**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

** **

**Washington, D.C. 20549**

** **

**FORM 10-K**

 

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

** **

**For the fiscal year ended December 31, 2007**

**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 of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.

 

Yes  x    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

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller

reporting company. Seedefinitions of “large accelerated filer," "accelerated filer,” and"smaller reporting company" in Rule 12b-2 of

the Exchange Act. (Checkone):

 

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

 

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

 

Asof June 30, 2007, the aggregate market value of the voting stock held bynon-affiliates of the Registrant was approximately $67.3 million, based on thesales price reported to the Registrant on that date of $12.59 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 February 29,2008 was 7,662,715.

** **

**DOCUMENTS INCORPORATED BY REFERENCE**

 

 

 

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Portionsof the Proxy Statement relating to the Annual Meeting of Shareholders to beheld on June 5, 2008, are incorporated by reference into Part III ofthis Report.

 

 

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**TABLE OF CONTENTS**

 
| PART I   |   |                                                                                                                    | 4      |   |
|---------------|--------|-------------------------------------------------------------------------------------------------------------------------|--------|--------|
|          |   |                                                                                                                    |   |   |
|          |   | Item 1. Business                                                                                                        | 4      |   |
|          |   |                                                                                                                    |   |   |
|          |   | Item 1a. Risk Factors                                                                                                   | 17     |   |
|          |   |                                                                                                                    |   |   |
|          |   | Item 1b. Unresolved Staff Comments                                                                                      | 20     |   |
|          |   |                                                                                                                    |   |   |
|          |   | Item 2. Properties                                                                                                      | 21     |   |
|          |   |                                                                                                                    |   |   |
|          |   | Item 3. Legal Proceedings                                                                                               | 23     |   |
|          |   |                                                                                                                    |   |   |
|          |   | Item 4. Submission of Matters to a Vote of Security  Holders                                                            | 23     |   |
|          |   |                                                                                                                    |   |   |
| PART II  |   |                                                                                                                    | 23     |   |
|          |   |                                                                                                                    |   |   |
|          |   | Item 5. Market for Registrants Common Equity and  Related Shareholder Matters and Issuer Purchases of Equity Securities | 23     |   |
|          |   |                                                                                                                    |   |   |
|          |   | Item  6. Selected Financial Data                                                                                        | 27     |   |
|          |   |                                                                                                                    |   |   |
|          |   | Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations                    | 28     |   |
|          |   |                                                                                                                    |   |   |
|          |   | Item 7a.  Quantitative and Qualitative Disclosures About Market Risk                                                    | 51     |   |
|          |   |                                                                                                                    |   |   |
|          |   | Item 8. Financial  Statements and Supplementary Data                                                                    | 51     |   |
|          |   |                                                                                                                    |   |   |
|          |   | Item 9. Changes  in and Disagreements with Accountants on Accounting and Financial Disclosure                           | 51     |   |
|          |   |                                                                                                                    |   |   |
|          |   | Item 9a. Controls  and Procedures                                                                                       | 51     |   |
|          |   |                                                                                                                    |   |   |
|          |   | Item 9b. Other  Information                                                                                             | 52     |   |
|          |   |                                                                                                                    |   |   |
| PART III |   |                                                                                                                    | 52     |   |
|          |   |                                                                                                                    |   |   |
|          |   | Item 10.  Directors and Executive Officers and Corporate Governance                                                     | 52     |   |
|          |   |                                                                                                                    |   |   |
|          |   | Item 11. Executive  Compensation                                                                                        | 52     |   |
|          |   |                                                                                                                    |   |   |
|          |   | Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related  Stockholder Matters               | 52     |   |
|          |   |                                                                                                                    |   |   |
|          |   | Item 13.  Certain Relationships and Related Transactions and Director Independence                                      | 52     |   |
|          |   |                                                                                                                    |   |   |
|          |   | Item 14.  Principal Accountant Fees and Services                                                                        | 52     |   |
|          |   |                                                                                                                    |   |   |
| PART IV  |   |                                                                                                                    | 52     |   |
|          |   |                                                                                                                    |   |   |
|          |   | Item 15.  Exhibits, Financial Statement Schedules, and Reports on Form 8-K                                         | 52     |   |
|          |   |                                                                                                                    |   |   |
| SIGNATURES    |   |                                                                                                                    | 54     |   |

 

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**PART I**

 

**Item 1.    Business**

 

**Forward Looking Statements**

 

Certain statementscontained in this Annual Report on Form 10-K that are not statements ofhistorical fact constitute forward-looking statements within the meaning of thePrivate Securities Litigation Reform Act of 1995 (the “Act”), notwithstandingthat such statements are not specifically identified. These statements are based on management’s beliefs and assumptions, andon information available to management as of the date of this document.Forward-looking statements include the information concerning possible orassumed future results of operations of the Company set forth under the heading“Management’s Discussion and Analysis of Financial Condition and Results ofOperations.” Forward-looking statements also include statements in which wordssuch as “expect,” “anticipate,” “intend,” “plan,” “believe,” “estimate,” “consider”or similar expressions are used. Forward-looking statements are not guaranteesof future performance. They involve risks, uncertainties and assumptions,including the risks discussed under the heading “Risk Factors” and elsewhere inthis report. The Company’s actual future results and shareholder values maydiffer materially from those anticipated and expressed in these forward-lookingstatements. Many of the factors that will determine these results and values,including those discussed under the heading “Risk Factors That May AffectResults,” 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.

 

**General**

 

**The Company**

 

Community Valley Bancorp(the “Company”) is a California corporation registered as a financial holdingcompany under the Financial  HoldingCompany Act of 1956, as amended (the “BHC Act”), and is headquartered in Chico,California. The Company was incorporated in July, 2001 and acquired all of theoutstanding shares of Butte Community Bank (the “Bank”) in May, 2002. TheCompany’s principal subsidiary is the Bank. The Company also has subsidiariesin the names of Community Valley Bancorp Trust I, which was formed in December,2002 and Community Valley Bancorp Trust II, which was formed in July 2007.  Both of these trusts were formed solely tofacilitate the issuance of capital trust pass-through securities. The Companyalso has an insurance subsidiary in the name of Community Valley BancorpInsurance Agency, LLC (subsequently changed to Butte Community InsuranceAgency, LLC) which was formed in December 2004 to provide a full serviceinsurance agency offering all lines of coverage. The Company exists primarilyfor the purpose of holding the stock of the Bank and of such other subsidiariesas it may acquire or establish.

 

The Company’s principalsource of income is currently dividends from the Bank, but the Company intendsto explore additional supplemental sources of income in the future. Theexpenditures of the Company, including (but not limited to) the payment ofdividends to shareholders, if and when declared by the Board of Directors, andthe cost of servicing debt will generally be paid from such payments made tothe Company by the Bank.

 

At December 31,2007, the Company had consolidated assets of $580.6 million, deposits of $501million and shareholders’ equity of $51 million.

 

The Company’sAdministrative 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 the Bank, unless the context indicatesotherwise.

 

The Company files annual, quarterly and other reportsunder the Securities Exchange Act of 1934 with the Securities and ExchangeCommission. These reports are posted and are available at no cost on theCompany’s website,

 

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www.communityvalleybancorp.com through the reportslink, as soon as reasonably practicable after the Company files such documentswith the SEC. The Company’s filings are also available through the SEC’swebsite at www.sec.gov.

 

**The Bank**

 

Butte Community Bank wasincorporated under the laws of the State of California on May 11, 1990 andcommenced operations as a California state-chartered commercial bank on December 14,1990. The Bank’s Administrative Office is located at 1360 East Lassen Avenue,Chico, California. The Bank is an insured bank under the Federal Deposit InsuranceAct up to the maximum limits thereof. The Bank is not a member of the FederalReserve System. At December 31, 2007, the Bank had approximately $579.3million in assets, $441.4 million in loans and $513.8 million in deposits.

 

We operate seven full-servicebranch offices in four Butte County communities, one full-service branch officein Sutter County, two full-service branches in Tehama County, one full-servicebranch in Yuba County, one full-service branch in Colusa County, threefull-service branches in Shasta County, one Loan Production office inSacramento County, and one Loan Production office in Butte County. We offer afull range of banking services to individuals and various-sized businesses inthe communities 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                                             |
|            |   |                                                                 |   |                 |   |                                                               |
| Citrus  Heights |   | Citrus Heights Loan Office  5959 Greenback Lane#450                  |   | Yuba  City           |   | Yuba City Branch  1600 Butte House Road                            |
|            |   |                                                                 |   |                 |   |                                                               |
|            |   |                                                                 |   |                 |   |                                                               |
| Redding         |   | Redding Branch  2951 Churn Creek  Hilltop Branch  1335 Hilltop Drive |   | Red  Bluff  Anderson |   | Red Bluff Branch  10 Gilmore Rd  Anderson Branch  5026 Rhonda Road |
|            |   |                                                                 |   |                 |   |                                                               |
|            |   |                                                                 |   |                 |   |                                                               |
| Marysville      |   | Marysville Branch                                                    |   | Colusa               |   | Colusa Branch                                                      |
|            |   | 904 B Street                                                         |   |                 |   | 1017 Bridge Street                                                 |
|            |   |                                                                 |   |                 |   |                                                               |
| Gridley         |   | Gridley Loan Office                                                  |   | Corning              |   | Corning Branch                                                     |
|            |   | 1010 Spruce Street                                                   |   |                 |   | 950 Hwy 99W                                                        |

 

In addition, our, DataProcessing, Call Center and Bank Card Center are located at 1390 RidgewoodDrive, Chico. Our Real Estate Loan Center and Central Note Department arelocated at 1360 East Lassen Avenue, Chico. We also have specialized credit centers for agricultural lending andconstruction and real estate lending within a number of these branch offices.These facilities are located in the cities of Chico, Paradise, and Oroville inButte County, the city of Yuba City in Sutter County, The cities of Red Bluffand Corning in Tehama County, the city of Marysville in Yuba County, the cityof Colusa in Colusa County, the city of Citrus Heights in Sacramento County,and the cities of Anderson and Redding in Shasta County.

