing loan.  Currently, early cost estimates are onlyrequired for home-purchase loans.  Consumers cannot be charged any feeuntil after they receive the early disclosures, except a reasonable fee forobtaining the consumer’s credit history.

 

For all mortgages, the rule also sets additional advertisingstandards.  Advertising rules now require additional information aboutrates, monthly payments, and other loan features.  The final rule bansseven deceptive or misleading advertising practices, including representingthat a rate or payment is “fixed” when it can change.  The rule’sdefinition of “higher-priced mortgage loans” will capture virtually all loansin the subprime market, but generally exclude loans in the prime market. To provide an index, the Federal Reserve Board will publish the “average primeoffer rate,” based on a survey currently published by Freddie Mac.  A loanis higher-priced if it is a first-lien mortgage and has an annual percentagerate that is 1.5 percentage points or more above this index, or 3.5 percentagepoints if it is a subordinate-lien mortgage.  The new rules takeeffect on October 1, 2009.  The single exception is the escrowrequirement, which will be phased induring 2010 to allow lenders to establish new systems as needed.

 

In California, theenactment of AB329 in 2009, the Reverse Mortgage Elder Protection Act of 2009prohibits a lender or any other person who participates in the origination ofthe mortgage from participation in, being associated with, or employing anyparty that participates in or is associated with any other financial orinsurance activity or referring a prospective borrower to anyone for thepurchase of other financial or insurance products; and imposes certaindisclosure requirements on the lender.

 

The enactment of AB1160in 2009, requires a supervised financial institution in California thatnegotiates primarily in any of a number of specified languages in the course ofentering into a contract or agreement for a loan or extension of credit securedby residential real property, to deliver, prior to the execution of thecontract or agreement, and no later than 3 business days after receiving thewritten application, a specified form in that language summarizing the terms ofthe contract or agreement; provides for administrative penalties forviolations; and requires the California Department of Corporations and the Departmentof Financial Institutions to create a form for providing translations and makeit available in Spanish, Chinese, Tagalog, Vietnamese and Korean.  The statute becomes operative on July 1,2010, or 90 days after issuance of the form, whichever occurs later.

 

The enactment of AB 1291in 2009 makes changes to the California Unclaimed Property Law including (amongother things): allowing electronic notification to customers who have consentedto electronic notice; requiring that notices contain certain information andallow the holder to provide electronic means to enable the owner to contact theholder in lieu of returning the prescribed form to declare the owner’s intent;authorizing the holder to give additional notices; and requiring, beginning January 1,2011, a banking or financial organization to provide a written notice regardingescheat at the time a new account or safe deposit box is opened.

 

The enactment of SB306makes specified changes to clarify existing law related to filing a notice ofdefault on residential real property in California, including (among otherthings): clarifying that the provisions apply to mortgages and deeds of trustrecorded from January 1, 2003 through December 31, 2007, secured byowner-occupied 3-4 residential real property containing no more than 4 dwellingunits; revising the declaration to be filed with the notice of default;specifying how the loan servicers have to maximize net present value undertheir pooling and servicing agreements applies to certain investors; specifyinghow and when the notice to residents of property subject to foreclosure is tobe mailed; and extending the time during which the notice of sale must berecorded from 14 to 20 days.  The billalso makes certain changes related to short-pay agreements and short-pay demandstatements.

 

On February 20,2009, Governor Schwarzenegger signed ABX2 7 and SBX2 7, which established theCalifornia Foreclosure Prevention Act. The California Foreclosure Prevention Act modifies the foreclosureprocess to provide additional time for borrowers to work out loan modificationswhile providing an exemption for mortgage loan servicers that have implementeda comprehensive loan modification program. Civil Code Section 2923.52requires an additional 90 day period beyond the period already provided beforea Notice of Sale can be given in order to allow all parties to pursue a loanmodification to prevent foreclosure of loans meeting certain criteriaidentified in that section.

 

A mortgage loan servicerwho has implemented a comprehensive loan modification program may file anapplication for exemption from the provisions of Civil Code Section 2923.52.  Approval of this application provides themortgage loan servicer an exemption from the additional 90-day period beforefiling the Notice of Sale when foreclosing on real property covered by the newlaw.

 

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California Assembly Bill1301 was signed by the Governor on July 16, 2008 and became law on January 1,2009.  Among other things, the billeliminated unnecessary applications that consume time and resources of banklicensees and which in many cases are now perfunctory.  All of current Article 5 — “Locations ofHead Office” of Chapter 3, and all of Chapter 4 — “Branch Offices, Other Placesof Business and Automated Teller Machines” were repealed.  A new Chapter 4 — “Bank Offices” wasadded.  The new Chapter 4 requires noticeto the California Department of Financial Institutions (“DFI”) theestablishment of offices, rather than the current application process.  Many of the current branch applications areperfunctory in nature and/or provide for a waiver of application.  Banks, on an exception basis, may be subjectto more stringent requirements as deemed necessary.  As an example, new banks, banks undergoing achange in ownership and banks in less than satisfactory condition may berequired to obtain prior approval from the DFI before establishing offices ifsuch activity is deemed to create an issue of safety and soundness.  The bill eliminated unnecessary provisions inthe Banking Law that are either outdated or have become undue restrictions tobank licensees.  Chapter 6 — “Powers andMiscellaneous Provisions” was repealed. A new Chapter 6 - “Restrictions and Prohibited Practices” wasadded.  This chapter brings togetherrestrictions in bank activities as formerly found in Chapter 18 — “ProhibitedPractices and Penalties.”  However, inbringing the restrictions into the new chapter, various provisions were updatedto remove the need for prior approval by the DFI Commissioner.  The bill renumbered current Banking Lawsections to align like sections.  Chapter4.5 — “Authorizations for Banks” was added. The purpose of the chapter is toprovide exceptions to certain activities that would otherwise be prohibited byother laws outside of the Financial Code. The bill added Article 1.5 - “Loan and Investment Limitations” toChapter 10 — “Commercial Banks.”  Thisarticle is new in concept and acknowledges that investment decisions arebusiness decisions — so long as there is a diversification of the investmentsto spread any risk.  The risk isdiversified in this article by placing a limitation on the loans andinvestments that can be made to any one entity. This section is a trade-off for elimination of applications to the DFIfor approval of investments in securities, which were repealed.

 

Other changes AB 1301made to the Banking Law:

 

·                  Authorized a bank or trust acting in anycapacity under a court or private trust to arrange for the deposit ofsecurities in a securities depository or federal reserve bank, and provided howthey may be held by the securities depository;

·                  Reduced from 5% to 1% the amount ofeligible assets to be maintained at an approved depository by an office of aforeign (other nation) bank for the protection of the interests of creditors ofthe bank’s business in this state or for the protection of the public interest;

·                  Enabled the DFI to issue an order againsta bank licensee parent or subsidiary;

·                  Provided that the examinations may beconducted in alternate examination periods if the DFI concludes that anexamination of the state bank by the appropriate federal regulator carries outthe purpose of this section, but the DFI may not accept two consecutiveexamination reports made by federal regulators;

·                  Provided that the DFI may examinesubsidiaries of every California state bank, state trust company, and foreign(other nation) bank to the extent and whenever and as often as the DFI shalldeem advisable;

·                  Enabled the DFI to issue an order or afinal order to now include any bank holding company or subsidiary of the bank,trust company, or foreign banking corporation that is violating or failing tocomply with any applicable law, or is conducting activities in an unsafe orinjurious manner;

·                  Enabled the DFI to take action against aperson who has engaged in or participated in any unsafe or unsound act withregard to a bank, including a former employee who has left the bank.

 

**RecentAccounting Pronouncements**

 

Adoptionof New Financial Accounting Standards

 

*FASB Accounting StandardsCodificationTM (ASC or Codification)*

 

In June 2009, theFinancial Accounting Standards Board (FASB) issued new accounting standard ASC105-10 (previously SFAS No. 168), *The FASB AccountingStandards Codification**TM** and the Hierarchy of Generally AcceptedAccounting Principles.*  With the issuance of ASC105-10, the FASB Accounting Standards Codification (“the Codification” or “ASC”)becomes the single source of authoritative U.S. accounting and reportingstandards applicable for all nongovernmental entities.  Rules and interpretive releases of theSEC under the authority of federal securities laws are also sources ofauthoritative GAAP for SEC registrants. This change is effective for financial statements issued for interim orannual periods ended after September 15, 2009.  Accordingly, all specific references togenerally accepted accounting principles (GAAP) refer to the Codification.

 

*Noncontrolling Interests inConsolidated Financial Statements*

 

In December 2007,the FASB issued ASC 810-10-65-1, (previously SFAS No. 160), *Noncontrolling Interests in Consolidated Financial Statements.*  This standard requires that a noncontrollinginterest in a subsidiary be reported separately within equity and the amount ofconsolidated net income specifically attributable to the noncontrollinginterest be identified in the consolidated financial statements.  It also calls for consistency in the mannerof reporting changes in the parent’s ownership interest and requires fair valuemeasurement of any noncontrolling equity investment retained in adeconsolidation.  This standard waseffective for fiscal years, and interim periods within those fiscal years,beginning on or after December 15, 2008. We adopted the provisions of this standard on January 1, 2009without a material impact on our financial condition or results of operations.

 

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*FASB ClarifiesOther-Than-Temporary Impairment*

 

In April 2009, theFASB issued ASC No. 320-10-35 (previously FSP 115-2 and 124-2 and EITF99-20-2*)*, *Recognition andPresentation of Other-Than-Temporary-Impairment. *This standard (i) changespreviously existing guidance for determining whether an impairment to debtsecurities is other than temporary and (ii) replaces the previouslyexisting requirement that the entity’s management assert it has both the intentand ability to hold an impaired security until recovery with a requirement thatmanagement assert: (a) it does not have the intent to sell the security;and (b) it is more likely than not it will not have to sell the securitybefore recovery of its cost basis.  Underthis standard, declines in fair value below cost that are deemed to be otherthan temporary are reflected in earnings as realized losses to the extent theimpairment is related to credit losses for both held-to-maturity andavailable-for-sale securities.  Theamount of impairment related to other factors is recognized in othercomprehensive income.  These changes wereeffective for interim and annual periods ended after June 15, 2009.  We****adopted theprovisions of this standard on April 1, 2009 and they did not have amaterial impact on our financial condition or results of operations.

 

*FASB Clarifies Application ofFair Value Accounting*

 

In April 2009, theFASB issued ASC 820-10 (previously FSP FAS 157-4), *DeterminingFair Value When the Volume and Level of Activity for the Asset or LiabilityHave Significantly Decreased and Identifying Transactions That Are NotOrderly. *This standardaffirms the objective of fair value when a market is not active, clarifies andincludes additional factors for determining whether there has been asignificant decrease in market activity, eliminates the presumption that alltransactions are distressed unless proven otherwise, and requires an entity todisclose a change in valuation technique. This standard was effective for interim and annual periods ended after June 15,2009.  We adopted the provisions of thisstandard on April 1, 2009 and they did not have a material impact on ourfinancial condition or results of operations.

 

*Measuring Liabilities at FairValue*

 

In August 2009, theFASB issued ASU No. 2009-05, *Fair Value Measurementsand Disclosures (ASC Topic 820) — Measuring Liabilities at Fair Value*.  This update provides amendments for the fair valuemeasurement of liabilities. It provides clarification that in circumstances inwhich a quoted price in an active market for the identical liability is notavailable, a reporting entity is required to measure fair value using one ormore techniques.  It also clarifies thatwhen estimating the fair value of a liability, a reporting entity is notrequired to include a separate input or adjustment to other inputs relating tothe existence of a restriction that prevents the transfer of the liability.  This update was effective for the firstreporting period (including interim periods) beginning after August 2009.  We adopted the provisions of this update on October 1,2009 and they did not have a material impact on our financial condition orresults of operations.

 

*Business Combinations*

 

In December 2007,the FASB issued ASC Topic 805 (previously SFAS 141(R)), *BusinessCombinations.* This standardbroadens the guidance for business combinations and extends its applicabilityto all transactions and other events in which one entity obtains control overone or more other businesses.  Itbroadens the fair value measurement and recognition of assets acquired,liabilities assumed, and interests transferred as a result of businesscombinations.  The acquirer is no longerpermitted to recognize a separate valuation allowance as of the acquisitiondate for loans and other assets acquired in a business combination.  It also requires acquisition-related costsand restructuring costs that the acquirer expected but was not obligated toincur to be expensed separately from the business combination.  It also expands on required disclosures toimprove the ability of the users of the financial statements to evaluate thenature and financial effects of business combinations.  This standard was effective for the firstannual reporting period beginning on or after December 15, 2008.

 

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**Item 1a. Risk Factors**

 

This discussion providesinsight into Management’s assessment of risks relating to our business and itsexpectations for 2010. 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:

 

·                  declines in the Company’s and the Bank’sregulatory capital ratios which have resulted in the issuance of a goingconcern emphasis of a matter paragraph in the audit report issued by theCompany’s independent registered public accounting firm;

 

·                  operating restrictions placed on theCompany and the Bank by its regulators;

 

·                  continued deterioration in real estatemarkets and in general economic conditions, internationally, nationally and inthe State of California;

 

·                  increased loan delinquencies, foreclosures,and customer bankruptcies due to the decline in the value of real estatecollateral securing such loans and the high unemployment rate;

 

·                  changes in the interest rate environmentwhich have reduced interest margins and increased interest rate risk;

 

·                  the availability of sources of liquidityat a reasonable cost;

 

·                  increased competitive pressure amongfinancial services companies;

 

·                  legislative or regulatory changes adversely affecting the business inwhich the Company engages;

 

·                  technology implementation problems, computer system failures orsecurity breaches; and

 

·                  raising additional capital that could have a dilutive effect on theexisting holders of the Company’s common stock.

 

**Going Concern Risk.*** *The Companyand its subsidiary Bank have been significantly and adversely impacted by thecontinued decline in economic conditions in the U.S. and, more specifically,Northern California.  The Bank faces unprecedented challenges with theincreasing level of nonperforming loans and related foreclosed real estate,both of which are severely impacted by the steep declines in the underlyingvalue of real estate collateral which has resulted in greater provisions forloan losses and write downs of other real estate values.  Shareholders’equity of the Company has decreased from $40.1 million at December 31,2008 to $16.0 million at December 31, 2009.  As a result, the Company and the Bank areconsidered to be “undercapitalized” for bank regulatory purposes as of December 31,2009.  These conditions create a substantial doubt about the Company’s andBank’s ability to continue as a going concern.  The Company’s AnnualReport on Form 10-K for 2009 includes an audit report by the Company’sindependent registered public accounting firm containing an emphasis of a matter paragraph related tothe Company’s ability to continue as a goingconcern.

 

**The Company’s agreement with the Federal ReserveBoard of Governors (“FRB”). **We entered into an agreement (“FRBAgreement”) with the FRB where we agreed to certain covenants and conditionsthat require us, among other things:

 

·                  to not receive dividends or distributions thatrepresent a reduction of capital from the Bank, without the prior approval ofthe FRB;

·                  to not declare or pay dividends or distributionswithout the prior approval of the FRB;

·                  to not incur any new debt, increase or renew anyexisting debt, or guarantee any debt, without the prior approval of the FRB;

·                  to not issue any trust preferred securities withoutthe prior approval of the FRB; and

·                  to not purchase, redeem, or otherwise acquire any ofour stock without the prior approval of the FRB.

 

**The Bank is subject to certain operatingrestrictions.**  The Bank agreed to certain covenants andconditions in the informal joint Memorandum of Understanding effective April 21,2009 between the Bank and its primary regulators, the Federal Deposit InsuranceCorporation (FDIC) and California Department of Financial Institutions(DFI)  that restrict the operations ofthe Bank, including retaining qualified management, improving asset quality byreducing classified assets by collection or charge-off, maintaining an adequateloan loss allowance, reducing the aggregate amount of credit outstanding forborrowers of non-owner occupied commercial real estate and construction landdevelopment loans, improving the Bank’s overall risk profile, increasing theBank’s Tier 1 capital ratio to equal or exceed 10% and not paying cashdividends without the prior written consent of the FDIC and DFI.  Management of the Bank expects to fullycomply with such operating restrictions, to include the raising of additionalcapital discussed at Note 2 to the Consolidated Financial Statements.  However, there are no assurances that theactions by management of the Bank and the Company to comply with such restrictionswill be fully compliant.

 

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As a result of aregularly scheduled and recently concluded joint FDIC and DFI examination,management expects to receive a formal order (“Order”) from the FDIC and theDFI which will replace the informal Memorandum of Understanding discussedabove.   The Order is expected to includeprovisions to further strengthen and improve asset quality, enhance problem loanidentification policies and procedures including identification of impairedloans and troubled debt restructured loans, reduce the level of classifiedassets, maintain certain capital ratios and request regulatory approval priorto paying any cash dividends. At this time, management does not know whatimpact the Order will have on the Company’s business strategies. Furthermore asthe Bank is considered “undercapitalized” for bank regulatory purposes underthe Prompt Corrective Action regulations, it will be required to file a capitalrestoration plan and is automatically subject to among other things,restrictions on dividends, restrictions on access to the Federal Reserve’sdiscount window, restrictions on asset growth, and being prohibited fromopening new branches, making acquisitions or engaging in new lines of businesswithout the approval of the FDIC.

 

**Continueddeterioration of real estate markets could result in further losses for theCompany as nonperforming assets take significant time to resolve and adverselyaffect our results of operations and financial condition.** Asof December 31, 2009, approximately 58% of the loans of the Bank weresecured by real estate.  The risk ofnonpayment of loans is inherent in commercial banking.  Such nonpayment, if it occurs, would likelyhave a material adverse effect on the Bank’s earnings and the overall financialcondition of the Company.  Furthermore,the ability of the Bank to originate loans secured by real estate may beimpaired by adverse changes in local and regional economic conditions in thereal estate market, increasing interest rates or by acts of nature, includingearthquakes and flooding.  Due to ourconcentration of real estate collateral, these events could have a materialadverse impact on the value of the collateral underlying loans resulting inlosses.  Such resulting losses mightmaterially adversely affect our financial condition.

 

At December 31,2009, our nonperforming loans were 11.8% of total loans, and at December 31,2009, our nonperforming assets (which includes foreclosed real estate) were 12%of total assets.  Nonperforming assetsadversely affect our net income in various ways.  Until economic and market conditions improve,we expect to continue to incur losses relating to nonperforming assets.  We generally do not record interest income onnonperforming loans or other real estate, thereby adversely affecting ourincome and increasing our loan administration costs.  When we take collateral in foreclosures andsimilar proceedings, we are required to mark the related asset to the then fairmarket value of the collateral, which may result in a loss.  An increase in the level of non-performingassets increases our risk profile and may impact the capital levels ourregulators believe are appropriate in light of the ensuing risk profile.  When we reduce problem assets through loansales, workouts, restructurings and otherwise, decreases in the value of theunderlying collateral, or in these borrowers’ performance or financialcondition, whether or not due to economic and market conditions beyond ourcontrol, could adversely affect our business, results of operations andfinancial condition.  In addition, theresolution of nonperforming assets requires significant commitments of timefrom management and our directors, which can be detrimental to the performanceof their other responsibilities.  Therecan be no assurance that we will not experience future increases innonperforming assets or that the disposition of such non-performing assets willnot adversely affect our profitability.

 

**Continueddeterioration of economic conditions could hurt the financial condition of theCompany and the Bank.**  The banking business isaffected by general economic and political conditions, both domestic andinternational.  The weakened generaleconomic conditions have adversely affected the profitability of the Companyand the Bank.

 

Most of the Bank’s assets and deposits are generatedin California.  As a result, pooreconomic conditions in California have caused the Bank to incur lossesassociated with higher default rates and decreased collateral values in itsloan portfolio.  Economic conditions inCalifornia are subject to various uncertainties at this time, including theimpact of the decline in real estate values, higher unemployment, inflation inenergy costs and consumer prices, and the fiscal crisis of the state ofCalifornia.  If economic conditions inCalifornia continue to decline, the Bank expects that its level of problem assetscould increase accordingly.

 

The operations of theCompany are primarily located in Northern California.  As a result of this geographicalconcentration, the Company’s results depend largely upon the economicconditions in Northern California. Adverse economic conditions in Northern California may have a materialadverse affect on the financial condition and results of operations of theCompany.  A further deterioration ineconomic conditions locally, regionally or nationally could result in a furthereconomic downturn in Northern California with the following consequences, anyof which could further adversely affect our business:

 

·                  loan delinquencies and defaults mayincrease;

·                  problem assets and foreclosures mayincrease;

·                  demand for our products and services maydecline;

·                  low cost or noninterest bearing depositsmay decrease;

·                  collateral for loans may decline invalue, in turn reducing customers’ borrowing power, and reducing the value ofassets and collateral as sources of repayment of existing loans;

·                  foreclosed assets may not be able to besold;

·                  volatile securities market conditionscould adversely affect valuations of investment portfolio assets; and

·                  reputational risk may increase due topublic sentiment regarding the banking industry.

 

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**Tightcredit markets and liquidity risk could adversely affect our business,financial condition and results of operations. **Continuedtight credit markets and/or any inability to obtain adequate funds forcontinued loan growth at an acceptable cost could adversely affect our assetgrowth and liquidity position and, therefore, our earnings capability.  In addition to core deposit growth, maturityof investment securities and loan payments, we also rely on nonbrokered timecertificates of deposits. Our ability to obtain additional sources is impairedby the deterioration in our financial condition as well as factors that are notspecific to us, such as a disruption in the financial markets or negative viewsand expectations for the financial services industry or serious dislocation inthe general credit markets.  In the eventsuch a disruption should occur, our ability to access these sources could beadversely affected both as to price and availability, which would limit orpotentially raise the cost of the funds available to us.

 

**Our focuson lending to small to mid-sized community-based businesses may increase ourcredit risk. **As of December 31, 2009, ourcommercial real estate loans amounted to $228.7 million, or 52.79% of our totalloan portfolio, and our commercial business loans amounted to $80.8 million, or18.64% of our total loan portfolio. Commercial real estate and commercial business loans generally areconsidered riskier than single-family residential loans because they havelarger balances to a single borrower or group of related borrowers.  Commercial real estate and commercialbusiness loans involve risks because the borrowers’ ability to repay the loanstypically depends primarily on the successful operation of the businesses orthe properties securing the loans.  Mostof the Bank’s commercial real estate and commercial business loans are made tosmall business or middle market customers who may have a heightenedvulnerability to economic conditions. Moreover, a portion of these loans have been made by us in recent yearsand the borrowers may not have experienced a complete business or economiccycle.  Furthermore, the deterioration ofour borrowers’ businesses may hinder their ability to repay their loans withus, which could adversely affect our results of operations.

 

**Changesin net interest income and net interest margin. **Netinterest income is the difference or spread between the interest and feesearned on loans and investments (the Company’s earning assets) and the interestexpense paid on deposits and other liabilities. Net interest margin****is net interest income expressed as a percentage of averageearning assets. It is used to measure the difference between the average rateof interest earned on assets and the average rate of interest that must be paidon liabilities used to fund those assets. To maintain its net interest margin,the Company must manage the relationship between interest earned and paid. Ashift in the relative size of these major balance sheet categories has animpact on net interest income and net interest margin. To the extent that fundsinvested in securities can be repositioned into loans, earnings increasebecause of the higher rates paid on loans. However, additional credit risk isincurred with loans compared to the very low risk of loss on securities, andthe Company must carefully monitor the underwriting process to ensure that thebenefit of the additional interest earned is not offset by additional creditlosses. In general, depositors are willing to accept a lower rate on theirfunds than are other providers of funds because of FDIC insurance coverage. Tothe extent that the Company can fund asset growth by deposits, especially thelower cost transaction accounts, rather than borrowing funds from otherfinancial institutions, the average rates paid on funds will be less, and netinterest income more.

 

Although the Companyexpects to continue to realize income from its net interest margin spread, anincrease in interest rates may adversely affect the ability of borrowers withvariable rate loans to pay the interest on, and principal of, theirobligations. The Company cannot control these factors. The changes in levels ofmarket interest rates could materially affect our net interest spread, assetquality, loan origination volume and overall profitability.

 

**TheCompany faces intense competition from larger, more established institutions.** The banking business in California is highly competitive with respect tovirtually all products and services and has become increasingly so in recentyears. With respect to commercial bank competitors, major banks dominate theindustry.  Most such banks offer certainservices which the Bank is not equipped to offer directly (but some of whichthe Bank offers indirectly through correspondent institutions) and, by virtueof their greater total capitalization, such banks also have substantiallyhigher lending limits than the Bank has. In addition to commercial banks, the Bank competes with savingsinstitutions, credit unions, and numerous nonbanking companies that offer moneymarket and mutual funds, wholesale finance, credit card, and other consumerfinance services, including on-line banking services and personal financesoftware.  Mergers between financialinstitutions, federal and state interstate banking laws, and technologicalinnovation have also resulted in increased competition in the financialservices markets.  No assurance can begiven that the Bank’s efforts to compete with these other financialinstitutions will be successful.

 

**TheCompany is dependent on management.**  The success ofthe Company is dependent on the services and prospective customer relationshipsof its key officers.  The loss of any keyofficer for any reason could have a material adverse effect on theCompany.  There is also no guaranty thatthe Company would be able to replace such individuals with persons ofcomparable skills or with comparable customer relationships.  The Company also may not be able to attractand retain additional key personnel with the skills and expertise necessary toachieve and manage its operations.

 

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**Governmental supervision of banking,monetary policies and intervention to stabilize the U.S. financial system mayaffect our business and are beyond our control.**  Banks aresubject to extensive governmental supervision, regulation and control byregulatory agencies and entities, which have materially affected the businessof financial institutions.  In recentyears the regulations applicable to banks have changed dramatically, havesubstantially affected the banking business and increased the cost of doingbusiness.  The primary objective of theseagencies and entities is to protect bank depositors and other customers and notshareholders, whose respective interests will often differ.  The regulatory agencies and entities have thelegal authority to impose restrictions which they believe are needed to protectdepositors and customers of banking institutions, even if the restrictionslimit the ability of the banking institution to expand its business andintroduce new financial products and services. Such regulatory restrictions are likely to reduce the amount ofinvestment risk and resulting potential financial gains that banks may assume.

 

Recent legislationincluding the Emergency Economic Stabilization Act of 2008 (the “EESA”), signedinto law by President Bush on October 3, 2008, and the American Recoveryand Reinvestment Act of 2009 (the “ARRA”), signed into law by President Obamaon February 17, 2009, each include programs that are intended to helpstabilize the U.S. financial system. However, it is uncertain whether such legislation will sufficientlyresolve the volatility of capital and credit markets or improve capital andliquidity problems confronting the financial system.  The failure of the EESA or ARRA to mitigateor eliminate such volatility and problems affecting the financial markets and acontinuation or worsening of current financial market conditions could limitour access to capital or sources of liquidity in amounts and at times necessaryto conduct operations in compliance with applicable regulatory requirements.

 

Recent regulations issuedby the FDIC to limit the interest rate that may be paid on deposits and thetype of deposits that may be taken by insured depository institutions that areless than “well capitalized”, including the Bank, may result in lower total depositsat the Bank that may require the Bank to sell assets to compensate for lowertotal deposits.  The sale of assets atless than cost by the Bank to compensate for lower deposits may result inlosses for the Bank.  In addition, theinability to bring in deposits will restrict the future growth of theBank.  The Company will be required toraise additional capital to provide the necessary capital to the Bank to allowit to be “well capitalized” and be exempt from such interest rate limitations.

 

**Technologyimplementation problems or computer system failures could adversely affectus. **Our future growth prospects will be highly dependenton the ability of the Bank to implement changes in technology that affect thedelivery of banking services such as the increased demand for computer accessto bank accounts and the availability to perform banking transactionselectronically. The Bank’s ability to compete will depend upon its ability tocontinue to adapt technology on a timely and cost-effective basis to meet suchdemands. In addition, the Company’s business and operations and those of theBank could be susceptible to adverse effects from computer failures,communication and energy disruption, and activities such as fraud of unethicalindividuals with the technological ability to cause disruptions or failures ofthe Bank’s data processing system.

 

**Informationsecurity breaches or other technological difficulties could adversely affectus. **We cannot be certain that the continued implementationof safeguards will eliminate the risk of vulnerability to technologicaldifficulties or failures or ensure the absence of a breach of informationsecurity. The Bank will continue to rely on the services of various vendors whoprovide data processing and communication services to the banking industry.Nonetheless, if information security is compromised or other technologydifficulties or failures occur at the Bank or with one of our vendors,information may be lost or misappropriated, services and operations may beinterrupted and the Bank could be exposed to claims from its customers as aresult.

 

**Ourcontrols over financial reporting and related governance procedures may fail orbe circumvented.**  Management regularly reviews and updates ourinternal control over financial reporting, disclosure controls and procedures,and corporate governance policies and procedures.  We maintain controls and procedures tomitigate risks such as processing system failures or errors and customer or employeefraud, and we maintain insurance coverage for certain of these risks.  Any system of controls and procedures,however well designed and operated, is based in part on certain assumptions andprovides only reasonable, not absolute, assurances that the objectives of thesystem are met.  Events could occur whichare not prevented or detected by our internal controls, are not insuredagainst, or are in excess of our insurance limits. Any failure or circumventionof our controls and procedures, or failure to comply with regulations relatedto controls and procedures, could have an adverse effect on our business.

 

**Theeffects of legislation in response to current credit conditions may adverselyaffect us. **Legislation that has or may be passed atthe federal level and/or by the State of California in response to currentconditions affecting credit markets could cause us to experience higher creditlosses if such legislation reduces the amount that the Bank’s borrowers areotherwise contractually required to pay under existing loan contracts. Such legislationcould also result in the imposition of limitations upon the Bank’s ability toforeclose on property or other collateral or make foreclosure less economicallyfeasible. Such events could result in increased loan and lease losses andrequire a material increase in the allowance for loan and lease losses.

 

**Theeffects of changes to FDIC insurance coverage limits are uncertain andincreased premiums adversely affect us.**  EESA includeda provision for an increase in the amount of deposits insured by the FDIC to$250,000. In addition, the FDIC recently adopted a final rule revising itsrisk-based assessment system, effective April 1, 2009.  The changes to the assessment system involveadjustments to the risk-based calculation of an institution’s unsecured debt,secured liabilities and brokered deposits. Further potential increases in FDICinsurance premiums will add to our cost of operations and could have asignificant impact on us.  On September 30,

 

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2009 the Bank paid aspecial FDIC insurance assessment of $267,513. The FDIC also adopted a rule requiring all insured depositoryinstitutions including the Bank to prepay three years of FDIC assessments inthe fourth quarter of 2009.  The amountof this prepaid assessment was $3,879,000 which is to be charged against incomeover a three year period.  While theprepaid assessments are not charged to income for 2009, but rather will beexpensed based on the Bank’s quarterly assessments under the new risk-basedassessment system, the amount paid in December will reduce the cash andliquidity of the Bank at year end 2009. Due to the significant losses at failedbanks and expected losses for banks that will fail, it is likely that FDICinsurance fund assessments on the Bank will increase, and such assessments maymaterially adversely affect the profitability of the Bank.

 

**We mayraise additional capital, which could have a dilutive effect on the existingholders of our common stock and adversely affect the market price of our commonstock. **We are not restricted from issuing additional sharesof common stock or securities that are convertible into or exchangeable for, orthat represent the right to receive, common stock.  We are evaluating opportunities to access thecapital markets taking into account our regulatory capital ratios, financialcondition and other relevant considerations. Such actions could include, among other things, the issuance ofadditional shares of common stock in public or private transactions in order tofurther increase our capital levels above the requirements for awell-capitalized institution established by the Federal banking regulatoryagencies as well as other regulatory targets.

 

The issuance of anyadditional shares of common stock or securities convertible into orexchangeable for common stock or that represent the right to receive commonstock, or the exercise of such securities including, without limitation,securities issued upon exercise of outstanding stock options under our stockoption plans, could be substantially dilutive to shareholders of our commonstock Holders of our shares of common stock have no preemptive rights thatentitle holders to purchase their pro rata share of any offering of shares ofany class or series and, therefore, such sales or offerings could result inincreased dilution to our shareholders.

 

**We areunable to pay cash dividends in the foreseeable future due to dividendrestrictions on common stock under the Regulatory Agreement and FRBAgreement. **Under the FRB Agreement, we****may not pay any dividends on common stock without the priorpermission of the FRB for the duration of such agreement.  It is expected that prior permission of theFRB will not be allowed until the financial condition of The Company and theBank improves significantly.

 

**Item 1b.Unresolved Staff****Comments**

 

Nocomments have been submitted to the registrant by the staff of the SecuritiesExchange Commission.

 

**Item 2.****          ****Properties**

 

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

 
| **Location**                                                                 | ** ** | **Use of Facilities** | ** ** | **Square Feet of  Office Space** | ** ** | **Building Cost** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------|------------|----------------------------------|------------|-------------------|------------|
|                                                                         |       |                  |       |                             |       |              |       |
| 237 West East Avenue  Chico, California  (building is owned, land is leased) |       | Branch Office         |       | 4,771                            |       | $                 | 845,493    |   |
|                                                                         |       |                  |       |                             |       |              |       |
| 1335 Hilltop Dr  Redding,California  (building is owned, land is leased)     |       | Branch Office         |       | 4,150                            |       | $                 | 1,447,000  |   |
|                                                                         |       |                  |       |                             |       |              |       |
| 5026 Rhonda Rd  Anderson, California  (building is owned, land is leased)    |       | Branch Office         |       | 3,202                            |       | $                 | 1,012,000  |   |

 

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Thefollowing facilities are leased by the Company:

 
| ** **                                    | ** ** | ** **                          | ** ** | **Square  Feet of** | ** ** | **Monthly  Rent**   | ** ** | **Term of** | ** ** |
|-----------------------------------------------|------------|-------------------------------------|------------|---------------------|------------|---------------------|------------|-------------|------------|
| **Location**                                  | ** ** | **Use of  Facilities**              | ** ** | **Office  Space**   | ** ** | **as of  12/31/09** | ** ** | **Lease**   | ** ** |
|                                          |       |                                |       |                |       |                |       |        |       |
| 14001 Lakeridge  Circle                       |       | Branch Office                       |       | 600                 |       | $                   | 619        |        | 3/31/2013  | (1) |
| Magalia,  California                          |       |                                |       |                |       |                |       |        |       |
|                                          |       |                                |       |                |       |                |       |        |       |
| 237 West East  Ave.                           |       | Branch Office                       |       |                |       | $                   | 4,552      |        | 10/31/2028 | (2) |
| Chico,  California                            |       |                                |       |                |       |                |       |        |       |
| land lease only                               |       |                                |       |                |       |                |       |        |       |
|                                          |       |                                |       |                |       |                |       |        |       |
| 900 Mangrove  Ave.                            |       | Branch Office                       |       | 6,000               |       | $                   | 7,132      |        | 9/30/2011  | (3) |
| Chico,  California                            |       |                                |       |                |       |                |       |        |       |
|                                          |       |                                |       |                |       |                |       |        |       |
| 6653 Clark Road                               |       | Branch Office                       |       | 4,640               |       | $                   | 5,405      |        | 3/31/2013  | (4) |
| Paradise,  California                         |       |                                |       |                |       |                |       |        |       |
|                                          |       |                                |       |                |       |                |       |        |       |
| 5959 Greenback  #430                          |       | Loan Office                         |       | 1,315               |       | $                   | 3,223      |        | 7/31/2012  | (5) |
| Citrus Heights,  California                   |       |                                |       |                |       |                |       |        |       |
|                                          |       |                                |       |                |       |                |       |        |       |
| 936 Mangrove  Ave.                            |       | General Offices                     |       | 6,000               |       | $                   | 4,881      |        | 2/28/2013  | (6) |
| Chico,  California                            |       |                                |       |                |       |                |       |        |       |
|                                          |       |                                |       |                |       |                |       |        |       |
| 904 B Street                                  |       | Branch office                       |       | 4,742               |       | $                   | 10,670     |        | 10/31/2016 | (7) |
| Marysville CA                                 |       |                                |       |                |       |                |       |        |       |
|                                          |       |                                |       |                |       |                |       |        |       |
| 1017 Bridge St                                |       | Branch office                       |       | 1,500               |       | $                   | 1,300      |        | 2/28/2014  | (8) |
| Colusa CA                                     |       |                                |       |                |       |                |       |        |       |
|                                          |       |                                |       |                |       |                |       |        |       |
| 950 Hwy 99W                                   |       | Branch office                       |       | 5,300               |       | $                   | 13,250     |        | 10/31/2026 | (9) |
| Corning CA                                    |       |                                |       |                |       |                |       |        |       |
|                                          |       |                                |       |                |       |                |       |        |       |
| 1335 Hilltop Dr                               |       | Branch office                       |       |                |       | $                   | 6,250      |        | 2/28/2021  | (10) |
| Redding CA                                    |       |                                |       |                |       |                |       |        |       |
| land lease only                               |       |                                |       |                |       |                |       |        |       |
|                                          |       |                                |       |                |       |                |       |        |       |
| 5026 Rhonda Rd                                |       | Branch Office                       |       |                |       | $                   | 4,500      |        | 12/31/2027 | (11) |
| Anderson, CA                                  |       |                                |       |                |       |                |       |        |       |
| land lease only                               |       |                                |       |                |       |                |       |        |       |
|                                          |       |                                |       |                |       |                |       |        |       |
| 672 Pearson Road  Paradise, California        |       | Branch Office                       |       | 4,200               |       | $                   | 10,073     |        | 2/28/2023  | (12) |
|                                          |       |                                |       |                |       |                |       |        |       |
| 2227 Myers  Street  Oroville, California      |       | Branch Office                       |       | 9,800               |       | $                   | 7,707      |        | 2/28/2023  | (13) |
|                                          |       |                                |       |                |       |                |       |        |       |
| 2041 Forest  Avenue  Chico, California        |       | Branch Office                       |       | 8,000               |       | $                   | 19,960     |        | 2/28/2023  | (14) |
|                                          |       |                                |       |                |       |                |       |        |       |
| 1390 Ridgewood  Drive  Chico California       |       | Central Services/  Information Svcs |       | 8,432               |       | $                   | 7,187      |        | 2/28/2023  | (15) |
|                                          |       |                                |       |                |       |                |       |        |       |
| 1600 Butte House  Road  Yuba City, California |       | Branch Office                       |       | 6,580               |       | $                   | 20,775     |        | 2/28/2023  | (16) |
|                                          |       |                                |       |                |       |                |       |        |       |
| 10 Gilmore Road  Red Bluff, California        |       | Branch Office                       |       | 8,000               |       | $                   | 16,732     |        | 2/28/2023  | (17) |
|                                          |       |                                |       |                |       |                |       |        |       |
| 1360 East Lassen  Avenue  Chico, California   |       | Administration  Credit Services     |       | 17,000              |       | $                   | 18,161     |        | 2/28/2023  | (18) |

 

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(1)  This is thetermination date of the current 5-year lease. The Company also has one renewal option for five years.

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

(3)  This is thetermination date of the current 10-year lease. The Company also has three renewal options for five years each.

(4)  This is thetermination date of the current 10-year lease. The Company also has two renewal options for five years each.

(5)  This is thetermination date of the current 5-year lease. The Company does not have renewaloptions on this property.

(6)  This is thetermination date of the current 10-year lease. The Conpany also has one renewal option for ten years.

(7)  This is thetermination date of the current 10-year lease. The Company has two renewal options for five years each.

(8) This is thetermination date of the current 10-year lease. The Company does not have renewal options on this property.

(9) This is thetermination date of the current 20 year lease. The Company does not have renewal options on this property.

(10) This is thetermination date of the current 15 year land lease.  The Company has three renewal options forfive years each.

(11) This is thetermination date of the current 15 year lease. The company has three renewal options for five years each.

(12) This is thetermination date of the current 15 year lease. The company has two renewal options for ten years each.

(13) This is the terminationdate of the current 15 year lease.  Thecompany has two renewal options for ten years each.

(14) This is thetermination date of the current 15 year lease. The company has two renewal options for ten years each.

(15) This is thetermination date of the current 15 year lease. The company has two renewal options for ten years each.

(16) This is thetermination date of the current 15 year lease. The company has two renewal options for ten years each.

(17) This is thetermination date of the current 15 year lease. The company has two renewal options for ten years each.

(18) This is thetermination date of the current 15 year lease. The company has two renewal options for ten years each.

 

**Item 3.****   ****Legal Proceedings**

 

Fromtime to time, the Company is a party to claims and legal proceedings arising inthe ordinary course of business. After taking into consideration informationfurnished by counsel to the Company as to the current status of these claims orproceedings to which the Company is a party, management is of the opinion thatthe ultimate aggregate liability represented thereby, if any, will not have amaterial adverse affect on the financial condition of the Company.

 

**Item 4.****   ****Not Applicable**

 

**PART II**

 

**Item 5.****   ****Market for Registrants Common Equity and RelatedShareholder Matters and Issuer Purchases of Equity Securities**

 

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

 

CommunityValley Bancorp was previously listed on the NASD OTC Bulletin Board starting June 17,2002 (the effective date of the holding company reorganization), and ButteCommunity Bank was previously also listed on the NASD OTCBB. Our Common Stocktraded under the symbol CVLL and the CUSIP number for such common stock is#20415P101. Previously the Butte Community Bank CUSIP number for the commonstock was #12406Q107.  On May 1,2006 the Company began trading on the Nasdaq Capital Market.   Trading in the Company has not beenextensive and such trades cannot be characterized as amounting to an activetrading market.