 

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Throughout the history ofButte Community Bank, our growth has been exclusively by establishing de novofull-service branch offices and credit centers in various locations inCalifornia’s Northern Sacramento Valley and foothill region.  With a predominant focus on personal service,Butte Community Bank has positioned itself as a multi-community independentbank serving the financial needs of individuals and businesses, includingagricultural and real estate customers in Butte and other surrounding counties.Our principal retail lending services include home equity and consumer loans.In addition, we have three other significant dimensions which surround thiscore of retail community banking: Agricultural lending, commercial lending, and real estate financing(both construction and long term).

 

The Agricultural CreditCenters located in Yuba City, Chico, and Red Bluff provide a complete line ofcredit services in support of the agricultural activities which are key to thecontinued economic development of the communities we serve. “Ag lending”clients include a full range of individual farming customers and small businessfarming 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 and Yuba City and Redding offices with real estate lendingspecialists. These officers are responsible for a complete line of landacquisition and development loans, construction loans for residential andcommercial development, and the origination of multifamily credit facilities.Secondary market services are provided through the Bank’s affiliations withFannie Mae and various non-governmental programs. Traditionally the Bankserviced real estate loans sold on the secondary market, but in September 2007the servicing portfolio was sold and since that time as these loans are sold,the servicing is also released.   We alsohave an orientation toward Small Business Administration lending and have beendesignated as a Preferred Lender since 1998. The Bank’s SBA program generatedapproximately $4.1 million in loans during the past year. It is anticipatedthat loans under this program will be an increasing segment of our loanportfolio over the next few years.  TheBank was also recognized as the number one USDA Business and Industry (B&I)Lender in the nation during 2007 for number of loans made having originatedtwenty loans totaling more than $30 million. The primary purpose of the B&I program is to stimulate the localeconomy, create additional employment, attract additional commercial investmentcapital and support potential growth in tax revenue, which will improve thequality of life for rural residents.

 

As of December 31,2007, the principal areas in which we directed our lending activities, and thepercentage of our total loan portfolio for which each of these areas wasresponsible, were as follows: (i) agricultural loans (6%); (ii) commercialand industrial (including SBA and B&I) loans (17%); (iii) real estateloans (commercial and construction) (65%); (iv) consumer loans (12%).

 

In addition to thelending activities noted above, we offer a wide range of deposit products forthe retail banking market including checking, interest bearing transaction,savings, time certificates of deposit and retirement accounts, as well astelephone banking and internet banking with bill pay options. As of December 31,2007, we had 35,946 deposit accounts with balances totaling approximately $501million, compared to 34,021 deposit accounts with balances totalingapproximately $484 million at December 31, 2006. Butte Community Bankattracts deposits through its customer-oriented product mix, competitivepricing, convenient locations, extended hours drive-up and on-line banking, allprovided with the highest level of customer service.

 

We also offer otherproducts and services to our customers, which complement the lending anddeposit services previously reviewed. These include cashier’s checks, traveler’schecks, bank-by-mail, ATM, night depository, safe deposit boxes, directdeposit, automated payroll services, cash management, lockbox and othercustomary banking services. Shared ATM and Point of Sale (POS) networks allowcustomers access to the national and international funds transfer networks.During the past few years we have substantially enhanced our ATM locations toinclude off-site areas not previously served by cash or deposit facilities. Wenow have a total of five such remote ATM’s at five different locations,including two hospitals, two convenience stores, and an entertainment center.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 providesafe deposit, wire transfer capabilities and a convenient customer servicegroup in our Call Center to answer questions and assure a high level ofcustomer satisfaction with the level of services and products we provide.  Our newest service offering is RemoteDeposit which utilizes a scanner that connects to the customer’s computer andthe Internet. With it, the customer can scan checks received and issue depositselectronically to the Bank.

 

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Most of the Bank’sdeposits are attracted from individuals, business-related sources and smallermunicipal entities. This results in a relatively modest average deposit balanceof approximately $14,000 at December 31, 2007, but makes the Bank lesssubject to adverse effects from the loss of a substantial depositor who may beseeking higher yields in other markets or who may have need of money otherwiseon deposit with the Bank, especially during periods of inflation orconservative monetary policies. The Bank has had a relationship with a localtitle company for many years. They have kept substantial deposit balances overthe years but during 2007, with the downturn in the real estate market, these balancesdecreased.

 

For non-deposit services,we have a strategic alliance with Linsco Private Ledger Financial Services.Through this arrangement, our registered and licensed representatives provideBank customers with convenient access to annuities, insurance products, mutualfunds, and a full range of investment products which are not FDIC insured. Theyconduct business from all of our full service offices.

 

We do not believe thereis a significant demand for additional trust services in our service areas, andwe do not operate or have any present intention to seek authority to operate aTrust Department. We believe that the cost of establishing and operating such adepartment would not be justified by the potential income to be gained therefrom.

 

The officers andemployees of the Bank are continually engaged in marketing activities,including the evaluation and development of new products and services, whichenable the Bank to retain and improve its competitive position in its servicearea. All of these developments are meant to increase public convenience andenhance public access to the electronic payments system. The cost to the Bankfor these development, implementation, and marketing activities cannotexpressly be calculated with any degree of certainty.

 

The Bank holds no patentsor licenses (other than licenses required by appropriate bank regulatoryagencies), franchises, or concessions. The Bank is not dependent on a singlecustomer or group of related customers for a material portion of its deposits,nor is a material portion of the Bank’s loans concentrated within a singleindustry or group of related industries. There has been no material effect uponthe Bank’s capital expenditures, earnings, or competitive position as a resultof Federal, state, or local environmental regulation.

 

**Recent Developments**

 

On June 15, 2007 theCompany filed applications with the California Department of FinancialInstitutions and the Federal Deposit Insurance Corporation for permission toopen a branch office in the city of Redding. This branch subsequently opened on August 13, 2007.

 

On June 15, 2007 theCompany filed applications with the California Department of FinancialInstitutions and the Federal Deposit Insurance Corporation for permission toopen a branch office in the city of Anderson. This branch subsequently openedon August 22, 2007.

 

**Competition**

 

The banking business inCalifornia generally, and specifically in our market areas, is highlycompetitive with respect to virtually all products and services and has becomeincreasingly more so in recent years. The industry continues to consolidate andstrong, unregulated competitors have entered banking markets with focusedproducts targeted at highly profitable customer segments. Many largelyunregulated competitors are able to compete across geographic boundaries andprovide customers increasing access to meaningful alternatives to bankingservices in nearly all significant products. These competitive trends arelikely to continue.

 

With respect tocommercial bank competitors, the business is largely dominated by a relativelysmall 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.

 

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In addition to otherbanks, competitors include savings institutions, credit unions, and numerousnon-banking institutions such as finance companies, leasing companies,insurance companies, brokerage firms, and investment banking firms. In recentyears, increased competition has also developed from specialized finance andnon-finance companies that offer wholesale finance, credit card, and otherconsumer finance services, including on-line banking services and personalfinance software. Strong competition for deposit and loan products affects therates of those products as well as the terms on which they are offered tocustomers. Mergers between financial institutions have placed additionalpressure on banks within the industry to streamline their operations, reduceexpenses, and increase revenues to remain competitive. Competition has also intensifieddue to recently enacted federal and state interstate banking laws, which permitbanking organizations to expand geographically, and the California market hasbeen particularly attractive to out-of-state institutions. The FinancialModernization Act, which, effective March 11, 2000, has made it possiblefor full affiliations to occur between banks and securities firms, insurancecompanies, and other financial companies, is also expected to intensifycompetitive conditions.

 

Technological innovationhas also resulted in increased competition in financial services markets. Suchinnovation has, for example, made it possible for non-depository institutionsto offer customers automated transfer payment services that previously havebeen considered traditional banking products. In addition, many customers nowexpect a choice of several delivery systems and channels, including telephone,mail, home computer, ATMs, self  servicebranches, and/or in-store branches. In addition to other banks, the sources ofcompetition for such products include savings associations, credit unions,brokerage firms, money market and other mutual funds, asset management groups,finance and insurance companies, internet-only financial intermediaries, andmortgage banking firms.

 

For many years, we havecountered this increasing competition by providing our own style ofcommunity-oriented, personalized service. We rely upon local promotionalactivity, personal contacts by our officers, directors, employees, andshareholders, automated 24-hour banking, and the individualized service whichwe can provide through our flexible policies. In addition, to meet the needs ofcustomers with electronic access requirements, the Company has embraced theelectronic age and installed telephone banking and personal computer andinternet banking with bill payment capabilities. 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.