 

InSeptember 2009, the Company voluntarily delisted from the Nasdaq capitalMarket and is now traded on NASD OTCBB under the symbol CVLL.OB. CUSIP remains20415P101. In December 2009 the Company issued two series of PreferredStock, both of which are currently restricted. Community Valley BancorpPreferred Stock Series A CUSIP is 20415P200. Preferred Stock Series Bdoes not have a CUSIP.

 

Managementis aware of the following securities dealers who make a market in the Company’sstock: Howe Barnes Hoefer & Arnett Inc., San Francisco, California,Wedbush Morgan Securities, Lake Oswego, Oregon and Sandler O’Neill &Partners, LP, New York, NY, (the “Securities Dealers”).

 

Thefollowing table summarizes trades of the Company setting forth the approximatehigh and low sales prices and volume of trading for the periods indicated,based upon information provided by public sources. The information in thefollowing table does not include trading activity between dealers.

 

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| ** **              | ** ** | **Sale Price  of the Company’s** | ** ** | **Approximate**     | ** ** |
|-------------------------|------------|---------------------------------------|------------|---------------------|------------|
| **Calendar**            | ** ** | **Common  Stock**                     | ** ** | **Trading  Volume** | ** ** |
| **Quarter Ended**       | ** ** | **High**                              | ** ** | **Low**             | ** ** | **Shares** | ** ** |
| March 31, 2008     |       | 12.50                                 |       | 9.20                |       | 193,391 |   |
| June 30, 2008      |       | 12.35                                 |       | 6.75                |       | 95,659 |   |
| September 30, 2008 |       | 9.39                                  |       | 6.00                |       | 69,789 |   |
| December 31, 2008  |       | 7.50                                  |       | 4.14                |       | 72,247 |   |
| March 31, 2009     |       | 5.00                                  |       | 2.28                |       | 224,332 |   |
| June 30, 2009      |       | 4.28                                  |       | 3.11                |       | 65,907 |   |
| September 30, 2009 |       | 5.84                                  |       | 2.81                |       | 135,034 |   |
| December 31, 2009  |       | 3.45                                  |       | 0.65                |       | 129,406 |   |

######  

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

######  

###### On April 12, 2010 there were approximately 542 shareholders ofrecord of the Company.

######  

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

 

Asa financial holding company which currently has no significant assets otherthan its equity interest in the Bank and the proceeds from the issuance of theTrust Preferred Securities previously mentioned, the Company’s ability todeclare dividends depends primarily upon dividends it receives from the Bank.The Bank’s dividend practices in turn depend upon the Bank’s earnings,financial position, current and anticipated cash requirements and other factorsdeemed relevant by the Bank’s Board of Directors at that time.

 

Thepolicy is to declare and pay dividends of no more than 40% of its previous year’snet income to shareholders. However, no assurance can be given that the Bank’sand the Company’s future earnings and/or growth expectations in any given yearwill justify the payment of such a dividend. In addition, the Company’sagreement with the Federal Reserve requires regulatory approval prior todeclaring or paying dividends.

 

TheCompany paid cash dividends during the first three quarters of 2008 beforesuspending the dividend payment in the fourth quarter.  A total of $1.1 million or $0.16 per sharewas paid in 2008, representing 18% of the prior year’s earnings.   The Company suspended its payment ofdividends to shareholders in 2009 to preserve its capital as it became apparenteconomic conditions would not support the payment of dividends and themaintenance of minimum capital ratios established by the Company.

 

Theability of the Bank’s Board of Directors to declare cash dividends is alsolimited by statutory and regulatory restrictions which restrict the amountavailable for cash dividends depending upon the earnings, financial conditionand cash needs of the Bank, as well as general business conditions. A detaileddiscussion is located in Item 1 above.

 

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

 

There was no stockrepurchase plan in place for 2009.

 

In March 2008,Community Valley Bancorp announced an offer to purchase up to 1,000,000 sharesof its common stock at a purchase price of $13.00.  Based on the final count by the depositaryfor the tender offer, shareholders properly tendered 1,572,907 shares of itscommon stock.  The Board of Directors ofCommunity Valley Bancorp elected to not exercise its oversubscriptionprivileges in the tender offer to purchase more than 1,000,000 properlytendered shares and purchased a total of 999,939 shares at $13.00 per sharerepresenting a pro-rata share of the tendered shares of 63.38%, on May 5,2008.

 

TheBoard of Directors approved a plan to repurchase up to $6,000,000 of theoutstanding common stock of the Company in 2007. Stock repurchases were madefrom time to time on the open market or through privately negotiatedtransactions. The timing of purchases and the exact number of shares purchasedwas dependent on market conditions. The share repurchase program did notinclude specific price targets or timetables and could have been suspended atany time. During 2008, 12,067 shares were repurchased for $119,000 at anaverage price of $9.84 per share. During 2009, no shares of the Company’scommon stock were repurchased.

 

TheBoard of Directors approved a plan to repurchase up to $3,000,000 of theoutstanding common stock of the Company in 2003. Stock repurchases were madefrom time to time on the open market or through privately negotiatedtransactions. The timing of purchases and the exact number of shares purchasedwas dependent on market conditions. The share repurchase program did not includespecific price targets or timetables and could have been suspended at any time.During 2006, 143,950 shares were repurchased for $2,498,000 at an average priceof $17.35 per share. During 2005, no shares of the Company’s common stock wererepurchased. There were no shares available for repurchase under this planafter December 31, 2006.

 

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**(e)****          ****EquityCompensation Plan Information**

 

The following chart setsforth information for the fiscal year ended December 31, 2009, regardingequity based 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     |       | 311,751                                                                                               |       | $                                                                                    | 7.35       |                                                                                                                                                  | 127,092    |   |
|                                                        |       |                                                                                                  |       |                                                                                 |       |                                                                                                                                                  |       |
| Equity compensation plans not approved by security  holders |       | None                                                                                                  |       | None                                                                                 |       | None                                                                                                                                                  |       |
|                                                        |       |                                                                                                  |       |                                                                                 |       |                                                                                                                                                  |       |
| Total                                                       |       | 311,751                                                                                               |       | $                                                                                    | 7.35       |                                                                                                                                                  | 127,092    |   |

 

**(f)****           ****Salesof Unregistered Securities**

 

OnJuly 10, 2007 the Company issued an aggregate of $8,000,000 in principalamount of its Fixed Rate Middle Market Capital Securities due 2037 (the “SubordinatedDebt Securities”). All of the Subordinated Debt Securities were issued toCommunity Valley Trust II, a Delaware statutory business trust and awholly-owned but unconsolidated subsidiary of the Company (the “Trust”). TheSubordinated Debt Securities were not registered under the Securities Act inreliance on the exemption set forth in Section 4(2) thereof. TheSubordinated Debt Securities were issued to the Trust in consideration for thereceipt of the net proceeds raised by the Trust from the sale of $8,000,000 inprincipal amount of the Trust’s Fixed Rate Capital Trust Pass-throughSecurities (the “Trust Preferred Securities”). Sandler O’Neill &Partners, L.P. acted as the placement agent in connection with the offering ofthe Trust Preferred Securities.  The saleof the Trust Preferred Securities was part of a larger transaction arranged bySandler O’Neill & Partners, L.P. pursuant to which the Trust PreferredSecurities were deposited into a special purpose vehicle along with similarsecurities issued by a number of other banks and the special purpose vehiclethen issued its securities to the public (the “Pooled Trust PreferredSecurities”). The Pooled Trust Preferred Securities were sold by Sandler O’Neill &Partners, L.P. only (i) to those entities Sandler O’Neill &Partners, L.P. reasonably believed were qualified institutional  buyers (as defined in Rule 144A underthe Securities Act), (ii) to “accredited investors” (as defined in Rule 501(a)(1),(2), (3) or (7) or Regulation D promulgated under the Securities Act)or (iii) in offshore transactions in compliance with Rule 903 ofRegulation S under the Securities Act. The Trust Preferred Securities were notregistered under the Securities Act in reliance on exemptions set forth in Rule 144A,Regulation D and Regulation S, as applicable. The proceeds of the sale wereused in 2008 to retire the previously outstanding subordinated debt securitiesof Community Valley Trust I and that trust was dissolved.

 

On December 30,2009, the Company, pursuant to a loan participation and debt conversionagreement (“Agreement”) converted $3.3 million in outstanding debt intoshareholder equity by issuing Company preferred stock in a private placementtransaction under Section 4(2) of the Securities Act of 1933. The $3.3 million outstanding debt of the Company was the net balance of theprincipal amount of a loan from Pacific Coast Bankers’ Bank (“PCBB”) to theCompany that was collateralized by all of the outstanding common stock of theBank.  As part of the transaction, $1.2 million of the $3.3 million loanfrom PCBB was participated by PCBB to certain accredited investors, includingcertain directors of the Company in a private placement transaction underSection 4(2) of the Securities Act of 1933.  The participateddebt of $1.2 million was then converted into 240,000 shares of 6% MandatoryConvertible Cumulative Preferred Stock Series A (“Preferred StockSeries A”).  The remaining $2.1 million of $3.3 million debt wasconverted into 105,647 shares of 8% Cumulative Perpetual Preferred StockSeries B (“Preferred Stock Series B”) that was issued in a privateplacement transaction Section 4(2) of the Securities Act of 1933 toPacific Coast Bankers’ Bank.

 

Both Preferred StockSeries A and Preferred Stock Series B are voting and have votingrights of one vote per share and have the same voting rights as commonshares.  In addition the Preferred Stock Series A, with a liquidationvalue of $5 per share and cumulative dividends at 6% per annum, are mandatorilyand optionally convertible into common stock at a conversion ratio of $2 percommon share, subject to adjustment.  The Preferred Stock Series B,with a liquidation value of $20 per share and cumulative dividends at 8% perannum, are perpetual in life and are optionally convertible into common stockat a conversion ratio of $2.50 per common share, subject to adjustment. PCBB also has certain rights to require the Company to register the Company’scommon stock issued by the Company to PCBB in the conversion of the PreferredStock Series B into common stock.  In the debt conversion, all of theoutstanding shares of common stock of Bank held as collateral for the $3.3million debt was released by PCBB to the Company.  The Company has theoption to redeem at a premium the outstanding shares of Preferred StockSeries A and the Preferred Stock Series B.

 

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

 

The“selected financial data” which follows has been derived from the auditedConsolidated Financial Statements of the Company and other data from ourinternal accounting system. The selected financial data should be read inconjunction 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**

(dollars in thousands, except per share data)

 
| ** **                                                 | ** ** | **As of December 31,** | ** ** |
|------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                 | ** ** | **2009**                    | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Income  Statement Summary**                              |       |                        |       |   |   |   |   |   |   |   |   |
| Interest income                                            |       | $                           | 28,866     |   | $ | 37,315 |   | $ | 43,223 |   | $ | 40,814 |   | $ | 32,438 |   |
| Interest expense                                           |       | $                           | 6,710      |   | $ | 10,365 |   | $ | 13,889 |   | $ | 9,532 |   | $ | 5,331 |   |
| Net interest income before  provision for loan losses      |       | $                           | 22,156     |   | $ | 26,950 |   | $ | 29,334 |   | $ | 31,282 |   | $ | 27,107 |   |
| Provision / credit for loan  losses                        |       | $                           | 23,057     |   | $ | 3,742 |   | $ | (16 | ) | $ | 638 |   | $ | 825 |   |
| Non-interest income                                        |       | $                           | 11,769     |   | $ | 8,939 |   | $ | 8,475 |   | $ | 6,769 |   | $ | 6,711 |   |
| Non-interest expense                                       |       | $                           | 32,272     |   | $ | 28,276 |   | $ | 26,927 |   | $ | 25,160 |   | $ | 20,824 |   |
| (Loss) income before  provision for income taxes           |       | $                           | (21,404    | ) | $ | 3,871 |   | $ | 10,898 |   | $ | 12,253 |   | $ | 12,169 |   |
| Provision for income taxes                                 |       | $                           | 6,104      |   | $ | 1,132 |   | $ | 4,439 |   | $ | 5,102 |   | $ | 4,971 |   |
| Net (loss) income                                          |       | $                           | (27,508    | ) | $ | 2,739 |   | $ | 6,459 |   | $ | 7,151 |   | $ | 7,198 |   |
|                                                       |       |                        |       |   |   |   |   |   |   |   |   |
| **Balance  Sheet Summary**                                 | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |   |   |   |
| Total loans, net                                           |       | $                           | 420,035    |   | $ | 486,522 |   | $ | 441,350 |   | $ | 442,251 |   | $ | 401,221 |   |
| Allowance for loan losses                                  |       | $                           | (12,975    | ) | $ | (7,826 | ) | $ | (5,232 | ) | $ | (5,274 | ) | $ | (4,716 | ) |
| Investment securities  available for sale                  |       | $                           | 4,377      |   | $ | 6,462 |   | $ | 4,668 |   | $ | 3,350 |   | $ | 4,381 |   |
| Investment securities held  to maturity                    |       | $                           | 1,229      |   | $ | 634 |   | $ | 1,596 |   | $ | 1,777 |   | $ | 2,295 |   |
| Interest-bearing deposits  in banks                        |       | $                           | 2,740      |   | $ | 2,576 |   | $ | 4,250 |   | $ | 2,278 |   | $ | 6,636 |   |
| Cash and due from banks                                    |       | $                           | 12,119     |   | $ | 21,743 |   | $ | 31,714 |   | $ | 20,558 |   | $ | 18,988 |   |
| Federal funds  sold & other                       |       | $                           | 46,535     |   | $ | 36,605 |   | $ | 54,290 |   | $ | 42,070 |   | $ | 29,015 |   |
| Premises and equipment, net                                |       | $                           | 5,271      |   | $ | 7,013 |   | $ | 17,905 |   | $ | 15,359 |   | $ | 11,221 |   |
| Total interest-earning  assets                             |       | $                           | 474,916    |   | $ | 532,799 |   | $ | 506,154 |   | $ | 491,726 |   | $ | 443,548 |   |
| Total assets                                               |       | $                           | 538,512    |   | $ | 594,602 |   | $ | 580,011 |   | $ | 549,531 |   | $ | 493,851 |   |
| Total interest-bearing  deposits                           |       | $                           | 420,823    |   | $ | 444,326 |   | $ | 423,417 |   | $ | 407,868 |   | $ | 350,682 |   |
| Total deposits                                             |       | $                           | 498,163    |   | $ | 526,485 |   | $ | 500,991 |   | $ | 484,856 |   | $ | 434,018 |   |
| Total liabilities                                          |       | $                           | 522,560    |   | $ | 555,105 |   | $ | 529,646 |   | $ | 504,310 |   | $ | 453,222 |   |
| Total shareholders’ equity                            |       | $                           | 15,952     |   | $ | 40,139 |   | $ | 50,974 |   | $ | 45,726 |   | $ | 41,555 |   |
| **Per Share  Data (1)**                                    | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |   |   |   |
| Basic (loss) earnings per  share                           |       | $                           | (4.21      | ) | $ | 0.39 |   | $ | 0.87 |   | $ | 0.98 |   | $ | 1.00 |   |
| Diluted earnings per share                                 |       | —                      |       | $ | 0.39 |   | $ | 0.85 |   | $ | 0.93 |   | $ | 0.95 |   |
| Book value per weighted  average share                     |       | $                           | 2.44       |   | $ | 5.78 |   | $ | 6.81 |   | $ | 6.28 |   | $ | 5.80 |   |
| Cash dividends                                             |       | $                           | —     |   | $ | 0.16 |   | $ | 0.32 |   | $ | 0.26 |   | $ | 0.16 |   |
|                                                       |       |                        |       |   |   |   |   |   |   |   |   |
| Weighted average common  shares outstanding, basic         |       | 6,537,983                   |       | 6,940,876 |   | 7,416,874 |   | 7,279,969 |   | 7,166,258 |   |
| Weighted average common  shares outstanding, diluted       |       | —                      |       | 7,008,838 |   | 7,611,959 |   | 7,661,045 |   | 7,611,704 |   |
|                                                       |       |                        |       |   |   |   |   |   |   |   |   |
| **Key  Operating Ratios:**                                 | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |   |   |   |
| **Performance  Ratios:**                                   | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |   |   |   |
| Return on Average Equity  (2)                              |       | (75.25                      | )%         | 6.11 | % | 13.22 | % | 15.99 | % | 18.82 | % |
| Return on Average Assets  (3)                              |       | (4.78                       | )%         | 0.47 | % | 1.13 | % | 1.38 | % | 1.51 | % |
| Net Interest Margin (4)                                    |       | 4.22                        | %          | 5.09 | % | 5.68 | % | 6.62 | % | 6.32 | % |
| Dividend Payout Ratio (5)                                  |       | —                      |       | 41.03 | % | 36.74 | % | 26.47 | % | 15.93 | % |
| Equity to Assets Ratio (6)                                 |       | 6.35                        | %          | 6.74 | % | 8.78 | % | 8.64 | % | 8.02 | % |
| Net Loans to Total Deposits  at Period End                 |       | 84.32                       | %          | 92.41 | % | 88.10 | % | 91.21 | % | 92.44 | % |
| **Asset  Quality Ratios:**                                 | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |   |   |   |
| Non Performing Loans to  Total Loans                       |       | 11.76                       | %          | 3.01 | % | 0.06 | % | 0.51 | % | 0.00 | % |
| Nonperforming Assets to  Total Loans and Other Real Estate |       | 14.42                       | %          | 3.41 | % | 0.06 | % | 0.51 | % | 0.00 | % |
| Net Charge-offs to Average  Loans                          |       | 3.78                        | %          | 0.24 | % | 0.00 | % | 0.02 | % | 0.00 | % |
| Allowance for Loan Losses  to Gross Loans at Period End    |       | 2.99                        | %          | 1.58 | % | 1.17 | % | 1.18 | % | 1.16 | % |
|                                                       |       |                        |       |   |   |   |   |   |   |   |   |
| **Capital  Ratios (Company):**                             | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |   |   |   |
| Tier 1 Capital to Adjusted  Total Assets                   |       | 3.0                         | %          | 8.1 | % | 11.5 | % | 10.1 | % | 9.8 | % |
| Tier 1 Capital to Total  Risk-Weighted Assets              |       | 3.5                         | %          | 8.8 | % | 13.1 | % | 10.9 | % | 11.4 | % |
| Total Capital to Total  Risk-Weighted Assets               |       | 6.2                         | %          | 10.0 | % | 14.1 | % | 11.9 | % | 12.5 | % |

 

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(1)          All per share data and theaverage number of shares outstanding have been retroactively restated on asplit-adjusted basis.

(2)          Net income divided by averageshareholders’ equity.

(3)          Net income divided by averagetotal assets.

(4)          Net interest income dividedby average earning assets.

(5)          Dividends declared per sharedivided by net income per share.

(6)          Average equity divided byaverage total assets.

 

**Item 7.****   ****Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

Thisdiscussion presents Management’s analysis of the financial condition as of December 31,2009 and 2008 and results of operations of the Company for each of the years inthe three-year period ended December 31, 2009. The discussion should beread in conjunction with the Consolidated Financial Statements of the Companyand the Notes related thereto presented elsewhere in this Form 10-K AnnualReport (see Item 8).

 

*Statements contained in this report that are not purely historical areforward looking statements within the meaning of Section 21E of theSecurities Exchange Act of 1934 as amended, including the Company’sexpectations, intentions, beliefs, or strategies regarding the future. Allforward-looking statements concerning economic conditions, rates of growth,rates of income or values as may be included in this document are based oninformation available to the Company on the date noted, and the Company assumesno obligation to update any such forward-looking statements. It is important tonote that the Company’s actual results could materially differ from those insuch forward-looking statements. Factors that could cause actual results todiffer materially from those in such forward-looking statements arefluctuations in interest rates, inflation, government regulations, economicconditions, customer disintermediation and competitive product and pricingpressures in the geographic and business areas in which the Company conductsits operations.*

 

**CriticalAccounting Policies**

 

*General*

 

The Company’s significantaccounting policies 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 a significantextent, financial information that is based on measures of the financialeffects of transactions and events that have already occurred. Some of theCompany’s accounting policies require significant judgment to estimate valuesof assets or liabilities. In addition, certain accounting policies requiresignificant 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 policies.

 

*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) ASC450 which requires that losses be accrued when they are probable of occurringand estimable and (2) ASC 310 which requires that losses be accrued onimpaired loans based on the differences between the value of collateral,present value of future cash flows or values that are observable in thesecondary market and the loan balance.

 

TheCompany performs periodic and systematic detailed evaluations of its lendingportfolio to identify and estimate the inherent risks and assess the overallcollectibility. These evaluations include general conditions such as theportfolio composition, size and maturities of various segmented portions of theportfolio such as secured, unsecured, construction, and Small BusinessAdministration (“SBA”).  Additional factors include concentrationsof borrowers, industries, geographical sectors, loan product, loan classes andcollateral types, volume and trends of loan delinquencies and non-accrual,criticized and classified assets and trends in the aggregate in significantcredits identified as watch list items. There are several components to thedetermination of the adequacy of the ALL. Each of these components isdetermined based upon estimates that can and do change when the actual eventsoccur. The Company estimates the ASC 450 portion of the ALL based on thesegmentation of its portfolio. For those segments that require an ALL, theCompany estimates loan losses on a monthly basis based upon its ongoing loan reviewprocess and analysis of loan performance. The Company follows a systematic andconsistently applied approach to select the most appropriate loss measurementmethods and support its conclusions and rationale with written documentation.One method of estimating loan losses for groups of loans is through theapplication of loss rates to the groups’ aggregate loan balances. Such ratestypically reflect historical loss experience for each group of loans, adjustedfor relevant economic factors over a defined period of time. The Companyevaluates and modifies its loss estimation model as needed to ensure that theresulting loss estimate is consistent with GAAP.

 

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For individually impaired loans, ASC 310provides guidance on the acceptable methods to measure impairment.Specifically, ASC 310 states that when a loan is impaired, the Company shouldmeasure impairment based on the present value of expected future principal andinterest cash flows discounted at the loan’s effective interest rate, exceptthat as a practical expedient, a creditor may measure impairment based on a loan’sobservable market price or the fair value of collateral, if the loan iscollateral dependent. When developing the estimate of future cash flows for aloan, the Company considers all available information reflecting past eventsand current conditions, including the effect of existing environmental factors.

 

*Loan Sales and Servicing*

 

The Company originatesgovernment guaranteed loans and mortgage loans that may be sold in thesecondary market. The amounts of gains recorded on sales of loans and the initialrecording of servicing assets and interest only (I/O) strips is based on theestimated fair values of the respective components. In recording the initialvalue of the servicing assets and the fair value of the I/O strips receivable,the Company uses estimates which are made based on management’s expectations offuture prepayment and discount rates. Servicing assets are amortized over theestimated life of the related loan. I/O strips are not significant at December 31,2009. These prepayment and discount rates were based on current marketconditions and historical performance of the various pools of serviced loans.If actual prepayments with respect to sold loans occur more quickly thanprojected, the carrying value of the servicing assets may have to be adjustedthrough a charge to earnings.

 

*Stock-Based Compensation*

 

Compensation cost is recognized for all share-based payments over therequisite service periods of the awards based on the grant date fair value ofthe options determined using the Black-Scholes-Merton based option valuationmodel.  Critical assumptions that areassessed in computing the fair value of share-based payments include stockprice volatility, expected dividend rates, the risk free interest rate and theexpected lives of such options. Compensation cost recorded is net of estimatedforfeitures expected to occur prior to vesting. For further information on thecomputation of the fair value of share-based payments, see Notes 1 and 11 tothe Consolidated Financial Statements in Part II Item 8.

 

*Impairment of Investment Securities*

 

Investment securities are evaluated for other-than-temporary impairmenton at least a quarterly basis and more frequently when economic or marketconditions warrant such an evaluation to determine whether a decline in theirvalue below amortized cost is other than temporary. Management utilizescriteria such as the magnitude and duration of the decline, the financialcondition of the issuer, rating agency changes related to the issuer’ssecurities and the intent and ability of the Bank to retain its investment inthe issues for a period of time sufficient to allow for an anticipated recoveryin fair value, in addition to the reasons underlying the decline, to determinewhether the loss in value is other than temporary. The term “other thantemporary” is not intended to indicate that the decline is permanent, butindicates that the prospects for a near-term recovery of value is notnecessarily favorable, or that there is a lack of evidence to support arealizable value equal to or greater than the carrying value of the investment.Once a decline in value is determined to be other than temporary, the value ofthe security is reduced and a corresponding charge to earnings is recognized.During 2008, the Company recognized an impairment charge of $1,489,000 on atrust preferred security it held for investment. In January 2009, thesecurity was sold at a loss of $172,000.

 

*Revenue Recognition*

 

The Company’s primary source of revenue is netinterest income, which is the difference between the interest income itreceives on interest-earning assets and the interest expense it pays oninterest-bearing liabilities, and (ii) fee income, which includes feesearned on deposit services, income from government guaranteed lending, electronic-basedcash management services, mortgage brokerage fee income and payroll services.Interest income is recorded on an accrual basis. Note 1 to the ConsolidatedFinancial Statements offers an explanation of the process for determining whenthe accrual of interest income is discontinued on an impaired loan.

 

*Income Taxes*

 

The Company accounts for income taxes under the assetand liability method. Under the asset and liability method, deferred tax assetsand liabilities are recognized for the future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases. Deferred tax assets andliabilities are measured using currently enacted tax rates applied to suchtaxable income in the years in which those temporary differences are expectedto be recovered or settled. The effect on deferred tax assets and liabilitiesof a change in tax rates is recognized in income in the period that includesthe enactment date. If future income should prove non-existent or less than theamount of deferred tax assets within the tax years to which they may beapplied, the asset may not be realized and our net income will be reduced. Since January 1,2007, the Company has accounted for uncertainty in income taxes under ASC 740, *Accounting for Uncertainty in Income Taxes*.  Under the provisions of ACS 740, only taxpositions that meet the more likely than not recognition threshold that the taxposition will be sustained in a tax examination are recognized.

 

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We use a comprehensive model for recognizing, measuring, presenting anddisclosing in the financial statements tax positions taken or expected to betaken on a tax return.  A tax position isrecognized as a benefit only if it is “more likely than not” that the taxposition would be sustained in a tax examination, with a tax examination beingpresumed to occur.  The amount recognizedis the largest amount of tax benefit that is greater than 50% likely of beingrealized on examination.  For taxpositions not meeting the “more likely than not” test, no tax benefit isrecorded.

 

If Managementdetermines, based on available evidence at the time, that it is more likelythan not that some portion or all of the deferred tax assets will not berealized, then a valuation allowance against the deferred tax asset must beestablished. In evaluating the likelihood of realizing the benefit of thedeferred tax asset, Management estimates future taxable income based onManagement’s business plans and ongoing tax planning strategies against whichthe deferred tax asset may be applied. This process involves significantjudgment about assumptions that are subject to revision from period to periodbased on changes in tax laws or variances between the Company’s projectedoperating performance and the Company’s actual results and other factors. Avaluation allowance for deferred tax assets is established through an expenserecorded in the statement of operations.

 

For the threeyears ended December 31, 2009, 2008 and 2007, the Company is in acumulative pretax loss position. For purposes of establishing a deferred taxvaluation allowance, this cumulative pretax loss position is consideredsignificant, objective evidence that the Company may not be able to realize theCompany’s deferred tax assets in the future. The cumulative pretax lossposition was caused primarily by the significant amount of loan loss provisionand other real estate expense taken in 2009. As a result of these losses, avaluation allowance was recorded at December 31, 2009.

 

The amount ofdeferred tax assets considered realizable is subject to adjustment in futureperiods. Management will need to continue to monitor all available evidencerelated to the Company’s ability to utilize its net deferred tax assets. TheCompany’s income tax expense in future periods will be increased or reduced tothe extent of offsetting increases or decreases to the Company’s net deferredtax asset valuation allowance.

 

###### **Summaryof Performance**

######  

For 2009, the net loss was $(27.51) million,compared to the net income of $2.74 million earned in 2008 and $6.46 million in2007. Net loss per share was $(4.21) for 2009, as compared to net income perdiluted share of $.39 during 2008 and $.87 in 2007. The Company’s Return onAverage Assets (“ROAA”) was (4.78)% and Return on Average Equity (“ROAE”) was(75.25)% in 2009, as compared to .47% and 6.11%, in 2008 and 1.13% and 13.22%,for 2007, respectively.

 

The significant factors impacting the netloss in 2009 were:

 

·                  The provisionfor loan losses of $23.1 million due to net charge-offs totaling $17.9 millionand related other real estate expenses of $6.64 million. This is a directresult of the deterioration of the economy, the effect of declining real estatevalues and the increasing unemployment rate;

 

·                  The downwardmovement in rates of 400 basis points by the FOMC (Federal Open MarketCommittee) throughout 2008 which remained unchanged in 2009 had a negativeimpact on the net interest margin. This compression of interest rates, inaddition to the significant increases in nonaccrual loans, decreased netinterest income by $4.8 million from 2008 to 2009;

 

·                  FDICassessments increased $1.3 million in 2009 from 2008; and

 

·                  A valuationallowance of $15.2 million was established against the Company’s deferred taxassets.

 

These expenses were partially offset by adecrease in salaries and employee benefits and the gain on the sale of themerchant processing portfolio.

 

The economic downturn and the downward trendsin the real estate market had a negative effect on our construction loanbusiness and the related mortgage loans that in the past had providedsubstantial gains when the loans sold on the secondary market. Even in thecurrent environment the Company was able to continue to sell several USDABusiness and Industry guaranteed loans and SBA loans allowing us to realizegains during 2009 approximately equal to $510,000 over the gains in 2008.

 

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

 

**The Impact of Changes in Assetsand Liabilities to Net Interest Income and Net Interest Margin**

 

We monitor asset and deposit levels,developments and trends in interest rates, liquidity, capital adequacy andmarketplace opportunities.  We respond toall of these to protect and maximize income while managing risks withinacceptable levels as set by the 

 

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Company’s policies.  In addition, alternative business plans andcontemplated transactions are analyzed for their impact on the level of riskassumed by the Company.  This process,known as asset/liability management, is carried out by changing the maturitiesand relative proportions of the various types of loans, investments, depositsand other borrowings in ways described below. The management staff responsible for asset/liability management operatesunder the oversight of the Asset/Liability Committee and provides regular reportsto the Board of Directors.  Board approvalis obtained for major actions or the occasional exception to policy.

 

###### **Net Interest Income and Net Interest Margin**

######  

The Company earns income from two primarysources. The first is net interest income brought about by income from thesuccessful deployment of earning assets less the costs of interest-bearingliabilities. The second is non-interest income, which generally comes fromcustomer service charges and fees, but can also result from non-customersources such as gains on loan sales. The majority of the Company’s non-interestexpenses are operating costs which relate to providing a full range of bankingservices to our customers and the costs related to foreclosed real estate.

 

Net interest income, which is simply totalinterest income (including fees) less total interest expense, was $22.2 millionin 2009 compared to $26.9 million and $29.3 million in 2008 and 2007,respectively. This represents a decrease of 17.8% in 2009 from 2008 and adecrease of 8.2% in 2008 from 2007. The amount by which interest income exceedsinterest expense depends on several factors. Among those factors are yields onearning assets, the cost of interest-bearing liabilities, the relative volumeof total earning assets and total interest-bearing liabilities, and the mix of productswhich comprise the Company’s earning assets, deposits, and otherinterest-bearing liabilities. Change in the amount and mix of interest-earningassets and interest-bearing liabilities is referred to as “volume change.”  Change in interest rates earned on assets andrates paid on deposits and other borrowed funds is referred to as “rate change.”

 

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**Distribution,Rate & Yield**

 
| ** **                                            | ** ** | **Year  Ended December 31,** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                            | ** ** | **2009  (a)**                     | ** ** | **2008  (a)** | ** ** | **2007  (a)** | ** ** |
| **(In thousands, except percentages)**                | ** ** | **Average  Balance**              | ** ** | **Interest** | ** ** | **Avg  Rate  (4)** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Avg  Rate  (4)** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Avg  Rate  (4)** | ** ** |
| **Assets**                                            |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Investments:                                          |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Federal funds  sold                                   |       | $                                 | 42,580     |   | $ | 96 |   | 0.23 | % | $ | 31,086 |   | $ | 602 |   | 1.94 | % | $ | 51,358 |   | $ | 2,475 |   | 4.82 | % |
| Taxable                                               |       | 4,852                             |       | 205 |   | 4.23 | % | 7,054 |   | 410 |   | 5.81 | % | 4,053 |   | 229 |   | 5.66 | % |
| Non-taxable (1)                                       |       | 1,404                             |       | 65 |   | 4.63 | % | 1,386 |   | 65 |   | 4.69 | % | 1,377 |   | 65 |   | 4.70 | % |
| Interest bearing  deposits in banks                   |       | 2,666                             |       | 74 |   | 2.78 | % | 7,950 |   | 389 |   | 4.89 | % | 2,509 |   | 182 |   | 7.24 | % |
| Total investments                                     |       | 51,502                            |       | 440 |   | 0.85 | % | 47,476 |   | 1,466 |   | 3.09 | % | 59,297 |   | 2,951 |   | 4.98 | % |
| Loans:                                                |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Agricultural                                          |       | 36,677                            |       | 2,209 |   | 6.02 | % | 33,097 |   | 2,301 |   | 6.95 | % | 30,832 |   | 2,818 |   | 9.14 | % |
| Commercial                                            |       | 83,211                            |       | 5,532 |   | 6.65 | % | 84,422 |   | 6,954 |   | 8.24 | % | 70,732 |   | 7,242 |   | 10.24 | % |
| Real estate                                           |       | 289,817                           |       | 16,359 |   | 5.64 | % | 305,871 |   | 22,482 |   | 7.35 | % | 307,430 |   | 26,472 |   | 8.61 | % |
| Consumer                                              |       | 64,072                            |       | 4,326 |   | 6.75 | % | 58,818 |   | 4,112 |   | 6.99 | % | 48,039 |   | 3,740 |   | 7.79 | % |
| Total loans                                           |       | 473,777                           |       | 28,426 |   | 6.00 | % | 482,208 |   | 35,849 |   | 7.43 | % | 457,033 |   | 40,272 |   | 8.81 | % |
| Total earning  assets (2)                             |       | 525,279                           |       | 28,866 |   | 5.50 | % | 529,684 |   | 37,315 |   | 7.04 | % | 516,330 |   | 43,223 |   | 8.37 | % |
| Non earning  assets                                   |       | 54,653                            |       |   |   |   |   | 47,667 |   |   |   |   |   | 56,122 |   |   |   |   |   |
| Average total  assets                                 |       | $                                 | 579,932    |   |   |   |   |   | $ | 577,351 |   |   |   |   |   | $ | 572,452 |   |   |   |   |   |
|                                                  |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities &  Shareholders’ Equity** |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  deposits:                           |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| NOW                                                   |       | $                                 | 124,368    |   | $ | 391 |   | 0.31 | % | $ | 117,903 |   | $ | 634 |   | 0.54 | % | $ | 116,403 |   | $ | 919 |   | 0.79 | % |
| Savings                                               |       | 110,780                           |       | 1,005 |   | 0.91 | % | 115,116 |   | 2,039 |   | 1.77 | % | 113,913 |   | 3,567 |   | 3.13 | % |
| Money market                                          |       | 26,999                            |       | 288 |   | 1.07 | % | 33,357 |   | 531 |   | 1.59 | % | 32,440 |   | 631 |   | 1.94 | % |
| TDOAs and IRAs                                        |       | 9,863                             |       | 245 |   | 2.48 | % | 7,941 |   | 298 |   | 3.75 | % | 7,632 |   | 343 |   | 4.49 | % |
| Certificates of  deposit < $100,000                |       | 86,333                            |       | 1,778 |   | 2.06 | % | 73,815 |   | 2,686 |   | 3.64 | % | 77,341 |   | 3,655 |   | 4.73 | % |
| Certificates of  deposit > $100,000                |       | 82,562                            |       | 2,213 |   | 2.68 | % | 85,683 |   | 3,407 |   | 3.98 | % | 74,230 |   | 3,656 |   | 4.93 | % |
| Total interest  bearing deposits                      |       | 440,905                           |       | 5,920 |   | 1.34 | % | 433,815 |   | 9,595 |   | 2.21 | % | 421,959 |   | 12,771 |   | 3.03 | % |
| Borrowed Funds:                                       |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total borrowed  funds                                 |       | 13,117                            |       | 790 |   | 6.02 | % | 11,445 |   | 770 |   | 6.73 | % | 13,523 |   | 1,118 |   | 8.27 | % |
| Total interest  bearing liabilities                   |       | 454,022                           |       | 6,710 |   | 1.48 | % | 445,260 |   | 10,365 |   | 2.33 | % | 435,482 |   | 13,889 |   | 3.19 | % |
| Demand deposits                                       |       | 73,610                            |       |   |   |   |   | 73,545 |   |   |   |   |   | 81,860 |   |   |   |   |   |
| Other liabilities                                     |       | 11,757                            |       |   |   |   |   | 13,718 |   |   |   |   |   | 6,251 |   |   |   |   |   |
| Total liabilities                                     |       | 539,389                           |       |   |   |   |   | 532,523 |   |   |   |   |   | 523,593 |   |   |   |   |   |
| Shareholders’  equity                            |       | 38,445                            |       |   |   |   |   | 44,828 |   |   |   |   |   | 48,859 |   |   |   |   |   |
| Average  liabilities and equity                       |       | $                                 | 577,834    |   |   |   |   |   | $ | 577,351 |   |   |   |   |   | $ | 572,452 |   |   |   |   |   |
|                                                  |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest  income & margin (3)            |       |                              |       | $ | 22,156 |   | 4.22 | % |   |   | $ | 26,950 |   | 5.09 | % |   |   | $ | 29,334 |   | 5.68 | % |

 

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(a)    Average balances are obtainedfrom the best available daily or monthly data.

(1)    Yields on tax exempt incomehave not been computed on a tax equivalent basis.

(2)             Average non-accrual loan balances of$26.74 million for 2009, $10.14 million for 2008 and $194 thousand for 2007have been included in total average loans for purposes of calculating averagetotal earning assets.

(3)    Represents net interest income as a percentage of averageinterest-earning assets.

(4)            Yields andamounts earned on loans include loan fees of $1,522,000, $1,761,000 and$1,936,000 for the years ended December 31, 2009, 2008 and 2007respectively.

 

During 2009, the Company’s net interestmargin declined primarily as a result of the change in interest rates as theFederal Open Market Committee (FOMC) lowered rates throughout 2008 illustratedby the decline in the average prime interest rate to 3.25% in 2009 from 5.09%in 2008. Additionally, interest earned in the Company’s loan portfoliodeclined because of an increase in average non-accrual loans of $16.6 millionin 2009 compared to 2008. Excluding non-accrual average balances from totalloans at December 31, 2009, the average rate on loans would have been6.36% and the net interest margin would have been 4.44%. Average investments,primarily Federal funds sold, increased by 8.5% while loan growth, on anaverage basis, decreased by 1.75%. Although mitigated by the decline in therates paid on interest bearing liabilities, this combination resulted in anoverall decrease of 87 basis points in the net 

 

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interest margin. On an average basis, therates on loans decreased 143 basis points resulting in a decrease in interestincome of $6.8 million, additionally the decrease in average volume of loans of$8.4 million resulted in a decrease in interest income of $626,000. On anaverage basis, the rate on investments decreased by 224 basis points resultingin a decrease in interest income of $863,000. This decrease is largely due tothe fed funds average rate decrease from 1.94% in 2008 to .23% in 2009.  The increase in average volume of investmentsecurities of $4.0 million was offset by this decrease in rate and resulted ina decrease in interest income of $164,000. Overall, interest income on earning assets decreased by $8.4 million.

 

The Company’s net interest margin is its netinterest income expressed as a percentage of average earning assets. TheCompany’s net interest margin for 2009 was 4.22%, a decrease of 87 basis pointsfrom the 5.09% reported in 2008. For the year 2007, this margin was 5.68%. TheDistribution, Rate and Yield table shows, for each of the past three years, therates earned on each component of the Company’s investment and loan portfolioand the rates paid on each segment of the Company’s interest bearingliabilities. That same table also shows the Company’s average daily balancesfor each principal category of assets, liabilities and shareholders’ equity,the amount of interest income or interest expense, and the average yield orrate for each category of interest-earning asset and interest-bearing liabilityalong with the net interest margin for each of the reported periods.

 

A large portion of the Bank’s loans carryvariable rates and re-price immediately, subject to certain floors, versus alarge base of core deposits which are generally slower to re-price. Interestexpense decreased in 2009 as rates decreased in line with 2008 prime ratedecreases while the Company’s mix of average deposits remained consistent withthe 2008 levels.  The average rates paidon interest bearing deposits for 2009 decreased 87 basis points to 1.34%compared to 2.21% in 2008 and 3.03% in 2007. The changes in deposit rates in2009 compared to 2008 were primarily due to the changes in interest ratesbrought on by Federal Reserve Board actions in 2008 as discussed previously.The average rates that are paid on deposits generally trail behind thesechanges for two reasons: (1) financial institutions do not always changedeposit rates with each small increase or decrease in short-term rates; and (2) withtime deposit accounts, even when new offering rates are established, theaverage rates paid during the year are a blend of the rate paid on all of theindividual accounts. Only new accounts and those that mature and are renewedwill bear the new rate. The average balances of interest bearing liabilities of$454.0 million were $8.8 million or 2.0% higher in 2009 than 2008.  On an average basis, NOW account depositswere up $6.5 million, savings account deposits down $4.3 million, money marketaccount deposits were down $6.4 million and certificate of deposit balanceswere up $11.4 million.  The averagebalance of non-interest bearing demand deposits decreased by only $259,000 from2008 to 2009.

 

From 2008 to 2009, the Company’s average loanportfolio decreased by approximately $8.4 million, or 1.7%, compared to thegrowth of $25.2 million, or 5.5% in 2008 over 2007.   During 2009, the loan portfolio averaged81.7% of total assets, while for 2008 and 2007 such balances represented 83.5%and 79.8%, respectively, of average assets. In addition to the decline in yieldrelated to a decline in market interest rates, loan yields for 2009 reflect anincrease in the balance of average non-accrual loans.

 

Based on current economic conditions, theCompany expects moderate decreases in the rates paid on interest-bearingliabilities and rates earned on both the investment and loan portfolio during2010. It is anticipated that the Federal Reserve Board will not adjust interestrates in the foreseeable future.  It isalso anticipated that the Company’s net interest margin may improve as timedeposits reprice and loan rates remain stable.

 

The Volume and Rate Variances table which followssets forth the dollar amount of changes in interest earned and paid for eachmajor category of interest-earning assets and interest-bearing liabilities andthe amount of change attributable to changes in average balances (volume) orchanges in average 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.

 

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| ** **                          | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------|------------|-----------------------------------|------------|
| ** **                          | ** ** | **2009 over 2008**                | ** ** | **2008 over 2007** | ** ** |
| ** **                          | ** ** | **Increase (decrease) due to:**   | ** ** | **Increase (decrease) due to:** | ** ** |
| ** **                          | ** ** | **Volume**                        | ** ** | **Rate** | ** ** | **Net** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Net** | ** ** |
| **Earning  Assets:**                |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Loans (1)                           |       | $                                 | (626       | ) | $ | (6,797 | ) | $ | (7,423 | ) | $ | 2,218 |   | $ | (6,641 | ) | $ | (4,423 | ) |
| Federal funds  sold                 |       | 223                               |       | (729 | ) | (506 | ) | (977 | ) | (896 | ) | (1,873 | ) |
| Investment  securities:             |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                             |       | (128                              | )          | (77 | ) | (205 | ) | 170 |   | 11 |   | 181 |   |
| Non-taxable (2)                     |       | —                            |       | (1 | ) | — |   | — |   | — |   | — |   |
| Interest bearing  deposits in banks |       | (259                              | )          | (56 | ) | (315 | ) | 394 |   | (187 | ) | 207 |   |
| Total                               |       | (789                              | )          | (7,660 | ) | (8,449 | ) | 1,805 |   | (7,713 | ) | (5,908 | ) |
|                                |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| **Interest-bearing  liabilities:**  |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  deposits:         |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| NOW and money  market deposits      |       | 1                                 |       | (487 | ) | (486 | ) | 25 |   | (410 | ) | (385 | ) |
| Savings deposits                    |       | (77                               | )          | (957 | ) | (1,034 | ) | 38 |   | (1,566 | ) | (1,528 | ) |
| Time deposits                       |       | 432                               |       | (2,587 | ) | (2,155 | ) | 396 |   | (1,659 | ) | (1,263 | ) |
| Total interest  bearing deposits    |       | 356                               |       | (4,031 | ) | (3,675 | ) | 459 |   | (3,635 | ) | (3,176 | ) |
|                                |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Other borrowings                    |       | 112                               |       | (92 | ) | 20 |   | (172 | ) | (176 | ) | (348 | ) |
| Total interest  bearing liabilities |       | 468                               |       | (4,123 | ) | (3,655 | ) | 287 |   | (3,811 | ) | (3,524 | ) |
| Net interest  margin/income         |       | $                                 | (1,257     | ) | $ | (3,537 | ) | $ | (4,794 | ) | $ | 1,518 |   | $ | (3,902 | ) | $ | (2,384 | ) |

 

----

(1)          Non-accrual loans have been included in total loans inthe above calculations.

(2)          Yields on tax exempt incomehave not been computed on a tax equivalent basis.

 

###### **Non-interest Income**

(dollars in thousands, unaudited)

######  

| **Non-interest  income:**                                        | ** ** | **2009** | ** ** | **% of Total** | ** ** | **2008** | ** ** | **% of Total** | ** ** | **2007** | ** ** | **% of Total** | ** ** |
|------------------------------------------------------------------|------------|----------|------------|----------------|------------|----------|------------|----------------|------------|----------|------------|----------------|------------|
| Sale of merchant  processing portfolio                           |       | $        | 2,640      |           | 22.43      | %        | $          | —         |       | —   |       | $              | —     |   | — |   |
| Loss on sale of  investment security                             |       | (172     | )          | -1.46          | %          | —   |       | —         |       | —   |       | —         |       |
| Service charges  on deposit accounts                             |       | 3,613    |       | 30.70          | %          | 3,904    |       | 43.67          | %          | 3,422    |       | 40.37          | %          |
| Gain on sale of  loans                                           |       | 1,612    |       | 13.70          | %          | 1,102    |       | 12.33          | %          | 1,506    |       | 17.77          | %          |
| Loan servicing  income                                           |       | 1,119    |       | 9.51           | %          | 556      |       | 6.22           | %          | 395      |       | 4.66           | %          |
| Alternative  investment fees                                     |       | 423      |       | 3.59           | %          | 545      |       | 6.10           | %          | 354      |       | 4.18           | %          |
| Merchant card  processing fees                                   |       | 86       |       | 0.73           | %          | 409      |       | 4.58           | %          | 403      |       | 4.76           | %          |
| Earnings from  cash surrender value of bank owned life insurance |       | 421      |       | 3.58           | %          | 564      |       | 6.31           | %          | 383      |       | 4.52           | %          |
| Other                                                            |       | 2,027    |       | 17.22          | %          | 1,859    |       | 20.80          | %          | 2,012    |       | 23.74          | %          |
| Total  non-interest income                                       |       | $        | 11,769     |           | 100.00     | %        | $          | 8,939          |       | 100.00   | %          | $              | 8,475      |   | 100.00 | % |
| As a percentage  of average earning assets                       |       | 2.24     | %          |           |       | 1.69     | %          |           |       | 1.64     | %          |           |       |

 

For the year 2009, non-interest incomeincreased $2,830,000 or 31.7% to $11,769,000 as compared to $8,939,000 for2008. Noninterest income in 2007 was $8,475,000. The primary sources of non-interestincome for the Company are service charges on deposit accounts, gains on thesale of loans, loan servicing income, the amortization of the gain on the saleand lease-back of certain properties beginning in 2008, alternative investmentfees earned on the sale of non-deposit investment products, merchant creditcard fees, earnings from changes in the cash surrender value of bank owned lifeinsurance, and a one time gain of $2,640,000 on the sale of the merchantprocessing portfolio. Service charges on deposit accounts and loan sales incomein 2009 accounted for 30.7% and 13.7%, respectively, of total non-interestincome, as compared to 43.7% and 12.3%, respectively, for 2008 and 40.4% and17.8%, respectively, for 2007. Loan servicing income, alternative investmentfees, merchant credit card fees, and earnings from the cash surrender value ofbank owned life insurance for 2009 were 9.5%, 3.6%, 0.7%, and 3.6%,respectively, of total non-interest income, as compared to 6.2%, 6.1%, 4.6%,and 6.3%, respectively, for 2008 and 4.7%, 4.2%, 4.8%, and 4.5%, respectively,for 2007.  Other non-interest incomerepresented 17.2%, 20.8%, and 23.7%, respectively in 2009, 2008, and 2007.  Included in other non-interest income for2009 was the amortization of the gain on the sale and lease-back of the sevenproperties which totaled $372,000 or 3.2%.

 

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Theprimary source of non-interest income during 2009 was from service charges ondeposit accounts which totaled $3,613,000, a decrease of $291,000.  This was followed by the one time pre-taxgain of $2,640,000 realized in the first quarter of 2009 from the sale of themerchant processing portfolio.  Gains onsales of loans increased $510,000 from $1,102,000 in 2008 to $1,612,000 in2009. This was a result of the Government Lending Department selling theguaranteed portion of loans they originated.

 

Theloan portfolio includes loans which are 75% to 90% guaranteed by the SmallBusiness Administration (SBA), U.S. Department of Agriculture, RuralBusiness-Cooperative Service (RBS) and Farm Services Agency (FSA). Theguaranteed portion of these loans may be sold to a third party, with theCompany retaining the unguaranteed portion. The Company generally receives apremium in excess of the adjusted carrying value of the loan at the time ofsale. The portfolio of SBA, RBS and FSA government guaranteed loans beingserviced by the Company increased by 12% from 2008 to 2009. The increase inloan servicing income of $563,000 from $556,000 in 2008 to $1,119,000 in 2009was due to the retention of the servicing rights on these loans in addition toFannie Mae mortgage servicing rights.

 

Alternativeinvestment fees earned on the sales of non-deposit investment productsdecreased by $122,000 from $545,000 in 2008 to $423,000 in 2009 primarily as aresult of less consumer investing in the securities market.

 

Merchantcredit card processing fees decreased $323,000 from $409,000 in 2008 to $86,000in 2009 after a slight increase of $6,000 from $403,000 in 2007 to 2008. Thecompany sold the merchant processing portfolio in March 2009.

 

Theoperating efficiency ratio is often used to compare the Company’s expenses tothose of other financial institutions. This ratio factors in that for many financial institutions some of theirincome is not asset-based, it is based on fees for services provided ratherthan income earned from a spread between the interest earned on assets andinterest paid on liabilities.  Theoperating efficiency ratio measures what portion of each dollar of net revenueis spent earning that revenue.  With aportion of the Company’s revenues coming from such areas as the InsuranceAgency, Payroll Services and Merchant Services, i.e., from programs thatrequire operating expenses to run but are not related to assets on the Company’sbalance sheet, management focuses more on this ratio than the operating expenseto assets ratio.    The Company isincreasingly focused on enhancing its fee income. Based on the Company’sefficiency ratio of 95.13% for 2009, 80.4% for 2008, and 70.6% for 2007 ascompared to the 52% and lower ratios of certain major financial institutions,it is expected that this focus will continue for the foreseeable future.

 

**Non-interestExpense**

(dollarsin thousands, unaudited)

 
| **Non-interest expense:**                     |   |   |   |   |   |   |   |   |   |   |   |   |   |
|-----------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
| Salaries  and employee benefits               |   | $      | 12,645 |   | 39.18  | %      | $      | 14,585 |   | 51.58  | %      | $      | 15,630 |   | 58.05 | % |
| Occupancy  and equipment                      |   | 5,300  |   | 16.42  | %      | 5,425  |   | 19.19  | %      | 4,221  |   | 15.68  | %      |
| Professional  fees                            |   | 1,440  |   | 4.46   | %      | 1,161  |   | 4.11   | %      | 1,516  |   | 5.63   | %      |
| Telephone  and postage                        |   | 662    |   | 2.05   | %      | 659    |   | 2.33   | %      | 594    |   | 2.21   | %      |
| Stationery  and supply costs                  |   | 512    |   | 1.59   | %      | 747    |   | 2.64   | %      | 828    |   | 3.08   | %      |
| Director  fees and retirement accrual         |   | 413    |   | 1.28   | %      | 508    |   | 1.80   | %      | 482    |   | 1.79   | %      |
| Advertising  and promotion                    |   | 923    |   | 2.86   | %      | 1,136  |   | 4.02   | %      | 752    |   | 2.79   | %      |
| Impairment  recognized on investment security |   | — |   | — |   | 1,489  |   | 5.27   | %      | — |   | — |   |
| FDIC  assessments                             |   | 1,582  |   | 4.90   | %      | 313    |   | 1.11   | %      | 75     |   | 0.28   | %      |
| Other  real estate                            |   | 6,641  |   | 20.58  | %      | 92     |   | 0.33   | %      | 30     |   | 0.11   | %      |
| Other                                         |   | 2,154  |   | 6.67   | %      | 2,161  |   | 7.64   | %      | 2,799  |   | 10.39  | %      |
| Total  non-interest expense                   |   | $      | 32,272 |   | 100.00 | %      | $      | 28,276 |   | 100.00 | %      | $      | 26,927 |   | 100.00 | % |
| As a  percentage of average earning assets    |   | 6.14   | %      |   |   | 5.34   | %      |   |   | 5.22   | %      |   |   |

 

TheCompany’s total non-interest expense increased to $32,272,000 in 2009, ascompared to $28,276,000 in 2008, and $26,927,000 in 2007. The increase is dueto FDIC assessments totaling $1,582,000 in 2009 as compared to $313,000 and$75,000 in 2008, and 2007, respectively. In addition, other real estatewrite-downs and expenses totaled $6,641,000 in 2009 as compared to $92,000 and$30,000 in 2008 and 2007, respectively.

 

Salariesand employee benefits decreased $1,940,000 or 13.3% from 2008 to 2009. Includedwithin salaries and benefits are actual salaries, bonuses, commissions,retirement benefits, payroll taxes, and stock option expense.  This decrease was primarily the result of theelimination of bonuses and decreased commissions paid during 2009 and adecrease in the number of employees.  Thedecrease in 

 

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salariesand benefits in 2008 compared to 2007 was $1,045,000, or 6.7%. Full timeequivalent employees were 227, 248 and 260 at December 31, 2009, 2008 and2007, respectively.  Benefit costs andemployer taxes decreased commensurate with the salaries.  In February 2009 additional reductionsin staffing resulted in a decrease of 14 full time equivalent employees.   The Company continued to reduce staffingthrough attrition. It is management’s opinion that the Company can operateefficiently and maintain quality customer service with the reductions in staff.

 

Occupancyand equipment expenses were $5,300,000, a decrease of $125,000 or 2.3% whencompared to the 2008 total of $5,425,000. The increase in occupancy expenses in 2008 compared to 2007 was$1,204,000 or 28.5% primarily related to the new headquarters building as wellas furniture, fixtures and equipment for the new Anderson and Redding brancheswhich opened in the third quarter of 2007.

 

Themajority of the increases in professional services costs of $279,000 from 2008to 2009 were due to fees associated with management strategic initiatives andlegal fees related to loan foreclosures. The decrease in 2008 of $355,000 compared to 2007 relates to the reducedamount of earnings credit for vendor services to a title and escrow company theBank has had a long-term relationship with. Advertising and marketing expenses decreased $213,000 from $1,136,000 in2008 to $923,000 in 2009. The increase by 51% in 2008 from 2007 was largely dueto a mass mailing and promotional campaign provided by a third party vendor toobtain new checking accounts.

 

Expensesrepresenting telephone and data communications, postage and mail, stationeryand supplies, director fees, retirement accruals and other expenses totaled$3,741,000 for 2009 compared to $4,075,000 in 2008 and $4,703,000 in 2007.Management initiated these decreases in response to a direct effort to reduceexpenses.  Additionally, in the fourthquarter of 2008, the Company recognized an impairment charge of $1,489,000 oncollateralized debt obligations that were backed by trust-preferred securities.

 

The Company issues stockoptions under one shareholder approved stock-based compensation plan, the CommunityValley Bancorp 2000 Stock Option Plan. The Plan does not provide for the settlement of awards in cash and newshares are issued upon exercise of the options. The plan requires that the option price may not be less than the fairmarket value of the stock at the date the option is granted, and that the stockmust be paid for in full at the time the option is exercised. The optionsexpire on a date determined by the Board of Directors, but not later than tenyears from the date of grant. The vesting period is determined by the Board ofDirectors and is generally over five years. Under the Company’s 2000 stockoption plan, 311,751 shares of common stock remain reserved for issuance toemployees and directors. There are 127,092 shares available for future grants.

 

Management estimates thefair value of each option award as of the date of the grant using aBlack-Sholes-Merton option pricing model. Expected volatility is based on historical volatility of the Company’sstock over a preceding period commensurate with the expected term of theoption.  The “simplified” methoddescribed in SEC Staff Accounting Bulletin No. 107, as amended by SECStaff Accounting Bulletin 110, was used to determine the expected term of theCompany’s options for 2007.  The risk freeinterest rate for the expected term of the option is based on U.S. Treasuryyield curve in effect at the time of the grant. The expected dividends yield was determined based on the budgeted cashdividends of the Company at the time of the grant.  In addition to these assumptions, managementmakes estimates regarding pre-vesting forfeitures that will impact totalcompensation expense recognized under the Plan. There were no options grantedin 2009 or 2008.

 

At December 31,2009, the total compensation cost related to non-vested stock option awardsgranted to employees under the Company’s stock option plan but not yetrecognized was $39,000. Stock option compensation expense is recognized on astraight-line basis over the vesting period of the option. This cost isexpected to be recognized over a weighted average remaining period of 2.0 yearsand will be adjusted for subsequent changes in estimated forfeitures.  See Notes 1 and 11 to the auditedConsolidated Financial Statements in Item 8.

 

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

######  

Creditrisk is inherent in the business of making loans. The Company sets aside anallowance for loan losses through a provision charged to earnings. The chargesare shown in the income statements as provisions for loan losses, andspecifically identifiable and quantifiable losses are immediately charged offagainst the allowance.

 

TheCompany’s provisions for loan losses and undisbursed commitments in 2009, 2008and 2007 were $23,008,000, $3,175,000 and $225,000, respectively. The amountsallocated to the provision for loan losses and the undisbursed commitments were$23,057,000 and $(49,000) respectively for 2009, $3,742,000 and $(567,000) for2008, and $(16,000) and $241,000 for 2007.

 

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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 14 inthe Notes to the Consolidated Financial Statements in Item 8, the provision forincome taxes is the sum of two components, the provision for current taxes anddeferred taxes. The provision for current taxes results from applying thecurrent tax rate to taxable income (loss), and represents the actual currentincome tax liability (benefit). Some items of income and expense are recognizedin different years for tax purposes than when applying accounting principlesgenerally accepted in the United States of America, however, leading todifferences between the Company’s actual tax liability and the amount accruedfor this liability based on book income. These temporary timing differencescomprise the deferred portion of the Company’s tax provision.

 

Mostof the Company’s temporary differences involve recognizing more expenses in itsfinancial statements than it has been allowed to deduct for tax purposes, and,therefore, the Company normally carries a net deferred tax asset on its books.At December 31, 2009, the Company’s $15.2 million net deferred tax assetwas primarily due to temporary differences in the reported allowance for loanlosses, deferred compensation, other real estate and future benefit of statetax deduction offset by the temporary differences related to certain deferredtax liabilities.

 

The determination of theamount of deferred income tax assets which are more likely than not to berealized is primarily dependent on historical cumulative pre-tax loses andprojections of future earnings which are subject to uncertainty and estimatesthat may change given economic conditions and other factors.  The realization of deferred income tax assetsis assessed and a valuation allowance is recorded if it is “more likely thannot” that all or a portion of the deferred tax asset will not be realized.  “More likely than not” is defined as greaterthan a 50% chance.  All availableevidence, both positive and negative is considered to determine whether, basedon the weight of that evidence, a valuation allowance is needed.  Due to deteriorating market conditions andthe net loss experienced during 2009, the Company determined at December 31,2009 that it was more likely than not that the Company would not generatesufficient taxable income in the foreseeable future to realize all of itsdeferred tax asets. Based on its determination, the Company provided a 100%valuation allowance against its net deferred tax assets.

 

For the year ended December 31,2009, 2008 and 2007, the provision for income taxes was $6.1 million, $1.1million and $4.4 million, respectively. The $6.1 million tax expense for theyear ended December 31, 2009 is the net result of a tax benefit of $9.1million related to the pre-tax loss of $21.4 million offset by a full valuationallowance of $15.2 million. The $6.1 million expense resulted in an effectivetax rate of (28.5)%.

 

To the extent that theCompany can generate taxable income in the future sufficient to offset the taxdeductions represented by the net deferred tax asset, the valuation allowancethat has been established may be partially or entirely reduced. If thevaluation allowance is reduced or eliminated, future tax benefits will berecognized that will have a positive impact on the Company’s net income andstockholders’ equity.

 

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

######  

Thefollowing discussion of the financial condition of the Company is grouped intoearning assets, comprised of loans and investments; non-earning assets,comprised of cash and due from banks, premises and equipment and other assets;liabilities, consisting of deposits and other borrowings; capital resources;and liquidity and market risk. Each section provides details where applicable onvolume, rates of change, and significance relative to the overall activities ofthe Company.

 

Acomparison between the summary year-end balance sheets for 2005 through 2009was presented previously in the table of Selected Financial Data (see Item 6above). As indicated in that table, the Company’s total assets and depositshave grown each year until 2009, with asset growth, in terms of total dollars,most pronounced in 2006 when the Company grew by $55 million, or 11.2%.  This was followed by growth in the Company’stotal assets during 2005 of $45 million or 10%, growth in the Company’s totalassets during 2007 of approximately $30 million, or 5.6% and the growth intotal assets during 2008 of approximately $15 million, or 2.5%. In 2009, therewas a decrease in total assets of approximately $56 million or 9.4%. Thedecrease in assets is part of Management’s strategic plan as it focuses itsefforts on decreasing classified loans and reducing its concentrations inconstruction and commercial real estate loans.

 

Themix of our core deposit base changed during 2009. On an average basis, NOWaccount balances increased by 5.4%, Money Market account balances decreased by19.1%, savings balances decreased by 3.8%, and certificates of deposit balancesincreased by 6.8%.  The weighted averagerates of our NOW and Money market account balances were .31% and 1.07%respectively.  The weighted average rateof our certificates of deposit was 1.9% compared to .91% for the savingsproducts.

 

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Depositinterest rates decreased throughout 2009 following the rate reductions by theFederal Reserve Board in 2008.  On anaverage basis, interest bearing deposits increased $7.1 million while theaverage rates paid on all interest bearing deposits decreased by 87 basispoints and on all interest bearing liabilities by 85 basis points.

 

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

######  

TheCompany offers a wide variety of loan types and terms to customers along withvery competitive pricing and quick delivery of the credit decision. The Company’sloan portfolio represents the single largest portion of invested assets,substantially greater than the investment portfolio or any other assetcategory. At December 31, 2009, gross loans represented 80.5% of totalassets, as compared to 83.1% and 77.1% at December 31, 2008 and 2007,respectively. The Company’s total loans declined in 2009 by $61.6 million fromthe December 31, 2008 balances as real estate commercial and constructionloans are generally not being made as a result of the economic downturn and therisk associated with these loans. Further reductions have also been the resultof foreclosures and reclassifications to other real estate (ORE). The qualityand diversification of the Company’s loan portfolio are importantconsiderations when reviewing the Company’s results of operations.

 

TheSelected Financial Data table in Item 6 reflects the net amount of loansoutstanding at December 31st for eachyear between 2005 and 2009. The Loan Distribution table which follows setsforth the amount and composition of the Company’s total loans outstanding ineach category at the dates indicated.

 

**Loan Distribution**

(dollars in thousands)

 
| ** **                    | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2009**              | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Agriculture                   |       | $                     | 38,444     |   | $ | 28,628 |   | $ | 26,347 |   | $ | 25,745 |   | $ | 24,803 |   |
| Commercial                    |       | 80,758                |       | 83,786 |   | 78,521 |   | 65,241 |   | 61,162 |   |
| Real  estate- commercial      |       | 228,678               |       | 252,018 |   | 207,590 |   | 208,102 |   | 173,449 |   |
| Real  estate- construction    |       | 22,990                |       | 65,004 |   | 81,914 |   | 105,449 |   | 111,130 |   |
| Installment                   |       | 62,324                |       | 65,390 |   | 52,898 |   | 43,789 |   | 36,501 |   |
|                          |       | 433,194               |       | 494,826 |   | 447,270 |   | 448,326 |   | 407,045 |   |
|                          |       |                  |       |   |   |   |   |   |   |   |   |
| Deferred  loan fees, net      |       | (183                  | )          | (478 | ) | (688 | ) | (801 | ) | (1,108 | ) |
| Allowance  for loan losses    |       | (12,975               | )          | (7,826 | ) | (5,232 | ) | (5,274 | ) | (4,716 | ) |
|                          |       | $                     | 420,036    |   | $ | 486,522 |   | $ | 441,350 |   | $ | 442,251 |   | $ | 401,221 |   |
|                          |       |                  |       |   |   |   |   |   |   |   |   |
| **Percentage of Total Loans** |       |                  |       |   |   |   |   |   |   |   |   |
| Agriculture                   |       | 8.87                  | %          | 5.79 | % | 5.89 | % | 5.74 | % | 6.09 | % |
| Commercial                    |       | 18.64                 | %          | 16.93 | % | 17.56 | % | 14.55 | % | 15.03 | % |
| Real  estate- commercial      |       | 52.79                 | %          | 50.93 | % | 46.41 | % | 46.42 | % | 42.61 | % |
| Real  estate- construction    |       | 5.31                  | %          | 13.14 | % | 18.31 | % | 23.52 | % | 27.30 | % |
| Installment                   |       | 14.39                 | %          | 13.21 | % | 11.83 | % | 9.77 | % | 8.97 | % |
|                          |       | 100.00                | %          | 100.00 | % | 100.00 | % | 100.00 | % | 100.00 | % |

 

Asreflected in the Loan Distribution table, the net loan balances have increased$85 million, or 21%, from 2005 to 2008 then decreased by $62 million, or 12%,in 2009. The decline in loans for 2009 is commensurate with the downturn in theeconomy as property values continued to decline and the unemployment rate grew.In 2009 every loan category decreased except agriculture as the Company shiftedits focus from the real estate market to agriculture loans.  Until 2009, the largest percentage of growthfrom 2005 to 2008 was in installment loans which grew by $29 million or79%.  The largest dollar volume increaseduring that period was in commercial real estate which grew by $78.6 million or45%.  Reflective of the current economyand the residential real estate markets, real estate construction loansdecreased beginning in 2006.

 

Loangrowth in the Company’s immediate market has been oriented toward loans securedby real estate, commercial loans, including Small Business Administration andother government guaranteed loans, as well as installment loans. As a result,these areas have comprised the major portion of the Company’s loan growth overthe past few years. During 2009 loans secured by real estate declined by $65million, or 20.6%, and agriculture loans grew by $9.8 million, or 34.3%.  Commercial and installment loans decreased by$3 million, or 3.6%, and $3 million, or 4.7%, respectively.  Loans secured by real estate and commercialloans comprised 58.1% and 18.6%, respectively, of the Bank’s total loanportfolio at December 31, 2009.

 

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The Company’s commercialloans are centered in locally oriented commercial activities in the markets wherethe Company has a presence. Additionally, the Company has a Government LendingDivision dedicated to the U.S. Small Business Administration (SBA)and the USDA Business and Industry (B&I) Guaranteed LoanPrograms. The Company has consistently been recognized among themost active USDA Business and Industry (B&I) lenders in thenation.  The Company is also designated as an SBA Preferred Lender,which means it has the authority to underwrite and approve SBA loans locally.This recognition lends credence to the Company’s success in meeting the needsof smaller business owners in the communities in which the Company conducts itsbanking activities.

 

Themost significant shift in the loan portfolio mix over the past four years hasbeen in loans secured by real estate construction, which decreased from 27.3%of total loans at the end of 2005 to 5.3% of total loans at the end of 2009.Real estate lending continues to be an important part of the Company’sportfolio even though this segment of loans has decreased since 2006 and islikely to continue to decrease in the future due to current economicconditions. Commercial loans have increased slightly at 18.6% of total loanbalances at the end of 2009 compared to 15.3% at the end of 2005, andagricultural loans also increased during the same period to 8.9% of the totalloan balances from 6.1%. The increase in the percentage of agricultural loansto total loans over the last year has been due to the conscious effort to growother lending areas as the real estate market slowed. Agricultural borrowingrelationships have remained consistent year after year and we have expandedthis part of our business.  Installmentloans have increased from 9% of the portfolio in 2005 to 14.4% of total loansat the end of 2009.

 

Anotherimportant aspect of the Company’s loan business is related to residential realestate loans which are generated internally by the real estate mortgage loandepartment and then sold in the secondary market to government sponsoredenterprises or other long-term lenders. The Company has consistently been amongthe largest real estate mortgage lenders in Butte County for the past severalyears. As a result of the low mortgage rates in 2009, the Company originatedand sold aggregate balances of approximately $66.5 million. While a majority ofsuch loans were refinances, this represents a $33.5 million increase from the$31 million originated and sold in 2008.

 

Inthe normal course of business, the Company makes commitments to extend creditas long as there are no violations of any condition established in thecontractual arrangement. Total outstanding commitments to extend credit were$111 million at December 31, 2009 as compared to $148 million at December 31,2008. These commitments represented 26% and 30% of outstanding gross loans at December 31,2009 and December 31, 2008, respectively. The Company’s standby letters ofcredit at December 31, 2009 were $4.4 million and $6.5 million at December 31,2008, respectively, which represented approximately 3.8% and 4.4% of totalcommitments outstanding at the end of 2009 and 2008. It is not anticipated thatall of these commitments or standby letters of credit will fund.

 

Approximatelyone half of the loans held by the Company have floating rates of interest tiedto the Company’s base lending rate or to another market rate indicator so thatthey may be re-priced as interest rates change. In periods offalling interest rates, especially when rates on floating rate loans decline,the Company has established interest rate floors under some of its loans sothat no matter how far loan rates fall, it is guaranteed a minimum rate ofreturn.

 

Thesame interest rate and liquidity risks that apply to securities are alsoapplicable to lending activity. Fixed-rate loans are subject to marketrisk:  they decline in value as interestrates rise. The Company’s loans that have fixed rates generally have relativelyshort maturities or amortize monthly, which effectively lessens the marketrisk. The table in Note 16 to the consolidated financial statements in Item 8shows that at December 31, 2009, the carrying amount of loans, i.e., theirface value, is about $6.7 million or 1.6 % less than their fair value. At theend of 2008, the carrying amount of loans was about $1.1 million or .22% lessthan their fair value.

 

Becausethe Company is not involved with chemicals or toxins that might have an adverseeffect on the environment, its primary exposure to environmental legislation isthrough its lending activities. The Company’s lending procedures include stepsto identify and monitor this exposure to avoid any significant loss orliability related to environmental regulations.

 

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**LoanMaturities**

 

Thefollowing Loan Maturity table shows the amounts of total loans outstanding asof December 31, 2009, which, based on remaining scheduled repayments ofprincipal, are due within one year, after one year but less than five years,and in more than five years. (Non-accrual loans are intermixed within eachcategory.)

 

(dollars in thousands)

 
| ** **                  | ** ** | **One year or less** | ** ** | **One to five  years** | ** ** | **Over five  years** | ** ** | **Total** | ** ** | **Floating rate:  due after one  year** | ** ** | **Fixed rate:  due after  one year** | ** ** |
|-----------------------------|------------|----------------------|------------|------------------------|------------|----------------------|------------|-----------|------------|-----------------------------------------|------------|--------------------------------------|------------|
| Agricultural                |       | $                    | 24,426     |                   | $          | 12,538               |       | $         | 1,480      |                                    | $          | 38,444                               |       | $ | — |   | $ | 14,018 |   |
| Commercial                  |       | 19,306               |       | 12,751                 |       | 48,701               |       | 80,758    |       | 16,815                                  |       | 44,637                               |       |
| Real  estate - commercial   |       | 109,674              |       | 100,382                |       | 18,622               |       | 228,678   |       | 4,104                                   |       | 114,900                              |       |
| Real  estate - construction |       | 22,675               |       | 315                    |       | —               |       | 22,990    |       | —                                  |       | 315                                  |       |
| Installment                 |       | 12,108               |       | 21,816                 |       | 28,400               |       | 62,324    |       | —                                  |       | 50,216                               |       |
|                        |       |                 |       |                   |       |                 |       |      |       |                                    |       |                                 |       |
| Total                       |       | $                    | 188,189    |                   | $          | 147,802              |       | $         | 97,203     |                                    | $          | 433,194                              |       | $ | 20,919 |   | $ | 224,086 |   |

 

Thisschedule, which aggregates contractual principal repayments by time period, canbe used in combination with the Investment Maturities table in the InvestmentSecurities section and the Deposit Maturities table in the Deposits section toidentify time periods with potential liquidity exposure. The referencedmaturity schedules do not convey a complete picture of the Company’s re-pricingexposure or interest rate risk, however. For details on the re-pricingcharacteristics of the Company’s balance sheet and a more comprehensivediscussion of the Company’s sensitivity to changes in interest rates, see the “Liquidityand Market Risk” section.

 

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

######  

Bankshave generally suffered their most severe earnings declines as a result ofcustomers’ inability to generate sufficient cash flow to service their debts,or as a result of the downturns in national and regional economies which havebrought 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.

 

TheCompany achieves a certain level of loan quality by establishing a sound creditplan, which includes defining goals and objectives and devising and documentingcredit policies and procedures. These policies and procedures identify certainmarkets, set goals for portfolio growth or contraction, and establish limits onindustry and geographic concentrations. In addition, these policies establishthe Company’s underwriting standards and the methods of monitoring ongoingcredit quality. Unfortunately, however, the Company’s asset-quality risk may beaffected by external factors such as the level of interest rates, employment,general economic conditions, real estate values and trends in particularindustries or certain geographic markets. The Company’s internal factors forcontrolling risk are centered in underwriting practices, credit grantingprocedures, training, risk management techniques, and familiarity with our loancustomers as well as the relative diversity and geographic concentration of ourloan portfolio.

 

Fromtime to time, Management has reason to believe that certain borrowers may notbe able to repay their loans within the parameters of the present repaymentterm, even though, in some cases, the loans are current at the time. Theseloans are regarded as potential problem loans, and a portion of the allowanceis assigned and/or allocated, as discussed below, to cover the Company’sexposure to loss should the borrowers indeed fail to perform according to theterms of the notes. This class of loans is in addition to the loans in anonaccrual status or 90 days or more delinquent but still accruing, which areshown in the table below.

 

Asa multi-community, independent bank headquartered in and serving Butte County(with a smaller presence in each of Colusa, Sutter, Sacramento, Shasta, Tehama,and Yuba counties); the Company has mitigated its risk to any one segment ofthese Northern Sacramento Valley markets. The Company’s asset quality has beena strength for many years; but due to the current economic downturn, the levelof non performing loans and assets and loan delinquency ratios have increasedsignificantly. The Company is diligently working with borrowers that are havingdifficulty meeting their contractual obligations.

 

Non-performingassets are comprised of loans on non-accrual status, loans 90 days or more pastdue and still accruing interest, loans restructured where the terms ofrepayment have been renegotiated resulting in a deferral of interest orprincipal and other real estate (“ORE”). Loans are generally placed onnon-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.

 

TheBank considers a loan or lease impaired if, based on current information andevents, it is probable that the Bank will be unable to collect the scheduledpayments of principal or interest when due according to the contractual termsof the loan agreement.  The measurementof impaired loans and leases is generally based on the present value ofexpected future cash flows discounted at the historical effective interestrate, except that all collateral-dependent loans and leases are measured forimpairment based on the fair value of the collateral less selling costs.

 

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Management’sclassification of a loan as non-accrual is an indication that there isreasonable doubt as to the full collectibility of principal or interest on theloan; at that point, the Company stops recognizing income from the interest onthe loan and reverses any uncollected interest that had been accrued butunpaid. These loans may or may not be collateralized, but collection effortsare continuouslypursued.

 

A loan may be restructured when Management determinesthat a borrower’s financial condition has deteriorated, but still has theability to repay the loan. A loan is considered to be troubled debtrestructured (TDR) when the original terms have been modified in favor of theborrower such that either principal or interest has been forgiven, contractualpayments are deferred, or the interest rate is reduced. Once a loan has beenrestructured for a customer, the Bank generally considers the loan to benon-accrual for a minimum of six months. Once the borrower has made theirpayments as contractually required for six months, the loan is reviewed andinterest may again be accrued. The economic downturn has also contributed tothe increase in TDRs. In 2009, Management worked with its customers to modifytheir loan or loan terms so that they could be current with their loanpayments.

 

The following tableprovides information with respect to components of the Company’s non-performingassets at the date indicated. The Company has not had any loans 90 days pastdue and still accruing interest in any periods presented.

 

**Non-performingAssets**

(dollarsin thousands)

 
| ** **                                                               | ** ** | **As of December 31,** | ** ** |
|--------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                               | ** ** | **2009**                    | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Nonaccrual Loans:**                                                    |       |                        |       |   |   |   |   |   |   |   |   |
| Agricultural                                                             |       | $                           | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Commercial  and Industrial                                               |       | 2,218                       |       | 395 |   | — |   | 1,502 |   | — |   |
| **Real Estate**                                                          |       |                        |       |   |   |   |   |   |   |   |   |
| Secured  by Commercial/Professional Office                               |       | 13,128                      |       | 2,721 |   | — |   | — |   | — |   |
| Properties  Including Construction and Development                       |       | 31,412                      |       | 9,061 |   | 233 |   | — |   | — |   |
| Secured  by Residential Properties                                       |       | 4,238                       |       | 2,708 |   | 20 |   | 780 |   | — |   |
| Secured  by Farmland                                                     |       | —                      |       | — |   | — |   | — |   | — |   |
| Consumer  Loans                                                          |       | 79                          |       | — |   | — |   | — |   | 9 |   |
| **SUBTOTAL**                                                             |       | 51,075                      |       | 14,885 |   | 253 |   | 2,282 |   | 9 |   |
|                                                                     |       |                        |       |   |   |   |   |   |   |   |   |
| Other  Real Estate (ORE)                                                 |       | 13,493                      |       | 2,068 |   | — |   | — |   | — |   |
| Total  non-performing Assets                                             |       | $                           | 64,568     |   | $ | 16,953 |   | $ | 253 |   | $ | 2,282 |   | $ | 9 |   |
| Restructured  Loans (1)                                                  |       | $                           | 22,593     |   | $ | 15,878 |   | $ | — |   | $ | — |   | $ | — |   |
| Non-performing  loans as % of total gross loans                          |       | 11.76                       | %          | 3.01 | % | 0.06 | % | 0.51 | % | 0.00 | % |
| Non-performing  assets as a % of total gross loans and other real estate |       | 14.42                       | %          | 3.41 | % | 0.06 | % | 0.51 | % | 0.00 | % |

 

----

(1) $15,870 and$4,471 of the restructured loans are on nonaccrual and are included in thenonaccrual loans above for the year ended 2009 and 2008, respectively.

 

**Impaired,Nonaccrual, Past Due and Restructured Loans and Leased and Other NonperformingAssets:**

 

Non-performing loans(defined as non-accrual loans and loans 90 days or more past due and stillaccruing interest) totaled $51,075,000 at December 31, 2009, an increaseof $36,190,000 from $14,885,000 at December 31, 2008, primarily as aresult of increasing problem loans in the Company’s real estate/developmentportfolio. Specific reserves on the non-performing loans of $4,045,000 havebeen recorded at December 31, 2009. Nonperforming loans as a percentage of total loans were 11.8% at December 31,2009 compared to 3.1% at December 31, 2008.

 

Non-performing assets,(non-performing loans and ORE) totaled $64,568,000 at December 31, 2009,an increase of $47,615,000 from $16,953,000 at December 31, 2008.  Non-performing assets as a percentage oftotal assets were 12% at December 31, 2009 compared to 2.9% at December 31,2008.

 

Total non-performingloans consist of seventy-seven loans for a total of $51,075,000 that are onnon-accrual and forty-five properties for a total of $13,493,000 classified asother real estate (ORE).  Other than theloans included as non-performing assets at December 31, 2009, the Companyhas not identified any potential problem loans that would result in any loan beingincluded as a non-performing asset at the current date.

 

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Set forth below is atable of our significant non-performing loans with net exposures of $1,500,000or more at December 31, 2009:

 

Significant Non-Performing Loans:

(in thousands)

 
| ** **       | ** ** | ** **    | ** ** | **Loan  Balance**            | ** ** | ** **    | ** ** | ** **     | ** ** | ** **    | ** ** | **Specific  Reserve**        | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------|------------|---------------|------------|------------------------------|------------|---------------|------------|----------------|------------|---------------|------------|------------------------------|------------|------------|------------|------------|------------|
| ** **       | ** ** | ** **    | ** ** | **As of  December 31,** | ** ** | **Apprasial** | ** ** | **Nonaccrual** | ** ** | **Appraised** | ** ** | **As of  December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Loan**         | ** ** | **Type**      | ** ** | **2008**                     | ** ** | **2009**      | ** ** | **Date**       | ** ** | **Date**      | ** ** | **Value**                    | ** ** | **2008**   | ** ** | **2009**   | ** ** | **Chargeoffs** | ** ** | **Current  Collateral** | ** ** |
| 1                |       | Commerical RE |       | $                            | 4,478      |          | $          | 4,326          |       | Apr-09        |       | Jan-09                       |       | $          | 4,129      |       | $          | — |   | $ | 43 |   | $ | 152 |   | 28 Cottages |   |
| 2                |       | Development   |       | 4,167                        |       | 3,839         |       | Aug-09         |       | Dec-09        |       | 2,592                        |       | —     |       | 1,400      |       | — |   | 21 finished  lots & 29 paper lots |   |
| 3                |       | Development   |       | 2,072                        |       | 1,977         |       | Jan-10         |       | Dec-09        |       | 2,070                        |       | —     |       | —     |       | 500 |   | 14.88 acres of land |   |
| 4 & 5   |       | Development   |       | 8,331                        |       | 6,601         |       | Sep-09         |       | Jun-09        |       | 7,614                        |       | 150        |       | —     |       | 882 |   | 148 finished lots, a  24.95 acre parcel and a 5 acre parcel |   |
| 6                |       | Development   |       | 2,281                        |       | 2,239         |       | Nov-09         |       | Dec-09        |       | 2,592                        |       | —     |       | —     |       | — |   | 18 hole golf course |   |
| 7 & 8   |       | Commerical RE |       | 1,912                        |       | 1,902         |       | Sep-09         |       | Dec-09        |       | 5,900                        |       | —     |       | —     |       | — |   | Hotel/inn |   |
| 9                |       | Development   |       | 1,960                        |       | 1,614         |       | Jan-10         |       | Dec-09        |       | 1,700                        |       | —     |       | —     |       | 346 |   | 4290 sq.ft home on 20  acres |   |
| 10               |       | Development   |       | 3,400                        |       | 2,471         |       | Oct-09         |       | Dec-09        |       | 2,605                        |       | 68         |       | —     |       | 929 |   | 250 acres of land |   |
| 11               |       | Commerical RE |       | 1,629                        |       | 1,598         |       | Mar-10         |       | Dec-09        |       | 2,980                        |       | —     |       | —     |       | — |   | 67,600 sq.ft. industrial  office/warehouse building |   |
| 12 & 13 |       | Development   |       | 3,642                        |       | 2,250         |       | Dec-09         |       | Dec-09        |       | 4,550                        |       | 297        |       | 151        |       | 1,398 |   | 31 finished  lots & 2 completed homes |   |
| 14               |       | Development   |       | —                       |       | 2,451         |       | Sep-09         |       | Dec-09        |       | 1,915                        |       | —     |       | 637        |       | — |   | 12 lot subdivision |   |
|             |       |          |       | $                            | 33,872     |          | $          | 31,268         |       |          |       |                         |       |       |       | $          | 515        |   | $ | 1,594 |   | $ | 4,207 |   |   |   |
|                  |            |               |            |                              |            |               |            |                |            |               |            |                              |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

Loan1 is a government guaranteed loan under the United States Department ofAgriculture (USDA) Business and Industry program with an 80% guarantee andmaximum exposure to the Company of $743,000. In October of 2008, the Bank received notice that our borrower hadfiled bankruptcy under Chapter 11.  Itwas at this time that the Bank stopped receiving payments. The Company isprevented from pursuing any additional legal action due to the pendingbankruptcy.