 

Our credit card businessis subject to an even higher level of competitive pressure than our generalbanking business. There are a number of major banks and credit card issuersthat are able to finance often highly successful advertising campaigns withwhich community banks generally do not have the resources to compete. As aresult, our credit card balances outstanding are much more likely to increaseat a slower rate than that which might be seen in nationwide issuers’ year-endstatistics. Additional competition comes from many non-financial institutions,such as providers of various retail products, which offer many types of creditcards.

 

**Employees**

 

As of December 31,2007 the Company had 190 full-time and 101 part-time employees. On a full timeequivalent basis, the Company’s staff level was 260 at December 31, 2007,as compared to 263 at December 31, 2006. None of our employees isconcurrently represented by a union or covered by a collective bargainingagreement. Management of the Company believes its employee relations aresatisfactory.

 

**Regulation and Supervision**

 

The Company and the Bankare subject to significant regulation by federal and state regulatory agencies.The following discussion of statutes and regulations is only a brief summaryand does not purport to be complete. This discussion is qualified in itsentirety by reference to such statutes and regulations. No assurance can begiven that such statutes or regulations will not change in the future.

 

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**The Company**

 

The Company is afinancial holding company within the meaning of the Financial Holding CompanyAct of 1956 and is registered as such with the Board of Governors of theFederal Reserve System (the “Federal Reserve Board”). A financial holdingcompany is required to file with the Federal Reserve Board annual reports andother information regarding its business operations and those of itssubsidiaries. It is also subject to examination by the Federal Reserve Boardand is required to obtain Federal Reserve Board approval before acquiring,directly or indirectly, ownership or control of any voting shares of any bankif, after such acquisition, it would directly or indirectly own or control morethan 5% of the voting stock of that bank, unless it already owns a majority ofthe voting stock of that bank.

 

The Federal Reserve Boardhas by regulation determined certain activities in which a financial holdingcompany may or may not conduct business. A financial holding company mustengage, with certain exceptions, in the business of banking or managing orcontrolling banks or furnishing services to or performing services for itssubsidiary banks. The permissible activities and affiliations of certain bankholding companies have recently been expanded. (See “Financial ModernizationAct” below.)

 

**The Bank**

 

As a Californiastate-chartered bank whose accounts are insured by the FDIC up to a maximum of$100,000 per depositor, the Bank is subject to regulation, supervision andregular examination by the Department of Financial Institutions (the “DFI”) andthe FDIC. In addition, while the Bank is not a member of the Federal ReserveSystem, it is subject to certain regulations of the Federal Reserve Board. Theregulations of these agencies govern most aspects of the Bank’s business,including the making of periodic reports by the Bank, and the Bank’s activitiesrelating to dividends, investments, loans, borrowings, capital requirements,certain check-clearing activities, branching, mergers and acquisitions,reserves against deposits and numerous other areas. Supervision, legal actionand examination of the Bank by the FDIC are generally intended to protectdepositors and are not intended for the protection of shareholders.

 

The earnings and growthof the Bank are largely dependent on its ability to maintain a favorabledifferential or “spread” between the yield on its interest-earning assets andthe rate paid on its deposits and other interest-bearing liabilities. As aresult, the Bank’s performance is influenced by general economic conditions,both domestic and foreign, the monetary and fiscal policies of the federalgovernment, and the policies of the regulatory agencies, particularly theFederal Reserve Board. The Federal Reserve Board implements national monetarypolicies (such as seeking to curb inflation and combat recession) by itsopen-market operations in United States Government securities, by adjusting therequired level of reserves for financial institutions subject to its reserverequirements and by varying the discount rate applicable to borrowings by bankswhich are members of the Federal Reserve System. The actions of the FederalReserve Board in these areas influence the growth of bank loans, investmentsand deposits and also affect interest rates charged on loans and deposits. Thenature and impact of any future changes in monetary policies cannot bepredicted.

 

**Capital Adequacy Requirements**

 

The Company and the Bankare subject to the regulations of the Federal Reserve Board and the FDIC,respectively, governing capital adequacy. Those regulations incorporate bothrisk-based and leverage capital requirements. Each of the federal regulatorshas established risk-based and leverage capital guidelines for the banks orbank holding companies it regulates, which set total capital requirements anddefine capital in terms of “core capital elements,” or Tier 1 capital; and “supplementalcapital elements,” or Tier 2 capital. Tier 1 capital is generally defined asthe sum of the core capital elements less goodwill and certain otherdeductions, notably the unrealized net gains or losses (after tax adjustments)on available for sale investment securities carried at fair market value. Thefollowing items are defined as core capital elements: (i) commonshareholders’ equity; (ii) trust preferred securities are a form oflong-term borrowing that currently qualifies as Tier 1 capital not to exceed25% of pro-forma Tier 1 capital; (iii) qualifying non-cumulative perpetualpreferred stock and related surplus (not to exceed 25% of pro-forma Tier 1capital); and (iv) minority interests in the equity accounts ofconsolidated subsidiaries. Supplementary capital elements include:  (i) allowance for loan and lease losses(but not more than 1.25% of an institution’s risk-weighted assets); (ii) perpetualpreferred stock and related surplus not qualifying as core capital; (iii) hybridcapital instruments, perpetual debt and mandatory convertible debt instruments;and (iv) term subordinated debt and intermediate-term preferred stock and

 

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related surplus. Themaximum amount of supplemental capital elements which qualifies as Tier 2capital is limited to 100% of Tier 1 capital, net of goodwill.

 

The minimum requiredratio of qualifying total capital to total risk-weighted assets is 8.0% (“TotalRisk-Based Capital Ratio”), at least one half of which must be in the form ofTier 1 capital, and the minimum required ratio of Tier 1 capital to totalrisk-weighted assets is 4.0% (“Tier 1 Risk-Based Capital Ratio”). Risk-basedcapital ratios are calculated to provide a measure of capital that reflects thedegree of risk associated with a banking organization’s operations for bothtransactions reported on the balance sheet as assets, and transactions, such asletters of credit and recourse arrangements, which are recorded as off-balancesheet items. Under the risk-based capital guidelines, the nominal dollaramounts of assets and credit-equivalent amounts of off-balance sheet items aremultiplied by one of several risk adjustment percentages, which range from 0%for assets with low credit risk, such as certain U. S. Treasury securities, to100% for assets with relatively high credit risk, such as business loans. As ofDecember 31, 2007 and 2006, the Bank’s Total Risk-Based Capital Ratioswere 11.4% and 11.1%, respectively and its Tier 1 Risk-Based CapitalRatios were 10.4% and 10.0%, respectively. As of December 31, 2007 and2006, the Company’s Total Risk-Based Capital was 14.1% and 11.9% respectively,and its Tier 1 Risk-Based Capital Ratio was 13.1% and 10.9% respectively. Therisk-based capital requirements also take into account concentrations of credit(i.e., relatively large proportions of loans involving one borrower, industry,location, collateral or loan type) and the risks of “non-traditional”activities (those that have not customarily been part of the banking business).The regulations require institutions with high or inordinate levels of risk tooperate with higher minimum capital standards, and authorize the regulators toreview an institution’s management of such risks in assessing an institution’scapital adequacy.

 

The risk-based capitalregulations also include exposure to interest rate risk as a factor that theregulators will consider in evaluating a bank’s capital adequacy. Interest raterisk is the exposure of a bank’s current and future earnings and equity capitalarising from adverse movements in interest rates. While interest risk isinherent in a bank’s role as financial intermediary, it introduces volatilityto bank earnings and to the economic value of the bank.

 

The FDIC and the FederalReserve Board also require the maintenance of a leverage capital ratio designedto supplement the risk-based capital guidelines. Banks and bank holding companiesthat have received the highest rating of the five categories used by regulatorsto rate banks and are not anticipating or experiencing any significant growthmust maintain a ratio of Tier 1 capital (net of all intangibles) to adjustedtotal assets (“Leverage Capital Ratio”) of at least 3%. All other institutionsare required to maintain a leverage ratio of at least 100 to 200 basis pointsabove the 3% minimum, for a minimum of 4% to 5%. Pursuant to federalregulations, banks must maintain capital levels commensurate with the level ofrisk to which they are exposed, including the volume and severity of problemloans, and federal regulators may, however, set higher capital requirementswhen a bank’s particular circumstances warrant. As of December 31, 2007and 2006, the Bank’s Leverage Capital Ratios were 9.3% and 9.0%, respectively.

 

As of December 31,2007 and 2006, the Company’s leverage capital ratios were 11.6% and 10.1%,respectively, exceeding regulatory minimums. At December 31, 2007 and 2006the Company met all of its capital adequacy guidelines and the Bank wasconsidered “well capitalized” under the prompt corrective action provisions.See Part II, Item 7, Management’s Discussion and Analysis of FinancialCondition and Results of Operation — Liquidity and Market Risk Management.