 

The remainder of thenon-performing loans consists primarily of twelve impaired single family homeloans that total $3,623,000, twenty- seven impaired lot loans that total$8,933,000, seven commercial real estate loans that total $5,128,000, eightcommercial/industrial loans that total $1,184,000, seven single family homeloans secured with 2nd deeds of trust for $860,000, and two consumerloans that total $79,000. These loans are to borrowers who are locatedthroughout Northern California from the Sacramento area to Redding.  The current appraised values provided theCompany with adequate margins in some cases; however, the Bank has allocated aspecific reserve that totals an additional $4,045,000 on these loans.

 

Other Real Estate

 

The largest of our ORE atDecember 31, 2009 is a commercial real estate loan for the construction of50,396 sq. feet of industrial condos in Shingle Springs, California for$2,704,000.  The property was transferredto ORE on December 24, 2009. To identify the Company’s potential lossexposure and properly value the collateral support provided by the property, anupdated appraisal was received on December 1, 2009.  The appraisal demonstrated the continuingdecline in the value of the underlying project. The company charged off an additional $338,000 against the allowance forloan losses at the date of transfer and upon the receipt of the new appraisal.The December appraisal put the value at $3,005,000.  The property is currently in escrow for $2,775,000.

 

A single familyresidential loan for the construction of a home located at Shaver Lake, Ca.with a fair market value of $824,000 was included in ORE assets at December 31,2009.  The property transferred to ORE onAugust 17, 2009.  To identify theCompany’s potential loss exposure and properly value the collateral supportprovided by the residence, an appraisal was received on October 6,2009.  This appraisal estimated the valueat $1,100,000.  With the decline in theappraised value, the Company charged-off $270,000 against ORE.  With an accepted offer of $880,000 in December 2009,the Company charged-off an additional $166,500 as of December 31, 2009.

 

Another developmentproperty with a fair market value of $809,000 at December 31, 2009 is includedin our ORE assets.  This loan representsa 32% participation interest in a loan originated by another bank. The projectconsists of 46 lots of an original 49 lot subdivision located in Nevada County,California.  The borrower made thedecision to “Deed in Lieu” the property back to the lead bank due to slow salesand the continued weak real estate market. To identify the Company’s potential loss exposure and properly value thecollateral support provided by the property, an appraisal was ordered and receivedon December 15, 2009.  Thisappraisal 

 

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reflected the downturn inreal estate values and demonstrated the continuing decline in the value of theunderlying project; consequently, the Company charged off an additional$666,277 in December 2009.  Theappraisal for the entire project supported a value of $2,810,000 of which our32% interest represents approximately $899,200.

 

A development loan with afair market value of $950,000 at December 31, 2009 was included in OREassets at December 31, 2009.  Theproperty was transferred to ORE on March 2009.  The project consists of 46 finishedlots.  To identify the Company’spotential loss exposure and properly value the collateral support provided bythe property, an appraisal was ordered and subsequently received on August 18,2009 with a value of $1,380.000.  Theappraisal demonstrated the continuing decline in the value of the underlyingproject. The Company charged-off $972,000 upon receipt of the new appraisal.With an accepted offer of $950,000, in December 2009, the Companycharged-off $292,000. The property subsequently sold in January 2010.

 

The last significant OREat December 31, 2009 is a development loan to purchase 7.5 acres ofproperty along the Sacramento River located in Anderson, California for$1,237,000.  The original plans were todevelop a fishing lodge and restaurant. The collateral for the loan consists of 7.5 acres plus six 20 acreparcels located in Red Bluff, California. This loan was transferred to ORE in October 2009.  Due to the continued decline in real estatemarket, the Company ordered an updated appraisal to understand the potentialloss exposure and properly value the collateral.  This appraisal valued the property at$1,380,000. In December, the Company charged-off an additional $3,335 againstORE.  No additional write-downs wererecorded at December 2009.

 

The remainder of the non-performingassets includes twenty-five SFR lots that have a current value of $3,435,000and are in ORE.  There are also tensingle family homes that are included in ORE at a combined balance of$1,935,000.  The amounts included in OREare supported by current appraisals received by the Company, all within thepast 12 months. In addition, there are five commercial real estate propertiesthat are included in ORE at December 31, 2009 at a combined balance of$1,599,000 supported by current appraisals. When loans are placed into ORE, the Company determines the fair marketvalue less the estimated selling costs. The shortfalls are charged to the allowance for loan losses at the timeof transfer.  Properties placed in OREare reviewed continuously and the Company will reappraise the property if it isdeemed necessary.  At a minimum,properties are appraised annually.  Ifvalues have declined, the Company will establish a valuation allowance for theORE through a separate provision for losses on ORE.

 

Restructured Loans

 

**RestructuredLoans**

(dollars inthousands)

 
| ** **                                         | ** ** | **As of December 31,** | ** ** |
|----------------------------------------------------|------------|-----------------------------|------------|
| ** **                                         | ** ** | **2009**                    | ** ** | **2008** | ** ** |
| ** **                                         | ** ** | **Accrual**                 | ** ** | **Non  Accrual** | ** ** | **Unfunded** | ** ** | **Accrual** | ** ** | **Non  Accrual** | ** ** | **Unfunded** | ** ** |
| Agricultural                                       |       | $                           | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Commercial  and Industrial                         |       | —                      |       | — |   | — |   | 536 |   | 2,256 |   | — |   |
| **Real Estate**                                    |       |                        |       |   |   |   |   |   |   |   |   |   |   |
| Secured  by Commercial/Professional Office         |       | —                      |       | 4,386 |   | — |   | — |   | — |   | — |   |
| Properties  Including Construction and Development |       | 6,723                       |       | 10,147 |   | 424 |   | 10,666 |   | 2,042 |   | — |   |
| Secured  by Residential Properties                 |       | —                      |       | 835 |   | — |   | 205 |   | 173 |   | — |   |
| Secured  by Farmland                               |       | —                      |       | — |   | — |   | — |   | — |   | — |   |
| Consumer  Loans                                    |       | —                      |       | 502 |   | — |   | — |   | — |   | — |   |
|                                               |       |                        |       |   |   |   |   |   |   |   |   |   |   |
| Total  Restructured Loans                          |       | $                           | 6,723      |   | $ | 15,870 |   | $ | 424 |   | $ | 11,407 |   | $ | 4,471 |   | $ | — |   |
|                                               |       |                        |       |   |   |   |   |   |   |   |   |   |   |
| Restructured  loans as % of total gross loans      |       | 5.20                        | %          |   |   |   |   | 3.21 | % |   |   |   |   |

 

Restructured loans totaled $22,593,000 at December 31,2009, an increase of $6,815,000 from the total at December 31, 2008.  A loan may be restructured when the Bankdetermines that a borrower’s financial condition has deteriorated, but stillhas the ability to repay the loan. A loan is considered to be TDR when theoriginal terms have been modified in favor of the borrower such that eitherprincipal or interest has been forgiven, contractual payments are deferred, orthe interest rate is reduced. Once the borrower has made their payments ascontractually required for six months, the loan is reviewed and interest mayagain be accrued. No additional funds were lent to the borrowers of therestructured loans.

 

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

######  

Theallowance for loan losses is established through a provision for loan lossesbased on management’s evaluation of known and inherent risk in our loanportfolio. The allowance is increased by provisions charged against currentearnings and reduced by net charge-offs. Loans are charged off when they aredeemed to be uncollectible; recoveries are generally recorded only when cashpayments are received subsequent to the charge-off. The following tablesummarizes the activity in the allowance for loan losses for the past fiveyears.

 

**Allowancefor Loan Losses**

(Inthousands, except for percentages)

 
| ** **                                                      | ** ** | **As of December 31,** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                      | ** ** | **2009**                    | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Balances:**                                                   |       |                        |       |   |   |   |   |   |   |   |   |
| Average  loans outstanding during period                        |       | $                           | 473,777    |   | $ | 482,208 |   | $ | 456,818 |   | $ | 445,119 |   | $ | 382,659 |   |
| Gross  loans outstanding at end of period                       |       | $                           | 434,148    |   | $ | 494,826 |   | $ | 447,270 |   | $ | 448,326 |   | $ | 407,045 |   |
|                                                            |       |                        |       |   |   |   |   |   |   |   |   |
| **Allowance for Loan Losses:**                                  |       |                        |       |   |   |   |   |   |   |   |   |
| Allowance  for possible loan losses at beginning of period      |       | $                           | 7,826      |   | $ | 5,232 |   | $ | 5,274 |   | $ | 4,716 |   | $ | 4,000 |   |
| Adjustments                                                     |       | —                      |       | — |   | — |   | — |   | — |   |
| Provision  charged to expense                                   |       | 23,057                      |       | 3,742 |   | (16 | ) | 638 |   | 724 |   |
| Loans  charge-offs                                              |       |                        |       |   |   |   |   |   |   |   |   |
| Agricultural                                                    |       | —                      |       | — |   | 2 |   | — |   | — |   |
| Commercial &  industrial loans                         |       | 1,936                       |       | 71 |   | 13 |   | 42 |   | — |   |
| Real  estate                                                    |       | 15,921                      |       | 1,046 |   | 8 |   | 31 |   | — |   |
| Consumer                                                        |       | 205                         |       | 41 |   | 3 |   | 9 |   | 9 |   |
| Credit  card loans                                              |       | —                      |       | — |   | — |   | — |   | — |   |
| Total                                                           |       | 18,062                      |       | 1,158 |   | 26 |   | 82 |   | 9 |   |
|                                                            |       |                        |       |   |   |   |   |   |   |   |   |
| Recoveries                                                      |       |                        |       |   |   |   |   |   |   |   |   |
| Agricultural                                                    |       | —                      |       | — |   | — |   | — |   | — |   |
| Commercial                                                      |       | 1                           |       | 2 |   | — |   | 2 |   | 1 |   |
| Real  estate                                                    |       | 112                         |       | 5 |   | — |   | — |   | — |   |
| Consumer                                                        |       | 41                          |       | 3 |   | — |   | — |   | — |   |
| Credit  card loans                                              |       | —                      |       | — |   | — |   | — |   | — |   |
| Total                                                           |       | 154                         |       | 10 |   | — |   | 2 |   | 1 |   |
| Net  loan charge-offs                                           |       | 17,908                      |       | 1,148 |   | 26 |   | 80 |   | 8 |   |
| Allowance  for loan losses at end of period                     |       | $                           | 12,975     |   | $ | 7,826 |   | $ | 5,232 |   | $ | 5,274 |   | $ | 4,716 |   |
|                                                            |       |                        |       |   |   |   |   |   |   |   |   |
| **Ratios:**                                                     |       |                        |       |   |   |   |   |   |   |   |   |
| Net  loan charge-offs to average loans                          |       | 3.78                        | %          | 0.24 | % | 0.01 | % | 0.02 | % | 0.00 | % |
| Allowance  for loan losses to gross loans at end of period      |       | 2.99                        | %          | 1.58 | % | 1.17 | % | 1.18 | % | 1.16 | % |
| Allowance  for loan losses to non-performing loans              |       | 25.40                       | %          | 52.58 | % | 2067.98 | % | 231.11 | % | 52400.00 | % |
| Net  charge-offs to allowance for loan losses at end of period  |       | 138.02                      | %          | 14.67 | % | 0.50 | % | 1.52 | % | 0.17 | % |
| Net  loan charge-offs to provision charged to operating expense |       | 77.67                       | %          | 30.68 | % | (162.50 | )% | 12.54 | % | 1.10 | % |

 

Weemploy a systematic methodology for determining the allowance for loan lossesthat includes a monthly review process and monthly adjustment of the allowance.Our process includes a periodic review of individual loans that have beenspecifically identified as problem loans or have characteristics which couldlead to impairment, as well as detailed reviews of other loans (eitherindividually or in pools). While this methodology utilizes historical and otherobjective information, the establishment of the allowance for loan losses andthe classification of loans are, to some extent, based on management’s judgmentand experience.

 

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Ourmethodology incorporates a variety of risk considerations, both quantitativeand qualitative, in establishing an allowance for loan losses that managementbelieves is appropriate at each reporting date. Quantitative factors includeour historical loss experience, delinquency and charge-off trends, collateralvalues, 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.

 

Qualitativefactors include the general economic environment in Northern California and, inparticular, in our markets wherein we monitor the state of the agricultureindustry and other key industries in the Northern Sacramento Valley. The way aparticular loan might be structured, the extent and nature of waivers ofexisting loan policies, loan concentrations and the rate of portfolio growthare other qualitative factors that are considered.

 

Ourmethodology is, and has been, consistently followed. However, as we add newproducts, increase in complexity, and expand our geographic coverage, we expectto enhance our methodology to keep pace with the size and complexity of theloan portfolio. On an ongoing basis we engage outside firms to independentlyassess our methodology, and to perform independent credit reviews of our loanportfolio. The FDIC and the California Department of Financial Institutionsreview the allowance for loan losses as an integral part of the examinationprocess. Management believes that our current methodology is appropriate givenour size and level of complexity. Further, management believes that theallowance for loan losses is adequate as of December 31, 2009 to coverknown and inherent risks in the loan portfolio. However, fluctuations in creditquality, or changes in economic conditions or other factors could causemanagement to increase or decrease the allowance for loan losses as necessary.

 

Thefollowing table provides a summary of the allocation of the allowance for loanlosses for specific loan categories at the dates indicated. The allocationpresented should not be interpreted as an indication that charges to theallowance for loan losses will be incurred in these amounts or proportions, orthat the portion of the allowance allocated to each loan category representsthe total amounts available for charge-offs that may occur within thesecategories. The total allowance is applicable to the entire loan portfolio.

 

**Allocationof Loan Loss Allowance**

(dollars in thousands)

 
| ** **         | ** ** | **As  of December 31,** | ** ** |
|--------------------|------------|------------------------------|------------|
| ** **         | ** ** | **2009**                     | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **         | ** ** | ** **                   | ** ** | **% Total  (1)** | ** ** | ** ** | ** ** | **% Total  (1)** | ** ** | ** ** | ** ** | **% Total  (1)** | ** ** | ** ** | ** ** | **% Total  (1)** | ** ** | ** ** | ** ** | **% Total  (1)** | ** ** |
| ** **         | ** ** | **Amount**                   | ** ** | **Loans** | ** ** | **Amount** | ** ** | **Loans** | ** ** | **Amount** | ** ** | **Loans** | ** ** | **Amount** | ** ** | **Loans** | ** ** | **Amount** | ** ** | **Loans** | ** ** |
| Agricultural       |       | $                            | 81         |   | 0.62 | % | $ | 94 |   | 1.16 | % | $ | 313 |   | 5.89 | % | $ | 219 |   | 5.74 | % | $ | 200 |   | 6.09 | % |
| Commercial         |       | 1,837                        |       | 14.16 | % | 1,037 |   | 12.77 | % | 631 |   | 16.13 | % | 626 |   | 14.55 | % | 1,123 |   | 15.03 | % |
| Real  Estate       |       | 8,808                        |       | 67.88 | % | 6,511 |   | 80.19 | % | 4,628 |   | 65.95 | % | 4,172 |   | 69.94 | % | 3,488 |   | 69.91 | % |
| Installment  Loans |       | 2,250                        |       | 17.34 | % | 477 |   | 5.88 | % | 520 |   | 12.03 | % | 876 |   | 9.77 | % | 386 |   | 8.97 | % |
| **TOTAL**          |       | $                            | 12,975     |   | 100.00 | % | $ | 8,119 |   | 100.00 | % | $ | 6,092 |   | 100.00 | % | $ | 5,893 |   | 100.00 | % | $ | 5,197 |   | 100.00 | % |

 

----

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

 

At December 31, 2009,the Company’s allowance for loan losses was $13.0 million. The loan lossprovision in 2009, 2008 and 2007 totaled $23,057,000, $3,742,000, $(16,000)respectively. From 2005 to 2008, net charge-offs averaged $316,000. The Companyended 2009 with net loan losses of $17,908,000, compared to net losses of $1,148,000during 2008.  A total of $16.3 million inlosses during 2009 were partial write downs or full charge-offs due todecreased appraised values.

 

**OtherLoan Portfolio Information**

 

LoanConcentrations:  Theconcentration profile of the Company’s loans is discussed in Note 10 to theaccompanying Consolidated Financial Statements.

 

LoanSales and Servicing Rights:  The Company sells or brokers some of theloans it originates through the SBA and USDA B&I programs. The Company alsooriginated loans throughout 2009 through FNMA; however, in January 2010,FNMA terminated the mortgage selling contract due to the Company not meetingthe minimum total risk based capital of 10% required to participate in theprogram. Some of the loans are sold “servicing released” and the purchasertakes over the collection of the payments. However, some 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 the 

 

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Companyin the event the borrower does not perform according to the terms of the note.When loans are sold, a portion of the sale is attributed to the right toreceive the fee for servicing and this value is recorded as a separateservicing asset. Servicing rights are amortized over the expected term of therelated servicing income.  At December 31,2009 and 2008, the amortized cost of these servicing assets was $3,463,000 and$2,004,000 respectively.

 

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

######  

Theinvestment securities portfolio had a carrying value of $5.4 million at December 31,2009. The Company classified its investments into two categories: “held-to-maturity”,and “available-for-sale”. The Company does not have any investments classifiedas trading. The held-to-maturity portfolio consists only of investments thatthe Company has both the intention and ability to hold until maturity, to besold only in the event of concerns with an issuer’s creditworthiness, a changein tax law that eliminates their tax exempt status or other infrequentsituations as permitted under GAAP. Given the small and non complex nature ofthe portfolio, management does not rely heavily on these investments as asource of funds for growth in the loan portfolio.

 

Securitiespledged as collateral on repurchase agreements, public deposits and for otherpurposes as required or permitted by law were $3,445,000 as of December 31,2009 and $4,356,000 as of December 31, 2008.

 

Thetotal investment portfolio decreased to $5.6 million as of December 31,2009 from $7.1 million at December 31, 2008. The Company’s investmentportfolio is composed primarily of: (1) U.S. Treasury and Agency issuesfor liquidity and pledging; and (2) state, county and municipalobligations which provide tax free income and pledging potential. Thedistribution of these groups within the overall portfolio remained relativelyconsistent.  The U.S. Treasury and Agencyissues continue to be the largest portion of the total portfolio at 73%, downfrom 77% at the end of 2008. Municipal issues comprised 26% of total investmentsat the end of 2009, up from 19% at the end of 2008.

 

During its assessment of the investment portfoliofor other-than-temporary impairment of investment securities, managementconsiders many factors.  In cases where asecurity is of a type for which there is very little active trading, if any,management must consider other factors when conducting its evaluation.  As of December 31, 2008, the Companyheld one such security, a trust preferred security.  Although all scheduled interest payments had beenreceived through December 31, 2008, management considered other factorsand made certain assumptions in reaching its conclusion.  Such factors and assumptions includedindependent indications of the fair value of the security, adverse conditionsrelated to the financial industry in general, the financial condition of theissuer, and certain assumptions regarding the impact of past events, currentconditions and the likelihood of future events and the timing of cash flows,including any recoveries. After giving consideration to all the above factors,management concluded that an other-than-temporary impairment had occurred andrecorded a $1,489,000 impairment charge through earnings on this trustpreferred security with an original par value of $1,750,000. In January 2009the security was sold at a $172,000 loss.

 

Thefollowing Investment Portfolio table reflects the amortized cost and fairmarket values for the total portfolio for each of the categories of investmentsfor the past three years.

 

Federal funds sold comprise the remainder of theassets that are not invested in the securities portfolio or in the loanportfolio.  These overnight transactionsare highly liquid and are returned to the Company the next day.  The Company sold $46.5 million and $36.6million in Federal funds as of December 31, 2009 and December 31,2008, respectively.

 

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**Investment Portfolio**

(dollarsin thousands)

 
| ** **                                      | ** ** | **As of December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------------|------------|
| ** **                                      | ** ** | **2009**                    | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                      | ** ** | **Amortized  Cost**         | ** ** | **Fair  Market  Value** | ** ** | **Amortized  Cost** | ** ** | **Fair  Market  Value** | ** ** | **Amortized  Cost** | ** ** | **Fair  Market  Value** | ** ** |
| Available  for sale                             | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| US  Government Agencies & Corporations |       | $                           | 2,807      |   | $ | 2,938 |   | $ | 5,080 |   | $ | 5,094 |   | $ | 3,282 |   | $ | 3,287 |   |
| State &  political subdivisions        |       | 1,358                       |       | 1,439 |   | 1,358 |   | 1,368 |   | 1,357 |   | 1,381 |   |
| Total  available for sale                       |       | 4,165                       |       | 4,377 |   | 6,438 |   | 6,462 |   | 4,639 |   | 4,668 |   |
| Held  to maturity                               |       |                        |       |   |   |   |   |   |   |   |   |   |   |
| US  Government Agencies & Corporations |       | 1,229                       |       | 1,243 |   | 373 |   | 377 |   | 1,596 |   | 1,602 |   |
| Other  securities                               |       | —                      |       | — |   | 261 |   | 261 |   | — |   | — |   |
| Total  held to maturity                         |       | 1,229                       |       | 1,243 |   | 634 |   | 638 |   | 1,596 |   | 1,602 |   |
| Total  investment securities                    |       | $                           | 5,394      |   | $ | 5,620 |   | $ | 7,072 |   | $ | 7,100 |   | $ | 6,235 |   | $ | 6,270 |   |

 

Theinvestment maturities table below summarizes the maturity of the Company’sinvestment securities and their weighted average yields at December 31,2009. 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, 2009** | ** ** |
|-------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                      | ** ** | **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** | ** ** |
| Available  for sale                             |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| US  Government agencies & corporations |       | —                            |       |   |   | 1,116 |   | 2.79 | % | 1,821 |   | 5.29 | % | — |   |   |   | 2,938 |   | 8.68 | % |
| State &  political subdivisions        |       | —                            |       |   |   | — |   |   |   | 525 |   |   |   | 914 |   | 7.59 | % | 1,439 |   | 7.59 | % |
| Total  available for sale                       |       | —                            |       |   |   | 1,116 |   | 2.79 | % | 2,347 |   | 5.29 | % | 914 |   | 7.59 | % | 4,377 |   | 5.26 | % |
| Held  to Maturity                               |       |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| US  Government agencies & corporations |       | —                            |       |   |   | 1,197 |   | 2.46 | % | 46 |   | 6.00 | % | — |   |   |   | 1,243 |   | 0.86 | % |
| Other  securities                               |       | —                            |       |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   |
| Total  held to maturity                         |       | —                            |       |   |   | 1,197 |   | 2.46 | % | 46 |   | 6.00 | % | — |   |   |   | 1,243 |   | 0.86 | % |
| Total  investment securities                    |       | $                                 | —     |   |   |   | $ | 2,313 |   | 2.62 | % | $ | 2,393 |   | 4.14 | % | $ | 914 |   | 7.59 | % | $ | 5,620 |   | 4.67 | % |
|                                                 |            |                                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Cashand Due From Banks**

 

Cashon hand and balances due from correspondent banks represent the major portionof the Company’s non-earning assets. At December 31, 2009 these areascomprised 2.2% of total assets, as compared to 3.7% of total assets at December 31,2008. The Company strives to maintain vault cash at a level consistent with thewithdrawal needs of its customers. The vault cash amount for December 31,2009 was $3.4 million.

 

TheCompany’s operating branches lie within the Federal Reserve Bank (FRB) of SanFrancisco’s responsibility area for check clearing activities, while theCompany’s item processing activities are performed in Chico. As a result of theFederal Reserve Banks’ Check 21 services, the Companyis taking advantage of quicker clearing times to offset timezone and geography challenges and improve availability. With traditional papercheck clearing, all non-local and country items in the 12th District receive availability that is at leastone day deferred. Under the programs currently available from the FederalReserve Banks, many of these items receive immediate availability ifreceived by the 1:00 a.m. Pacific time deadline. With file depositdeadlines starting as early as 5:00 p.m. through 9:00 a.m. Pacifictime, image cash letters enable institutions on the West Coast to reduce the clearingtime of many high value East Coast items by at least one business day, therebyincreasing funds available for investment and reducing risk.

 

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

######  

Premisesand equipment are stated at cost less accumulated depreciation andamortization. Depreciation is charged to income over the estimated useful livesof the assets and leasehold improvements are amortized over the terms of therelated lease, or the estimated useful lives of the improvements, whichever isshorter. Depreciation expense was $1,911,000 for the year ended December 31,2009 as compared to $2,084,000 during 2008 and $2,108,000 during 2007. Thefollowing premises and equipment table reflects the balances by major categoryof fixed assets:

 

**Premises & Equipment**

(dollarsin thousands)

 
| ** **                | ** ** | **As  of December 31,** | ** ** |
|---------------------------|------------|------------------------------|------------|
| ** **                | ** ** | **2009**                     | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                | ** ** | **Cost**                     | ** ** | **Accumulated  Depreciation** | ** ** | **Net  Book  Value** | ** ** | **Cost** | ** ** | **Accumulated  Depreciation** | ** ** | **Net  Book  Value** | ** ** | **Cost** | ** ** | **Accumulated  Depreciation** | ** ** | **Net  Book**

**Value** | ** ** |
| Land                      |       | $                            | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 2,176 |   | $ | — |   | $ | 2,176 |   |
| Buildings                 |       | 3,454                        |       | 435 |   | 3,019 |   | 3,454 |   | 305 |   | 3,149 |   | 12,927 |   | 2,069 |   | 10,858 |   |
| Leasehold  Improvements   |       | 2,467                        |       | 1,520 |   | 947 |   | 2,469 |   | 1,161 |   | 1,308 |   | 2,485 |   | 849 |   | 1,636 |   |
| Construction  in progress |       | —                       |       | — |   | — |   | — |   | — |   | — |   | 31 |   | — |   | 31 |   |
| Furniture  and Equipment  |       | 10,708                       |       | 9,403 |   | 1,305 |   | 10,754 |   | 8,198 |   | 2,556 |   | 9,867 |   | 6,663 |   | 3,204 |   |
| **Total**                 |       | $                            | 16,629     |   | $ | 11,358 |   | $ | 5,271 |   | $ | 16,677 |   | $ | 9,664 |   | $ | 7,013 |   | $ | 27,486 |   | $ | 9,581 |   | $ | 17,905 |   |

 

Thenet book value of the Company’s premises and equipment decreased by $1,742,000during 2009 compared to a decrease of $10,892,000 during 2008, primarily due toa sale and lease back transaction for seven buildings in February 2008.  As a percentage of total assets, the Company’spremises and equipment was 1.0%, at the end of 2009, 1.2% at the end of 2008and 3.1% at the end of 2007.

 

###### **Deposits**

 

Thecomposition and cost of the Company’s deposit base are important components inanalyzing the Company’s net interest margin and balance sheet liquiditycharacteristics, both of which are discussed in greater detail in othersections herein. Net interest margin is improved to the extent that growth indeposits can be concentrated in historically lower-cost core deposits, namelynon-interest-bearing demand, NOW accounts, savings accounts and money marketdeposit accounts. Liquidity is impacted by the volatility of deposits or otherfunding instruments, or, in other words, their propensity to leave theinstitution for rate-related or other reasons. Potentially, the most volatiledeposits in a financial institution are large certificates of deposit, whichgenerally mean time deposits with balances exceeding $100,000. Because these deposits(particularly when considered together with a customer’s other specificdeposits) may exceed FDIC insurance limits, depositors may select shortermaturities to offset perceived risk elements associated with deposits over$100,000.  The temporary increase in theinsurance limit to $250,000 effective through December 31, 2013 shouldhelp mitigate any perceived risk on time deposits maturing prior to thatdate.  In addition, the Bank isparticipating in the FDIC Transaction Account Guarantee Program.  Under that program, through December 31,2010, all noninterest-bearing transaction accounts are fully guaranteed by theFDIC for the entire amount in the account. Coverage under the Transaction Account Guarantee Program is in additionto and separate from the coverage available under the FDIC’s general depositinsurance rules.  Certificates ofdeposits exceeding $100,000 represented 16% of average total deposits in 2009,16.8% in 2008 and 14.7% in 2007.  Whilethe total of these deposits has been stable over the past three years, theCompany’s community-oriented deposit gathering activities in Butte, Colusa,Shasta, Sutter, Tehama, and Yuba counties have engendered a less volatile thanusual base of depositor certificates over $100,000.

 

TheCompany’s total deposit volume decreased to $498 million at the end of 2009, ascompared to $526 million at the end of 2008. The mix of the core deposits (demand deposits, savings, NOW, and moneymarket) changed from 2008 to 2009. Growth was achieved in NOW accounts of $6.5million and time deposits of $11.3 million. Noninterest bearing demand depositswere down $7.6 million, savings deposit totals were down by $4.3 million, andmoney market account balances were down by $6.4 million. We expect depositrates to be lower in 2010, and our focus will be to attract deposits at thelowest cost possible to fund our loans and maintain a reasonable net interestmargin in 2010.

 

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Thescheduled maturity distribution of the Company’s time deposits, including IRAaccounts, as of December 31, 2009 was as follows:

 

**Deposit Maturity Distribution**

(dollars in thousands)

 
| ** **                   | ** ** | **As of December 31, 2009** | ** ** |
|------------------------------|------------|----------------------------------|------------|
| ** **                   | ** ** | **Three  months or  less**       | ** ** | **Three to  twelve  months** | ** ** | **One to  three years** | ** ** | **Over  three  years** | ** ** | **Total** | ** ** |
| Time  Deposits < $100,000 |       | $                                | 28,056     |   | $ | 41,991 |   | $ | 2,055 |   | $ | 238 |   | $ | 72,340 |   |
| Time  Deposits > $100,000 |       | 22,433                           |       | 48,962 |   | 3,054 |   | 536 |   | 74,985 |   |
| TOTAL                        |       | $                                | 50,489     |   | $ | 90,953 |   | $ | 5,109 |   | $ | 774 |   | $ | 147,325 |   |

 

**NotesPayable and Other Borrowings**

 

TheCompany had no unsecured borrowing arrangements in 2009.  The Company previously had $15 million inunsecured borrowing arrangements with two of its correspondent banks to meetshort-term liquidity needs. There were no borrowings outstanding under thesearrangements at December 31, 2008.

 

OnJuly 10, 2007, Community Valley formed a wholly-owned subsidiary,Community Valley Bancorp Trust II (the “Trust”), which is a Delaware statutorybusiness trust, for the purpose of issuing trust preferred securities. Theproceeds from the Trust were used in 2008 to redeem 100% of the trust preferredsecurities issued by the 2002 Community Valley Bancorp Trust I.  After redemption Community Valley Trust I wasdissolved.

 

Thefollowing summarizes the debentures due to the Company’s subsidiary grantortrust at December 31, 2009 and 2008:

 
| ** **                                                                                                                                                                                                                                                                                                                                                                          | ** ** | **(Dollars in  thousands)** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| Subordinated debentures due to Community Valley  Bancorp Trust II with interest fixed and payable quarterly based on the 3-month  LIBOR of 5.57% in effect at the closing date plus 1.57% for the first 5  years; then converting to a floating rate using 3-month LIBOR plus  1.57% for the remaining term, beginning July 10, 2007, due  October 1, 2037 |       | $                                | 8,248      |   |
|                                                                                                                                                                                                                                                                                                                                                                                     |            |                                  |            |  |

 

TheCompany has guaranteed, on a subordinated basis, distributions and otherpayments due on trust preferred securities issued by the subsidiary grantortrust. Interest expense recognized by the Company for the years ended December 31,2009, 2008 and 2007 related to the junior subordinated debentures was $424,000,$566,000, and $1,024,000, respectively. A percentage of these juniorsubordinated debentures currently qualify as Tier 1 capital when determiningregulatory risk-based capital ratios.

 

OnApril 28, 2006 the ESOP obtained financing through a $1.3 millionunsecured line of credit from another financial institution with the Companyacting as the guarantor. The note has a variable interest rate, based on anindependent index, and a maturity date of April 10, 2014. In November 2008a change in terms was done on the ESOP note which increased the line back to$1,300,000 with a new maturity date of October 10, 2016.  At December 31, 2009, the interest ratewas 5.75%.

 

Asummary of the activity in this line of credit follows:

 

ESOP Note Payable

(dollars in thousands)

 
| ** **                                   | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|----------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                         |       |     |       |     |       |     |       |
| Balance  at December 31                 |       | $        | 1,122      |     | $          | 1,054    |       | $ | 1,092 |   |
|                                         |       |     |       |     |       |     |       |
| Average  amount outstanding                  |       | $        | 1,159      |     | $          | 1,026    |       | $ | 1,150 |   |
|                                         |       |     |       |     |       |     |       |
| Maximum  amount outstanding at any month end |       | $        | 1,234      |     | $          | 1,082    |       | $ | 1,215 |   |
|                                         |       |     |       |     |       |     |       |
| Average  interest rate for the year          |       | 5.75     | %          | 5.54     | %          | 8.08     | %          |

 

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Other Note Payable

(dollars in thousands)

 
| ** **                                   | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|----------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                         |       |     |       |     |       |     |       |
| Balance  at December 31                 |       | $        | —     |     | $          | 4,000    |       | $ | — |   |
|                                         |       |     |       |     |       |     |       |
| Average  amount outstanding                  |       | $        | 3,700      |     | $          | 2,000    |       | $ | — |   |
|                                         |       |     |       |     |       |     |       |
| Maximum  amount outstanding at any month end |       | $        | 4,000      |     | $          | 4,000    |       | $ | — |   |
|                                         |       |     |       |     |       |     |       |
| Average  interest rate for the year          |       | 7.16     | %          | 6.67     | %          | —   |       |

 

AtDecember 31, 2008 the Company’s note payable to Pacific Coast Bankers’Bank (PCBB), bearing a variable interest rate indexed to the three month LIBORplus 3.25% and collateralized by all of the outstanding shares of common stockof Butte Community Bank, had an outstanding balance of $4,000,000.  A total of $500,000 was repaid during 2009.  The remaining balance of $3,500,000, less theapplied interest reserve held by PCBB of $187,000, was extinguished through aloan participation and debt conversion agreement (“Agreement”).  The Agreement was entered into by theCompany, PCBB and certain accredited investors (“Investors”) who participated inthe PCBB loan, to include certain directors of the Company.  The Investors purchased a $1,200,000 portionof the note from PCBB for $1,000,000 and PCBB and the Investors converted thedebt into shares of the Company’s preferred stock on December 30, 2009.  The fair value of the preferred stock issuedwas equal to the Company’s carrying amount of the debt.

 

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

######  

AtDecember 31, 2009, the Company had total shareholders’ equity of $16million, comprised of $8.6 million in common stock, net of the unallocated ESOPshares, $3.3 million in preferred stock, $127,000 in accumulated othercomprehensive income, and $3.9 million in retained earnings. Total shareholders’equity at the end of 2008 was $40.1 million. The primary decrease inshareholders’ equity was from the net loss of $27.5 million in 2009.  Net income provided $9.2 million in capitalin 2007 and 2008, of which $3.6 million or approximately 39% was distributed individends. The retention of earnings has been the Company’s main source of capitalsince 1990, however the Company issued $8.2 million in Subordinated Debenturesin 2007 (used in 2008 to refund the 2002 Subordinated Debentures), the proceedsof which are considered Tier 1 capital for regulatory purposes, subject tocertain restrictions, but long-term debt in accordance with GAAP. At ourCompany level, trust preferred securities can be treated as Tier 1 capital upto 25% of total Tier 1 capital, with the remainder treated as Tier 2 capital.At December 31, 2009 the Company included $4.4 million of the trustpreferred securities in our Tier 1 capital for regulatory capital purposescompared to the entire $8.0 million at December 31, 2008. At December 31,2009, $3.6 million of the trust preferred securities qualified for Tier 2capital treatment.

 

TheCompany did not pay dividends in 2009. In 2008, the Company paid quarterly cashdividends totaling $1,148,000 or $.16 per share and $2,425,000 or $.32 pershare in 2007, representing 41.9% and 37.5%, respectively, of those year’searnings. The Company chose to suspend paying dividends in the fourth quarterof 2008 and throughout 2009.  Any futurepayment of dividends will be consistent with the general dividend policy.However, no assurance can be given that the Bank’s and the Company’s futureearnings and/or growth expectations in any given year will justify the paymentof such a dividend.

 

TheCompany 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 and certaintypes of debt equity, which the Company does not hold, as well as the allowancefor loan losses, subject to certain limitations. (For a more detaileddefinition, see “Item 1, Business-Supervision and Regulation — Capital AdequacyRequirements” herein.)

 

We will need to incuradditional debt or equity financing in the future to meet our capital needs. We cannot guarantee that such financingwill be available to us on acceptable terms or at all. If we are unable toobtain future financing, we may not have the resources available to fund our operations.

 

AtDecember 31, 2009, the Company had a Tier 1 risk based capital ratio of3.5%, a total capital to risk-weighted assets ratio of 6.2%, and a leverageratio of 3.0%. The Company had a Tier 1 risk based capital ratio of 8.8%, atotal capital to risk-weighted assets ratio of 10.0%, and a leverage ratio of8.1% at December 31, 2008. Note 12 of the Notes to Consolidated FinancialStatements provides more 

 

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detailedinformation concerning the Company’s capital amounts and ratios as of December 31,2009 and 2008. At December 31, 2009, the Company and the Bank wereconsidered under capitalized.  As aresult of a regulatory examination in 2009, the Bank must obtain the priorwritten consent of its primary regulators before paying dividends and hasagreed to increase its Leverage Ratio to 10%. In addition, the Bank is to maintain other capital ratios above well capitalizedthresholds.

 

Inan effort to strengthen the Company’s operations and capital position andenable it to better withstand these continued adverse market conditions, theCompany has developed capital initiatives which include improving asset qualitythrough a combination of efforts to reduce the current concentration ofclassified assets, prudently manage credit risk exposures in the existing loanportfolio, tighten credit underwriting standards and limit asset growth, as theCompany focuses on improving asset quality and implementing necessaryefficiency and risk management initiatives, compliance with applicable laws andregulations, including, to the maximum possible extent, regulatory capitalrequirements and the requirements of regulatory enforcement actions, continueto make progress on the sale of OREO properties and loan workout solutions,continue to improve the net interest margin through prudent pricing andimplement additional expense reduction actions.

 

****Off-Balance Sheet Itemsand 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, 2008commitments to extend credit and standby letters of credit were the Company’sonly financial instruments with off-balance sheet risk. Loan commitmentsdecreased to $111 million at December 31, 2009 from $148 million at December 31,2008. Standby letters of credit decreased to $4.4 million from $6.5 millionover the same period.  The commitmentsand standby letters of credit represent 27% of the total loans outstanding atyear-end 2009 versus 31% at December 31, 2008.

 

The following chart summarizes certain contractual obligations of the Company as of December 31, 2009:

 
| ** **                     | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  5 years** | ** ** | **Total** | ** ** |
|--------------------------------|------------|-----------------------|------------|---------------|------------|---------------|------------|------------------------|------------|-----------|------------|
|                           |       |                  |       |          |       |          |       |                   |       |      |       |
| Subordinated  debentures       |       | $                     | —     |          | $          | —        |       | $                      | —     |      | $          | 8,248 |   | $ | 8,248 |   |
| Operating  lease obligations   |       | 2,094                 |       | 3,028         |       | 3,510         |       | 14,358                 |       | 22,990    |       |
| Deferred  compensation **(1)** |       | —                |       | —        |       | —        |       | 6,683                  |       | 6,683     |       |
| Supplemental  retirement plans |       | 127                   |       | 264           |       | 281           |       | 1,125                  |       | 1,797     |       |
| Notes  payable                 |       | —                |       | —        |       | —        |       | 1,122                  |       | 1,122     |       |
| Total  contractual obligations |       | $                     | 2,221      |          | $          | 3,292         |       | $                      | 3,791      |      | $          | 31,536 |   | $ | 40,840 |   |

 

----

**(1) **These amounts represent theaccrued liabilities as of December 31, 2009 under the Company’s deferredcompensation and supplemental retirement plans. See Note 15 to the consolidatedfinancial statements at Item 8 of this report for additional informationrelated to the Company’s deferred compensation and supplemental retirement planliabilities.