 

**Prompt Corrective ActionProvisions**

 

Federal law requires eachfederal banking agency to take prompt corrective action to resolve the problemsof insured financial institutions, including but not limited to those that fallbelow one or more prescribed minimum capital ratios. The federal bankingagencies have by regulation defined the following five capital categories: “wellcapitalized” (Total Risk-Based Capital Ratio of 10%; Tier 1 Risk-Based CapitalRatio of 6%; and Leverage Ratio of 5%); “adequately capitalized” (TotalRisk-Based Capital Ratio of 8%; Tier 1 Risk-Based Capital Ratio of 4%; andLeverage Ratio of 4%) (or 3% if the institution receives the highest ratingfrom its primary regulator); “undercapitalized” (Total Risk-Based Capital Ratioof less than 8%; Tier 1 Risk-Based Capital Ratio of less than 4%; or LeverageRatio of less than 4%) (or 3% if the institution receives the highest ratingfrom its primary regulator); “significantly undercapitalized” (Total Risk-BasedCapital Ratio of less than 6%; Tier 1 Risk-Based Capital Ratio of less than 3%;or Leverage Ratio less than 3%); and “critically undercapitalized” (tangibleequity to total assets less than 2%). A bank may be treated as though it werein the next lower capital category if after notice and the opportunity for ahearing, the

 

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appropriate federalagency finds an unsafe or unsound condition or practice so warrants, but nobank may be treated as “critically undercapitalized” unless its actual capitalratio warrants such treatment.

 

At each successivelylower capital category, an insured bank is subject to increased restrictions onits operations. For example, a bank is generally prohibited from paying managementfees to any controlling persons or from making capital distributions if to doso would make the bank “undercapitalized.” Asset growth and branching restrictions apply to undercapitalized banks,which are required to submit written capital restoration plans meetingspecified requirements (including a guarantee by the parent holding company, ifany). “Significantly undercapitalized” banks are subject to broad regulatoryauthority, including among other things, capital directives, forced mergers, restrictionson the rates of interest they may pay on deposits, restrictions on asset growthand activities, and prohibitions on paying certain bonuses without FDICapproval. Even more severe restrictions apply to critically undercapitalizedbanks. Most importantly, except under limited circumstances, not later than 90days after an insured bank becomes critically undercapitalized, the appropriatefederal banking agency is required to appoint a conservator or receiver for thebank.

 

In addition to measures takenunder the prompt corrective action provisions, insured banks may be subject topotential actions by the federal regulators for unsafe or unsound practices inconducting their businesses or for violations of any law, rule, regulation orany condition imposed in writing by the agency or any written agreement withthe agency. Enforcement actions may include the issuance of cease and desistorders, termination of insurance of deposits (in the case of a bank), theimposition of civil money penalties, the issuance of directives to increasecapital, formal and informal agreements, or removal and prohibition ordersagainst “institution-affiliated” parties.

 

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** **

**Safety and Soundness Standards**

 

The federal bankingagencies have also adopted guidelines establishing safety and soundnessstandards for all insured depository institutions. Those guidelines relate tointernal controls, information systems, internal audit systems, loanunderwriting and documentation, compensation and interest rate exposure. Ingeneral, the standards are designed to assist the federal banking agencies inidentifying and addressing problems at insured depository institutions beforecapital becomes impaired. If an institution fails to meet these standards, theappropriate federal banking agency may require the institution to submit acompliance plan and institute enforcement proceedings if an acceptablecompliance plan is not submitted.

 

**Premiums for Deposit Insurance**

 

The FDIC merged the BankInsurance Fund (BIF) and the Savings Association Insurance Fund (SAIF) to formthe Deposit Insurance Fund (DIF) on March 31, 2006 in accordance with theFederal Deposit Insurance Reform Act of 2005. As a result of the merger of theBIF and SAIF, all insured institutions are subject to the same assessment rateschedule. The amount each institution is assessed is based upon statutoryfactors that include the balance of insured deposits as well as the degree ofrisk the institution poses to the insurance fund.

 

****Effective January 1, 2007******,**the previous nine risk classifications (the risk-basedassessment matrix) were consolidated into four risk categories. However,capital ratios and supervisory ratings continue to distinguish risk categories.The following table shows the relationship between the old nine-cell matrix andthe new risk categories as well as the initial assessment rates for each newrisk category. Supervisory Group A generally include institutions with CAMELScomposite ratings of 1 or 2; Supervisory Group B generally includesinstitutions with a CAMELS composite rating of 3; and Supervisory Group Cgenerally includes institutions with CAMELS composite ratings of 4 or 5.  The current DIF base assessment rates(expressed as cents per $100 of deposits) are summarized as follows:

 

| ** **             | ** ** | **Supervisory Group** | ** ** |
|------------------------|------------|-----------------------|------------|
| **Capital Group**      | ** ** | **A**                 | ** ** | **B** | ** ** | **C** | ** ** |
|                   | ** ** | **I**                 | ** ** | **II** | ** ** | **III** | ** ** |
| Well Capitalized       | ** ** | **5-7**               | ** ** | **10** | ** ** | **28** | ** ** |
| Adequately Capitalized |       |                  |       |   |   |   |   |
|                   | ** ** | **III**               | ** ** | **IV** | ** ** |
| Undercapitalized       | ** ** | **28**                | ** ** | **43** | ** ** |

 

**Dividends**

 

The Company is entitledto receive dividends, when and as declared by its subsidiary banks’ Boards ofDirectors. Those dividends may come from funds legally available for thosedividends, as specified and limited by the California Financial Code and the U.S.Code. Under the California Financial Code, funds available for cash dividendsby a California-chartered bank are restricted to the lesser of:(i) thebank’s retained earnings; or (ii) the bank’s net income for its last threefiscal years (less any distributions to shareholders made during such period).With the prior approval of the California Department of Financial Institutions(“DFI”) , cash dividends may also be paid out of the greater of: (i) thebank’s retained earnings; (ii) net income for the bank’s last precedingfiscal year; or (iii) net income for the bank’s current fiscal year. Ifthe DFI determines that the shareholders’ equity of the bank paying thedividend is not adequate or that the payment of the dividend would be unsafe orunsound for the bank, the DFI may order the bank not to pay the dividend.

 

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It is also possible,depending upon its financial condition and other factors, that a regulatoryagency could assert that the payment of dividends or other payments might,under some circumstances, constitute an unsafe or unsound practice and therebyprohibit such payments.

 

California CorporationsCode Section 500 allows the Company to pay a dividend to its shareholdersonly to the extent that it has retained earnings and, after the dividend, its:

 

·                  assets (exclusive of goodwill and otherintangible assets) would be 1.25 times its liabilities (exclusive of deferredtaxes, deferred income and other deferred credits); and

 

·                  current assets would be at least equal tocurrent liabilities.

 

Additionally, the FRB’spolicy regarding dividends provides that a bank holding company should not paycash dividends exceeding its net income or which can only be funded in waysthat weaken the bank holding company’s financial health, such as by borrowing.The FRB also possesses enforcement powers over bank holding companies and theirnon-bank subsidiaries to prevent or remedy actions that represent unsafe orunsound practices or violations of applicable statutes and regulations.

 

**Transactions with Affiliates**

 

The Company and any ofits subsidiaries and certain related interests are deemed to be affiliates ofits subsidiary banks within the meaning of Sections 23A and 23B of the FederalReserve Act. Under those terms, loans by a subsidiary bank to affiliates,investments by them in affiliates’ stock, and taking affiliates’ stock ascollateral for loans to any borrower is limited to 10% of the particularbanking subsidiary’s capital, in the case of any one affiliate, and is limitedto 20% of the banking subsidiary’s capital, in the case of all affiliates. Inaddition, such transactions must be on terms and conditions that are consistentwith safe and sound banking practices; in particular, a bank and itssubsidiaries generally may not purchase from an affiliate a low-quality asset,as defined in the Federal Reserve Act. These restrictions also prevent a bankholding company and its other affiliates from borrowing from a bankingsubsidiary of the bank holding company unless the loans are secured bymarketable collateral of designated amounts. The Company and its subsidiarybanks are also subject to certain restrictions with respect to engaging in theunderwriting, public sale and distribution of securities.

 

**Changes in Legislation andRegulation of Financial Institutions**

 

We are subject toextensive government regulation, which may impact our ability to increase ourassets and earnings.  Banking operationsare subject to regulation by federal and state and governmental authorities andare subject to various laws and judicial and administrative decisions imposingrequirements and restrictions on part or all of our operations.  Because our business is highly regulated, thelaws, rules, regulations and supervisory guidance and policies applicable to usare subject to regular modification and change. In addition, various laws, rules and regulations are periodicallyproposed, which, if adopted, could impact our operations by making compliancemuch more difficult or expensive, restricting our ability to originate or sellloans or further restricting our ability to originate or sell loans or furtherrestricting the amount of interest or other charges or fees earned on loans orother products.

 

*Amendments to Regulation H and Yfor Trust Preferred Securities**.*** The Federal Reserve Board issued a finalrule on March 1, 2005 that amends Regulation H and Regulation Y tolimit restricted core capital elements (including trust preferred securities)which count as Tier 1 capital to 25 percent of all core capital elements, netof goodwill less any associated deferred tax liability. Internationally activebank holding companies, will be subject to a 15 percent limit, but they mayinclude qualifying mandatory convertible preferred securities up to thegenerally applicable 25 percent limit. Amounts of restricted core capitalelements in excess of these limits generally may be included in Tier 2 capital.The final rule provides a five-year transition period, ending March 31,2009, for application of the quantitative limits.

 

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**Community Reinvestment Act**

 

The Bank is subject tocertain requirements and reporting obligations involving Community ReinvestmentAct (“CRA”) activities. The CRA generally requires the federal banking agenciesto evaluate the record of a financial institution in meeting the credit needsof its local communities, including low and moderate income neighborhoods. TheCRA further requires the agencies to take a financial institution’s record ofmeeting its community credit needs into account when evaluating applicationsfor, among other things, domestic branches, consummating mergers oracquisitions, or holding company formations. In measuring a bank’s compliancewith its CRA obligations, the regulators utilize a performance-based evaluationsystem which bases CRA ratings on the bank’s actual lending service andinvestment performance, rather than on the extent to which the institutionconducts needs assessments, documents community outreach activities or complieswith other procedural requirements. In connection with its assessment of CRAperformance, the FDIC assigns a rating of “outstanding,” “satisfactory,” “needsto improve” or “substantial noncompliance.” The Bank was last examined for CRA compliance in February 2007 andreceived a “satisfactory” CRA Assessment Rating.

 

###### **Other Consumer Protection Laws and Regulations**

######  

The bank regulatoryagencies are increasingly focusing attention on compliance with consumerprotection laws and regulations. Examination and enforcement has become intense,and banks have been advised to carefully monitor compliance with variousconsumer protection laws and their implementing regulations. The federalInteragency Task Force on Fair Lending issued a policy statement ondiscrimination in home mortgage lending describing three methods that federalagencies will use to prove discrimination: overt evidence of discrimination,evidence of disparate treatment, and evidence of disparate impact. In additionto CRA and fair lending requirements, the Bank is subject to numerous otherfederal consumer protection statutes and regulations. Due to heightenedregulatory concern related to compliance with consumer protection laws andregulations generally, the Bank may incur additional compliance costs or berequired to expend additional funds for investments in the local communities itserves.

 

**Interstate Banking and Branching**

 

The Riegle-NealInterstate Banking and Branching Efficiency Act of 1994 (the “InterstateBanking Act”) regulates the interstate activities of banks and bank holdingcompanies and establishes a framework for nationwide interstate banking andbranching. Since June 1, 1997, a bank in one state has generally beenpermitted to merge with a bank in another state without the need for explicitstate law authorization. However, states were given the ability to prohibitinterstate mergers with banks in their own state by “opting-out” (enactingstate legislation applying equality to all out-of-state banks prohibiting suchmergers) prior to June 1, 1997.

 

Since 1995, adequatelycapitalized and managed bank holding companies have been permitted to acquirebanks located in any state, subject to two exceptions: first, any state maystill prohibit bank holding companies from acquiring a bank which is less thanfive years old; and second, no interstate acquisition can be consummated by abank holding company if the acquirer would control more than 10% of thedeposits held by insured depository institutions nationwide or 30% percent ormore of the deposits held by insured depository institutions in any state inwhich the target bank has branches.

 

A bank may establish andoperate de novo branches in any state in which the bank does not maintain abranch if that state has enacted legislation to expressly permit all out-of-statebanks to establish branches in that state.

 

In 1995 Californiaenacted legislation to implement important provisions of the Interstate BankingAct discussed above and to repeal California’s previous interstate bankinglaws, which were largely preempted by the Interstate Banking Act.

 

The changes effected byInterstate Banking Act and California laws have increased competition in theenvironment in which the Bank operates to the extent that out-of-statefinancial institutions directly or indirectly enter the Bank’s market areas. Itappears that the Interstate Banking Act has contributed to the acceleratedconsolidation of the banking industry. While many large out-of-state banks havealready entered the California market as a result of this legislation, 

 

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it is not possible topredict the precise impact of this legislation on the Bank and the Company andthe competitive environment in which they operate.

 

**Financial Modernization Act**

 

Effective March 11,2000 the Gramm-Leach-Bliley Act eliminated most barriers to affiliations amongbanks and securities firms, insurance companies, and other financial serviceproviders, and enabled full affiliations to occur between such entities. Thislegislation permits bank holding companies to become “financial holdingcompanies” and thereby acquire securities firms and insurance companies andengage in other activities that are financial in nature. A bank holding companymay become a financial holding company if each of its subsidiary banks is wellcapitalized under the FDICIA prompt corrective action provisions, is wellmanaged, and has at least a satisfactory rating under the CRA by filing adeclaration that the bank holding company wishes to become a financial holdingcompany. No regulatory approval will be required for a financial holdingcompany to acquire a company, other than a bank or savings association, engagedin activities that are financial in nature or incidental to activities that arefinancial in nature, as determined by the Federal Reserve Board. The Companybecame a financial holding company in 2004 for the purpose of establishing thesubsidiary BCB Insurance Agency.

 

The Gramm-Leach-BlileyAct defines “financial in nature” to include securities underwriting, dealingand market making; sponsoring mutual funds and investment companies; insuranceunderwriting and agency; merchant banking activities; and activities that theBoard has determined to be closely related to banking. A national bank (andtherefore, a state bank as well) may also engage, subject to limitations oninvestment, in activities that are financial in nature, other than insuranceunderwriting, insurance company portfolio investment, real estate developmentand real estate investment, through a financial subsidiary of the bank, if thebank is well capitalized, well managed and has at least a satisfactory CRArating. Subsidiary banks of a financial holding company or national banks withfinancial subsidiaries must continue to be well capitalized and well managed inorder to continue to engage in activities that are financial in nature withoutregulatory actions or restrictions, which could include divestiture of thefinancial in nature subsidiary or subsidiaries. In addition, a financialholding company or a bank may not acquire a company that is engaged inactivities that are financial in nature unless each of the subsidiary banks ofthe financial holding company or the bank has a CRA rating of satisfactory orbetter.

 

The Gramm-Leach-BlileyAct also imposes significant new requirements on the sharing of customerinformation between financial institutions. The Company has responded to thesenew restrictions.

 

The Company and the Bankmust file periodic reports with the various regulators to keep them informed oftheir financial condition and operations as well as their compliance with allthe various regulations. Three regulatory agencies - the Federal Reserve Bankof San Francisco for the Company, and the FDIC and the California Department ofFinancial Institutions - conduct periodic examinations of the Company and theBank to verify their reporting is accurate and to ascertain that they are incompliance with regulations.

 

A banking agency may takeaction against a financial holding company or a bank should it find thefinancial institution has failed to maintain adequate capital. This action hasusually taken the form of restrictions on the payment of dividends toshareholders, requirements to obtain more capital from investors, andrestrictions on operations. The FDIC may also take action against a bank thatis not acting in a safe and sound manner. Given the strong capital position andperformance of the Company and the Bank, Management does not expect to beimpacted by these types of restrictions in the foreseeable future.

 

**Sarbanes-Oxley Act**

 

In 2002, theSarbanes-Oxley Act was enacted as Federal legislation. This legislation imposesa number of new requirements on financial reporting and corporate governance onall corporations. Passed in response to corporate accounting and reportingfailures, the act requires all public companies to document their internalcontrols over financial reporting, evaluate the design and effectiveness ofthose controls, periodically test all significant controls to ensure they arefunctioning, and provide a certification by the Chief Executive Officer andChief Financial Officer of the documentation, evaluation, and testing. The actfurther requires companies’ independent registered public accounting firm toevaluate this assertion.

 

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**Regulatory Capital Treatment ofEquity Investments.**

 

In December of 2001and January of 2002, the OCC, the FRB and the FDIC adopted final rules governingthe regulatory capital treatment of equity investments in non-financialcompanies held by banks, bank holding companies and financial holdingcompanies. The new capital requirements apply symmetrically to equityinvestments made by banks and their holding companies in non-financial companiesunder the legal authorities specified in the final rules. Among others, theseinclude the merchant banking authority granted by the Gramm-Leach-Bliley Actand the authority to invest in small business investment companies (“SBICs”)granted by the Small Business Investment Act. Covered equity investments willbe subject to a series of marginal Tier 1 capital charges, with the size of thecharge increasing as the organization’s level of concentration in equityinvestments increases. The highest marginal charge specified in the final rules requiresa 25 percent deduction from Tier 1 capital for covered investments thataggregate more than 25 percent of an organization’s Tier 1 capital. Equityinvestments through SBICs will be exempt from the new charges to the extentsuch investments, in the aggregate, do not exceed 15 percent of the bankingorganization’s Tier 1 capital. Grandfathered investments made by state banksunder section 24(f) of the Federal Deposit Insurance Act also are exemptedfrom coverage.

 

**Other Pending and ProposedLegislation**

 

Other legislative andregulatory initiatives which could affect the Company, the Bank and the bankingindustry in general are pending, and additional initiatives may be proposed orintroduced before the United States Congress, the California legislature andother governmental bodies in the future. Such proposals, if enacted, mayfurther alter the structure, regulation and competitive relationship amongfinancial institutions, and may subject the Bank to increased regulation,disclosure and reporting requirements. In addition, the various bankingregulatory agencies often adopt new rules and regulations to implement andenforce existing legislation. It cannot be predicted whether, or in what form,any such legislation or regulations may be enacted or the extent to which thebusiness of the Company or the Bank would be affected thereby.