 

###### **Liquidity and Market Risk Management**

######  

Global financial marketsrecently have been, and continue to be, extremely unstable and unpredictable,and economic conditions have been weak and appear to be deteriorating.Continued, and potentially increased volatility, instability and weakness couldaffect the Company’s ability to sell investment securities and other financialassets, which in turn could adversely affect the Company’s liquidity andfinancial position. This instability also could affect the prices at which theCompany could make any such sales, which could adversely affect its earningsand financial condition. Conditions could also negatively affect the Company’sability to secure funds or raise capital.

 

The Company must address ona daily basis the various and sundry factors which impact its continuingoperations. Three of these factors, the economic climate which encompasses ourbusiness environment, the regulatory framework which governs our practices andprocedures, and credit risk have been previously discussed. There are otherrisks specific to the operation of a financial institution which also need tobe managed, and this section will address liquidity risk and market risk.

 

Liquidityrefers to the Company’s ability to maintain a cash flow adequate to fundoperations, and to meet obligations and other commitments in a timely andcost-effective fashion. At various times the Company requires funds to meetshort-term cash requirements brought about by loan growth or deposit outflows,the purchase of assets, or liability repayments. To manage liquidity needsproperly, cash inflows must be timed to coincide with anticipated outflows, orsufficient liquidity resources must be available to meet varying demands. TheCompany manages its own liquidity in such a fashion as to be able to meetunexpected sudden changes in levels of its assets or deposit liabilities,without maintaining excessive amounts of on-balance sheet liquidity. Excessbalance sheet liquidity can negatively impact the interest margin.

 

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Anintegral 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 in itsservice area and which have, historically, been a very stable source of funds.

 

Additionally,the Company has the ability to raise nonbrokered deposits through an onlineresource, sell investment securities, or sell loans if required for liquiditypurposes. The Company is in the process of securing its access to the FederalReserve Bank of San Francisco’s Discount Window for short term borrowing.

 

Withthe Company’s under-capitalized position, brokered deposits, unsecured lines ofcredit, and the Federal Home Loan Bank, are no longer resources for liquidity.To compensate for this, management expanded its use of a six month rollingliquidity surplus and deficit analysis so that changes in liquidity needs couldbe identified and addressed well in advance of any issues or shortfalls. Inaddition, the Asset Liability Committee meets monthly to discuss and identifypotential crisis.

 

Marketrisk arises from changes in interest rates, exchange rates, commodity pricesand equity prices. The Company’s market risk exposure is primarily that ofinterest rate risk, and it has risk management policies to monitor and limitearnings and balance sheet exposure to changes in interest rates. The Companydoes not engage in the trading of financial instruments.

 

Theprincipal objective of interest rate risk management (often referred to as “asset/liabilitymanagement”) is to manage the financial components of the Company in a mannerthat will optimize the risk/reward equation for earnings and capital inrelation to changing interest rates. In order to identify areas of potentialexposure to rate changes, the Company calculates its re-pricing gap on amonthly basis. It also performs an earnings simulation analysis and a marketvalue of portfolio equity calculation on a monthly basis to identify moredynamic interest rate risk exposures than those apparent in the standardre-pricing gap analysis.

 

Modelingsoftware is used by the Company for asset/liability management in order tosimulate the effects of potential interest rate changes on the Company’s netinterest margin. These simulations can also provide both static and dynamicinformation on the projected fair market values of the Company’s financialinstruments under differing interest rate assumptions. The simulation program utilizesspecific individual loan and deposit maturities, embedded options, rates andre-pricing characteristics to determine the effects of a given interest ratechange on the Company’s interest income and interest expense. Rate scenariosconsisting of key rate and yield curve projections are run against the Company’sinvestment, loan, deposit and borrowed funds portfolios. These rate projectionscan be shocked (an immediate and sustained change in rates, up or down), ramped(an incremental increase or decrease in rates over a specified time period),economic (based on current trends and econometric models) or stable (unchangedfrom current actual levels). The Company typically uses seven standard interestrate scenarios in conducting the simulation, namely stable, an upward shock of100, 200, and 300 basis points, and a downward shock of 100, 200, and 300 basispoints.  The Company’s policy is to limitthe change in the Company’s net interest margin and economic value to plus orminus 10%, 20%, and 30% and 10%, 15%, and 20% respectively upon application ofinterest rate shocks of 100 bp, 200 bp, and 300 bp as compared to a base ratescenario. As of December 31, 2009, the Company had the following estimatednet 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  Interest Income Change |       | $                            | 401,000    |                         | $          | 252,000                      |       | $ | 965,000 |   | $ | (36,000 | ) | $ | 1,716,000 |   | $ | (137,000 | ) |
|                             |            |                              |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Theabove profile illustrates that if there were an immediate increase of 200 basispoints in interest rates, the Company’s annual net interest income would likelyincrease by about $965,000, or approximately 4.89%. Likewise, if there were animmediate downward adjustment of 200 basis points in interest rates, theCompany’s net interest income would likely decrease by approximately $36,000,or  -.18%, over the next year.  Many of the Company’s loans have variablerates with minimum thresholds called floors that they can adjust to in afalling rate environment.  However, thefloors that help to maintain a net interest margin spread in a falling rateenvironment create the lag in income in a raising rate environment as the loanswill not reprice until the base rate plus the loans’ margin exceed the floor.The results for the Company’s December 31, 2009 balances indicate that theCompany’s net interest income at risk over a one-year period and net economicvalue at risk from 2% shocks are within normal expectations for such suddenchanges.

 

Theamount of change is based on the profiles of each loan and deposit class, whichinclude the rate, the likelihood of prepayment or repayment, whether its rateis fixed or floating, the maturity of the instrument, and the particularcircumstances of the customer. The quantification of the change in economicvalue is somewhat apparent in Note 16, Fair Value of Financial Instruments, inthe consolidated financial statements; however, such values change over timebased on certain assumptions about interest rates and likely changes in theyield curve.

 

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**Selected Quarterly Financial Data (Unaudited)**

(Dollarsin thousands, except per share data)

 
| **2009 Quarter**                                     | ** ** | **1st** | ** ** | **2nd** | ** ** | **3rd** | ** ** | **4th** | ** ** |
|------------------------------------------------------|------------|---------|------------|---------|------------|---------|------------|---------|------------|
|                                                 |       |    |       |    |       |    |       |    |       |
| Interest  income                                     |       | $       | 7,170      |    | $          | 7,485   |       | $       | 7,079      |   | $ | 7,132 |   |
| Net  interest income                                 |       | $       | 5,079      |    | $          | 5,608   |       | $       | 5,650      |   | $ | 5,819 |   |
| Net  interest income after provision for loan losses |       | $       | 1,979      |    | $          | 1,608   |       | $       | (250       | ) | $ | (4,238 | ) |
|                                                 |       |    |       |    |       |    |       |    |       |
| Net  income (loss)                                   |       | $       | 100        |    | $          | (2,500  | )          | $       | (3,563     | ) | $ | (21,545 | ) |
|                                                 |       |    |       |    |       |    |       |    |       |
| Net  income (loss) per share, basic                  |       | $       | 0.02       |    | $          | (0.38   | )          | $       | (0.55      | ) | $ | (3.30 | ) |
|                                                 |       |    |       |    |       |    |       |    |       |
| Net  income per share, diluted                       |       | $       | 0.02       |    | $          | —  |       | $       | —     |   | $ | — |   |
|                                                 |       |    |       |    |       |    |       |    |       |
| Dividends  declared                                  |       | $       | —     |    | $          | —  |       | $       | —     |   | $ | — |   |

 
| **2008 Quarter**                                     | ** ** | **1st** | ** ** | **2nd** | ** ** | **3rd** | ** ** | **4th** | ** ** |
|------------------------------------------------------|------------|---------|------------|---------|------------|---------|------------|---------|------------|
|                                                 |       |    |       |    |       |    |       |    |       |
| Interest  income                                     |       | $       | 9,611      |    | $          | 9,298   |       | $       | 9,471      |   | $ | 8,935 |   |
| Net  interest income                                 |       | $       | 6,671      |    | $          | 6,716   |       | $       | 7,032      |   | $ | 6,531 |   |
| Net  interest income after provision for loan losses |       | $       | 6,446      |    | $          | 6,266   |       | $       | 6,282      |   | $ | 4,781 |   |
|                                                 |       |    |       |    |       |    |       |    |       |
| Net  income (loss)                                   |       | $       | 824        |    | $          | 1,043   |       | $       | 1,302      |   | $ | (430 | ) |
|                                                 |       |    |       |    |       |    |       |    |       |
| Net  income (loss) per share, basic                  |       | $       | 0.11       |    | $          | 0.15    |       | $       | 0.20       |   | $ | (0.07 | ) |
|                                                 |       |    |       |    |       |    |       |    |       |
| Net  income per share, diluted                       |       | $       | 0.11       |    | $          | 0.15    |       | $       | 0.20       |   | $ | — |   |
|                                                 |       |    |       |    |       |    |       |    |       |
| Dividends  declared                                  |       | $       | 0.08       |    | $          | 0.04    |       | $       | 0.04       |   | $ | — |   |

 

**Item 7a. Quantitative and Qualitative Disclosures About Market Risk**

 

Theinformation required by Item 7a of Form 10-K is contained in the Liquidityand Market Risk Management section of Item 7 — Managements Discussion andAnalysis of Financial Condition and Results of Operations.

 

**Item 8.****   ****FinancialStatements and Supplementary Data**

 

Thefinancial statements begin on page 65 of this report.

 

**Item 9.****   ****Changesin and Disagreements with Accountants on Accounting and Financial Disclosure**

 

Therewere no changes or disagreements with Accountants for the year 2009.

 

# **Item 9a.**** ****Controls and Procedures**

#  

Asof the end of the period covered by this report, we conducted an evaluation,under the supervision and with the participation of our Chief Executive Officerand Chief Financial Officer, of our disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934).  Based on this evaluation, our Chief ExecutiveOfficer and Chief Financial Officer concluded that our disclosure controls andprocedures are effective to ensure that information required to be disclosed byus 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 nochange in our internal control over financial reporting during our mostrecently completed fiscal quarter that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

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**REPORTOF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING**

 

Underthe supervision and with the participation of our management, including ourChief Executive Officer and Chief Financial Officer, we conducted an evaluationof our disclosure controls and procedures, as such term is defined under Rules 13a-15(f) and15d-15(f) under the Exchange Act. Based on this evaluation, our Chief Executive Officer and ChiefFinancial Officer concluded that our disclosure controls and procedures wereeffective as of December 31, 2009.

 

Managementis responsible for establishing and maintaining adequate internal control overfinancial reporting at the Company. Internal control over financial reporting is a process designed underthe supervision of the Chief Executive Officer and Chief Financial Officer toprovide reasonable assurance regarding the reliability of financial reportingand preparation of the Company’s financial statements for external reportingpurposes in accordance with accounting principles generally accepted in the UnitedStates of America.  A company’s internalcontrol over financial reporting includes policies and procedures that (1) pertainto the maintenance of records that accurately and fairly reflect, in reasonabledetail, transactions and dispositions of the company’s assets, (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with accounting principlesgenerally accepted in the United States of America and that receipts and expendituresare being made only in accordance with authorizations of management and thedirectors of the company; and (3) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or dispositionof the company’s assets that could have a material effect on the company’sfinancial statements.

 

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements.  Also,projections of any evaluation of effectiveness to future periods are subject torisk that controls may become inadequate because of changes in conditions, orthat the degree of compliance with the policies or procedures may deteriorate.

 

Asof December 31, 2009, the Company carried out an evaluation, under thesupervision and with the participation of the Company’s management, includingthe Company’s Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the Company’s internal control over financial reportingpursuant to Rule 13a-15(c), as adopted by the SEC under the ExchangeAct.  In evaluating the effectiveness ofthe Company’s internal control over financial reporting, management used theframework established in “*InternalControl—Integrated Framework*,” issued by the Committee of SponsoringOrganizations of the Treadway Commission (‘COSO).

 

Basedon this evaluation, management concluded that as of December 31, 2009, theCompany’s internal control over financial reporting was effective.

 

Thisannual report does not include an attestation report of the Company’sindependent registered public accounting firm regarding internal control overfinancial reporting. Management’s report was not subject to attestation by theCompany’s independent registered public accounting firm pursuant to the rules ofthe Securities and Exchange Commission that permit the Company to provide onlymanagement’s report in this annual report.

 

 
| /s/  John F. Coger                  |   |
|-------------------------------------|--------|
| John  F. Coger                      |   |
| President,  Chief Executive Officer |   |
|                                |   |
| /s/  Barbara A. Crouse              |   |
| Barbara  A. Crouse                  |   |
| Senior  Vice President, CFO         |   |
|                                |   |
| April 15,  2010                |   |

 

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**Item 9b. Other Information**

 

Notapplicable

 

**PART III**

 

**Item 10. Directors and Executive Officers andCorporate Governance**

 

Theinformation required by Item 10 of Form 10-K is incorporated by referenceto the information contained in the Company’s Proxy Statement for the 2009Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A.

 

**Item 11. Executive Compensation**

 

Theinformation required by Item 11 of Form 10-K is incorporated by referenceto the information contained in the Company’s Proxy Statement for the 2009Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A.

 

**Item 12. Security Ownership of Certain BeneficialOwners and Management and Related Stockholder Matters**

 

Theinformation required by Item 12 of Form 10-K is incorporated by referenceto the information contained in the Company’s Proxy Statement for the 2009Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A.

 

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

 

Theinformation required by Item 13 of Form 10-K is incorporated by referenceto the information contained in the Company’s Proxy Statement for the 2009Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A.

 

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

 

Theinformation required by Item 14 of Form 10-K is incorporated by referenceto the information contained in the Company’s Proxy Statement for the 2009Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A.

 

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**PART IV**

 

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

 

(a)           **List of documents filed as partof this report**

 

**(1)**           **Financial Statements**

 

The following financialstatements and independent auditor’s reports are included in this Annual Reporton Form 10-K immediately following. 

 
| I.   |   | Report of  Independent Registered Public Accounting Firm                                                             |
|------|--------|----------------------------------------------------------------------------------------------------------------------|
| II.  |   | Consolidated Balance  Sheet - December 31, 2009 and 2008                                                        |
| III. |   | Consolidated  Statement of Operations - Years Ended December 31, 2009, 2008 and 2007                            |
| IV.  |   | Consolidated  Statement of Changes in Shareholders’ Equity - Years Ended December 31,  2009, 2008 and 2007 |
| V.   |   | Consolidated  Statement of Cash Flows - Years Ended December 31, 2009, 2008 and 2007                            |
| VI.  |   | Notes to the  Consolidated Financial Statements                                                                      |

 

**(2)**        **FinancialStatement Schedules**

 

Schedulesto the financial statements are omitted because the required information is notapplicable or because the required information is presented in the Company’sConsolidated Financial Statements or related notes.

 

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**(3)**        **Exhibits**

 

**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.                                                                                                                                                                                                                                               |
| (3.3)       |       | Amendment  to Bylaws of the Company approved by Shareholders May 2006.                                                                                                                                                                                                                                                                                            |
| (4.0)       |       | Specimen  of Company’s Common Stock Certificate incorporated by reference from the  Company’s Registration Statement Form S-4EF, file #333-85950.                                                                                                                                                                                                  |
| (4.1)       |       | Certificate  of Determination of 6% Mandatory Convertible Cumulative Preferred Stock,  Series A of Community Valley Bancorp filed with the State of California  on December 23, 2009. Specimen of Company’s Preferred Stock Certificate  Series A.                                                                                                 |
| (4.2)       |       | Certificate  of Determination of 8% Cumulative Perpetual Preferred Stock, Series B of  Community Valley Bancorp filed with the State of California on  December 23, 2009, Specimen of Company’s Preferred Stock Certificate  Series B.                                                                                                             |
| (10.1)      |       | 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.                          |
| (10.1)(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.                                                              |
| (10.1)(2)   |       | Additional  Salary Continuation Agreement with Keith C. Robbins dated September 12,  2006, incorporated by reference to the Company’s Annual Report on  Form 10-K for the period ended December 31, 2006, filed with the  Commission on March 12, 2007.                                                                                       |
| (10.2)      |       | 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.          |
| (10.3)      |       | 2000  Stock Option Agreement for Keith C Robbins dated March 14, 2000.  Previously filed as Exhibit 10.5 in 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)      |       | Employment  Agreement with John F Coger dated April 27, 1995. Previously filed as  Exhibit 10.6 in the Company’s Quarterly Report on Form 10-Q for the  period ended June 30, 2002, filed with the Commission on August 14,  2002.                                                                                                       |
| (10.5)      |       | Salary  Continuation Agreement dated April 14, 1998, and Amendment to Salary  Continuation Agreement dated January 10, 2002, for John F Coger.  Previously filed as Exhibit 10.7 in the Company’s Quarterly Report on  Form 10-Q for the period ended June 30, 2002, filed with the  Commission on August 14, 2002.                 |
| (10.5)(1)   |       | Amendment  to Salary Continuation Agreement of April 14, 1998 for John F  Coger dated January 1, 2004.  Previously filed as  Exhibit 10.7.1 in the Company’s Annual Report on Form 10-K for the  period ended December 31, 2003, filed with the Commission on March 20,  2004.                                            |
| (10.6)      |       | Executive  Supplemental Retirement Plan dated August 1, 2000, and Amendment to  Executive Supplement Retirement Plan dated January 10, 2002, for John F  Coger. Previously filed as Exhibit 10.8 in 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)      |       | 2000  Stock Option Agreement for John F. Coger dated March 14, 2000.  Previously filed as Exhibit 10.9 in the Company’s Quarterly Report on  Form 10-Q for the period ended June 30, 2002, filed with the  Commission on August 14, 2002                                                                                                 |
| (10.8)      |       | 2000  Stock Option Agreement for M Robert Ching dated May 1, 2000. Previously  filed as Exhibit 10.11 in 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 D Lanam dated May 1, 2000. Previously  filed as Exhibit 10.15 in 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)     |       | 2000  Stock Option Agreement for Donald W. Leforce dated May 1, 2000.  Previously filed as Exhibit 10.17 in 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 James S. Rickards dated May 1, 2000.  Previously filed as Exhibit 10.23 in the Company’s Quarterly Report on  Form 10-Q for the period ended June 30, 2002, filed with the  Commission on August 14, 2002                                                                                               |

 

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| (10.12) |   | 2000  Stock Option Agreement for Gary B Strauss dated May 1, 2000. Previously  filed as Exhibit 10.25 in 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 Barbara A Crouse dated December 24, 2002.                                                                                                                                                                                                                                                                         |
| (10.14) |   | Director  Deferred Fee Agreement for M. Robert Ching dated April 8, 1998.  Previously filed as Exhibit 10.28 in 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) |   | Director  Retirement Agreement for M. Robert Ching dated April 14, 1998.  Previously filed as Exhibit 10.29 in 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) |   | Director  Retirement Agreement for Eugene B. Even dated April 14, 1998. Previously  filed as Exhibit 10.30 in 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) |   | Director  Retirement Agreement for John D Lanam dated April 14, 1998. Previously  filed as Exhibit 10.31 in 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) |   | Director  Deferred Fee Agreement for Donald W. Leforce dated April 14, 1998. Previously  filed as Exhibit 10.32 in 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) |   | Director  Retirement Agreement for Donald W. Leforce dated April 14, 1998.  Previously filed as Exhibit 10.33 in 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) |   | Director  Retirement Agreement for Ellis L Matthews dated April 14, 1998.  Previously filed as Exhibit 10.34 in the Company’s Quarterly Report on  Form 10-Q for the period ended June 30, 2002, filed with the  Commission on August 14, 2002.                                                                           |
| (10.21) |   | Director  Retirement Agreement for Robert L. Morgan dated April 14, 1998.  Previously filed as Exhibit 10.35 in 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) |   | Director  Retirement Agreement James S. Rickards dated April 14, 1998. Previously  filed as Exhibit 10.36 in 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) |   | Director  Retirement Agreement for Gary B Strauss dated April 14, 1998. Previously  filed as Exhibit 10.37 in 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) |   | Director  Retirement Agreement for Hubert I Townshend dated April 14, 1998.  Previously filed as Exhibit 10.38 in 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) |   | Lease  agreement between Butte Community Bank and Anna Laura Schilling Trust dated  March 20, 2001, related to 900 Mangrove Ave, Chico, California. Previously  filed as Exhibit 10.39 in 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) |   | 2000  Stock Option Agreement for Luther W McLaughlin dated March 10, 2003.  Previously filed as Exhibit 10.41 in the Company’s Annual Report on  Form 10-K for the period ended December 31, 2005, filed with the  Commission on March 14, 2006.                                                                          |
| (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                                                                                                                                                                                                                                                         |
| (21)    |   | List  of Subsidiaries: Butte Community Bank, Butte Community Insurance Agency LLC,  Community Valley Trust II (unconsolidated) as listed in text of document                                                                                                                                                                                            |
| (23.1)  |   | Consent  of Independent 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                                                                                                                                                                                                                                                                                             |
| (99.3)  |   | 2000  Stock Option Plan is incorporated by reference from the Company’s  Registration Statement Form S-8, filed August 14, 2002.                                                                                                                                                                                                         |
| (99.4)  |   | 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.                                                                                                                      |

 

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(b) Reports on Form 8-K

 

OnJanuary 30, 2009 the Company issued a press release announcing earningsfor the fourth quarter and year ending December 31, 2008.

 

OnFebruary 23, 2009 the Company announced the retirement of Charles J.Mathews from the Board of Directors of Community Valley Bancorp.

 

OnApril 30, 2009 the company issued a press release announcing the earningsfor the first quarter of 2009.

 

OnAugust 06, 2009 the Company issued a press release announcing the earningsfor the second quarter of 2009.

 

OnSeptember 18, 2009 the Company issued a press release announcing thevoluntary delisting from The NASDAQ Capital Market.

 

OnNovember 16, 2009 the Company issued a press release announcing theearnings for the third quarter of 2009.

 

OnDecember 31, 2009 the Company issued a press release announcing theissuance of MandatoryConvertible Cumulative Preferred Stock Series A and Cumulative PerpetualPreferred Stock Series B (“Preferred Stock Series B”).

 

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**SIGNATURES**

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities and ExchangeAct of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned thereunto duly authorized.

 
| Dated:  April 15, 2010 | **COMMUNITY  VALLEY BANCORP** |
|-----------------------------|-------------------------------|
|                        | a  California corporation     |
|                        |                          |   |
|                        | By                            | */s/  John F. Coger* |
|                        |                          | John F. Coger |
|                        |                          | President and Chief Executive Officer |
|                        |                          |   |
|                        | By                            | */s/  Barbara A. Crouse* |
|                        |                          | Barbara A. Crouse |
|                        |                          | Senior Vice President  Chief Financial Officer |

 

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.

 
| **Signature**            | ** ** | **Title**                                        | ** ** | **Date**            |
|--------------------------|------------|--------------------------------------------------|------------|---------------------|
|                     |       |                                             |       |                |
| */s/  M. Robert Ching*   |       | Director                                         |       | April 15, 2010 |
| M. Robert Ching          |       |                                             |       |                |
|                     |       |                                             |       |                |
| */s/  John F. Coger*     |       | President, Chief  Executive Officer and Director |       | April 15, 2010 |
| John F. Coger            |       |                                             |       |                |
|                     |       |                                             |       |                |
| */s/Eugene  B. Even*     |       | Director                                         |       | April 15, 2010 |
| Eugene B. Even           |       |                                             |       |                |
|                     |       |                                             |       |                |
| */s/  John D. Lanam*     |       | Director                                         |       | April 15, 2010 |
| John D. Lanam            |       |                                             |       |                |
|                     |       |                                             |       |                |
| */s/  Donald W. Leforce* |       | Chairman of the Board                            |       | April 15, 2010 |
| Donald W. Leforce        |       |                                             |       |                |
|                     |       |                                             |       |                |
| */s/  Ellis L. Matthews* |       | Director                                         |       | April 15, 2010 |
| Ellis L. Matthews        |       |                                             |       |                |
|                     |       |                                             |       |                |
| */s/  Luther McLaughlin* |       | Director and Vice  Chairman                      |       | April 15, 2010 |
| Luther McLaughlin        |       |                                             |       |                |
|                     |       |                                             |       |                |
| */s/  Robert L. Morgan*  |       | Director                                         |       | April 15, 2010 |
| Robert L. Morgan         |       |                                             |       |                |
|                     |       |                                             |       |                |
| */s/  Keith C. Robbins*  |       | Director                                         |       | April 15, 2010 |
| Keith C. Robbins         |       |                                             |       |                |
|                     |       |                                             |       |                |
| */s/  James S. Rickards* |       | Director and Corporate  Secretary                |       | April 15, 2010 |
| James S. Rickards        |       |                                             |       |                |
|                     |       |                                             |       |                |
| */s/  Gary B. Strauss*   |       | Director                                         |       | April 15, 2010 |
| Gary B. Strauss          |       |                                             |       |                |
|                     |       |                                             |       |                |
| */s/  Hubert Townshend*  |       | Director                                         |       | April 15, 2010 |
| Hubert Townshend         |       |                                             |       |                |

 

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**COMMUNITY VALLEY BANCORP AND SUBSIDIARIES**

** **

**CONSOLIDATED FINANCIAL STATEMENTS**

 

**AS OF DECEMBER 31, 2009 AND 2008**

 

**AND FOR THE YEARS ENDED**

 

**DECEMBER 31, 2009, 2008 AND 2007**

 

**AND**

 

**REPORT OF INDEPENDENT REGISTERED**

 

**PUBLIC ACCOUNTING FIRM**

 

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**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

 

TheBoard of Directors and Shareholders

CommunityValley Bancorp and Subsidiaries

 

Wehave audited the accompanying consolidated balance sheet of Community ValleyBancorp and subsidiaries (the “Company”) as of December 31, 2009 and 2008,and the related consolidated statements of operations, changes in shareholders’equity and cash flows for each of the years in the three-year period ended December 31,2009.  These consolidated financialstatements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these consolidated financial statements based on our audits.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtainreasonable assurance about whether the consolidated financial statements arefree of material misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation.  Webelieve that our audits provide a reasonable basis for our opinion.

 

Inour opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the consolidated financial position ofCommunity Valley Bancorp and subsidiaries as of December 31, 2009 and 2008and the consolidated results of their operations and their cash flows for eachof the years in the three-year period ended December 31, 2009, inconformity with accounting principles generally accepted in the United Statesof America.

 

Theaccompanying consolidated financial statements have been prepared assumingCommunity Valley Bancorp and subsidiaries will continue as a goingconcern.  As discussed in Note 12 to theconsolidated financial statements, quantitative measures established byregulation to ensure capital adequacy require the Company and its subsidiary,Butte Community Bank (“the Bank”), to maintain minimum amounts and ratios oftotal and Tier 1 capital (as defined in the regulations) to risk-weightedassets (as defined), and of Tier 1 capital (as defined) to average assets (asdefined).  In addition, the Bank entered intoan informal joint Memorandum of Understanding with the Federal DepositInsurance Corporation (“FDIC”) and the California Department of FinancialInstitutions (“DFI”) that requires it to increase Tier 1 capital to an amountto equal or exceed 10% of adjusted average assets.  At December 31, 2009, the Company andthe Bank are considered to be undercapitalized under the above regulatoryguidelines, and, accordingly, may be subject to further adverse regulatoryaction.  In addition, management expectsto receive a formal consent order (“Order”) from the FDIC and DFI as a resultof its 2010 regulatory examination which will replace the Bank’s Memorandum ofUnderstanding.  The Order is expected toinclude more stringent provisions to augment regulatory capital, to include acapital restoration plan acceptable to the regulators, and strengthen assetquality.  The Bank has suffered recurringasset deterioration and recorded a loss of $26,470,000 for the year ended December 31,2009.  In management’s opinion, the Bankwill not be allowed to operate for a full year from the balance sheet datewithout additional capital.  Failure tomeet capital requirements and interim capital targets included in a capitalrestoration plan acceptable to the Bank’s regulators exposes the Bank toregulatory sanctions that may include restrictions on operations and growth,mandatory asset dispositions, and assumption of control of the Bank.  These matters raise substantial doubt aboutthe ability of the Company to continue as a going concern.  The ability of the Company to continue as agoing concern is dependent on many factors, to include achieving regulatorycapital levels acceptable to the FDIC and DFI, improving asset quality andmeeting future liquidity requirements. Management’s plans in regard to these matters are described in Note2.  The accompanying consolidatedfinancial statements do not include any adjustments that would be necessaryshould the Company be unable to continue as a going concern.

 

Wewere not required or engaged to examine the effectiveness of the Company’sinternal control over financial reporting as of December 31, 2009 and,accordingly, we do not express an opinion thereon.

 
|                    | /s/  Perry-Smith LLP |
|-------------------------|----------------------|
| Sacramento,  California |                 |
| April 15,  2010    |                 |

 

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**COMMUNITY VALLEY BANCORP ANDSUBSIDIARIES**

 

**CONSOLIDATED BALANCE SHEET**

 

**December 31, 2009 and 2008**

 
| ** **                                                                                                                                                                      | ** ** | **2009**    | ** **  | **2008**    | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|-------------|-------------|------------|
| **ASSETS**                                                                                                                                                                      |       |        |        |        |       |
|                                                                                                                                                                            |       |        |        |        |       |
| Cash  and due from banks                                                                                                                                                        |       | $           | 12,119,000  |        | $          | 21,743,000 |   |
| Federal  funds sold                                                                                                                                                             |       | 46,535,000  |        | 36,605,000  |       |
| Total  cash & cash equivalents                                                                                                                                         |       | 58,654,000  |        | 58,348,000  |       |
|                                                                                                                                                                            |       |        |        |        |       |
| Interest-bearing  deposits in banks                                                                                                                                             |       | 2,740,000   |        | 2,576,000   |       |
| Loans  held for sale at lower of cost or market                                                                                                                                 |       | 1,137,000   |        | 320,000     |       |
| Investment  securities                                                                                                                                                          |       |        |        |        |       |
| Available-for-sale,  at fair value                                                                                                                                              |       | 4,377,000   |        | 6,462,000   |       |
| Held-to-maturity,  at cost                                                                                                                                                      |       | 1,229,000   |        | 634,000     |       |
| Loans,  net of allowance for loan losses of $12,975,000 at December 31, 2009 and  $ 7,826,000 at December 31, 2008                                               |       | 420,036,000 |        | 486,522,000 |       |
| Premises  and equipment, net                                                                                                                                                    |       | 5,271,000   |        | 7,013,000   |       |
| Other  real estate                                                                                                                                                              |       | 13,493,000  |        | 2,068,000   |       |
| Bank  owned life insurance                                                                                                                                                      |       | 11,680,000  |        | 11,199,000  |       |
| Accrued  interest receivable and other assets                                                                                                                                   |       | 19,845,000  |        | 20,102,000  |       |
| Total  assets                                                                                                                                                                   |       | $           | 538,462,000 |        | $          | 595,244,000 |   |
| ** **                                                                                                                                                                      |       |        |        |        |       |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                                                                                                                  |       |        |        |        |       |
|                                                                                                                                                                            |       |        |        |        |       |
| Deposits:                                                                                                                                                                       |       |        |        |        |       |
| Non-interest  bearing                                                                                                                                                           |       | $           | 77,340,000  |        | $          | 82,159,000 |   |
| Interest  bearing                                                                                                                                                               |       | 420,823,000 |        | 444,326,000 |       |
| Total  deposits                                                                                                                                                                 |       | 498,163,000 |        | 526,485,000 |       |
|                                                                                                                                                                            |       |        |        |        |       |
| ESOP  and other notes payable                                                                                                                                                   |       | 1,122,000   |        | 5,054,000   |       |
| Junior  subordinated debentures                                                                                                                                                 |       | 8,248,000   |        | 8,248,000   |       |
| Accrued  interest payable and other liabilities                                                                                                                                 |       | 14,977,000  |        | 15,318,000  |       |
| Total  liabilities                                                                                                                                                              |       | 522,510,000 |        | 555,105,000 |       |
| ** **                                                                                                                                                                      |       |        |        |        |       |
| Commitments  and contingencies (Note 10)                                                                                                                                        |       |        |        |        |       |
|                                                                                                                                                                            |       |        |        |        |       |
| Shareholders’  equity                                                                                                                                                      |       |        |        |        |       |
| Preferred  stock - no par value; 10,000,000 shares authorized; issued and outstanding  -345,647 shares at December 31, 2009 and none outstanding at  December 31,2008 |       | 3,313,000   |        | —      |       |
| Common  stock - no par value; 20,000,000 shares authorized; issued and outstanding  -6,699,603 shares at December 31, 2009 and 6,699,553 at  December 31,2008         |       | 10,186,000  |        | 10,147,000  |       |
| Unallocated  ESOP shares 160,826 shares at December 31, 2009 and 124,207 shares at  December 31, 2008 (at cost)                                                       |       | (1,582,000  | )           | (1,438,000  | )          |
| Retained  earnings                                                                                                                                                              |       | 3,908,000   |        | 31,416,000  |       |
| Accumulated  other comprehensive income, net of taxes                                                                                                                           |       | 127,000     |        | 14,000      |       |
|                                                                                                                                                                            |       |        |        |        |       |
| Total  shareholders’ equity                                                                                                                                                |       | 15,952,000  |        | 40,139,000  |       |
| Total  liabilities and shareholders’ equity                                                                                                                                |       | $           | 538,462,000 |        | $          | 595,244,000 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

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**COMMUNITY VALLEY BANCORP AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENT OF OPERATIONS**

 

**For the Years Ended December 31, 2009, 2008 and 2007**

 
| ** **                                                  | ** ** | **2009**    | ** **  | **2008**   | ** ** | **2007**   | ** ** |
|-------------------------------------------------------------|------------|-------------|-------------|------------|------------|------------|------------|
| Interest  income:                                           |       |        |        |       |       |       |       |
| Interest  and fees on loans                                 |       | $           | 28,426,000  |       | $          | 35,849,000 |       | $ | 40,272,000 |   |
| Interest  on Federal funds sold                             |       | 96,000      |        | 602,000    |       | 2,475,000  |       |
| Interest  on deposits in banks                              |       | 74,000      |        | 389,000    |       | 182,000    |       |
| Interest  on investment securities:                         |       |        |        |       |       |       |       |
| Taxable                                                     |       | 205,000     |        | 410,000    |       | 229,000    |       |
| Exempt  from Federal income tax                             |       | 65,000      |        | 65,000     |       | 65,000     |       |
| Total  interest income                                      |       | 28,866,000  |        | 37,315,000 |       | 43,223,000 |       |
| ** **                                                  |       |        |        |       |       |       |       |
| Interest  expense:                                          |       |        |        |       |       |       |       |
| Interest  expense on deposits                               |       | 5,920,000   |        | 9,595,000  |       | 12,771,000 |       |
| Interest  expense on junior subordinated debentures         |       | 424,000     |        | 566,000    |       | 1,024,000  |       |
| Interest  expense on notes payable                          |       | 366,000     |        | 204,000    |       | 94,000     |       |
| Total  interest expense                                     |       | 6,710,000   |        | 10,365,000 |       | 13,889,000 |       |
| Net  interest income before provision for loan losses       |       | 22,156,000  |        | 26,950,000 |       | 29,334,000 |       |
| Provision  for loan losses                                  |       | 23,057,000  |        | 3,742,000  |       | (16,000    | )          |
| Net  interest (loss) income after provision for loan losses |       | (901,000    | )           | 23,208,000 |       | 29,350,000 |       |
|                                                        |       |        |        |       |       |       |       |
| Non-interest  income:                                       |       |        |        |       |       |       |       |
| Service  charges and fees                                   |       | 3,613,000   |        | 3,904,000  |       | 3,422,000  |       |
| Sale  of merchant processing portfolio                      |       | 2,640,000   |        | —     |       | —     |       |
| Gain  on sale of loans                                      |       | 1,612,000   |        | 1,102,000  |       | 1,506,000  |       |
| Loan  servicing income                                      |       | 1,119,000   |        | 556,000    |       | 395,000    |       |
| Loss  on sale of investment security                        |       | (172,000    | )           | —     |       | —     |       |
| Other                                                       |       | 2,957,000   |        | 3,377,000  |       | 3,152,000  |       |
| Total  non-interest income                                  |       | 11,769,000  |        | 8,939,000  |       | 8,475,000  |       |
|                                                        |       |        |        |       |       |       |       |
| Non-interest  expenses:                                     |       |        |        |       |       |       |       |
| Salaries  and employee benefits                             |       | 12,645,000  |        | 14,585,000 |       | 15,630,000 |       |
| Occupancy  and equipment                                    |       | 5,300,000   |        | 5,425,000  |       | 4,221,000  |       |
| Other  real estate                                          |       | 6,641,000   |        | 92,000     |       | 30,000     |       |
| FDIC  assessments                                           |       | 1,582,000   |        | 313,000    |       | 75,000     |       |
| Impairment  recognized on investment security               |       | —      |        | 1,489,000  |       | —     |       |
| Other                                                       |       | 6,104,000   |        | 6,372,000  |       | 6,971,000  |       |
| Total  non-interest expenses                                |       | 32,272,000  |        | 28,276,000 |       | 26,927,000 |       |
|                                                        |       |        |        |       |       |       |       |
| (Loss)  income before provision for income taxes            |       | (21,404,000 | )           | 3,871,000  |       | 10,898,000 |       |
|                                                        |       |        |        |       |       |       |       |
| Provision  for income taxes                                 |       | 6,104,000   |        | 1,132,000  |       | 4,439,000  |       |
|                                                        |       |        |        |       |       |       |       |
| Net  (loss) income                                          |       | $           | (27,508,000 | )          | $          | 2,739,000  |       | $ | 6,459,000 |   |
|                                                        |       |        |        |       |       |       |       |
| Basic  (loss) earnings per share                            |       | $           | (4.21       | )          | $          | 0.39       |       | $ | 0.87 |   |
| Diluted  earnings per share                                 |       | $           | —      |       | $          | 0.39       |       | $ | 0.85 |   |
|                                                        |       |        |        |       |       |       |       |
| Cash  dividends per share                                   |       | $           | —      |       | $          | 0.16       |       | $ | 0.32 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

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#### **COMMUNITY VALLEY BANCORP ANDSUBSIDIARIES**

####  

**CONSOLIDATED STATEMENT OF CHANGESIN SHAREHOLDERS’ EQUITY**

 

**For the Years Ended December 31, 2009, 2008 and 2007**

 
| ** **                                                                  | ** ** | **Preferred  Stock** | ** ** | **Common  Stock** | ** ** | **Unallocated** | ** ** | **Retained** | ** ** | **Accum-  ulated Other  Compre-  hensive** | ** ** | **Total  Shareholders’** | ** ** | **Comprehensive** | ** ** |
|-----------------------------------------------------------------------------|------------|----------------------|------------|-------------------|------------|-----------------|------------|--------------|------------|--------------------------------------------|------------|-------------------------------|------------|-------------------|------------|
| ** **                                                                  | ** ** | **Shares**           | ** ** | **Amount**        | ** ** | **Shares**      | ** ** | **Amount**   | ** ** | **ESOP  shares**                           | ** ** | **Earnings**                  | ** ** | **Income**        | ** ** | **Equity** | ** ** | **Income  (Loss)** | ** ** |
| Balance,  January 1, 2007                                              |       | —               |       | $                 | —     |            | 7,394,664  |         | $          | 9,727,000                                  |       | $                             | (1,514,000 | )                 | $          | 37,505,000 |   | $ | 9,000 |   | $ | 45,727,000 |   |   |   |
|                                                                        |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       |              |       |   |   |   |   |
| Comprehensive  income                                                       |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       |              |       |   |   |   |   |
| Net  income                                                                 |       |                 |       |              |       |            |       |         |       |                                       |       | 6,459,000                     |       |              |       | 6,459,000 |   | $ | 6,459,000 |   |
| Other  comprehensive income:                                                |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       |              |       |   |   |   |   |
| Net change  in unrealized gains on available-for-sale investment securities |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       | 8,000             |       | 8,000 |   | 8,000 |   |
| Total  comprehensive income                                                 |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       |              |       |   |   | $ | 6,467,000 |   |
|                                                                        |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       |              |       |   |   |   |   |
| Exercise  of stock options and related tax benefit                          |       |                 |       |              |       | 232,108         |       | 1,104,000    |       |                                       |       |                          |       |              |       | 1,104,000 |   |   |   |
| Amortization  of stock compensation - ESOP shares                           |       |                 |       |              |       |            |       | 65,000       |       | 107,000                                    |       |                          |       |              |       | 172,000 |   |   |   |
|                                                                        |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       |              |       |   |   |   |   |
| Cash  dividends- $.32 per share                                             |       |                 |       |              |       |            |       |         |       |                                       |       | (2,425,000                    | )          |              |       | (2,425,000 | ) |   |   |
|                                                                        |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       |              |       |   |   |   |   |
| Stock  based compensation expense                                           |       |                 |       |              |       |            |       | 139,000      |       |                                       |       |                          |       |              |       | 139,000 |   |   |   |
|                                                                        |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       |              |       |   |   |   |   |
| Repurchase  and retirement of common stock                                  |       |                 |       |              |       | (18,864         | )          | (125,000     | )          |                                       |       | (85,000                       | )          |              |       | (210,000 | ) |   |   |
| Balance,  December 31, 2007                                            |       | —               |       | —            |       | 7,607,908       |       | 10,910,000   |       | (1,407,000                                 | )          | 41,454,000                    |       | 17,000            |       | 50,974,000 |   |   |   |
|                                                                        |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       |              |       |   |   |   |   |
| Comprehensive  income                                                       |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       |              |       |   |   |   |   |
| Net  income                                                                 |       |                 |       |              |       |            |       |         |       |                                       |       | 2,739,000                     |       |              |       | 2,739,000 |   | $ | 2,739,000 |   |
| Other  comprehensive income:                                                |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       |              |       |   |   |   |   |
| Net  change in unrealized gains on available-for-sale investment securities |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       | (3,000            | )          | (3,000 | ) | (3,000 | ) |
| Total  comprehensive income                                                 |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       |              |       |   |   | $ | 2,736,000 |   |
|                                                                        |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       |              |       |   |   |   |   |
| Exercise  of stock options and related tax benefit                          |       |                 |       |              |       | 103,651         |       | 654,000      |       |                                       |       |                          |       |              |       | 654,000 |   |   |   |
| Amortization  of stock compensation— ESOP shares                       |       |                 |       |              |       |            |       | (8,000       | )          | 90,000                                     |       |                          |       |              |       | 82,000 |   |   |   |
|                                                                        |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       |              |       |   |   |   |   |
| Shares  acquired or redeemed by ESOP                                        |       |                 |       |              |       |            |       |         |       | (121,000                                   | )          |                          |       |              |       | (121,000 | ) |   |   |
| Cash  dividends- $.16 per share                                             |       |                 |       |              |       |            |       |         |       |                                       |       | (1,148,000                    | )          |              |       | (1,148,000 | ) |   |   |
|                                                                        |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       |              |       |   |   |   |   |
| Stock  based compensation expense                                           |       |                 |       |              |       |            |       | 80,000       |       |                                       |       |                          |       |              |       | 80,000 |   |   |   |
| Repurchase  and retirement of common stock                                  |       |                 |       |              |       | (1,012,006      | )          | (1,489,000   | )          |                                       |       | (11,629,000                   | )          |              |       | (13,118,000 | ) |   |   |
| Balance,  December 31, 2008                                            |       | —               |       | —            |       | 6,699,553       |       | 10,147,000   |       | (1,438,000                                 | )          | 31,416,000                    |       | 14,000            |       | 40,139,000 |   |   |   |
|                                                                        |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       |              |       |   |   |   |   |   |   |   |   |   |   |
| Comprehensive  loss                                                         |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       |              |       |   |   |   |   |
| Net  loss                                                                   |       |                 |       |              |       |            |       |         |       |                                       |       | (27,508,000                   | )          |              |       | (27,508,000 | ) | $ | (27,508,000 | ) |
| Other  comprehensive income                                                 |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       |              |       |   |   |   |   |
| Net  change in unrealized gains on available-for-sale investment securities |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       | 113,000           |       | 113,000 |   | 113,000 |   |
| Total  comprehensive loss                                                   |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       |              |       |   |   | $ | (27,395,000 | ) |
|                                                                        |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       |              |       |   |   |   |   |
| Exercise  of stock options and related tax benefit                          |       |                 |       |              |       | 50              |       | —       |       |                                       |       |                          |       |              |       | — |   |   |   |
| Amortization  of stock compensation — ESOP shares                      |       |                 |       |              |       |            |       | (16,000      | )          | 72,000                                     |       |                          |       |              |       | 56,000 |   |   |   |
|                                                                        |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       |              |       |   |   |   |   |
| Shares  acquired or redeemed by ESOP                                        |       |                 |       |              |       |            |       |         |       | (216,000                                   | )          |                          |       |              |       | (216,000 | ) |   |   |
|                                                                        |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       |              |       |   |   |   |   |
| Sale  of stock - Preferred A                                                |       | 240,000              |       | 1,200,000         |       |            |       |         |       |                                       |       |                          |       |              |       | 1,200,000 |   |   |   |
| Sale  of stock - Preferred B                                                |       | 105,647              |       | 2,113,000         |       |            |       |         |       |                                       |       |                          |       |              |       | 2,113,000 |   |   |   |
|                                                                        |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       |              |       |   |   |   |   |
| Stock  based compensation expense                                           |       |                 |       |              |       |            |       | 55,000       |       |                                       |       |                          |       |              |       | 55,000 |   |   |   |
|                                                                        |       |                 |       |              |       |            |       |         |       |                                       |       |                          |       |              |       |   |   |   |   |
| Balance,  December 31, 2009                                            |       | 345,647              |       | $                 | 3,313,000  |            | 6,699,603  |         | $          | 10,186,000                                 |       | $                             | (1,582,000 | )                 | $          | 3,908,000 |   | $ | 127,000 |   | $ | 15,952,000 |   |   |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

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**COMMUNITY VALLEY BANCORP AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENT OF CASHFLOWS**

** **

**For the Years Ended December 31, 2009, 2008 and 2007**

 
| ** **                                                                                | ** ** | **2009**    | ** **  | **2008**    | ** ** | **2007**   | ** ** |
|-------------------------------------------------------------------------------------------|------------|-------------|-------------|-------------|------------|------------|------------|
|                                                                                      |       |        |        |        |       |       |       |
| Cash  flows from operating activities:                                                    |       |        |        |        |       |       |       |
| Net  (loss) income                                                                        |       | $           | (27,508,000 | )           | $          | 2,739,000  |       | $ | 6,459,000 |   |
| Adjustments  to reconcile net (loss) income to net cash provided by operating activities: |       |        |        |        |       |       |       |
| Provision  for loan losses                                                                |       | 23,057,000  |        | 3,742,000   |       | (16,000    | )          |
| Decrease  in deferred loan origination costs                                              |       | (295,000    | )           | (210,000    | )          | (113,000   | )          |
| Net  loss on sale and write-down of other real estate                                     |       | 6,438,000   |        | —      |       | —     |       |
| Loss  recognized on sale of investment security                                           |       | 172,000     |        | —      |       | —     |       |
| Depreciation,  amortization, and accretion, net                                           |       | 1,910,000   |        | 2,081,000   |       | 2,100,000  |       |
| Increase  in cash surrender value of bank-owned life insurance, net                       |       | (421,000    | )           | (564,000    | )          | (383,000   | )          |
| Non-cash  compensation expense associated with the ESOP                                   |       | 56,000      |        | 82,000      |       | 172,000    |       |
| Stock  based compensation                                                                 |       | 55,000      |        | 80,000      |       | 139,000    |       |
| Excess  tax benefit from exercise of stock-based compensation awards                      |       | —      |        | (166,000    | )          | (428,000   | )          |
| Impairment  recognized on investment security                                             |       | —      |        | 1,489,000   |       | —     |       |
| (Gain)  loss on disposition of premises and equipment                                     |       | (22,000     | )           | (9,000      | )          | 28,000     |       |
| Net  (increase) decrease in loans held for sale                                           |       | (817,000    | )           | (320,000    | )          | 790,000    |       |
| Increase  in accrued interest receivable and other assets                                 |       | (10,297,000 | )           | (771,000    | )          | (1,805,000 | )          |
| Decrease  (increase) in accrued interest payable and other liabilities                    |       | (341,000    | )           | 4,862,000   |       | 1,060,000  |       |
| Provision  for deferred income taxes and establishment of valuation allowance             |       | 10,292,000  |        | (4,448,000  | )          | (612,000   | )          |
| Net  cash provided by operating activities                                                |       | 2,279,000   |        | 8,587,000   |       | 7,391,000  |       |
|                                                                                      |       |        |        |        |       |       |       |
| Cash  flows from investing activities:                                                    |       |        |        |        |       |       |       |
| Purchase  of held-to-maturity investment securities                                       |       | (996,000    | )           | (1,750,000  | )          | —     |       |
| Purchase  of available-for-sale investment securities                                     |       | (1,000,000  | )           | (6,007,000  | )          | (3,437,000 | )          |
| Proceeds  from matured or called available-for-sale investment securities                 |       | 3,000,000   |        | 4,000,000   |       | 2,000,000  |       |
| Proceeds  from sale of called available-for-sale investment securities                    |       | 89,000      |        | 1,000,000   |       | —     |       |
| Proceeds  from principal payments on available-for-sale investment securities             |       | 275,000     |        | 211,000     |       | 133,000    |       |
| Proceeds  from principal payments on held-to-maturity investment securities               |       | 144,000     |        | 223,000     |       | 175,000    |       |
| Net  decrease (increase) in interest-bearing deposits in banks                            |       | (164,000    | )           | 1,674,000   |       | (1,972,000 | )          |
| Net  decrease (increase) in loans                                                         |       | 22,587,000  |        | (50,842,000 | )          | 1,030,000  |       |
| Premiums  paid for life insurance policies                                                |       | (60,000     | )           | (434,000    | )          | (20,000    | )          |
| Acquisition  of other real estate                                                         |       | (371,000    | )           | —      |       |       |       |
| Proceeds  from sale of other real estate                                                  |       | 3,645,000   |        | —      |       | —     |       |
| Purchases  of premises and equipment                                                      |       | (182,000    | )           | (900,000    | )          | (4,712,000 | )          |
| Proceeds  from sale of premises and equipment                                             |       | 30,000      |        | 9,717,000   |       | 43,000     |       |
| Net  cash provided by (used in) investing activities                                      |       | 26,997,000  |        | (43,108,000 | )          | (6,760,000 | )          |
|                                                                                           |            |             |             |             |            |            |            |  |  |  |

 

(Continued)

 

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**COMMUNITY VALLEY BANCORP AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENT OF CASHFLOWS**

**(continued)**

**For the Years Ended December 31, 2009, 2008 and 2007**

 
| ** **                                                                               | ** ** | **2009**    | ** ** | **2008**    | ** ** | **2007**    | ** ** |
|------------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|
| Cash  flows from financing activities:                                                   |       |        |       |        |       |        |       |
| Net  increase (decrease) in demand, interest-bearing and savings deposits                |       | $           | 3,350,000  |        | $          | (1,902,000  | )          | $ | 27,408,000 |   |
| Net  (decrease) increase in time deposits                                                |       | (31,672,000 | )          | 27,396,000  |       | (11,273,000 | )          |
| Proceeds  from notes payable                                                             |       | —      |       | 4,000,000   |       | (124,000    | )          |
| Repayment  of notes payable                                                              |       | (500,000    | )          | —      |       | —      |       |
| Proceeds  from ESOP note payable                                                         |       | 216,000     |       | 120,000     |       | —      |       |
| Repayments  of ESOP note payable                                                         |       | (148,000    | )          | (159,000    | )          | —      |       |
| Purchase  of unallocated ESOP shares                                                     |       | (216,000    | )          | (121,000    | )          | —      |       |
| Proceeds  from exercise of stock options, including tax benefit                          |       | —      |       | 654,000     |       | 1,104,000   |       |
| Payment  of cash dividends                                                               |       | —      |       | (1,757,000  | )          | (2,408,000  | )          |
| Repurchase  and retirement of common stock                                               |       | —      |       | (13,118,000 | )          | (210,000    | )          |
| (Repayment)  proceeds from issuance of junior subordinated debentures                    |       | —      |       | (8,248,000  | )          | 8,248,000   |       |
| Net  cash (used in) provided by financing activities                                     |       | (28,970,000 | )          | 6,865,000   |       | 22,745,000  |       |
|                                                                                     |       |        |       |        |       |        |       |
| Decrease  (increase) in cash and cash equivalents                                        |       | 306,000     |       | (27,656,000 | )          | 23,376,000  |       |
|                                                                                     |       |        |       |        |       |        |       |
| Cash  and cash equivalents at beginning of year                                          |       | 58,348,000  |       | 86,004,000  |       | 62,628,000  |       |
|                                                                                     |       |        |       |        |       |        |       |
| Cash  and cash equivalents at end of year                                                |       | $           | 58,654,000 |        | $          | 58,348,000  |       | $ | 86,004,000 |   |
|                                                                                     |       |        |       |        |       |        |       |
|                                                                                     |       |        |       |        |       |        |       |
| Supplemental  disclosure of cash flow information:                                       |       |        |       |        |       |        |       |
|                                                                                     |       |        |       |        |       |        |       |
| Cash  paid during the year for:                                                          |       |        |       |        |       |        |       |
| Interest                                                                                 |       | $           | 7,009,000  |        | $          | 10,705,000  |       | $ | 13,940,000 |   |
| Income  taxes                                                                            |       | $           | 1,980,000  |        | $          | 5,830,000   |       | $ | 4,665,000 |   |
|                                                                                     |       |        |       |        |       |        |       |
| Non-cash  investing activities:                                                          |       |        |       |        |       |        |       |
| Conversion  of debt into preferred stock                                                 |       | $           | 3,313,000  |        | —     |        | —     |   |
| Real  estate acquired through foreclosure                                                |       | $           | 21,137,000 |        | $          | 2,068,000   |       | $ | — |   |
| Net  change in unrealized gains on available-for-sale investment securities, net  of tax |       | $           | 113,000    |        | $          | (3,000      | )          | $ | 8,000 |   |
|                                                                                     |       |        |       |        |       |        |       |
| Non-cash  financing activities:                                                          |       |        |       |        |       |        |       |
| Release  of unallocated ESOP shares                                                      |       | $           | 72,000     |        | $          | 90,000      |       | $ | 107,000 |   |
| Accrual  of cash dividend declared                                                       |       | $           | —     |        | $          | —      |       | $ | 609,000 |   |
| Excess tax benefit from exercise of stock-based  compensation awards                     |       | $           | —     |        | $          | 166,000     |       | $ | 428,000 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

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##### **COMMUNITY VALLEY BANCORP ANDSUBSIDIARIES**

#####  

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

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

 

General

 

In May 2002, Community Valley Bancorp (“Community Valley”) wasincorporated as a bank holding company for the purpose of acquiring ButteCommunity Bank (the “Bank”) in a one bank holding company reorganization. In2004, Community Valley changed its status to a Financial Holding Company forthe purpose of establishing Butte Community Insurance Agency LLC (“BCBIA”). Thenew corporate structure gives Community Valley, the Bank and BCBIA greaterflexibility in terms of operation, expansion and diversification.

 

Founded in 1990, the Bank is a state-chartered financial institutionwith fourteen branches in eleven cities including Anderson, Chico, Colusa,Corning, Magalia, Marysville, Oroville, Paradise, Redding, Red Bluff, and YubaCity and a loan production office in Citrus Heights. The Bank providestraditional deposit and lending services including commercial and constructionloans, government guaranteed loans such as those available from the U.S.Department of Agriculture (USDA) and Small Business Administration (SBA),payroll services and investment services.

 

On July 10, 2007, Community Valley formed a wholly-ownedsubsidiary, Community Valley Bancorp Trust II (the “Trust”), which is aDelaware statutory business trust, for the purpose of issuing trust preferredsecurities. The proceeds from the Trust were used to redeem 100% of the trustpreferred securities issued by the 2002 Community Valley Bancorp Trust I.  After redemption, Community Valley Trust Iwas dissolved (see Note 9).

 

On December 1, 2004, Community Valley formed a wholly-ownedsubsidiary, Butte Community Insurance Agency LLC for the purpose of providinginsurance related services.

 

The deposits in the Bank are insured by the Federal DepositoryInsurance Corporation (“FDIC”) up to applicable legal limits.  The Bank is participating in the FDICTransaction Account Guarantee Program. Under that program, through December 31, 2010, allnoninterest-bearing transaction accounts are fully guaranteed by the FDIC forthe entire amount in the account. Coverage underthe Transaction Account Guarantee Program is in addition to and separate fromthe coverage available under the FDIC’s general deposit insurance rules.

 

The accounting andreporting policies of Community Valley Bancorp and its subsidiaries(collectively, the “Company”) conform with accounting principlesgenerally accepted in the United States of America and prevailing practicewithin the banking industry. The more significant of these policies applied inthe preparation of the accompanying consolidated financial statements arediscussed below.

 

Segment Information

 

Management has determined that since all of the banking products andservices offered by the Company are available in each branch of the Bank, allbranches are located within the same economic environment and management doesnot allocate resources based on the performance of different lending ortransaction activities, it is appropriate to aggregate the Bank branches andreport them as a single operating segment. No customer accounts for more than10 percent of revenues for the Company or the Bank.

 

Principlesof Consolidation

 

The accompanying consolidated financial statements include the accountsof Community Valley and its wholly-owned subsidiaries, Butte Community Bank andButte Community Insurance Agency LLC. Significant intercompany transactions andbalances have been eliminated in consolidation.

 

For financial reporting purposes, the Company’s investment in the Trustof $248,000 (see Note 9) is accounted for under the equity method and isincluded in accrued interest receivable and other assets on the consolidatedbalance sheet. The junior subordinated debentures issued and guaranteed by theCompany and held by the Trust are reflected as debt in the Company’sconsolidated balance sheet.

 

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Reclassifications

 

Certain reclassifications have been made to prior years’ balances toconform to classifications used in 2009.

 

Use of Estimates

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions. These estimates and assumptionsaffect the reported amounts of assets and liabilities at the date of thefinancial statements and the reported amounts of revenues and expenses duringthe reporting period. Actual results could differ from these estimates.

 

Cashand Cash Equivalents

 

For purposes of the consolidated statement of cash flows, cash and cashequivalents include cash and due from banks and Federal funds sold and otherinterest-bearing deposits in banks with maturities of less than 90 days atacquisition.  Federal funds are generallysold for one-day periods.

 

Investment Securities

 

Investmentsecurities are classified into the following categories:

 

·**             **Available-for-sale securities, reportedat fair value, with unrealized gains and losses excluded from earnings andreported, net of taxes, as accumulated other comprehensive income (loss) withinshareholders’ equity.

 

·**             **Held-to-maturity securities, whichmanagement has the positive intent and ability to hold, reported at amortizedcost, adjusted for the accretion of discounts and amortization of premiums.

 

Management determines the appropriate classification of its investmentsat the time of purchase and may only change the classification in certainlimited circumstances. All transfers between categories are accounted for atfair value. As of December 31, 2009 and 2008, the Company did not have anyinvestment securities classified as trading and there were no transfers ofsecurities between categories.

 

Gains or losses on the sale of investment securities are computed usingthe specific identification method. Interest earned on investment securities isreported in interest income, net of applicable adjustments for accretion ofdiscounts and amortization of premiums.

 

Investmentsecurities are evaluated for impairment on at least a quarterly basis and morefrequently when economic or market conditions warrant such an evaluation todetermine whether a decline in their value is other than temporary. Managementutilizes criteria such as the magnitude and duration of the decline and theintent and ability of the Company to retain its investment in the issues for aperiod of time sufficient to allow for an anticipated recovery in fair value,in addition to the reasons underlying the decline, to determine whether theloss in value is other than temporary. The term “other than temporary” is notintended to indicate that the decline is permanent, but indicates that theprospects for a near-term recovery of value is not necessarily favorable, orthat there is a lack of evidence to support a realizable value equal to orgreater than the carrying value of the investment. Once a decline in value isdetermined to be other than temporary and management does not intend to sellthe security or it is more likely than not that management will not be requiredto sell the security before recovery, only the portion of the impairment lossrepresenting credit exposure is recognized as a charge to earnings, with thebalance recognized as a charge to other comprehensive income. If managementintends to sell the security or it is more likely than not that the Companywill be required to sell the security before recovering its forecasted cost,the entire impairment loss is recognized as a charge to earnings.

 

Loans

 

Loansare stated at principal balances outstanding, except for loans transferred fromloans held for sale which are carried at the lower of principal balance ormarket value at the date of transfer, adjusted for accretion of discounts.Interest is accrued daily based upon outstanding loan balances. However, when,in the opinion of management, loans are considered to be impaired and thefuture collectibility of interest and principal is in serious doubt, loans areplaced on nonaccrual status and the accrual of interest income is suspended.Any interest accrued but unpaid is charged against income. Payments receivedare applied to reduce principal to the extent necessary to ensure collection.Subsequent payments on these loans, or payments received on nonaccrual loansfor which the ultimate collectibility of principal is not in doubt, are appliedfirst to earned but unpaid interest and then to principal.

 

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Substantiallyall loan origination fees, commitment fees, direct loan origination costs andpurchase premiums and discounts on loans are deferred and recognized as anadjustment of yield, to be amortized to interest income over the contractualterm of the loan. The unamortized balance of deferred fees and costs isreported as a component of net loans.

 

Loans Held for Sale, Loan Sales and Servicing Rights

 

The Company accounts for the transfer and servicing of financial assetsbased on the financial and servicing assets it controls and liabilities it hasincurred, derecognizes financial assets when control has been surrendered, andderecognizes liabilities when extinguished.

 

Servicing rights acquired through 1) a purchase or 2) the originationof loans which are sold with servicing rights retained are recognized asseparate assets or liabilities. Servicing assets or liabilities are recorded atthe difference between the contractual servicing fees and adequate compensationfor performing the servicing, and are subsequently amortized in proportion toand over the period of the related net servicing income or expense. Servicingassets are periodically evaluated for impairment. Fair values are estimatedusing discounted cash flows based on current market interest rates. Forpurposes of measuring impairment, servicing assets are stratified based on noterate and term. The amount of impairment recognized, if any, is the amount bywhich the servicing assets for a stratum exceed their fair value.

 

Any servicing assets in excess of the contractually specified servicingfees have been reclassified at fair value as an interest-only (IO) stripreceivable and treated like an available-for-sale security. The servicingasset, net of any required valuation allowance, and IO strip receivable areincluded in accrued interest and other assets. At December 31, 2009 and2008, IO strips were not significant.

 

*GovernmentGuaranteed Loans*

 

Included in the loan portfolio are loans which are 80% to 90%guaranteed by the Small Business Administration (SBA), U.S. Department ofAgriculture, Rural Business — Cooperative Service (RBS) and Farm ServicesAgency (FSA). The guaranteed portion of these loans may be sold to a thirdparty, with the Company retaining the unguaranteed portion. The Companygenerally receives a premium in excess of the adjusted carrying value of theloan at the time of sale. The Company may be required to refund a portionof the sales premium if the borrower defaults or the loan prepays within ninetydays of the settlement date.

 

The Company’s investment in the loan is allocated between the retainedportion of the loan, the servicing asset, the IO strip, and the sold portion ofthe loan based on their relative fair values on the date the loan is sold. Thegain on the sold portion of the loan is recognized as income at the time ofsale. The carrying value of the retained portion of the loan is discountedbased on the estimated value of a comparable non-guaranteed loan. The servicingasset and IO strip are recognized as discussed above. Significant futureprepayments of these loans will result in the recognition of additionalamortization of related servicing assets and an adjustment to the carryingvalue of related IO strips.

 

The Company serviced SBA, RBS and FSA government guaranteed loans forothers totaling $128,306,000 and $114,460,000 as of December 31, 2009 and2008, respectively.

 

*MortgageLoans*

 

TheCompany originates residential mortgage loans that are either held in theCompany’s loan portfolio or sold in the secondary market. Loans held for saleare carried at the lower of cost or market value. Market value is determined bythe specific identification method as of the balance sheet date or the datewhich the purchasers have committed to purchase the loans. At the time the loanis sold, the related right to service the loan is either retained, with theCompany recognizing the servicing asset, or released in exchange for a one-timeservicing-released premium. Loans subsequently transferred to the loanportfolio are transferred at the lower of cost or market value at the date oftransfer. Any difference between the carrying amount of the loan and itsoutstanding principal balance is recognized as an adjustment to yield by theinterest method.

 

The Company serviced loans for the Federal National MortgageAssociation (FNMA) totaling $ 70,434,000 and $9,308,000 as of December 31,2009 and 2008, respectively.  In September 2007,the Company sold the servicing rights for this portfolio of loans and continuedto originate and sell mortgage loans with servicing released through theremainder of 2007. In March 2008, the Company reentered the market andbegan servicing FNMA loans again. In January 2010, FNMA terminated themortgage selling contract due to the Company not meeting the minimum total riskbased capital ratio of 10% required to participate in the program.

 

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*Participation Loans*

 

The Company also serviced loans which it has participated with otherfinancial institutions totaling $2,519,000 and $2,622,000 as of December 31,2009 and 2008, respectively.

 

## Allowance for Loan Losses

##  

The allowance for loan losses is established through a provision forloan losses which is charged to expense. Additions to the allowance for loanlosses are expected to maintain the adequacy of the total allowance after loanlosses and loan growth. The allowance for loan losses is maintained to providefor losses related to impaired loans and other losses that can be reasonablyexpected to occur in the normal course of business. The determination of theallowance for loan losses is based on estimates made by management to includeconsideration of the character of the loan portfolio, specifically identifiedproblem loans, potential losses inherent in the portfolio taken as a whole andeconomic conditions in the Company’s service area.

 

Themethodology for evaluating the adequacy of the allowance for loan losses hastwo basic elements: first, the identification of impaired loans and themeasurement of impairment for each individual loan identified; and second, amethod for estimating a general allowance for loan losses.

 

Aloan is considered impaired when it is probable that all contractual principaland interest payments due will not be collected in accordance with the terms ofthe loan agreement. Impairment on individually identified loans that are notcollateral dependent is measured based on the present value of expected futurecash flows discounted at each loan’s original effective interest rate. Forloans that are collateral dependent, impairment is measured based on the fairvalue of the collateral less estimated selling costs.

 

Inestimating the general allowance of loan loses, the balance of the loanportfolio is grouped into segments that have common characteristics, such asloan type, collateral type or risk rating. Loans typically segregated by riskrating are those that have been assigned ratings (using regulatory definitions)of special mention, substandard and doubtful. Loans graded loss are generallycharged off immediately.

 

Foreach general allowance portfolio segment, loss factors are applied to calculatethe required allowance. These loss factors are based upon historical loss ratesadjusted for qualitative factors representing other significant factorsaffecting the loan portfolio including economic factors, credit policy andunderwriting, management and staff effectiveness, trends in delinquencies andlosses, and concentrations.

 

The Company’s Board of Directors reviews the adequacy of the allowancefor loan losses at least quarterly, to include considerationof the relative risks in the portfolio and current economic conditions. Theallowance for loan losses is adjusted based on that review if, in the judgmentof the Board of Directors and management, changes are warranted.

 

The allowance for loan losses at December 31, 2009 and 2008reflects management’s estimate of possible losses in the portfolio.

 

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

#####  

The Company maintains a separate allowance for losses related toundisbursed loan commitments. Management estimates the amount of probablelosses by applying the loss factors used in the allowance for loan lossmethodology to an estimate of the expected usage and applies the factor to theunused portion of undisbursed lines of credit. The allowance totaled $244,000and $293,000 at December 31, 2009 and 2008, respectively, and is includedin accrued interest payable and other liabilities on the balance sheet.

 

## OtherReal Estate

##  

The Company’s investment in other real estate, all of which is relatedto real estate acquired in full or partial settlement of loan obligations, was$13,493,000 and $2,068,000 at December 31, 2009 and 2008,respectively.  In 2009 subsequentwrite-downs totaled $5,528,000. There were no subsequent write-downs to otherreal estate in 2008. In 2009, twenty properties were sold with carrying valuestotaling $3,643,000 and net gains were recognized totaling $50,000. There wereno sales of other real estate in 2008. When property is acquired, any excess ofthe Company’s recorded investment in the loan balance 

 

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and accrued interest income over the estimated fair market value of theproperty less estimated costs to sell is charged to the allowance for loanlosses. When appropriate, a valuation allowance for losses on other real estateis maintained to provide for temporary declines in value.  Subsequent gains or losses on sales orwrite-downs resulting from further impairment are recorded in other income orexpenses as incurred.

 

Premisesand Equipment

 

Premises and equipment are carried at cost. Depreciation is determinedusing the straight-line method over the estimated useful lives of the relatedassets. The useful lives of premises are estimated to be thirty to thirty-nineyears. Leasehold improvements are amortized over the life of the improvement orthe life of the related lease, whichever is shorter. The useful lives offurniture, fixtures and equipment are estimated to be three to ten years. Whenassets are sold or otherwise disposed of, the cost and related accumulateddepreciation are removed from the accounts, and any resulting gain or loss isrecognized in income for the period. The cost of maintenance and repairs ischarged to expense as incurred.

 

The Company evaluates premises and equipment for financial impairmentas events or changes in circumstances indicate that the carrying amount of suchassets may not be fully recoverable.

 

Income Taxes

 

TheCompany files its income taxes on a consolidated basis with its subsidiaries.The allocation of income tax expense (benefit) represents each entity’sproportionate share of the consolidated provision for (benefit from) incometaxes.

 

TheCompany accounts for income taxes using the liability or balance sheet method.Under this method, deferred tax assets and liabilities are recognized for thetax consequences of temporary differences between the reported amounts ofassets and liabilities and their tax bases. Deferred tax assets and liabilitiesare adjusted for the effects of changes in tax laws and rates on the date ofenactment. On the consolidated balance sheet, net deferred tax assets(liabilities) are included in accrued interest receivable (payable) and otherassets (liabilities).

 

Thedetermination of the amount of deferred income tax assets which are more likelythan not to be realized is dependent upon historical cumulative pre-tax lossesand projections of future earnings which are subject to uncertainty andestimates that may change given economic conditions and other factors. Therealization of deferred income tax assets is assessed and a valuation allowanceis recorded if it is “more likely than not” that all or a portion of thedeferred tax assets will not be realized. All available evidence, both positiveand negative, is considered to determine whether, based on the weight of thatevidence, a valuation allowance is needed. Based upon management’s analysis ofavailable evidence, it was determined that it is “more likely than not” thatall of the deferred income tax assets as of December 31, 2009 will not befully realized and therefore a valuation allowance was recorded.

 

The Company uses acomprehensive model for recognizing, measuring, presenting and disclosing inthe financial statements tax positions taken or expected to be taken on a taxreturn.  A tax position is recognized asa benefit only if it is “more likely than not” that the tax position would besustained in a tax examination, with a tax examination being presumed tooccur.  The amount recognized is thelargest amount of tax benefit that is greater than 50% likely of being realizedon examination.  For tax positions notmeeting the “more likely than not” test, no tax benefit is recorded.

 

Interestexpense and penalties associated with unrecognized tax benefits, if any, areclassified as income tax expense in the consolidated statement of operation.

 

(Loss)Earnings Per Share

 

Basic (loss) earnings per share (EPS), which excludes dilution, iscomputed by dividing income available to common shareholders by theweighted-average number of common shares outstanding for the period, excludingthe effect of unallocated shares of the Employee Stock Ownership Plan.  Diluted EPS reflects the potential dilutionthat could occur if securities or other contracts to issue common stock, suchas stock options, result in the issuance of common stock which shares in theearnings of the Company.  The treasurystock method has been applied to determine the dilutive effect of stock optionsin computing diluted EPS. However, diluted earnings per share are not presentedwhen a loss occurs because the conversion of potential common stock isanti-dilutive.

 

ComprehensiveIncome (Loss)

 

Comprehensive income (loss) is a more inclusive financial reportingmethodology that includes disclosure of other comprehensive income (loss) thathistorically has not been recognized in the calculation of net income (loss).Unrealized gains or losses on the Company’s available-for-sale investmentsecurities and IO strips are the principle source of other comprehensive incomeor loss. Total comprehensive income (loss) and the components of accumulatedother comprehensive income (loss) are presented in the consolidated statementof changes in shareholders’ equity.

 

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Stock-BasedCompensation

 

TheCompany issues stock options under one shareholder approved stock-basedcompensation plan, the Community Valley Bancorp 2000 Stock Option Plan.  The Plan does not provide for the settlementof awards in cash and new shares are issued upon exercise of the options.  The plan requires that the option price maynot be less than the fair market value of the stock at the date the option isgranted, and that the stock must be paid for 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. Underthe Company’s 2000 stock option plan, 311,751 shares of common stock remainreserved for issuance to employees and directors. There are 127,092 shares thatare available for future grants.

 

Managementestimates the fair value of each option award as of the date of the grant usinga Black-Sholes-Merton option pricing model. Expected volatility is based on historical volatility of the Company’sstock over a preceding period commensurate with the expected term of theoption.  The expected term of optionsgranted is generally based on the historical experience behavior of full termoptions. The risk free interest rate for the expected term of the option isbased on U.S. Treasury yield curve in effect at the time of the grant.  The expected dividend yield was determinedbased on the budgeted cash dividends of the Company at the time of thegrant.  In addition to these assumptions,management makes estimates regarding pre-vesting forfeitures that will impacttotal compensation expense recognized under the Plan. No options were grantedduring 2009 or 2008.

 

Impact of NewFinancial Accounting Standards

 

*Accountingfor Transfers of Financial Assets*

 

In June 2009, theFASB issued ASC Topic 860 (previously SFAS No. 166), *Accountingfor Transfers of Financial Assets, an amendment of SFAS No. 140.*  This standard amends the derecognitionaccounting and disclosure guidance included in previously issuedstandards.  This standard eliminates theexemption from consolidation for qualifying special-purpose entities (SPEs) andalso requires a transferor to evaluate all existing qualifying SPEs todetermine whether they must be consolidated in accordance with ASC Topic810.  This standard also provides morestringent requirements for derecognition of a portion of a financial asset andestablishes new conditions for reporting the transfer of a portion of afinancial asset as a sale.  This standardis effective as of the beginning of the first annual reporting period that beginsafter November 15, 2009.  Managementis assessing the impact this standard may have on the Company’s financialcondition and results of operations.

 

*Transfersand Servicing*

 

In December 2009,the FASB issued Accounting Standards Update (ASU) No. 2009-16, *Transfers and Servicing (ASC Topic 860): Accounting for Transfers ofFinancial Assets,* which updates the derecognition guidance in ASCTopic 860 for previously issued SFAS No. 166.  This update reflects the Board’s response toissues entities have encountered when applying ASC 860, including: (1) requiresthat all arrangements made in connection with a transfer of financial assets beconsidered in the derecognition analysis, (2) clarifies when a transferredasset is considered legally isolated from the transferor, (3) modifies therequirements related to a transferee’s ability to freely pledge or exchangetransferred financial assets, and (4) provides guidance on when a portionof a financial asset can be derecognized. This update is effective for financial asset transfers occurring afterthe beginning of an entity’s first fiscal year that begins after November 15,2009.  Early adoption is prohibited.Management is assessing the impact of this standard on the Company’s financialcondition and results of operations.

 

*Improvementsto Financial Reporting of Interests in Variable Interest Entities*

 

In June 2009, theFASB issued ASC Topic 810 (previously SFAS No. 167), *Improvementsto Financial Reporting by Enterprises Involved with Variable Interest Entities.* This standard amends theconsolidation guidance applicable to variable interest entities.  The amendments to the consolidation guidanceaffect all entities currently within the scope of ASC Topic 810, as well asqualifying special-purpose entities that are currently excluded from the scopeof ASC Topic 810.  This standard iseffective as of the beginning of the first annual reporting period that beginsafter November 15, 2009. Management does not expect the adoption of thisstandard to have a material impact on the Company’s financial position orresults of operations.

 

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**2.****            ****GOINGCONCERN CONSIDERATIONS**

 

The Company incurred anet loss of $27,508,000 for the year ended December 31, 2009 and reportednet income of $2,739,000 and $6,459,000 for the years ended December 31,2008 and 2007, respectively. The 2009 loss was primarily the result ofsignificant increases in the provision for loan losses, increases in costsassociated with foreclosed real estate and continued compression of the netinterest margin caused by 2008 interest rate reductions, increased amounts ofnon-accrual loans and a decline in the amortization of net loan originationfees.  Furthermore, a valuation allowanceprovided against the Company’s deferred tax assets during the fourth quarter of2009 has also negatively impacted the Company’s results. This severe net losscaused the Bank to be undercapitalized, has restricted our operations and hashad a negative impact on our financial position and results of operations,including the adequacy of our liquidity and capital.

 

The accompanyingconsolidated financial statements have been prepared assuming the Company willcontinue as a going concern, which contemplates the realization of assets andthe discharge of liabilities in the normal course of business for theforeseeable future.  The Company hasdetermined that significant additional sources of liquidity and capital will berequired for it to continue operations through 2010 and beyond. The Company hasengaged a financial advisor to explore strategic alternatives to resolve thecapital deficiency. However, there can be no assurance that the Company will beable to maintain sufficient liquidity or to raise additional capital to satisfyregulatory requirements and meet obligations as they occur.   As described in Note 12, Regulatory Matters,the Company and the Bank did not meet either the minimum regulatory capitalrequirements or the leverage ratio requirement of 10% outlined in the Bank’sMemorandum of Understanding.  As such,the Company and the Bank are considered undercapitalized at December 31,2009, and, accordingly, may be subject to further adverse regulatoryaction.  In addition, management expectsto receive a formal order (“Order”) from the FDIC and the DFI as a result ofits 2010 regulatory examination which will replace the Bank’s Memorandum ofUnderstanding.  The Order is expected toinclude more stringent provisions to augment regulatory capital, furtherstrengthen and improve asset quality, enhance problem loan identificationpolicies and procedures and reduce the level of classified assets.  At this time, management does not know whatimpact the Order will have on the Company’s business strategies.  The accompanying financial statements do notreflect the impact, if any, of these conditions. Further, the regulators arecontinually monitoring liquidity and capital adequacy and evaluating theCompany’s ability to continue to operate in a safe and sound manner. The Bank’sregulators could, if deemed warranted, take further actions, including theassumption of control of the Bank, to protect the interests of depositorsinsured by the FDIC. The uncertainty regarding the Company’s ability to obtainadditional capital, improve asset quality and meet future liquidityrequirements raises substantial doubt about the Company’s ability to continueas a going concern.

 

Management’s primary focus is to strengthen theCompany’s operations and capital position. The Bank’s capital plan outlining its plans for attaining the requiredlevels of regulatory capital are included in its quarterly report to theregulators as required under the Memorandum of Understanding.  Various strategic options are being evaluatedand management continues to act upon both tactical and strategic alternativesto raise capital and restructure the Company’s balance sheet. The Companyformed a Board appointed Capital Augmentation Committee (“Committee”) and hasengaged a financial advisor to explore alternatives to assist the Company inresolving its capital deficiency issues. In this regard, the Committee has been in extensive discussions withseveral parties regarding the possibility of a substantial equity investment ora possible sale of the Company.  Inaddition, management has analyzed the impact of selling certain of the Bank’sbranches and restructuring certain components of the balance sheet that wouldrequire a less significant capital infusion and result in improvement to itscapital ratios.

 

In response to theMemorandum of Understanding, management has also developed a plan for improvingand sustaining bank earnings and improving the Bank’s overall riskprofile.  In general, the plan includes,but is not limited to, the following:

 

·**     **Establishing guidelines to improve the Bank’s overallrisk profile.

 

·**     **Evaluating capital management strategies, to includeraising capital through a private common stock or preferred stock offering,limiting growth and selling or disposing of certain assets.  Management and the Board of Directors arecurrently evaluating these options and have goals to execute the necessarystrategies to increase capital by the end of the second quarter of 2010.

 

·**     **Improving earnings performance by restructuring thebalance sheet to increase earning assets while limiting growth.  Financial performance will be positivelyaffected by reducing the level of nonperforming assets, controlling operatingexpenses, disposing of real estate acquired through foreclosure, and evaluatingthe Bank’s products and services offered to clients and the associated fee andpricing structures.

 

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·**     **Diversification of the loanportfolio away from construction and land development and commercial realestate.  We have several experiencedagricultural lenders with established relationships that go back many years.  We do not have a concentration in this areaand are emphasizing the importance of looking outside the commercial realestate type of lending to improve our concentration ratios.

 

While considerable risks to the Company’s futurefinancial performance exist, management believes the Company can effectivelyrespond to these risks and carry on operations while it implements thisstrategic plan and pursues opportunities with respect to augmenting capital. Ifsuccessfully implemented, The Company’s capital plan will address its near-termcapital resources and liquidity needs. However, there can be no guarantee thatany restructuring or recapitalization plan will be successfully implemented.

 

**3.****            ****INVESTMENTSECURITIES**

 

The amortized cost andestimated fair value of investment securities at December 31, 2009 and2008 consisted of the following:

 
| ** **                                        | ** ** | **2009**            | ** ** |
|---------------------------------------------------|------------|---------------------|------------|
| **Available for Sale**                            | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair Value** | ** ** |
|                                              |       |                |       |   |   |   |   |   |   |
| Debt  securities:                                 |       |                |       |   |   |   |   |   |   |
| U.S.  Government agencies                         |       | $                   | 2,807,000  |   | $ | 131,000 |   | $ | — |   | $ | 2,938,000 |   |
| Obligations  of states and political subdivisions |       | 1,358,000           |       | 81,000 |   | — |   | 1,439,000 |   |
|                                              |       | $                   | 4,165,000  |   | $ | 212,000 |   | $ | — |   | $ | 4,377,000 |   |

 
| ** **                                        | ** ** | **2008**            | ** ** |
|---------------------------------------------------|------------|---------------------|------------|
| ** **                                        | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair Value** | ** ** |
|                                              |       |                |       |   |   |   |   |   |   |
| Debt  securities:                                 |       |                |       |   |   |   |   |   |   |
| U.S.  Government agencies                         |       | $                   | 5,080,000  |   | $ | 24,000 |   | $ | (10,000 | ) | $ | 5,094,000 |   |
| Obligations  of states and political subdivisions |       | 1,358,000           |       | 16,000 |   | (6,000 | ) | 1,368,000 |   |
|                                              |       | $                   | 6,438,000  |   | $ | 40,000 |   | $ | (16,000 | ) | $ | 6,462,000 |   |

 

Net unrealized gains on available-for-sale investment securitiestotaling $212,000 and $24,000 were recorded net of $85,000 and $10,000 in taxexpenses, as accumulated other comprehensive income within shareholders’ equityat December 31, 2009 and 2008, respectively. There were no sales ofavailable-for-sale investment securities for the years ended December 31,2008 and 2007. There were no transfers of available-for-sale investmentsecurities in the years ended December 31, 2009, 2008 and 2007.