 

**Recent Accounting Pronouncements**

 

*Fair Value Measurements*

 

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement No. 157 (SFAS 157), *Fair Value Measurements*.  SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.  SFAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances.  In this standard, the FASB clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability.  In support of this principle, SFAS 157 establishes a fair value hierarchy that prioritizes the information used to develop those assumptions.  The provisions of SFAS 157 are effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years.  The provisions should be applied prospectively, except for certain specifically identified financial instruments.  The Company adopted SFAS 157 on January 1, 2008 and management does not believe its adoption will have a material impact on the Company’s financial position, results of operations or cash flows.

 

*The Fair Value Option for Financial Assets and Financial Liabilities*

 

In February 2007,the FASB issued Statement No. 159 (SFAS 159), *The FairValue Option for Financial Assets and Financial Liabilities — Including anAmendment of FASB Statement No. 115.*  This standard permits an entity to choose tomeasure many financial instruments and certain other items at fair value atspecified election dates.  The entitywill report unrealized gains and losses on items for which the fair valueoption has been elected in earnings at each subsequent reporting date.  The fair value option (a) may be appliedinstrument by instrument, with a few exceptions, such as investments otherwiseaccounted for by the equity method, (b) is irrevocable (unless a newelection date occurs), and (c) is applied only to entire instruments andnot to portions of instruments.  TheCompany adopted SFAS 159 on January 1, 2008 and management did not electthe fair value option for any of its financial instruments.

 

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*Accountingfor Business Combinations*

 

In December 2007,the FASB issued Statement of Financial Accounting Standards No. 141(revised 2007), *Business Combinations*(“SFASNo. 141R”).  SFAS No. 141(R),among other things, establishes principles and requirements for how theacquirer in a business combination (i) recognizes and measures in itsfinancial statements the identifiable assets acquired, the liabilities assumed,and any noncontrolling interest in the acquired business, (ii) recognizesand measures the goodwill acquired in the business combination or a gain from abargain purchase, and (iii) determines what information to disclose toenable users of the financial statements to evaluate the nature and financialeffects of the business combination.  TheCompany is required to adopt SFAS No. 141(R) for all businesscombinations for which the acquisition date is on or after January 1,2009.  Earlier adoption isprohibited.  This standard will changethe accounting treatment for business combinations on a prospective basis.

 

**Item 1a.Risk Factors**

 

This discussion andanalysis provides insight into Management’s assessment of the operating trendsover the last several years and its expectations for 2008. Such expressions ofexpectations are not historical in nature and are “forward-looking statements”within the meaning of the Private Securities Litigation Reform Act of 1995.Forward-looking statements are subject to risks and uncertainties that maycause actual future results to differ materially from those expressed in anyforward-looking statement. Such risks and uncertainties with respect to theCompany include:

 

·                  increased competitive pressure among financialservices companies;

 

·                  changes in the interest rate environment reducinginterest margins or increasing interest rate risk;

 

·                  deterioration in general economic conditions,internationally, nationally or in the State of California;

 

·                  the occurrence of future events such as the terroristacts of September 11, 2001;

 

·                  the availability of sources of liquidity at areasonable cost; and

 

·                  legislative or regulatory changes adversely affectingthe business in which the Company engages.

 

**Competition**

 

The Company facescompetition from other financial institutions and from businesses in otherindustries that have developed financial products. Banks once had an almostexclusive franchise for deposit products and provided the majority of businessfinancing. With deregulation in the 1980’s, other kinds of financialinstitutions began to offer competing products. Also, increased competition inconsumer financial products has come from companies not typically associatedwith the banking and financial services industry, such as AT &T,General Motors and various software developers. Similar competition is facedfor commercial financial products from insurance companies and investmentbankers. Community banks, including the Company, attempt to offset this trendby developing new products that capitalize on the service quality that a localinstitution can offer. Among these are new loan, deposit, and investmentproducts. The Company’s primary competitors are different for each specificproduct and market area. While this offers special challenges for the marketingof our products, it offers protection from one competitor dominating theCompany in its market areas. Many of these competitors are much larger in totalassets and capitalization, have greater access to capital markets and offer abroader array of financial services than we do, which creates certaincompetitive disadvantages for the Company.

 

**Changes in Economic Conditions**

 

Changes in economicconditions could materially affect the Company. Our business is directly affected by changes in economic conditions,including finance, legislative and regulatory changes and changes in governmentmonetary and fiscal policies and inflation, all of which are beyond our control.  Deterioration in economic conditions couldresult in the following consequences.

 

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·                  Problem assets and foreclosures mayincrease

 

·                  Demand for our products and services maydecline

 

·                  Low cost or non-interest bearing depositsmay decrease

 

·                  Collateral for loans, especially realestate, may decline in value, reducing the value of assets and collateralassociated with our existing loans.

 

In view of theconcentration of our operations and the collateral securing our loan portfolio,we may be particularly susceptible to the adverse economic conditions in thestate of California and in the seven counties where our business isconcentrated.

 

Beginning in the summerof 2004 the Federal Reserve Board began raising its target rate and by year endit had increased by 1.25% to 5.25%. Throughout 2005 the Federal Reserve Boardcontinued to increase its target rate and by year end it reached 7.25%. During2006 the target rate was increased 25 basis points four times ending on June 29,2006 at 8.25% where it remained through the end of the year.   In 2007 the rate was unchanged until September 18,when it was lowered by 25 basis points. Subsequent adjustments to lower the rate further were done in October andDecember with a year end rate of 7.25%. Then in January, at an unscheduled meeting, the Federal Reserve Boardlowered the target rate by 75 basis points to 6.50% and again by 50 basispoints on January 30, 2008 to 6.0%. These actions by the Federal ReserveBoard were brought on by conditions of slowing economic growth reflecting theintensification of the housing correction and declines in business and consumerspending.  These changes impacted theCompany as market rates for loans, investments and deposits respond to theFederal Reserve Board’s actions. A significant portion of our total loanportfolio is related to real estate obligations, particularly residential realestate loans. Our local economies are currently experiencing stabilization fromthe rapid pace of people moving into our service areas that we had becomeaccustomed to during the recent years. According to data provided by the Chico Association of Realtors, 996homes were sold in Chico in 2005, 904 in 2006, and 873 in 2007.  These numbers represent a decline of just 12%in two years.  For the entire state ofCalifornia the figure is 50%.

 

Dramatic negativedevelopments in the latter half of 2007 in the subprime mortgage market and thesecuritization markets for such loans have resulted in uncertainty in thefinancial markets generally and the expectation of a general economic downturnin 2008. Commercial as well as consumer loan portfolio performances havedeteriorated at many institutions and the competition for deposits and qualityloans has increased significantly. The values of real estate collateralsupporting many commercial loans and home mortgages have declined and may continue.Bank and bank holding company stock prices have been negatively affected as hasthe ability of banks and bank holding companies to raise capital or borrow inthe debt markets compared to recent years. There is potential for new federalor state laws and regulations regarding lending and funding practices andliquidity standards, and bank regulatory agencies are expected to be veryaggressive in responding to concerns and trends identified in examinations,including the expected issuance of many formal enforcement orders. The Companycannot predict whether or when potential legislation will be enacted, and ifenacted, the effect that it, or any implementing regulations and supervisorypolicies, would have on our financial condition or results of operations. Inaddition, the outcome of examinations, any litigation or any investigationsinitiated by state or federal authorities may result in necessary changes inour operations and increased compliance costs.

 

**Risk Management**

 

The Company sees theprocess of addressing the potential impacts of the external factors listedabove as part of its management of risk. In addition to common business riskssuch as disasters, theft, and loss of market share, the Company is subject tospecial types of risk due to the nature of its business. New and sophisticatedfinancial products are continually appearing with different types of risk whichneed to be defined and managed if the Company chooses to offer them to itscustomers. Also, the risks associated with existing products must be reassessedperiodically. The Company cannot operate risk-free and make a profit. Instead,the process of risk definition and assessment allows the Company to select theappropriate level of risk for the anticipated level of reward and then decideon the steps necessary to manage this risk. The Company’s Risk Officer and theother members of its Senior Management Team under the direction and oversightof the Board of Directors lead the risk management process.

 

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Some of the risks facedby the Company are those faced by most enterprises — reputational risk,operational risk, and legal risk. The special risks related to financialproducts are **credit risk** and **interest rate risk.**Credit risk relates to the possibilitythat a debtor will not repay according to the terms of the debt contract.Credit risk is discussed in the sections related to loans. Interest rate riskis discussed in the sections related to Liquidity and Market Risk Managementand relates to the adverse impacts of changes in interest rates. The effectivemanagement of these and other risks mentioned above is the backbone of theCompany’s business strategy.

 

**Managing Our Growth**

 

Our Company’s totalassets increased from $550 million at December 31, 2006 to $581 million atDecember 31, 2007. Management’s intention is to leverage the Company’scurrent infrastructure and by acquiring the lowest cost deposits available andallocating those deposits into the highest earning assets possible. Although noassurance can be provided that this strategy will result in significant growth.Our ability to manage growth will depend primarily on our ability to:

 

·      monitoroperations;

 

·      controlfunding costs and operating expenses;

 

·      maintainpositive customer relations; and

 

·      attract,assimilate and retain qualified personnel.