 

During its assessment of the investment portfoliofor other-than-temporary impairment of investment securities, managementconsiders many factors.  In cases where asecurity is of a type for which there is very little active trading, if any, managementmust consider other factors when conducting its evaluation.  As of December 31, 2008, the Companyheld one such security, a trust preferred security.  Although all scheduled interest payments hadbeen received through December 31, 2008, management considered otherfactors and made certain assumptions in reaching its conclusion.  Such factors and assumptions includedindependent indications of the fair value of the security, adverse conditionsrelated to the financial industry in general, the financial condition of theissuer, and certain assumptions regarding the impact of past events, currentconditions and the likelihood of future events and the timing of cash flows,including any recoveries. After giving consideration to all the above factors,management concluded that an other-than-temporary impairment had occurred andrecorded a $1,489,000 impairment charge through earnings on this trustpreferred security with an original par value of $1,750,000. The security wassold in January 2009 for gross proceeds of $89,000, and a loss of $172,000was recorded. There were no other sales of available-for-sale investmentsecurities for the year ended December 31. 2009.

 

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| ** **                | ** ** | **2009**            | ** ** |
|---------------------------|------------|---------------------|------------|
| **Held to Maturity**      | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair Value** | ** ** |
|                      |       |                |       |   |   |   |   |   |   |
| Debt  securities:         |       |                |       |   |   |   |   |   |   |
| U.S.  Government agencies |       | $                   | 1,229,000  |   | $ | 14,000 |   | $ | — |   | $ | 1,243,000 |   |
|                           |            |                     |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                | ** ** | **2008**            | ** ** |
|---------------------------|------------|---------------------|------------|
| ** **                | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair Value** | ** ** |
|                      |       |                |       |   |   |   |   |   |   |
| Debt  securities:         |       |                |       |   |   |   |   |   |   |
| U.S.  Government agencies |       | $                   | 373,000    |   | $ | 4,000 |   | $ | — |   | $ | 377,000 |   |
| Other  securities         |       | 261,000             |       | — |   | — |   | 261,000 |   |
|                      |       | $                   | 634,000    |   | $ | 4,000 |   | $ | — |   | $ | 638,000 |   |

 

Therewere no sales or transfers of held-to-maturity investment securities for theyears ended December 31, 2009, 2008 and 2007.

 

There were no investment securities with unrealizedlosses at December 31, 2009. Investment securities with unrealized lossesat December 31, 2008 are summarized and classified according to theduration of the loss period as follows:

 
| ** **                                        | ** ** | **2008**                | ** ** |
|---------------------------------------------------|------------|-------------------------|------------|
| ** **                                        | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total** | ** ** |
| ** **                                        | ** ** | **Fair Value**          | ** ** | **Unrealized  Losses** | ** ** | **Fair Value** | ** ** | **Unrealized  Losses** | ** ** | **Fair Value** | ** ** | **Unrealized  Losses** | ** ** |
|                                              |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| Debt securities:                                  |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| U.S. Government agencies                          |       | $                       | —     |   | $ | — |   | $ | 686,000 |   | $ | (10,000 | ) | $ | 686,000 |   | $ | (10,000 | ) |
| Obligations  of states and political subdivisions |       | 657,000                 |       | (6,000 | ) | — |   | — |   | 657,000 |   | (6,000 | ) |
|                                              |       | $                       | 657,000    |   | $ | (6,000 | ) | $ | 686,000 |   | $ | (10,000 | ) | $ | 1,343,000 |   | $ | (16,000 | ) |

 

Theamortized cost and estimated fair value of investment securities at December 31,2009, by contractual maturity, are shown below. Expected maturities will differfrom contractual maturities because the issuers of securities may have theright to call or prepay obligations with or without prepayment penalties.

 

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| ** **                                                | ** ** | **Available for Sale** | ** ** | **Held to Maturity**      | ** ** |
|-----------------------------------------------------------|------------|------------------------|------------|---------------------------|------------|
| ** **                                                | ** ** | **Amortized  Cost**    | ** ** | **Estimated  Fair Value** | ** ** | **Amortized  Cost** | ** ** | **Estimated  Fair Value** | ** ** |
|                                                      |       |                   |       |                      |       |   |   |   |   |
| Within  one year                                          |       | $                      | —     |                      | $          | — |   | $ | — |   | $ | — |   |
| After  one year through five years                        |       | 1,000,000              |       | 1,005,000                 |       | 1,000,000 |   | 1,001,000 |   |
| After  five years through ten years                       |       | 695,000                |       | 733,000                   |       | — |   | — |   |
| After  ten years                                          |       | 663,000                |       | 707,000                   |       |   |   |   |   |
|                                                      |       |                   |       |                      |       |   |   |   |   |
|                                                      |       | 2,358,000              |       | 2,445,000                 |       | 1,000,000 |   | 1,001,000 |   |
|                                                      |       |                   |       |                      |       |   |   |   |   |
| Investment  securities not due at a single maturity date: |       |                   |       |                      |       |   |   |   |   |
| SBA  loan pools                                           |       | 1,807,000              |       | 1,932,000                 |       | 229,000 |   | 242,000 |   |
|                                                      |       |                   |       |                      |       |   |   |   |   |
|                                                      |       | $                      | 4,165,000  |                      | $          | 4,377,000 |   | $ | 1,229,000 |   | $ | 1,243,000 |   |

 

Investmentsecurities with amortized costs totaling $3,445,000 and $4,356,000 and fairvalues totaling $3,446,000 and $4,382,000 were pledged to secure publicdeposits and treasury, tax and loan accounts at December 31, 2009 and2008, respectively.

 

**4.****            ****LOANSAND ALLOWANCE FOR LOAN LOSSES**

 

Outstandingloans are summarized as follows:

 
| ** **                 | ** ** | **December 31,** | ** **  |
|----------------------------|------------|-----------------------|-------------|
| ** **                 | ** ** | **2009**              | ** **  | **2008** | ** ** |
| Real  estate:              |       |                  |        |   |   |
| Mortgage                   |       | $                     | 228,678,000 |   | $ | 252,018,000 |   |
| Construction               |       | 22,990,000            |        | 65,004,000 |   |
| Commercial                 |       | 80,758,000            |        | 83,786,000 |   |
| Agriculture                |       | 38,444,000            |        | 28,628,000 |   |
| Installment                |       | 62,324,000            |        | 65,390,000 |   |
|                       |       |                  |        |   |   |
| Total  loans               |       | 433,194,000           |        | 494,826,000 |   |
|                       |       |                  |        |   |   |
| Deferred  loan fees, net   |       | (183,000              | )           | (478,000 | ) |
| Allowance  for loan losses |       | (12,975,000           | )           | (7,826,000 | ) |
|                       |       |                  |        |   |   |
| Total  net loans           |       | $                     | 420,036,000 |   | $ | 486,522,000 |   |

 

Changesin the allowance for loan losses were as follows:

 
| ** **                                | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|
| ** **                                | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance,  beginning of year               |       | $                                | 7,826,000  |   | $ | 5,232,000 |   | $ | 5,274,000 |   |
| Provision  charged/credited to operations |       | 23,057,000                       |       | 3,742,000 |   | (16,000 | ) |
| Losses  charged to allowance              |       | (18,062,000                      | )          | (1,158,000 | ) | (26,000 | ) |
| Recoveries                                |       | 154,000                          |       | 10,000 |   | — |   |
|                                      |       |                             |       |   |   |   |   |
| Balance,  end of year                     |       | $                                | 12,975,000 |   | $ | 7,826,000 |   | $ | 5,232,000 |   |

 

At December 31, 2009and 2008, impaired loans totaled $54,123,000 and $26,256,000,respectively.  Specific reserves recorded totaled $4,045,000 on impairedloans totaling $20,146,000 and specific reserves recorded totaled $1,156,000 onimpaired loans totaling $8,800,000 at December 31, 2009 and 2008,respectively.  The remaining impaired loans did not 

 

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require a specificreserve at December 31, 2009 or 2008.  The average recordedinvestment in impaired loans for the years ended December 31, 2009, 2008and 2007 was $26,735,000, $5,355,000 and $110,000, respectively.  Interestrecognized for cash payments received on impaired loans was not significant forthe years ended December 31, 2009, 2008 and 2007, respectively.   At December 31, 2009, the Company had$424,000 committed to lend additional funds to borrowers whose loans wererestructured.  At December 31, 2008,the Company was not committed to lend any additional funds to borrowers whoseloans were restructured.

 

At December 31, 2009 and 2008, nonaccrual loans totaled$51,075,000 and $14,885,000, respectively.  Interest foregone onnonaccrual loans totaled $1,967,000 for the year ended December 31, 2009,$262,000 for 2008 and $10,000 for 2007.  There were no loans greater thanninety days past due still accruing interest at December 31, 2009, 2008 or2007.

 

Salaries and employeebenefits totaling $406,000, $852,000 and $1,189,000 have been deferred as loanorigination costs for the years ended December 31, 2009, 2008 and 2007,respectively.

 

**5.****            ****ACCRUEDINTEREST RECEIVABLE AND OTHER ASSETS**

 

Accrued interest receivable and other assets consisted of thefollowing:

 
| ** **                   | ** ** | **December 31,** | ** ** |
|------------------------------|------------|-----------------------|------------|
| ** **                   | ** ** | **2009**              | ** ** | **2008** | ** ** |
|                         |       |                  |       |   |   |
| Accrued  interest receivable |       | $                     | 2,380,000  |   | $ | 3,838,000 |   |
| Deferred  tax assets, net    |       | —                |       | 10,282,000 |   |
| Loan  servicing assets       |       | 3,463,000             |       | 2,004,000 |   |
| Prepaid  expenses            |       | 5,144,000             |       | 1,358,000 |   |
| Income  tax receivable       |       | 6,149,000             |       | — |   |
| Other                        |       | 2,709,000             |       | 2,620,000 |   |
|                         |       |                  |       |   |   |
|                         |       | $                     | 19,845,000 |   | $ | 20,102,000 |   |

 

Originated servicing assets for Small Business Administration (SBA),Rural Business — Cooperative Service (RBS), Farm Services Agency (FSA) andresidential mortgage loans totaling $1,459,000, $900,000 and $232,000 wererecognized during the years ended December 31, 2009, 2008 and 2007,respectively.  Amortization of servicingassets totaled $590,000, $337,000 and $330,000 for the years ended December 31,2009, 2008 and 2007, respectively.  Inthe third quarter of 2007 the Company’s residential mortgage servicing assetswere sold for a one time pre tax gain of $730,000. In March of 2008, theCompany began servicing residential mortgage loans again.

 

**6.****            ****PREMISESAND EQUIPMENT**

 

Premisesand equipment consisted of the following:

 
| ** **                                      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **2009**              | ** ** | **2008** | ** ** |
|                                            |       |                  |       |   |   |
| Buildings  and improvements                     |       | $                     | 3,454,000  |   | $ | 3,454,000 |   |
| Furniture,  fixtures, and equipment             |       | 10,708,000            |       | 10,754,000 |   |
| Leasehold  Improvements                         |       | 2,467,000             |       | 2,469,000 |   |
|                                            |       |                  |       |   |   |
| ** **                                      |       | 16,629,000            |       | 16,677,000 |   |
|                                            |       |                  |       |   |   |
| Less  accumulated depreciation and amortization |       | 11,358,000            |       | 9,664,000 |   |
|                                            |       |                  |       |   |   |
| ** **                                      |       | $                     | 5,271,000  |   | $ | 7,013,000 |   |

 

Depreciation and amortization included in occupancy and equipmentexpense totaled $1,916,000, $2,084,000 and $2,108,000 for the years ended December 31,2009, 2008 and 2007 respectively.

 

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In February 2008, theCompany sold and simultaneously entered into long-term operating leaseagreements on seven of its properties with proceeds from the sale totaling$15,300,000 and a net gain of $5,592,000 which is being deferred and recognizedover the 15 year term of the leases. Gains recognized included in other non-interest income totaled $372,000and $326,000 for the years ended December 31, 2009 and 2008,respectively.  Rent expense recognized onthese leases was $1,204,000 and $1,156,000 for the years ended December 31,2009 and 2008, respectfully.  Futureminimum lease payments on the leases for the next five years are estimated tobe $1,236,000 per year, see Note 10.

 

**7.****            ****INTEREST-BEARINGDEPOSITS**

 

Interest-bearingdeposits consisted of the following:

 
| ** **                      | ** ** | **December 31,** | ** **  |
|---------------------------------|------------|-----------------------|-------------|
| ** **                      | ** ** | **2009**              | ** **  | **2008** | ** ** |
|                            |       |                  |        |   |   |
| Savings                         |       | $                     | 109,281,000 |   | $ | 107,129,000 |   |
| Money  market                   |       | 25,571,000            |        | 33,058,000 |   |
| NOW  accounts                   |       | 127,920,000           |        | 116,224,000 |   |
| Individual  retirement accounts |       | 10,726,000            |        | 8,918,000 |   |
| Time,  $100,000 or more         |       | 74,985,000            |        | 101,222,000 |   |
| Other  time                     |       | 72,340,000            |        | 77,775,000 |   |
|                            |       | $                     | 420,823,000 |   | $ | 444,326,000 |   |

 

Aggregateannual maturities of time deposits at December 31, 2009 are as follows:

 
| **Year Ending  December 31,** |   |      |        |
|------------------------------------|--------|-----------|-------------|
|                               |   |      |        |
| 2010                               |   | $         | 141,442,000 |   |
| 2011                               |   | 2,748,000 |        |
| 2012                               |   | 2,361,000 |        |
| 2013                               |   | 748,000   |        |
| 2014                               |   | 26,000    |        |
|                               |   |      |        |
|                               |   | $         | 147,325,000 |   |

 

Interest expense recognized on interest-bearing deposits consisted ofthe following:

 
| ** **                      | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
|                            |       |                             |       |   |   |   |   |
| Savings                         |       | $                                | 1,005,000  |   | $ | 2,039,000 |   | $ | 3,567,000 |   |
| Money  market                   |       | 288,000                          |       | 531,000 |   | 631,000 |   |
| NOW  accounts                   |       | 391,000                          |       | 634,000 |   | 919,000 |   |
| Individual  retirement accounts |       | 245,000                          |       | 298,000 |   | 343,000 |   |
| Time,  $100,000 or more         |       | 2,213,000                        |       | 3,407,000 |   | 3,729,000 |   |
| Other  time                     |       | 1,778,000                        |       | 2,686,000 |   | 3,582,000 |   |
|                            |       | $                                | 5,920,000  |   | $ | 9,595,000 |   | $ | 12,771,000 |   |

 

**8.****            ****NOTESPAYABLE AND OTHER BORROWING ARRANGEMENTS**

 

Employee Stock Ownership Plan (ESOP) Note

 

TheESOP obtained financing through a $1,300,000 unsecured line of credit fromanother financial institution with the Company acting as the guarantor (seeNote 15). The note has a variable interest rate, based on an independentindex, and a maturity date of October 16, 2016. The interest rate was5.75% at December 31, 2009 and 2008. Balances on the line of credittotaled $1,122,000 and $1,054,000 at December 31, 2009 and 2008,respectively.

 

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Pacific Coast Bankers’ Bank Note

 

AtDecember 31, 2008 the Company’s note payable to Pacific Coast Bankers’Bank (PCBB), bearing a variable interest rate indexed to the three month LIBORplus 3.25% and collateralized by all of the outstanding shares of common stockof Butte Community Bank, had an outstanding balance of $4,000,000.  A total of $500,000 was repaid during2009.  The remaining balance of$3,500,000, less the applied interest reserve held by PCBB of $187,000, wasextinguished through a loan participation and debt conversion agreement (“Agreement”).  The Agreement was entered into by theCompany, PCBB and certain accredited investors (“Investors”) who participatedin the PCBB loan, to include certain directors of the Company.  The Investors purchased a $1,200,000 portionof the note from PCBB for $1,000,000 and PCBB and the Investors converted thedebt into shares of the Company’s preferred stock on December 30,2009.  The fair value of the preferredstock issued was equal to the Company’s carrying amount of the debt.  (See Note 11 for further discussion of thepreferred stock.)

 

Short-term Borrowing Arrangements

 

TheCompany had a total of $15,000,000 in unsecured borrowing arrangements with twoof its correspondent banks at December 31, 2008.  There were no amounts outstanding under thesearrangements at that date.  Theseborrowing arrangements were suspended by the correspondent banks during 2009.  In February 2010, the Bank was approvedfor discount window access by the Federal Reserve Bank of San Francisco(FRB).  The Bank is currently in theprocess of pledging the required collateral for this borrowing arrangement.

 

**9.**                                      JUNIOR SUBORDINATED DEBENTURES

** **

CommunityValley Bancorp Trust I and II (CVB Trust I and II) are Delaware statutorybusiness trusts formed by the Company for the sole purpose of issuing trustpreferred securities fully and unconditionally guaranteed by the Company. Underapplicable regulatory guidance, the amount of trust preferred securities thatis eligible as Tier 1 capital is limited to twenty-five percent of the Company’sTier 1 capital on a pro forma basis. At December 31, 2009, the Companyincluded $4,389,000 of the trust preferred securities in its Tier 1 capital forregulatory capital purposes compared to the full amount of $8,000,000 at December 31,2008. At December 31, 2009, $3,611,000 of the trust preferred securitiesqualified for Tier 2 capital treatment.

 

In December 2002, the Company issued to CVB Trust I SubordinatedDebentures due December 31, 2032. Simultaneously, CVB Trust I issued 8,000floating rate trust preferred securities, with liquidation values of $1,000 persecurity, for gross proceeds of $8,000,000. The Subordinated Debenturesrepresent the sole assets of the Trust. The Subordinated Debentures areredeemable by the Company, subject to certain requirements.  On January 7, 2008, the Company, having metall of the redemption requirements, redeemed 100% of the Trust I SubordinatedDebentures primarily through utilizing the proceeds from the issuance of the July 2007Trust II Subordinated Debentures and dissolved CVB Trust I.

 

In July 2007, the Company issued to CVB Trust II SubordinatedDebentures due October 1, 2037. Simultaneously, CVB Trust II issued 8,000fixed rate trust preferred securities, with liquidation values of $1,000 persecurity, for gross proceeds of $8,000,000. The Subordinated Debenturesrepresent the sole assets of the Trust. The Subordinated Debentures areredeemable by the Company, subject to receipt by the Company of prior approvalfrom the Federal Reserve Bank (FRB), if then required under applicable capitalguidelines or policies of the FRB. The Company may redeem the SubordinatedDebentures held by CVB Trust II on any October 1st on or after October 1,2012. The redemption price shall be par plus accrued and unpaid interest,except in the case of redemption under a special event, which is defined in thedebenture. The fixed rate trust preferred securities are subject to mandatoryredemption to the extent of any early redemption of the Subordinated Debenturesand upon maturity of the Subordinated Debentures on October 1, 2037.

 

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 SubordinatedDebentures are the same and are computed on a 360-day basis. The statedinterest rate for the initial five year term of 7.14% was calculated on theclosing date of the transaction, July 10, 2007, using the three-monthLondon Interbank Offered Rate (LIBOR) plus 1.57%.  At the end of the initial five year periodthe rate will convert to a floating rate using the three-month LIBOR plus 1.57%for the remaining term.

 

Interest expense recognized by the Company for theyears ended December 31, 2009, 2008 and 2007 related to the subordinateddebentures was $424,000, $566,000 and $1,024,000, respectively. There was nodeferred interest payments at December 31, 2009, 2008 or 2007.

 

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In the first quarter of 2010, the Company elected todefer regularly scheduled interest payments on its outstanding $8,000,000 ofjunior subordinated notes relating to its trust preferred securities. Duringthe deferral period, interest will continue to accrue on the juniorsubordinated notes at the stated coupon rate, including the deferred interest. In addition,if the Company defers interest payments on the junior subordinated notes formore than 20 consecutive quarters, the Company would be in default under thegoverning agreements for such notes and the amount due under such agreementswould be immediately due and payable.

 

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

 

Leases

 

The Company leases certain of its branch offices under noncancellableoperating leases. These leases expire on various dates through 2023 and havevarious renewal options ranging from five to fifteen years. In February 2008,the Company sold and simultaneously entered into long-term operating leasearrangements on seven of its properties (see Note 5). Rental payments includeminimum rentals, plus adjustments for changing price indexes. Future minimumlease payments and sublease rental income are as follows:

 
| **Year Ending  December 31,** | ** ** | **Minimum  Lease  Payments** | ** ** | **Minimum  Sublease  Rental  Income** | ** ** |
|------------------------------------|------------|------------------------------|------------|---------------------------------------|------------|
|                               |       |                         |       |                                  |       |
| 2010                               |       | $                            | 2,094,000  |                                  | $          | 375,000 |   |
| 2011                               |       | 2,030,000                    |       | 265,000                               |       |
| 2012                               |       | 1,899,000                    |       | 162,000                               |       |
| 2013                               |       | 1,760,000                    |       | 77,000                                |       |
| 2014                               |       | 1,750,000                    |       | 44,000                                |       |
| Thereafter                         |       | 14,358,000                   |       | 120,000                               |       |
|                               |       |                         |       |                                  |       |
|                               |       | $                            | 23,891,000 |                                  | $          | 1,043,000 |   |

 

Rental expense included in occupancy and equipment expense totaled$2,256,000, $2,211,000 and $1,027,000 for the years ended December 31,2009, 2008 and 2007, respectively. Sublease income netted against the occupancyexpense totaled $377,000, $373,000 and $321,000 for the years ended December 31,2009, 2008 and 2007, respectively.

 

Financial Instruments With Off-Balance-Sheet Risk

 

TheCompany is a party to financial instruments with off-balance-sheet risk in thenormal course of business in order to meet the financing needs of itscustomers. These financial instruments include commitments to extend credit andstandby letters of credit. These instruments involve, to varying degrees,elements of credit and interest rate risk in excess of the amount recognized onthe consolidated balance sheet.

 

The Company’s exposure to credit loss in the event of nonperformance bythe other party for commitments to extend credit and standby letters of creditis represented by the contractual amount of those instruments. The Company usesthe same credit policies in making commitments and standby letters of credit asit does for loans included on the consolidated balance sheet.

 

The following financial instruments represent off-balance-sheet creditrisk:

 
| ** **                    | ** ** | **December 31,** | ** **  |
|-------------------------------|------------|-----------------------|-------------|
| ** **                    | ** ** | **2009**              | ** **  | **2008** | ** ** |
| ** **                    | ** ** | ** **            | ** **  | ** ** | ** ** |
| Commitments  to extend credit |       | $                     | 110,890,000 |   | $ | 147,614,000 |   |
| Standby  letters of credit    |       | $                     | 4,387,000   |   | $ | 6,482,000 |   |

 

Commitmentsto extend 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.

 

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Standby letters of credit are conditional commitments issued to guaranteethe performance of a customer to a third party. The credit risk involved inissuing standby letters of credit is essentially the same as that involved inextending loans to customers. The fair value of the liability related to thesestandby letters of credit, which represents the fees received for issuing theguarantees, was not significant at December 31, 2009 and 2008. The Companyrecognizes these fees as revenues over the term of the commitment or when thecommitment is used.

 

Commercial loan commitments and standby letters of credit representapproximately 23% of total commitments and are generally unsecured or securedby collateral other than real estate and have variable interest rates.Agricultural loan commitments represent approximately 20% of total commitmentsand are generally secured by crop assignments, accounts receivable and farmequipment and have variable interest rates. Real estate loan commitmentsrepresent approximately 20% of total commitments and are generally secured byproperty with a loan-to-value ratio not to exceed 80%. The majority of realestate commitments also have variable interest rates. Personal lines of creditand home equity lines of credit represent the remaining 37% of totalcommitments and are generally unsecured or secured by residential real estateand have both variable and fixed interest rates.

 

Concentrations of Credit Risk

 

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

 

Although the Company has a diversified loan portfolio, a substantialportion of its portfolio is secured by commercial and residential real estate.However, personal and business income represents the primary source ofrepayment for a majority of these loans.

 

In addition, the Company’s real estate mortgage and construction loansrepresent approximately 58% and 64% of outstanding loans at December 31,2009 and 2008, respectively. Management has been reducing concentration levels in these loan typesto assist with mitigating concentration risk. Collateral values associatedwith this lending concentration vary significantly based on the general levelof interest rates and both local and regional economic conditions. A continuedsubstantial decline in the performance of the economy in general or a continueddecline in real estate values in the Company’s primary market areas, inparticular, continue to have an adverse impact on the collectibility of theseloans.

 

CorrespondentBanking Agreements

 

The Company maintains funds on deposit with other federally insuredfinancial institutions under correspondent banking agreements. Those insuredfinancial institutions have elected to participate in the FDIC sponsoredTransaction Account Guarantee program. Under that program, through December 31,2010, all noninterest bearing transaction accounts are fully guaranteed by theFDIC for the entire amount in the account. Coverage under the TransactionAccount Guarantee program is in addition to and separate from the coverageavailable under the FDIC’s general deposit insurance rules.

 

FederalReserve Requirements

 

Banks are required to maintain reserves with the Federal Reserve Bankequal to a percentage of their reservable deposits less vault cash. The Bank’svault cash fulfilled its reserve requirement at December 31, 2009.

 

Contingencies

 

The Company is subject to legal proceedings and claims which arise inthe ordinary course of business. In the opinion of management, the amount ofultimate liability with respect to such actions will not materially affect theconsolidated financial position or consolidated results of operations of theCompany.

 

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

 

Preferred Stock

 

On December 30,2009, the Company, pursuant to a loan participation and debt conversionagreement (“Agreement”) converted $3,313,000 in outstanding debt intoshareholders’ equity by issuing Community Valley Bancorp preferred stock in aprivate placement transaction.  The $3,313,000 outstanding debt of theCompany was the net balance of the principal amount of a loan from PacificCoast Bankers’ Bank (“PCBB”) to the Company that was collateralized by all ofthe outstanding common stock of the Company’s bank subsidiary, Butte CommunityBank.  As part of the transaction, $1,200,000 of the $3,313,000 loan fromPCBB was participated by PCBB to certain accredited investors, includingcertain directors of the Company.  The participated debt of $1,200,000 wasthen converted into 240,000 shares of 6% Mandatory 

 

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ConvertibleCumulative Preferred Stock Series A (“Preferred Stock Series A”). The remaining $2,113,000 of $3,313,000 debt was converted into 105,647 sharesof 8% Cumulative Perpetual Preferred Stock Series B (“Preferred Stock Series B”)that was issued to PCBB.

 

Both Preferred Stock Series A and Preferred Stock Series Bare voting and have voting rights of one vote per share and have the samevoting rights as common shares. In addition, the Preferred Stock Series A,with a liquidation value of $5 per share and cumulative dividends at 6% perannum, are mandatorily and optionally convertible into common stock at aconversion ratio of $2 per common share, subject to adjustment. The PreferredStock Series B, with a liquidation value of $20 per share and cumulativedividends at 8% per annum, are perpetual in life and are optionally convertibleinto common stock at a conversion ratio of $2.50 per common share, subject toadjustment. As part of the debt conversion, all of the outstanding shares ofcommon stock of Butte Community Bank held as collateral for the $3,313,000 debtwere released to the Company. The Company has the option to redeem theoutstanding shares of Preferred Stock Series A and Preferred Stock Series Bat a premium of $0.25 and $2.00 per share, respectively, subject to approval ofthe FRB.

 

StockRepurchase Plan

 

InMarch 2008, the Company announced an offer to purchase up to 1,000,000shares of its common stock at a purchase price of $13.00.  Based on the final count by the depositaryfor the tender offer, shareholders properly tendered 1,572,907 shares of itscommon stock. On May 5, 2008 the Board of Directors elected to notexercise its oversubscription privileges in the tender offer to purchase morethan 1,000,000 properly tendered shares and purchased a total of 999,939 sharesfor $12,999,000 at $13.00 per share representing a pro-rata share of thetendered shares of 63.38%.

 

In2007 the Board of Directors approved a plan to repurchase up to $6,000,000 ofthe outstanding common stock of the Company. Stock repurchases were made fromtime to time on the open market or through privately negotiated transactions.The timing of purchases and the exact number of shares purchased was dependenton market conditions. The share repurchase program did not include specificprice targets or timetables and could have been suspended at any time byaction of the Board of Directors. During 2009 no shares were repurchased.During 2008, 12,067 shares were repurchased for $119,000 at an average price of$9.84 per share.  During 2007, 18,864shares were repurchased for $210,000 at an average price of $11.15 per share.

 

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Stock-BasedCompensation

 

Stock option activity for the years ended December 31, 2009, 2008and 2007 is summarized as follows:

 
| ** **                              | ** ** | **2009**    | ** ** | **2008**                               | ** ** | **2007**    | ** ** |
|-----------------------------------------|------------|-------------|------------|----------------------------------------|------------|-------------|------------|
| ** **                              | ** ** | **Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Incentive  Options                      |       |        |       |                                   |       |        |       |   |   |   |   |   |   |
|                                    |       |        |       |                                   |       |        |       |   |   |   |   |   |   |
| Options  outstanding, beginning of year |       | 247,035     |       | $                                      | 9.61       |        | 289,710    |   | $ | 8.48 |   | 438,196 |   | $ | 7.35 |   |
|                                    |       |        |       |                                   |       |        |       |   |   |   |   |   |   |
| Options  granted                        |       | —      |       |                                   |       | —      |       |   |   | 1,000 |   | 13.95 |   |
| Options  exercised                      |       | (50         | )          | 4.71                                   |       | (19,636     | )          | 4.69 |   | (138,332 | ) | 2.59 |   |
| Options  cancelled                      |       | (33,098     | )          | 10.68                                  |       | (23,039     | )          | 13.17 |   | (11,154 | ) | 10.70 |   |
|                                    |       |        |       |                                   |       |        |       |   |   |   |   |   |   |
| Options  outstanding, end of year       |       | 213,887     |       | 9.45                                   |       | 247,035     |       | 9.61 |   | 289,710 |   | 8.48 |   |
|                                    |       |        |       |                                   |       |        |       |   |   |   |   |   |   |
| Options  exercisable, end of year       |       | 201,687     |       | 9.03                                   |       | 213,699     |       | 8.78 |   | 229,240 |   | 8.28 |   |
|                                    |       |        |       |                                   |       |        |       |   |   |   |   |   |   |
| Non-Qualified  Options                  |       |        |       |                                   |       |        |       |   |   |   |   |   |   |
|                                    |       |        |       |                                   |       |        |       |   |   |   |   |   |   |
| Options  outstanding, beginning of year |       | 103,196     |       | 4.44                                   |       | 187,211     |       | 4.44 |   | 280,987 |   | 4.44 |   |
|                                    |       |        |       |                                   |       |        |       |   |   |   |   |   |   |
| Options  exercised                      |       | —      |       |                                   |       | (84,015     | )          | 4.71 |   | (93,776 | ) | 3.39 |   |
| Options  cancelled                      |       | (5,332      | )          | 9.66                                   |       | —      |       |   |   | — |   |   |   |
|                                    |       |        |       |                                   |       |        |       |   |   |   |   |   |   |
| Options  outstanding, end of year       |       | 97,864      |       | 4.92                                   |       | 103,196     |       | 5.17 |   | 187,211 |   | 4.93 |   |
|                                    |       |        |       |                                   |       |        |       |   |   |   |   |   |   |
| Options  exercisable, end of year       |       | 97,064      |       | 4.85                                   |       | 101,596     |       | 5.04 |   | 183,743 |   | 4.83 |   |
|                                         |            |             |            |                                        |            |             |            |  |  |  |  |  |  |  |  |  |

 

A summary of optionsoutstanding at December 31, 2009 follows:

 
| **Range of Exercise Prices** | ** ** | **Number of  Options  Outstanding  December 31,  2009** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Number of  Options  Exercisable  December 31,  2009** | ** ** | **Number of  Options  Expected to  Vest December  31, 2009** | ** ** |
|------------------------------|------------|--------------------------------------------------------------|------------|-----------------------------------------------------|------------|--------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| Incentive  Options           |       |                                                         |       |                                                |       |                                                         |       |                                                         |       |
| $4.54  - $7.12               |       | 124,077                                                      |       | 1.83 years                                          |       | 124,077                                                      |       | 124,077                                                      |       |
| $7.13  - $12.36              |       | 7,478                                                        |       | 3.63 years                                          |       | 7,478                                                        |       | 7,478                                                        |       |
| $12.37  - $13.99             |       | 45,332                                                       |       | 4.71 years                                          |       | 44,732                                                       |       | 45,320                                                       |       |
| $14.00  - $17.80             |       | 37,000                                                       |       | 5.95 years                                          |       | 25,400                                                       |       | 36,768                                                       |       |
|                         |       | 213,887                                                      |       |                                                |       | 201,687                                                      |       | 213,643                                                      |       |
|                         |       |                                                         |       |                                                |       |                                                         |       |                                                         |       |
| Non-qualified  Options       |       |                                                         |       |                                                |       |                                                         |       |                                                         |       |
| $4.71                        |       | 95,460                                                       |       | 0.33 years                                          |       | 95,460                                                       |       | 95,460                                                       |       |
| $13.25                       |       | 2,404                                                        |       | 5.18 years                                          |       | 1,604                                                        |       | 2,388                                                        |       |
|                         |       | 97,864                                                       |       |                                                |       | 97,064                                                       |       | 97,848                                                       |       |

 

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Theweighted average grant date fair value of options granted during the year endedDecember 31, 2007 was $6.02.  Therewere no options granted during 2009 or 2008.

 

Theaggregate intrinsic value is calculated as the difference between the exerciseprice of the underlying awards and the quoted price of the Company’s commonstock for options that were in-the-money at December 31, 2009. There wasno aggregate intrinsic value of options outstanding and no intrinsic value foroptions vested or expected to vest for the year ended December 31,2009.  There was no intrinsic value foroptions exercised for the years ended December 31, 2009 and 2008. Theintrinsic value of options exercised for the year ended December 31, 2007totaled $1,663,000. The total fair value of the options that vested during theyears ended December 31, 2009, 2008 and 2007 totaled $30,000, $109,000 and$535,000, respectively.

 

Thecompensation cost charged against income for stock options was $55,000,$80,000, and $139,000 for the years ended December 31, 2009, 2008 and 2007,respectively. There were no income tax benefits recognized for the year ended December 31,2009. Income tax benefits recognized for the years ended December 31, 2008and 2007 totaled $166,000 and $428,000, respectively. Management’s estimate ofexpected forfeitures for the remaining non-vested options is approximately 2%and compensation costs are recognized only for those equity awards expected tovest.

 

AtDecember 31, 2009, the total compensation cost related to non-vested stockoption awards granted to employees under the Company’s stock option plans butnot yet recognized was $39,000. Stock option compensation expense is recognizedon a straight-line basis over the vesting period of the option. This cost isexpected to be recognized over a weighted average remaining period of 2.0 yearsand will be adjusted for subsequent changes in estimated forfeitures.

 

Cashflows from the tax benefits resulting from tax deductions in excess ofcompensation cost recognized for those options (excess tax benefits) areclassified as a cash flow from financing activities in the consolidatedstatement of cash flows. There were no excess tax benefits for the year ended December 31,2009. These excess tax benefits for the years ended December 31, 2008and 2007 totaled $166,000 and $428,000, respectively.

 

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(Loss)Earnings Per Share

 

A reconciliation of the numerators and denominators ofthe basic and diluted (loss) earnings per share computations is as follows:

 
| **For the Year Ended**            | ** ** | **Net Income** | ** **  | **Weighted  Average  Number of  Shares  Outstanding** | ** ** | **Per Share  Amount** | ** ** |
|-----------------------------------|------------|----------------|-------------|-------------------------------------------------------|------------|-----------------------|------------|
|                              |       |           |        |                                                  |       |                  |       |
| December 31,  2009           |       |           |        |                                                  |       |                  |       |
|                              |       |           |        |                                                  |       |                  |       |
| Basic  and diluted loss per share |       | $              | (27,508,000 | )                                                     | 6,537,983  |                  | $          | (4.21 | ) |
|                              |       |           |        |                                                  |       |                  |       |
| December 31,  2008           |       |           |        |                                                  |       |                  |       |
|                              |       |           |        |                                                  |       |                  |       |
| Basic  earnings per share         |       | $              | 2,739,000   |                                                  | 6,940,876  |                  | $          | 0.39 |   |
|                              |       |           |        |                                                  |       |                  |       |
| Effect  of dilutive stock options |       |           |        | 67,962                                                |       |                  |       |
|                              |       |           |        |                                                  |       |                  |       |
| Diluted  earnings per share       |       | $              | 2,739,000   |                                                  | 7,008,838  |                  | $          | 0.39 |   |
|                              |       |           |        |                                                  |       |                  |       |
| December 31,  2007           |       |           |        |                                                  |       |                  |       |
|                              |       |           |        |                                                  |       |                  |       |
| Basic  earnings per share         |       | $              | 6,459,000   |                                                  | 7,416,874  |                  | $          | 0.87 |   |
|                              |       |           |        |                                                  |       |                  |       |
| Effect  of dilutive stock options |       |           |        | 195,085                                               |       |                  |       |
|                              |       |           |        |                                                  |       |                  |       |
| Diluted  earnings per share       |       | $              | 6,459,000   |                                                  | 7,611,959  |                  | $          | 0.85 |   |

 

Stockoptions totaling 122,000 were excluded from the computation of diluted earningsper share for the year ended December 31, 2008 due to the stock optionsbeing considered anti-dilutive.

 

**12.****         ****REGULATORY MATTERS**

 

Regulatory Agreements

 

Effective April 21,2009, in connection with the Bank’s regularly scheduled 2009 FDIC examination,the Bank entered into a Memorandum of Understanding (Memorandum) with the FDICand the California DFI. The Memorandum covers actions to be taken by the Boardof Directors and management including retaining qualified management,improving asset quality by reducing classified assets by collection orcharge-off, maintaining an adequate loan loss allowance, reducing the aggregateamount of credit outstanding for borrowers of non-owner occupied commercialreal estate and construction land development loans, improving the Bank’soverall risk profile, increasing the Bank’s Tier 1 to average assets capitalratio to equal or exceed 10% and not paying cash dividends without the priorwritten consent of the FDIC and DFI.  As of December 31, 2009, the Bank’sTier 1 capital to average assets ratio was 4.1%.

 

Effective July 30,2009, the Company entered into a Memorandum of Understanding with the FederalReserve Bank of San Francisco (FRB) to not declare or pay any dividends, makeany payments of principal or interest on trust preferred securities, or makeany other capital distributions without the prior written approval of the FRB;to not incur, increase or renew any exiting debt or guarantee any debt withoutthe prior written approval of the FRB; to comply with certain notice provisionsin the case of any new director or senior executive officer; and to comply withany legal restrictions regarding indemnification and severance payments toinstitution-affiliated parties without written approval from the FRB andconcurrence from the FDIC.

 

While management believesthat progress has been made in addressing many of the requirements set forth inthe Memorandums of Understanding, it is also management’s opinion that fullcompliance has not yet been achieved.

 

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Asa result of the regularly scheduled and recently concluded 2010 joint FDIC andDFI examination of the Bank, management expects to receive a formal order (“Order”)from the FDIC and the DFI which will replace the Bank’s Memorandum discussedabove.  The Order is expected to includemore stringent provisions to augment regulatory capital, strengthen and improveasset quality, enhance problem loan identification policies and proceduresincluding identification of impaired loans and troubled debt restructuredloans, reduce the level of classified assets and request regulatory approvalprior to paying any cash dividends. At this time, management does not know whatimpact the Order will have on the Company’s business strategies.

 

Regulatory Capital

 

The Company and the Bank are subject to certain regulatory capitalrequirements administered by the Board of Governors of the Federal ReserveSystem and the FDIC. Failure to meet these minimum capital requirements caninitiate certain mandatory, and possibly additional discretionary, actions byregulators that, if undertaken, could have a direct material effect on theCompany’s consolidated financial statements. Under capital adequacy guidelines,the Company and the Bank must meet specific capital guidelines that involvequantitative measures of their assets, liabilities and certain off-balancesheet items as calculated under regulatory accounting practices.  These quantitative measures are establishedby regulation and require that minimum amounts and ratios of total and Tier 1capital to risk-weighted assets and of Tier 1 capital to average assets bemaintained.  Capital amounts andclassifications are also subject to qualitative judgments by the regulatorsabout components,risk weightings and other factors. Accordingly, the regulators have requiredthe Bank to increase its Tier 1 to average assets capital ratio to equal orexceed 10% under the Memorandum of Understanding.   The Company and the Bank are considered tobe undercapitalized at December 31, 2009 under these regulatoryguidelines.

 

The Bank is alsosubject to additional capital guidelines under the regulatory framework forprompt corrective action.  To becategorized as well capitalized, the Bank must maintain minimum totalrisk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in thetable below.  At December 31, 2009,the Bank is considered undercapitalized under the prompt corrective capitalregulations and will be required to file a capital restoration plan and isautomatically subject to among other things, restrictions on dividends,restrictions on access to the Federal Reserve’s discount window, restrictionson asset growth, and being prohibited from opening new branches, makingacquisitions or engaging in new lines of business without the approval of theFDIC.

 

In an effort tostrengthen the Company’s operations and capital position and enable it tobetter withstand these continued adverse market conditions, the Company hasdeveloped capital initiatives which include the following components:

 

·      Improving assetquality through a combination of efforts to reduce the current balance ofclassified assets.

 

·      Prudentlymanaging credit risk exposures in the existing loan portfolio and tighteningcredit underwriting standards.

 

·      Prudentreduction in the asset size of the Bank commensurate with its liquidity andcapital requirements as the Company focuses on improving asset quality andimplementing necessary efficiency and risk management initiatives.

 

·      Continuing tomake progress on sale of OREO properties and loan workout solutions.

 

·      Continuing toimprove the net interest margin through prudent pricing while consideringliquidity, interest rate and credit risk.

 

·      Additionalexpense reduction actions.

 

·      Retaininginvestment bankers to assist in the identification of additional capitalsources and alternatives inclusive of a strategic combination.