 

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

 

The Company earns incomefrom two sources. The primary source is from the management of its financialassets and liabilities and the second is from charging fees for servicesprovided. The first source involves functioning as a **financialintermediary**, that is, the Company accepts funds from depositors orobtains funds from other creditors and then either lends the funds to borrowersor invests those funds in securities or other financial instruments. Income isearned as a spread between the interest earned from the loans or investmentsand the interest paid on the deposits and other borrowings. The second source,fee income, is discussed in other sections of this analysis, specifically in “NoninterestRevenue.”

 

**Changes in Net Interest Incomeand Net Interest Margin**

 

**Net interest income** is the difference or spread between theinterest and fees earned on loans and investments (the Company’s **earning assets**) and the interest expense paid on depositsand other liabilities. The amount by which interest income will exceed interestexpense depends on two factors: (1) the volume or balance of earning assetscompared to the volume or balance of interest-bearing deposits and liabilities,and (2) the interest rate earned on those interest earning assets comparedwith the interest rate paid on those interest-bearing deposits and liabilities.

 

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

 

19

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**The Allowance for Loan Losses May NotCover Actual Loan Losses.******Weattempt to limit the risk that borrowers will fail to repay loans by carefullyunderwriting the loans, nevertheless losses can and do occur. We create anallowance for loan losses in our accounting records, based on estimates of thefollowing:

 

·                  industry standards;

 

·                  historical experience with our loans;

 

·                  evaluation of qualitative factors such as loanconcentrations and local economic conditions;

 

·                  regular reviews of the quality, mix and size of theoverall loan portfolio;

 

·                  regular reviews of delinquencies; and

 

·                  the quality of the collateral underlying our loans;

 

·                  loan impairment.

 

We maintain an allowancefor loan losses at a level which we believe is adequate to absorb anyspecifically identified losses as well as any other losses inherent in our loanportfolio. However, changes in economic, operating and other conditions,including changes in interest rates, which are beyond our control, may causeour actual loan losses to exceed our current allowance estimates. If the actualloan losses exceed the amount reserved, it will hurt our business. In addition,the FDIC and the California Department of Financial Institutions, as part oftheir supervisory functions, periodically review our allowance for loan losses.Such agencies may require us to increase our provision for loan losses or torecognize further loan losses, based on their judgments, which may be differentfrom those of our management. Any increase in the allowance required by theFDIC or the California Department of Financial Institutions could also impactour business.

 

**Item 1b.Unresolved Staff Comments**

 

No comments have beensubmitted to the registrant by the staff of the Securities Exchange Commission.

 

20

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

 

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

 

 
| ** **                        | ** ** | ** **            | ** ** | **Square Feet of** | ** ** | **Land and**      | ** ** |
|-----------------------------------|------------|-----------------------|------------|--------------------|------------|-------------------|------------|
| **Location**                      | ** ** | **Use of Facilities** | ** ** | **Office Space**   | ** ** | **Building Cost** | ** ** |
| 672 Pearson Road                  |       |                  |       |               |       |              |       |
| Paradise, California              |       |                  |       |               |       |              |       |
| (Opened December 1990)            |       | Branch Office         |       | 4,200              |       | $                 | 1,039,475  |   |
|                              |       |                  |       |               |       |              |       |
| 2227 Myers Street                 |       |                  |       |               |       |              |       |
| Oroville, California              |       |                  |       |               |       |              |       |
| (Opened December 1990)            |       | Branch Office         |       | 9,800              |       | $                 | 1,029,737  |   |
|                              |       |                  |       |               |       |              |       |
| 2041 Forest Avenue                |       |                  |       |               |       |              |       |
| Chico, California                 |       |                  |       |               |       |              |       |
| (Opened September 1996)           |       | Branch Office         |       | 8,000              |       | $                 | 1,543,845  |   |
|                              |       |                  |       |               |       |              |       |
| 1390 Ridgewood Drive              |       |                  |       |               |       |              |       |
| Chico California                  |       | Central Services/     |       |               |       |              |       |
| Opened May 1998)                  |       | Information Svcs      |       | 8,432              |       | $                 | 1,098,293  |   |
|                              |       |                  |       |               |       |              |       |
| 1600 Butte House Road             |       |                  |       |               |       |              |       |
| Yuba City, California             |       |                  |       |               |       |              |       |
| (Opened September 1997)           |       | Branch Office         |       | 6,580              |       | $                 | 1,448,340  |   |
|                              |       |                  |       |               |       |              |       |
| 237 West East Avenue              |       |                  |       |               |       |              |       |
| Chico, California                 |       |                  |       |               |       |              |       |
| (Branch opened June 1999, moved   |       |                  |       |               |       |              |       |
| to this site November 2003)       |       |                  |       |               |       |              |       |
| building is owned, land is leased |       | Branch Office         |       | 4,771              |       | $                 | 845,493    |   |
|                              |       |                  |       |               |       |              |       |
| 10 Gilmore Road                   |       |                  |       |               |       |              |       |
| Red Bluff, California             |       |                  |       |               |       |              |       |
| (Branch opened May 2004,          |       |                  |       |               |       |              |       |
| moved to this site June 2006)     |       | Branch Office         |       | 8,000              |       | $                 | 1,790,000  |   |
|                              |       |                  |       |               |       |              |       |
| 1360 East Lassen Avenue           |       |                  |       |               |       |              |       |
| Chico, California                 |       | Administration        |       |               |       |              |       |
| (Opened January 2007)             |       | Credit Services       |       | 17,000             |       | $                 | 3,097,961  |   |
|                              |       |                  |       |               |       |              |       |
| 1335 Hilltop Dr                   |       |                  |       |               |       |              |       |
| Redding, California               |       |                  |       |               |       |              |       |
| (Opened August 2007)              |       | Branch office         |       | 4,150              |       | $                 | 1,447,000  |   |
|                              |       |                  |       |               |       |              |       |
| 5026 Rhonda Rd.                   |       |                  |       |               |       |              |       |
| Anderson, California              |       |                  |       |               |       |              |       |
| (Opened August 2007)              |       | Branch office         |       | 3,202              |       | $                 | 1,012,000  |   |

 

21

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The following facilities are leased by the Company:

 

 
| ** **                 | ** ** | ** **            | ** ** | **Square Feet of** | ** ** | **Monthly Rent**   | ** ** | **Term of** | ** **     |
|----------------------------|------------|-----------------------|------------|--------------------|------------|--------------------|------------|-------------|----------------|
| **Location**               | ** ** | **Use of Facilities** | ** ** | **Office Space**   | ** ** | **as of 12/31/07** | ** ** | **Lease**   | ** **     |
| 14001 Lakeridge Circle     |       | Branch Office         |       | 600                |       | $                  | 570        |        | 3/31/2008      | (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              |       | $                  | 6,954      |        | 9/30/2011      | (3) |
| Chico, California          |       |                  |       |               |       |               |       |        |           |
|                       |       |                  |       |               |       |               |       |        |           |
| 6653 Clark Road            |       | Branch Office         |       | 4,640              |       | $                  | 5,170      |        | 3/31/2013      | (4) |
| Paradise, California       |       |                  |       |               |       |               |       |        |           |
|                       |       |                  |       |               |       |               |       |        |           |
| 2951 Churn Creek Rd        |       | Branch Office         |       | 15,000             |       | $                  | 9,300      |        | 6/30/2011      | (5) |
| Redding, California        |       |                  |       |               |       |               |       |        |           |
|                       |       |                  |       |               |       |               |       |        |           |
| 5959 Greenback #430        |       | Loan Office           |       | 1,864              |       | $                  | 3,130      |        | 7/31/2012      | (6) |
| Citrus Heights, California |       |                  |       |               |       |               |       |        |           |
|                       |       |                  |       |               |       |               |       |        |           |
| 936 Mangrove Ave.          |       | General Offices       |       | 6,000              |       | $                  | 4,692      |        | 2/28/2013      | (7) |
| Chico, California          |       |                  |       |               |       |               |       |        |           |
|                       |       |                  |       |               |       |               |       |        |           |
| 904 B Street               |       | Branch office         |       | 16,742             |       | $                  | 10,670     |        | 10/31/2016     | (8) |
| Marysville, California     |       |                  |       |               |       |               |       |        |           |
|                       |       |                  |       |               |       |               |       |        |           |
| 1017 Bridge St             |       | Branch office         |       | 1,500              |       | $                  | 1,300      |        | 2/28/2014      | (9) |
| Colusa, California         |       |                  |       |               |       |               |       |        |           |
|                       |       |                  |       |               |       |               |       |        |           |
| 1010 Spruce Street         |       | Loan Office           |       | 960                |       | $                  | 900        |        | month to month |   |
| Gridley, California        |       |                  |       |               |       |               |       |        |           |
|                       |       |                  |       |               |       |               |       |        |           |
| 950 Hwy 99W                |       | Branch office         |       | 5,300              |       | $                  | 13,250     |        | 10/31/2016     | (10) |
| Corning, California        |       |                  |       |               |       |               |       |        |           |
|                       |       |                  |       |               |       |               |       |        |           |
| 1335 Hilltop Dr            |       | Branch office         |       |               |       | $                  | 6,250      |        | 2/28/2021      | (11) |
| Redding, California        |       |                  |       |               |       |               |       |        |           |
| land lease only            |       |                  |       |               |       |               |       |        |           |
|                       |       |                  |       |               |       |               |       |        |           |
| 5026 Rhonda Rd.            |       | Branch office         |       |               |       | $                  | 4,500      |        | 12/31/2027     | (12) |
| Anderson, California       |       |                  |       |               |       |               |       |        |           |
| land lease only            |       |                  |       |               |       |               |       |        |           |

 

Additionally, the Bankhas five remote ATM locations. The amount of monthly rent at these locations isminimal.