 

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| ** **                                | ** ** | **Actual** | ** ** | **For Capital Adequacy  Purposes** | ** ** | **To Be Well Capitalized  Under Prompt Corrective  Action Provisions** | ** ** |
|-------------------------------------------|------------|------------|------------|----------------------------------------------|------------|------------------------------------------------------------------------------------------------------|------------|
| ** **                                | ** ** | **Amount** | ** ** | **Ratio**                                    | ** ** | **Minimum  Amount**                                                                                  | ** ** | **Minimum  Ratio** | ** ** | **Minimum  Amount** | ** ** | **Minimum  Ratio** | ** ** |
| ** **                                | ** ** | ** ** | ** ** | ** **                                   | ** ** | ** **                                                                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| December 31,  2009                   |       |       |       |                                         |       |                                                                                                 |       |   |   |   |   |   |   |
|                                      |       |       |       |                                         |       |                                                                                                 |       |   |   |   |   |   |   |
| Company:                                  |       |       |       |                                         |       |                                                                                                 |       |   |   |   |   |   |   |
| Total  capital (to risk-weighted assets)  |       | $          | 29,560,000 |                                         | 6.2        | %                                                                                               | $          | 38,378,000 |   | 8.0 | % | n/a |   | n/a |   |
| Tier  1 capital (to risk-weighted assets) |       | $          | 16,555,000 |                                         | 3.5        | %                                                                                                    | $          | 19,189,000 |   | 4.0 | % | n/a |   | n/a |   |
| Tier  1 capital (to average assets)       |       | $          | 16,555,000 |                                         | 3.0        | %                                                                                                    | $          | 23,197,000 |   | 4.0 | % | n/a |   | n/a |   |
|                                      |       |       |       |                                         |       |                                                                                                 |       |   |   |   |   |   |   |
| Bank:                                     |       |       |       |                                         |       |                                                                                                 |       |   |   |   |   |   |   |
| Total  capital (to risk- weighted assets) |       | $          | 28,815,000 |                                         | 6.0        | %                                                                                                    | $          | 38,297,000 |   | 8.0 | % | $ | 47,871,000 |   | 10.0 | % |
| Tier  1 capital (to risk-weighted assets) |       | $          | 22,742,000 |                                         | 4.8        | %                                                                                                    | $          | 19,148,000 |   | 4.0 | % | $ | 28,723,000 |   | 6.0 | % |
| Tier  1 capital (to average assets)       |       | $          | 22,742,000 |                                         | 4.1        | %                                                                                                    | $          | 23,082,000 |   | 4.0 | % | $ | 28,852,000 |   | 5.0 | % |
| ** **                                |       |       |       |                                         |       |                                                                                                 |       |   |   |   |   |   |   |
| December 31,  2008                   |       |       |       |                                         |       |                                                                                                 |       |   |   |   |   |   |   |
|                                      |       |       |       |                                         |       |                                                                                                 |       |   |   |   |   |   |   |
| Company:                                  |       |       |       |                                         |       |                                                                                                 |       |   |   |   |   |   |   |
| Total  capital (to risk-weighted assets)  |       | $          | 53,668,000 |                                         | 10.0       | %                                                                                                    | $          | 42,390,000 |   | 8.0 | % | n/a |   | n/a |   |
| Tier  1 capital (to risk-weighted assets) |       | $          | 48,139,000 |                                         | 8.8        | %                                                                                                    | $          | 21,195,000 |   | 4.0 | % | n/a |   | n/a |   |
| Tier  1 capital (to average assets)       |       | $          | 48,139,000 |                                         | 8.1        | %                                                                                                    | $          | 23,608,000 |   | 4.0 | % | n/a |   | n/a |   |
|                                      |       |       |       |                                         |       |                                                                                                 |       |   |   |   |   |   |   |
| Bank:                                     |       |       |       |                                         |       |                                                                                                 |       |   |   |   |   |   |   |
| Total  capital (to risk- weighted assets) |       | $          | 54,822,000 |                                         | 10.4       | %                                                                                                    | $          | 42,348,000 |   | 8.0 | % | $ | 52,935,000 |   | 10.0 | % |
| Tier  1 capital (to risk-weighted assets) |       | $          | 48,187,000 |                                         | 9.1        | %                                                                                                    | $          | 21,174,000 |   | 4.0 | % | $ | 31,761,000 |   | 6.0 | % |
| Tier  1 capital (to average assets)       |       | $          | 48,187,000 |                                         | 8.2        | %                                                                                               | $          | 23,611,000 |   | 4.0 | %  | $ | 29,568,000 |   | 5.0 | % |

 

Dividend Restrictions

 

The holders of Common Stock of the Company will beentitled to receive dividends when and as declared by its Board of Directors,out of funds legally available for the payment of dividends, as provided in theCalifornia General Corporation Law. The California general corporation lawprohibits the Company from paying dividends on its common stock unless: (i) itsretained earnings, immediately prior to the dividend payment, equals or exceedsthe amount of the dividend or (ii) immediately after giving effect to thedividend, the sum of the Company’s assets (exclusive of goodwill and deferredcharges) would be at least equal to 125% of its liabilities (not includingdeferred taxes, deferred income and other deferred liabilities) and the currentassets of the Company would be at least equal to its current liabilities, or,if the average of its earnings before taxes on income and before interestexpense for the two preceding fiscal years was less than the average of itsinterest expense for the two preceding fiscal years, at least equal to 125% ofits current liabilities. The Company is currently required to obtain the priorapproval of the Federal Reserve Board to make capital distributions to itsshareholders.

 

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Dividends from the Bank to the Company are restricted under certainfederal laws and regulations governing banks. In addition, California lawrestricts the total dividend payments of any bank to the lesser of the bank’sretained earnings or the bank’s net income for the latest three fiscal years,less dividends previously paid during that period. Under the Memorandums ofUnderstanding discussed above, the Bank must obtain approval to pay cashdividends to the company from the FDIC and the California Department ofFinancial Institutions (DFI) and the Company must obtain approval from theFederal Reserve Bank (FRB).

 

**13.****         ****OTHER NON-INTEREST INCOME ANDEXPENSES**

 

Other non-interest income consisted of the following:

 
| ** **                                                       | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                       | ** ** | **2009**                                   | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                             |       |                                       |       |   |   |   |   |
| Alternative  investment fees                                     |       | $                                          | 423,000    |   | $ | 545,000 |   | $ | 354,000 |   |
| Merchant  card processing fees                                   |       | 86,000                                     |       | 409,000 |   | 403,000 |   |
| Earnings  from cash surrender value of bank owned life insurance |       | 421,000                                    |       | 564,000 |   | 383,000 |   |
| Gain  on sale of mortgage servicing assets                       |       | —                                     |       | 22,000 |   | 730,000 |   |
| Payroll  services                                                |       | 393,000                                    |       | 352,000 |   | 207,000 |   |
| Insurance  sales                                                 |       | 273,000                                    |       | 233,000 |   | 207,000 |   |
| Sale-leaseback  gains                                            |       | 372,000                                    |       | 326,000 |   | — |   |
| Other                                                            |       | 989,000                                    |       | 926,000 |   | 868,000 |   |
|                                                             |       |                                       |       |   |   |   |   |
|                                                             |       | $                                          | 2,957,000  |   | $ | 3,377,000 |   | $ | 3,152,000 |   |

 

Other expenses consisted ofthe following:

 
| ** **                            | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------|------------|--------------------------------------------|------------|
| ** **                            | ** ** | **2009**                                   | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                  |       |                                       |       |   |   |   |   |
| Professional  fees                    |       | $                                          | 1,440,000  |   | $ | 1,161,000 |   | $ | 1,516,000 |   |
| Telephone  and postage                |       | 662,000                                    |       | 659,000 |   | 594,000 |   |
| Stationery  and supplies              |       | 512,000                                    |       | 747,000 |   | 828,000 |   |
| Advertising  and promotion            |       | 923,000                                    |       | 1,136,000 |   | 763,000 |   |
| Director  fees and retirement accrual |       | 413,000                                    |       | 508,000 |   | 482,000 |   |
| Other                                 |       | 2,154,000                                  |       | 2,161,000 |   | 2,788,000 |   |
|                                  |       |                                       |       |   |   |   |   |
|                                  |       | $                                          | 6,104,000  |   | $ | 6,372,000 |   | $ | 6,971,000 |   |

 

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**14.****         ****INCOMETAXES**

 

The provision for income taxes for the years ended December 31,2009, 2008 and 2007 consisted of the following:

 
| ** **                            | ** ** | **Federal** | ** ** | **State**  | ** ** | **Total**  | ** ** |
|---------------------------------------|------------|-------------|------------|------------|------------|------------|------------|
| 2009                                  |       |        |       |       |       |       |       |
|                                  |       |        |       |       |       |       |       |
| Current                               |       | $           | (4,190,000 | )          | $          | 2,000      |       | $ | (4,188,000 | ) |
| Deferred                              |       | (2,374,000  | )          | (2,577,000 | )          | (4,951,000 | )          |
| Establishment  of valuation allowance |       | 10,108,000  |       | 5,135,000  |       | 15,243,000 |       |
|                                  |       |        |       |       |       |       |       |
| Provision  for income taxes           |       | $           | 3,544,000  |       | $          | 2,560,000  |       | $ | 6,104,000 |   |
|                                  |       |        |       |       |       |       |       |
| 2008                                  |       |        |       |       |       |       |       |
|                                  |       |        |       |       |       |       |       |
| Current                               |       | $           | 4,323,000  |       | $          | 1,257,000  |       | $ | 5,580,000 |   |
| Deferred                              |       | (3,277,000  | )          | (1,171,000 | )          | (4,448,000 | )          |
|                                  |       |        |       |       |       |       |       |
| Provision  for income taxes           |       | $           | 1,046,000  |       | $          | 86,000     |       | $ | 1,132,000 |   |
|                                  |       |        |       |       |       |       |       |
| 2007                                  |       |        |       |       |       |       |       |
|                                  |       |        |       |       |       |       |       |
| Current                               |       | $           | 3,735,000  |       | $          | 1,316,000  |       | $ | 5,051,000 |   |
| Deferred                              |       | (470,000    | )          | (142,000   | )          | (612,000   | )          |
|                                  |       |        |       |       |       |       |       |
| Provision  for income taxes           |       | $           | 3,265,000  |       | $          | 1,174,000  |       | $ | 4,439,000 |   |

 

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Deferred taxassets (liabilities) are comprised of the following at December 31, 2009and 2008:

 
| ** **                                                   | ** ** | **2009**    | ** ** | **2008**   | ** ** |
|--------------------------------------------------------------|------------|-------------|------------|------------|------------|
| Deferred  tax assets:                                        |       |        |       |       |       |
| Allowance  for loan losses                                   |       | $           | 5,938,000  |       | $          | 3,686,000 |   |
| Deferred  compensation                                       |       | 3,549,000   |       | 3,387,000  |       |
| Accrued  Compensation                                        |       | 88,000      |       | —     |       |
| Future  benefit of state tax deduction                       |       | 1,000       |       | 447,000    |       |
| Premises  and equipment                                      |       | 1,100,000   |       | 794,000    |       |
| Stock  based compensation                                    |       | 24,000      |       | 24,000     |       |
| Sale/leaseback                                               |       | 2,195,000   |       | 2,414,000  |       |
| Other  Real Estate                                           |       | 2,877,000   |       | —     |       |
| Net  operating loss carryovers                               |       | 1,254,000   |       | —     |       |
| Credit  carryovers                                           |       | 63,000      |       | —     |       |
| Impairment  of investment security                           |       | —      |       | 683,000    |       |
| Other                                                        |       | 211,000     |       | 48,000     |       |
|                                                         |       |        |       |       |       |
| Total  deferred tax assets before valuation allowance        |       | 17,300,000  |       | 11,483,000 |       |
| Valuation  allowance                                         |       | (15,243,000 | )          | —     |       |
| Total  deferred tax assets                                   |       | 2,057,000   |       | 11,483,000 |       |
|                                                         |       |        |       |       |       |
| Deferred  tax liabilities:                                   |       |        |       |       |       |
| Future  liability of state deferred tax assets               |       | (1,746,000  | )          | (895,000   | )          |
| Accrual  to cash - deferred loan costs                       |       | (55,000     | )          | (40,000    | )          |
| Prepaid  expenses                                            |       | (256,000    | )          | (256,000   | )          |
| Unrealized  loss on available-for-sale investment securities |       | (85,000     | )          | (10,000    | )          |
| Other                                                        |       | —      |       | —     |       |
|                                                         |       |        |       |       |       |
| Total  deferred tax liabilities                              |       | (2,142,000  | )          | (1,201,000 | )          |
|                                                         |       |        |       |       |       |
| Net  deferred tax (liabilities) assets                       |       | $           | (85,000    | )          | $          | 10,282,000 |   |

 

The Company recognizes deferred tax assets andliabilities for the future tax consequences related to differences between thefinancial statement carrying amounts of existing assets and liabilities andtheir respective tax bases, and for tax credits. Net deferred tax liabilitiestotaled $85,000, after recognition of a valuation allowance against its netdeferred tax assets, at December 31, 2009. Net deferred tax assets totaled $10.3 million as of December 31,2008. Management evaluates the Company’s deferred tax assets for recoverabilityusing a consistent approach which considers the relative impact of negative andpositive evidence, including the Company’s historical profitability andprojections of future taxable income. The Company is required to establish avaluation allowance for deferred tax assets and record a charge to income ifmanagement determines, based on available evidence at the time thedetermination is made, that it is “more likely than not” that some portion orall of the deferred tax assets will not be realized.

 

For the three year period ended December 31,2009, the Company is in a cumulative pretax loss position. For purposes ofestablishing a deferred tax valuation allowance, this cumulative pretax lossposition is considered significant, objective evidence that the Company may notbe able to realize some portion of its deferred tax assets in the future. TheCompany’s cumulative pretax loss position was caused by the negative impactresulting from the weak housing and credit market conditions, whichdeteriorated dramatically during 2009. As a result, management assessed theneed for a valuation allowance and determined that it is “more likely than not”that the Company will not be able to realize the benefit of its deferred taxassets. Accordingly, management established a $15,243,000 valuation allowanceagainst the Company’s deferred tax assets at December 31, 2009. Managementwill continue to evaluate the potential realizability of its deferred taxassets.

 

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

 

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| ** **                                                | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                | ** ** | **2009**                                   | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                | ** ** | **Amount**                                 | ** ** | **Rate %** | ** ** | **Amount** | ** ** | **Rate %** | ** ** | **Amount** | ** ** | **Rate %** | ** ** |
| ** **                                                | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Federal  income tax (benefit) expense, at statutory rate  |       | $                                          | (7,277,000 | ) | 34.0 |   | $ | 1,355,000 |   | 35.0 |   | $ | 3,814,000 |   | 35.0 |   |
| State  franchise (benefit) tax, net of Federal tax effect |       | (1,664,000                                 | )          | 7.8 |   | 56,000 |   | 1.4 |   | 763,000 |   | 7.0 |   |
| Tax-exempt  income from life insurance policies           |       | (143,000                                   | )          | 0.7 |   | (197,000 | ) | (5.1 | ) | (134,000 | ) | (1.2 | ) |
| Valuation  allowance                                      |       | 15,243,000                                 |       | (71.2 | ) |   |   |   |   |   |   |   |   |
| Other                                                     |       | (55,000                                    | )          | 0.2 |   | (82,000 | ) | (2.1 | ) | (4,000 | ) | (0.0 | ) |
|                                                      |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
|                                                      |       | $                                          | 6,104,000  |   | (28.5 | ) | $ | 1,132,000 |   | 29.2 |   | $ | 4,439,000 |   | 40.8 |   |

 

The Company and its subsidiary file income tax returns in the U.S.federal and California jurisdictions. The Company conducts all of its business activities in the State ofCalifornia.  There are currently nopending U.S. federal, state, and local income tax or non-U.S. income taxexaminations by tax authorities.  Withfew exceptions, the Company is no longer subject to tax examinations by U.S.Federal taxing authorities for years ended before December 31, 2005, andby state and local taxing authorities for years ended before December 31,2004.  Management determined theunrecognized tax benefits and changes therein and the interest and penaltiesaccrued by the Company were not significant at December 31, 2009.

 

**15.****         ****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 2009:

 
| Balance,  January 1, 2009                                      |   | $          | 4,291,000 |   |
|---------------------------------------------------------------------|--------|------------|-----------|--------|
|                                                                |   |       |      |
| Disbursements                                                       |   | 6,524,000  |      |
| Amounts  repaid                                                     |   | (3,072,000 | )         |
|                                                                |   |       |      |
| Balance,  December 31, 2009                                    |   | $          | 7,743,000 |   |
|                                                                |   |       |      |
| Undisbursed  commitments to related parties, December 31, 2009 |   | $          | 550,000   |   |

 

TheCompany engages a related party for certain construction projects related tothe Company’s buildings.  Total fees paidto this related party for construction activities for the years ended December 31,2009, 2008 and 2007 were $11,000, $36,000, and $624,000, respectively.

 

**16.****         ****EMPLOYEE BENEFIT PLANS**

 

Salary Continuation and Retirement Plans

 

Salary continuation plans are in place for sixteen key executives. Inaddition, a retirement plan is in place for members of the Board of Directors.Under these plans, the directors and executives, or designated beneficiaries,will receive monthly payments for five to twenty years after retirement ordeath. These benefits are substantially equivalent to those available underinsurance policies purchased by the Company on the lives of the directors andexecutives. In addition, the estimated present value of these future benefitsis accrued over the period from the effective dates of the plans until theirexpected retirement dates. The expense recognized under these plans for theyears ended December 31, 2009, 2008 and 2007 totaled $830,000, $711,000,and $944,000, respectively.

 

In connection with these plans, the Company purchased single premium lifeinsurance policies with cash surrender values totaling $11,680,000 and$11,199,000 at December 31, 2009 and 2008, respectively. Income earned onthese policies, net of expenses, totaled $421,000, $564,000 and $383,000 forthe years ended December 31, 2009, 2008 and 2007, respectively.

 

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SavingsPlan

 

The Butte Community Bank 401(k) Savings Plan commenced January 1,1993 and is available to employees meeting certain service requirements. Underthe plan, employees may defer a selected percentage of their annualcompensation. The Bank may make a discretionary contribution to the planwhich would be allocated 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 each participant’scontribution bears to total compensation.

 

There were no employer contributions for the years ended December 31,2009, 2008 or 2007.

 

Employee Stock Ownership Plan

 

Under the Butte Community Bank Employee Stock Ownership Plan (“ESOP”),employees who have been credited with at least 1,000 hours of service during atwelve month period and who have attained age eighteen are eligible toparticipate. The ESOP has funded purchases of the Bank’s common stock through aline of credit from another financial institution (see Note 7). The line ofcredit is repaid from discretionary contributions to the ESOP determined by theBank’s Board of Directors. Annual contributions are limited on aparticipant-by-participant basis to the lesser of $30,000 or twenty-five percentof the participant’s compensation for the year. Employee contributions are notpermitted.

 

As a leveraged ESOP, interest expense is recognized on the line ofcredit in the Company’s consolidated financial statements. Shares are allocatedon the basis of eligible compensation, as defined in the ESOP plan document, inthe year of allocation. Benefits generally become 100% vested after seven yearsof credited service. Employees with at least three, but fewer than seven, yearsof credited service receive a partial vesting according to a sliding schedule.However, in the event of normal retirement, disability, or death, any unvestedportion of benefits vests immediately.

 

As shares are purchased by the ESOP with proceeds from the line ofcredit, the Company records the cost of these unearned ESOP shares as acontra-equity account. These amounts are shown as a reduction of shareholders’equity in the Company’s consolidated balance sheet. As the debt is repaid, theshares are released from unallocated ESOP shares in proportion to the debtservice paid during the year and allocated to eligible employees. As shares arereleased from unallocated ESOP shares, the Company reports compensation expenseequal to the current market price of the shares, and the shares are recognizedas outstanding for earnings per share computations. Benefits are distributed inthe form of qualifying Company securities. However, the Company will issuea put option to each participant upon distribution of the securities which, ifexercised, requires the Company to purchase the qualifying securities at fairmarket value.

 

During 2009 and2008 the ESOP purchased 51,929 and 16,903 shares of the Company’s common stockat a cost of $216,000 and $121,000 using the proceeds from the line of creditto the ESOP.  During 2007, the ESOP didnot purchase any shares of the Company’s stock. Interest expense of $67,000, $59,000 and $94,000 was recognized inconnection with the line of credit during the years ended December 31,2009, 2008 and 2007, respectively.

 

Compensationexpense of $56,000, $82,000 and $172,000 was recognized for the years ended December 31,2009, 2008 and 2007.

 

Allocated and unallocated ESOP shares at December 31, 2009, 2008and 2007 were as follows:

 
| ** **                       | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                             |       |     |       |     |       |     |       |
| Allocated shares                 |       | 342,136  |       | 335,810  |       | 316,524  |       |
| Unallocated Shares               |       | 160,826  |       | 124,207  |       | 126,590  |       |
|                             |       |     |       |     |       |     |       |
| Total ESOP Shares                |       | 502,962  |       | 460,017  |       | 443,114  |       |
|                             |       |     |       |     |       |     |       |
| Fair value of unallocated shares |       | $        | 231,000    |     | $          | 528,000  |       | $ | 1,276,000 |   |
|                                  |            |          |            |          |            |          |            |  |  |  |

 

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**17.****         ****FAIR VALUE MEASUREMENTS**

 

The carryingamounts and estimated fair values of the Company’s financial instruments are asfollows:

 
| ** **                                                  | ** ** | **December 31, 2009** | ** **  | **December 31, 2008** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|
| ** **                                                  | ** ** | **Carrying  Amount**            | ** **  | **Fair Value**             | ** ** | **Carrying  Amount** | ** ** | **Fair Value** | ** ** |
|                                                        |       |                            |        |                            |       |   |   |   |   |
| Financial  assets:                                          |       |                            |        |                            |       |   |   |   |   |
| Cash  and due from banks                                    |       | $                               | 12,119,000  |                            | $          | 12,119,000 |   | $ | 21,743,000 |   | $ | 21,743,000 |   |
| Federal  Funds sold and other                               |       | 46,535,000                      |        | 46,535,000                      |       | 36,605,000 |   | 36,605,000 |   |
| Interest-bearing  deposits in banks                         |       | 2,740,000                       |        | 2,742,000                       |       | 2,576,000 |   | 2,595,000 |   |
| Loans  held for sale                                        |       | 1,137,000                       |        | 1,137,000                       |       | 320,000 |   | 320,000 |   |
| Investment  securities                                      |       | 5,606,000                       |        | 5,620,000                       |       | 7,096,000 |   | 7,100,000 |   |
| Loans,  net                                                 |       | 420,036,000                     |        | 427,689,000                     |       | 486,522,000 |   | 487,578,000 |   |
| Other  investments                                          |       | 985,000                         |        | 985,000                         |       | 1,096,000 |   | 1,096,000 |   |
| Accrued  interest receivable                                |       | 2,380,000                       |        | 2,380,000                       |       | 3,838,000 |   | 3,838,000 |   |
| Cash  surrender value of Bank owned life insurance policies |       | 11,680,000                      |        | 11,680,000                      |       | 11,199,000 |   | 11,199,000 |   |
| Loan  servicing assets                                      |       | 3,463,000                       |        | 3,463,000                       |       | 2,004,000 |   | 2,004,000 |   |
|                                                        |       |                            |        |                            |       |   |   |   |   |
| Financial  liabilities:                                     |       |                            |        |                            |       |   |   |   |   |
| Deposits                                                    |       | $                               | 498,163,000 |                            | $          | 500,337,000 |   | $ | 526,485,000 |   | $ | 527,720,000 |   |
| Notes  payable                                              |       | 1,122,000                       |        | 1,122,000                       |       | 5,054,000 |   | 5,054,000 |   |
| Junior  subordinated debentures                             |       | 8,248,000                       |        | 6,787,000                       |       | 8,248,000 |   | 9,205,000 |   |
| Accrued  interest payable                                   |       | 346,000                         |        | 346,000                         |       | 645,000 |   | 645,000 |   |

 

Estimated fair values are disclosed for financial instruments for whichit is practicable to estimate fair value. These estimates are made at aspecific point in time based on relevant market data and information about thefinancial instruments. These estimates do not reflect any premium or discountthat could result from offering the Company’s entire holdings of a particularfinancial instrument for sale at one time, nor do they attempt to estimate thevalue of anticipated future business related to the instruments. In addition,the tax ramifications related to the realization of unrealized gains and lossescan have a significant effect on fair value estimates and have not beenconsidered in any of these estimates.

 

Because no market exists for a significant portion of the Company’sfinancial instruments, fair value estimates are based on judgments regardingcurrent economic conditions, risk characteristics of various financialinstruments and other factors. These estimates are subjective in nature andinvolve uncertainties and matters of significant judgment and therefore cannotbe determined with precision. Changes in assumptions could significantly affectthe fair values presented.

 

The followingmethods and assumptions were used by the Company to estimate the fair value ofits financial instruments at December 31, 2009 and 2008:

 

Cash and cash equivalents: Cash and cash equivalentsinclude cash and due from banks, Federal funds sold and certain short-terminterest-bearing deposits in banks and the carrying amount is estimated to befair value.

 

Interest-bearing deposits in banks: The fair values ofinterest-bearing deposits in banks are estimated by discounting their futurecash flows using rates at each reporting date for instruments with similarremaining maturities offered by comparable financial institutions.

 

Investment securities: For investment securities,fair values are based on quoted market prices, where available. If quotedmarket prices are not available, fair values are estimated using quoted marketprices for similar securities and indications of value provided by brokers.

 

Loans: Fair values of loans held for sale are estimatedusing quoted market prices for similar loans or the amount that purchasers havecommitted to purchase the loans. For variable-rate loans that repricefrequently with no significant change in credit risk, fair values are based oncarrying values.  The fair values forother loans are estimated using discounted cash flow analyses, using interestrates offered at each reporting date for loans with similar terms to borrowersof comparable creditworthiness adjusted for the allowance for loan losses. Thecarrying amount of accrued interest receivable approximates its fair value.

 

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Other investments: Other investments include non-marketableequity securities. The carrying value of these investments approximates theirfair value.

 

Bank owned life insurance policies: The fair values of lifeinsurance policies are based on cash surrender values at each reporting dateprovided by the insurers.

 

Loan servicing assets: The fair value of loan servicing assets isdetermined by an independent third party. The valuation model takes intoconsideration discounted cash flows using current interest rates and prepaymentspeeds for each type of underlying asset being serviced.

 

Deposits: The fair values for demand depositsare, by definition, equal to the amount payable on demand at each reportingdate represented by their carrying amount. Fair values for fixed-ratecertificates of deposit are estimated using a discounted cash flow analysisusing interest rates offered at each reporting date by the Bank forcertificates with similar remaining maturities. The carrying amount of accruedinterest payable approximates its fair value.

 

Notes payable: The notes payable reprice based upon anindependent index. The carrying amount of the notes payable approximates itsfair value.

 

Junior subordinated 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 to extend credit and standby letters of credit: Commitmentsto extend 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 was not significant and not included in the accompanying table.

 

Fair Value Hierarchy

 

The Company groups itsassets and liabilities measured at fair value in three levels, based on marketsin which the assets and liabilities are traded and the reliability of theassumptions used to determine fair value. Valuations within these levels arebased upon:

 

Level 1 – Quoted marketprices for identical instruments traded in active exchange markets.

 

Level 2 – Quoted prices ofsimilar instruments in active markets, quoted prices for identical or similarinstruments in markets that are not active, and model-based valuationtechniques for which all significant assumptions are observable or can becorroborated by observable market data.

 

Level 3 – Model-basedtechniques that use at least one significant assumption not observable in themarket.  These unobservable assumptionsreflect the Bank’s estimates of assumptions that market participants would useon pricing the asset or liability. Valuation techniques included managementjudgment and estimation which may be significant.

 

Assets Recorded at FairValue

 

The following tables presentinformation about the Company’s assets and liabilities measured at fair valueon a recurring and nonrecurring basis at December 31, 2009 and 2008.

 

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*RecurringBasis*

 

Assets and liabilitiesmeasured at fair value on a recurring basis are as follows (dollars inthousands):

 
| ** **                               | ** ** | **December 31, 2009** | ** ** |
|------------------------------------------|------------|---------------------------------|------------|
| ** **                               | ** ** | ** **                      | ** ** | **Quoted Prices in** | ** ** | **Other** | ** ** | **Significant** | ** ** |
| ** **                               | ** ** | ** **                      | ** ** | **Active Markets for** | ** ** | **Observable** | ** ** | **Unobservable** | ** ** |
| ** **                               | ** ** | ** **                      | ** ** | **Identical Assets** | ** ** | **Inputs** | ** ** | **Inputs** | ** ** |
| **Description**                          | ** ** | **Fair Value**             | ** ** | **(Level 1)** | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** |
| Investment  securities avaiable-for-sale | ** ** | $                               | 4,377      | ** ** | $ | — | ** ** | $ | 4,377 | ** ** | $ | — | ** ** |
|                                          |            |                                 |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                               | ** ** | **December 31, 2008** | ** ** |
|------------------------------------------|------------|---------------------------------|------------|
| ** **                               | ** ** | ** **                      | ** ** | **Quoted Prices in** | ** ** | **Other** | ** ** | **Significant** | ** ** |
| ** **                               | ** ** | ** **                      | ** ** | **Active Markets for** | ** ** | **Observable** | ** ** | **Unobservable** | ** ** |
| ** **                               | ** ** | ** **                      | ** ** | **Identical Assets** | ** ** | **Inputs** | ** ** | **Inputs** | ** ** |
| **Description**                          | ** ** | **Fair Value**             | ** ** | **(Level 1)** | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** |
| Investment  securities avaiable-for-sale | ** ** | $                               | 6,462      | ** ** | $ | — | ** ** | $ | 6,462 | ** ** | $ | — | ** ** |
|                                          |            |                                 |            |  |  |  |  |  |  |  |  |  |  |

 

Fair values forinvestment securities are based on quoted market prices for similar instrumentsin active markets.

 

*Non-recurringBasis*

 

Assets measured at fairvalue on a non-recurring basis are summarized below (dollars in thousands):

 
| ** **                                                    | ** ** | **December 31,  2009** | ** ** | **Total  Losses**       | ** ** |
|---------------------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| ** **                                                    | ** ** | ** **                  | ** ** | **Quoted  Prices in**   | ** ** | **Other** | ** ** | **Significant** | ** ** | **For  the Twelve** | ** ** |
| ** **                                                    | ** ** | ** **                  | ** ** | **Active  Markets for** | ** ** | **Observable** | ** ** | **Unobservable** | ** ** | **Months  Ended** | ** ** |
| ** **                                                    | ** ** | ** **                  | ** ** | **Identical  Assets**   | ** ** | **Inputs** | ** ** | **Inputs** | ** ** | **December 31,** | ** ** |
| **Description**                                               | ** ** | **Fair  Value**             | ** ** | **(Level  1)**          | ** ** | **(Level  2)** | ** ** | **(Level  3)** | ** ** | **2009** | ** ** |
| Impaired  loans                                               |       | $                           | 37,962     |                    | $          | — |   | $ | 34,548 |   | $ | 3,414 |   | $ | 13,473 |   |
| Real  estate owned                                            |       | 13,493                      |       | —                  |       | 13,493 |   | — |   | — |   |
| Total  assets measured at fair value on a non-recurring basis |       | $                           | 51,455     |                    | $          | — |   | $ | 48,041 |   | $ | 3,414 |   | $ | 13,473 |   |

 
| ** **                                                    | ** ** | **December 31,  2008** | ** ** | **Total  Losses**       | ** ** |
|---------------------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| ** **                                                    | ** ** | ** **                  | ** ** | **Quoted  Prices in**   | ** ** | **Other** | ** ** | **Significant** | ** ** | **For  the Twelve** | ** ** |
| ** **                                                    | ** ** | ** **                  | ** ** | **Active  Markets for** | ** ** | **Observable** | ** ** | **Unobservable** | ** ** | **Months  Ended** | ** ** |
| ** **                                                    | ** ** | ** **                  | ** ** | **Identical  Assets**   | ** ** | **Inputs** | ** ** | **Inputs** | ** ** | **December 31,** | ** ** |
| **Description**                                               | ** ** | **Fair  Value**             | ** ** | **(Level  1)**          | ** ** | **(Level  2)** | ** ** | **(Level  3)** | ** ** | **2008** | ** ** |
| Impaired  loans                                               |       | $                           | 8,390      |                    | $          | — |   | $ | 7,952 |   | $ | 437 |   | $ | 1,466 |   |
| Real  estate owned                                            |       | 2,068                       |       | —                  |       | 2,068 |   | — |   | — |   |
| Total  assets measured at fair value on a non-recurring basis |       | $                           | 10,458     |                    | $          | — |   | $ | 10,020 |   | $ | 437 |   | $ | 1,466 |   |

 

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***Impaired Loans*****— Impaired loans, carried at fair value, which aremeasured for impairment using the fair value of the collateral for collateraldependent loans, had a carrying amount of $37,962,000, with a specific reserveof $4,045,000. When the fair value of the collateral is based on a currentappraisal value which uses observable data, the Company records the impairedloans as Level 2.  Otherwise, the Companyrecords the impaired loans as Level 3.

 

At December 31,2008, impaired loans carried at fair value had a carrying amount of$8,390,000,  with a specific reserve of$1,165,000.

 

***Real Estate Owned*******— The fair value of real estate owned is basedprimarily on the values obtained through current property appraisals which useobservable data.

 

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| **18.** | **PARENT ONLY CONDENSED FINANCIAL STATEMENTS** |   |
|---------|------------------------------------------------|--------|

 

**CONDENSEDBALANCE SHEET**

 

**December 31,2009 and 2008**

 
| ** **                                            | ** ** | **2009**   | ** ** | **2008**   | ** ** |
|-------------------------------------------------------|------------|------------|------------|------------|------------|
|                                                  |       |       |       |       |       |
| **ASSETS**                                            |       |       |       |       |       |
|                                                  |       |       |       |       |       |
| Cash  and cash equivalents                            |       | $          | 737,000    |       | $          | 205,000 |   |
| Investment  in bank subsidiary                        |       | 23,215,000 |       | 49,297,000 |       |
| Investment  in non-bank subsidiary                    |       | 694,000    |       | 659,000    |       |
| Other  assets                                         |       | 676,000    |       | 3,428,000  |       |
|                                                  |       |       |       |       |       |
| Total  assets                                         |       | $          | 25,322,000 |       | $          | 53,589,000 |   |
|                                                  |       |       |       |       |       |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**        |       |       |       |       |       |
|                                                  |       |       |       |       |       |
| Liabilities:                                          |       |       |       |       |       |
| Note  payable                                         |       | $          | 1,122,000  |       | $          | 5,054,000 |   |
| Junior  subordinated debentures                       |       | 8,248,000  |       | 8,248,000  |       |
| Other  liabilities                                    |       | —     |       | 148,000    |       |
|                                                  |       |       |       |       |       |
| Total  liabilities                                    |       | 9,370,000  |       | 13,450,000 |       |
|                                                  |       |       |       |       |       |
| Shareholders’  equity:                           |       |       |       |       |       |
| Preferred  stock                                      |       | 3,313,000  |       | —     |       |
| Common  stock                                         |       | 10,186,000 |       | 10,147,000 |       |
| Unallocated  ESOP shares                              |       | (1,582,000 | )          | (1,438,000 | )          |
| Retained  earnings                                    |       | 3,908,000  |       | 31,416,000 |       |
| Accumulated  other comprehensive income, net of taxes |       | 127,000    |       | 14,000     |       |
|                                                  |       |       |       |       |       |
| Total  shareholders’ equity                      |       | 15,952,000 |       | 40,139,000 |       |
|                                                  |       |       |       |       |       |
| Total  liabilities and shareholders’ equity      |       | $          | 25,322,000 |       | $          | 53,589,000 |   |

 

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| **18.** | **PARENT ONLY CONDENSED FINANCIAL STATEMENTS** |   |
|---------|------------------------------------------------|--------|

 

**CONDENSED STATEMENT OF OPERATIONS**

 

**For the Years Ended December 31,2009, 2008 and 2007**

** **
| ** **                                                                  | ** ** | **2009**    | ** **  | **2008**   | ** ** | **2007**   | ** ** |
|-----------------------------------------------------------------------------|------------|-------------|-------------|------------|------------|------------|------------|
|                                                                        |       |        |        |       |       |       |       |
| Income:                                                                     |       |        |        |       |       |       |       |
| Dividends  declared by bank subsidiary                                      |       | $           | 225,000     |       | $          | 11,238,000 |       | $ | 4,251,000 |   |
|                                                                        |       |        |        |       |       |       |       |
| Expenses:                                                                   |       |        |        |       |       |       |       |
| Professional  fees                                                          |       | 679,000     |        | 518,000    |       | 367,000    |       |
| Interest  expense                                                           |       | 790,000     |        | 770,000    |       | 1,118,000  |       |
| Other  expenses                                                             |       | 231,000     |        | 282,000    |       | 380,000    |       |
|                                                                        |       |        |        |       |       |       |       |
| Total  expenses                                                             |       | 1,700,000   |        | 1,570,000  |       | 1,865,000  |       |
|                                                                        |       |        |        |       |       |       |       |
| (Loss)  income before equity in undistributed (loss) income of subsidiaries |       | (1,475,000  | )           | 9,668,000  |       | 2,386,000  |       |
|                                                                        |       |        |        |       |       |       |       |
| Equity  in undistributed (loss) income of subsidiaries                      |       | (26,659,000 | )           | (7,578,000 | )          | 3,335,000  |       |
|                                                                        |       |        |        |       |       |       |       |
| (Loss)  income before income tax benefit                                    |       | (28,134,000 | )           | 2,090,000  |       | 5,721,000  |       |
|                                                                        |       |        |        |       |       |       |       |
| Income  tax benefit                                                         |       | 626,000     |        | 649,000    |       | 738,000    |       |
|                                                                        |       |        |        |       |       |       |       |
| Net  (loss) income                                                          |       | $           | (27,508,000 | )          | $          | 2,739,000  |       | $ | 6,459,000 |   |

 

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| **18.** | **PARENT ONLY CONDENSED FINANCIAL STATEMENTS** |   |
|---------|------------------------------------------------|--------|

 

**CONDENSED STATEMENT OF CASHFLOWS**

 

**For the Years Ended December 31, 2009, 2008 and2007**

 
| ** **                                                                                | ** ** | **2009**   | ** **  | **2008**    | ** ** | **2007**   | ** ** |
|-------------------------------------------------------------------------------------------|------------|------------|-------------|-------------|------------|------------|------------|
|                                                                                      |       |       |        |        |       |       |       |
| Cash  flows from operating activities:                                                    |       |       |        |        |       |       |       |
| Net  (loss) income                                                                        |       | $          | (27,508,000 | )           | $          | 2,739,000  |       | $ | 6,459,000 |   |
|                                                                                      |       |       |        |        |       |       |       |
| Adjustments  to reconcile net (loss) income to net cash provided by operating activities: |       |       |        |        |       |       |       |
| Undistributed  net income of subsidiaries                                                 |       | 26,659,000 |        | 7,578,000   |       | (3,335,000 | )          |
| Stock-based  compensation                                                                 |       | 55,000     |        | 80,000      |       | 139,000    |       |
| Decrease  (increase) in other assets                                                      |       | 2,622,000  |        | 129,000     |       | (678,000   | )          |
| (Decrease)  increase in other liabilities                                                 |       | (148,000   | )           | (58,000     | )          | 146,000    |       |
| Net  cash provided by operating activities                                                |       | 1,680,000  |        | 10,468,000  |       | 2,731,000  |       |
|                                                                                      |       |       |        |        |       |       |       |
| Cash  flows from investing activities:                                                    |       |       |        |        |       |       |       |
| Investment  in Butte Community Bank                                                       |       | (500,000   | )           | (3,960,000  | )          | —     |       |
| Net  cash used in investing activities                                                    |       | (500,000   | )           | (3,960,000  | )          | —     |       |
|                                                                                      |       |       |        |        |       |       |       |
| Cash  flows from financing activities:                                                    |       |       |        |        |       |       |       |
| Proceeds  from notes payable                                                              |       | 216,000    |        | 4,120,000   |       | —     |       |
| Repayment  of notes payable                                                               |       | (648,000   | )           | (159,000    | )          | (124,000   | )          |
| Proceeds  from issuance of junior subordinated debentures                                 |       | —     |        | (8,248,000  | )          | 8,248,000  |       |
| Purchase  of unallocated ESOP shares                                                      |       | (216,000   | )           | (121,000    | )          | —     |       |
| Proceeds  from exercise of stock options, including tax benefit                           |       | —     |        | 654,000     |       | 1,104,000  |       |
| Payment  of cash dividends                                                                |       | —     |        | (1,757,000  | )          | (2,408,000 | )          |
| Repurchase  of common stock                                                               |       | —     |        | (13,118,000 | )          | (210,000   | )          |
| Net  cash (used in) provided by financing activities                                      |       | (648,000   | )           | (18,629,000 | )          | 6,610,000  |       |
|                                                                                      |       |       |        |        |       |       |       |
| Increase  (decrease) in cash and cash equivalents                                         |       | 532,000    |        | (12,121,000 | )          | 9,341,000  |       |
|                                                                                      |       |       |        |        |       |       |       |
| Cash  and cash equivalents at beginning of year                                           |       | 205,000    |        | 12,326,000  |       | 2,985,000  |       |
|                                                                                      |       |       |        |        |       |       |       |
| Cash  and cash equivalents at end of year                                                 |       | $          | 737,000     |        | $          | 205,000    |       | $ | 12,326,000 |   |

 

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