 

22

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----

 

(1) This is the termination date of the current 5-yearlease. The Company also has two renewal options for five years each. 

(2) This is the termination date of the current25-year lease. The Company also has three renewal options for five years each. 

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

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

(5) This is the termination date of the current 5-yearlease. The Company has two renewal options for five years each. 

(6) This is the termination date of the current 5-yearlease. The Company does not have renewal options on this property. 

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

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

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

(10) This is the termination date of the current 20year lease. The Company also has one renewal option for ten years. 

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

(12) This is the termination of the current 20yearland lease. The company also has three renewaloptions for ten years each. 

 

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

 

From time to time, theCompany is a party to claims and legal proceedings arising in the ordinarycourse of business. After taking into consideration information furnished bycounsel to the Company as to the current status of these claims or proceedingsto which the Company is a party, management is of the opinion that the ultimateaggregate liability represented thereby, if any, will not have a materialadverse affect on the financial condition of the Company.

 

**Item 4.****          ****Submission of Matters to aVote of Security Holders**

 

No matters were submittedto a vote of our shareholders’ during the fourth quarter of the fiscal yearended December 31, 2007.

 

 

**PART II**

 

**Item 5.****          ****Market for RegistrantsCommon Equity and Related Shareholder Matters and Issuer Purchases of EquitySecurities**

 

**(a)****                                 ****Market Information**

 

Community Valley Bancorpwas previously listed on the Nasdaq OTC Bulletin Board starting June 17,2002 (the effective date of the holding company reorganization), and ButteCommunity Bank was previously also listed on the Nasdaq OTC Bulletin Board. OurCommon Stock trades under the symbol CVLL and the CUSIP number for such commonstock is #20415P101. Previously the Butte Community Bank CUSIP number for thecommon stock 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. Management is aware of the following securities dealers whomake a market in the Company’s stock: Howe Barnes Hoefer & ArnettInc., San Francisco, California, Wachovia First Union Securities, Grass Valley,California, Wedbush Morgan Securities, Lake Oswego, Oregon and Sandler O’Neill &Partners, LP, New York, NY, (the “Securities Dealers”).

 

The graph that followsshows the total return performance of the Company as compared to the Russell3000 and the SNL $100 million to $500 million peer group of banks over the pastfive years.

 

23

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*** ***

***CommunityValleyBancorp***

 
| ** **                      | ** ** | **Period Ending** | ** ** |
|---------------------------------|------------|-------------------|------------|
| **Index**                       | ** ** | **12/31/02**      | ** ** | **12/31/03** | ** ** | **12/31/04** | ** ** | **12/31/05** | ** ** | **12/31/06** | ** ** | **12/31/07** | ** ** |
| Community Valley Bancorp        |       | 100.00            |       | 135.15 |   | 187.19 |   | 194.40 |   | 209.35 |   | 143.54 |   |
| Russell 3000                    |       | 100.00            |       | 131.06 |   | 146.71 |   | 155.69 |   | 180.16 |   | 189.42 |   |
| SNL Bank Pink $100M-$500M Index |       | 100.00            |       | 135.83 |   | 164.17 |   | 182.32 |   | 199.57 |   | 178.22 |   |
| SNL Bank Pink > $500M        |       | 100.00            |       | 139.37 |   | 163.02 |   | 173.49 |   | 190.35 |   | 175.39 |   |

 

The following tablesummarizes trades of the Company setting forth the approximate high and lowsales prices and volume of trading for the periods indicated, based uponinformation provided by public sources. The information in the following tabledoes not include trading activity between dealers.

 

 
| ** **         | ** ** | **Sale Price of the Company's** | ** ** | **Approximate**    | ** ** |
|--------------------|------------|---------------------------------|------------|--------------------|------------|
| **Calendar**       | ** ** | **Common Stock**                | ** ** | **Trading Volume** | ** ** |
| **Quarter Ended**  | ** ** | **High**                        | ** ** | **Low**            | ** ** | **Shares** | ** ** |
| March 31, 2006     |       | 15.75                           |       | 13.30              |       | 204,499 |   |
| June 30, 2006      |       | 19.79                           |       | 15.20              |       | 202,017 |   |
| September 30, 2006 |       | 17.95                           |       | 15.07              |       | 122,036 |   |
| December 31, 2006  |       | 17.80                           |       | 14.63              |       | 216,408 |   |
| March 31, 2007     |       | 15.00                           |       | 12.00              |       | 130,814 |   |
| June 30, 2007      |       | 14.00                           |       | 12.24              |       | 94,267 |   |
| September 30, 2007 |       | 14.59                           |       | 10.02              |       | 131,088 |   |
| December 31, 2007  |       | 13.85                           |       | 9.45               |       | 140,544 |   |

######  

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

######  

###### On March 5, 2008 there were approximately 555 shareholders ofrecord of the Company.

 

24

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

 

As a financial holdingcompany which currently has no significant assets other than its equityinterest in the Bank and the proceeds from the issuance of the Trust PreferredSecurities previously mentioned, the Company’s ability to declare dividendsdepends primarily upon dividends it receives from the Bank. The Bank’s dividendpractices in turn depend upon the Bank’s earnings, financial position, currentand anticipated cash requirements and other factors deemed relevant by the Bank’sBoard of Directors at that time.

 

The Company paid cashdividends quarterly totaling $2.4 million or $0.32 per share in 2007 and $1.9million or $0.26 per share in 2006, representing 37% and 27%, respectively ofthe prior year’s earnings. The Company anticipates paying dividends in thefuture consistent with the general dividend policy which declares thatdividends must meet applicable legal requirements while maintaining the minimumcapital ratios established by the Company.

 

The policy is to declareand pay dividends of no more than 40% of its previous years net income to shareholders.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.

 

The ability of the Bank’sBoard of Directors to declare cash dividends is also limited by statutory andregulatory restrictions which restrict the amount available for cash dividendsdepending upon the earnings, financial condition and cash needs of the Bank, aswell as general business conditions. A detailed discussion is located in Item 1above.

 

**(d)****                                 ****Stock Repurchase Plan**

 

The Board ofDirectors approved a plan to repurchase up to $3,000,000 of the outstandingcommon stock of the Company in 2003. Stock repurchases were made from time totime on the open market or through privately negotiated transactions. Thetiming of purchases and the exact number of shares purchased was dependent onmarket conditions. The share repurchase program did not include specific pricetargets or timetables and could have been suspended at any time. During2006, 143,950 shares were repurchased for $2,498,000 at an average price of$17.35 per share.   During 2005, noshares of the Company’s common stock were repurchased.  There were no shares available for repurchaseunder this plan after December 31, 2006.

 

The Board of Directorsapproved a plan to repurchase up to $6,000,000 of the outstanding common stockof the Company in 2007. Stock repurchases were made from time to time on theopen market or through privately negotiated transactions. The timing ofpurchases and the exact number of shares purchased was dependent on marketconditions. The share repurchase program did not include specific price targetsor timetables and could have been suspended at any time. During 2007,18,864 shares were repurchased for $210,000 at an average price of $11.15 pershare.

 

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

 

Thefollowing chart sets forth information for the fiscal year ended December 31,2007, regarding equity based compensation plans of the Company.

 
| **Plan Category**                                           | ** ** | **Number of securities to be issued upon exercise of outstanding  options, warrants, and rights  (a)** | ** ** | **Weighted average exercise price of outstanding options, warrants and  rights  (b)** | ** ** | **Number of securities remaining available for future issuance under  equity compensation plans (excluding securities reflected in column (a).  (c)** | ** ** |
|-------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  compensation plans approved by security holders     |       | 476,921                                                                                                |       | $                                                                                     | 6.75       |                                                                                                                                                  | 73,877     |   |
| Equity  compensation plans not approved by security holders |       | None                                                                                                   |       | None                                                                                  |       | None                                                                                                                                                  |       |
|                                                        |       |                                                                                                   |       |                                                                                  |       |                                                                                                                                                  |       |
| Total                                                       |       | 476,921                                                                                                |       | $                                                                                     | 6.75       |                                                                                                                                                  | 73,877     |   |

 

25

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**(f)****                                   ****Sales of Unregistered Securities**

 

On July 10, 2007 theCompany issued an aggregate of $8,000,000 in principal amount of its Fixed RateMiddle Market Capital Securities due 2037 (the “Subordinated Debt Securities”).All of the Subordinated Debt Securities were issued to Community Valley TrustII, a Delaware statutory business trust and a wholly-owned but unconsolidatedsubsidiary of the Company (the “Trust”). The Subordinated Debt Securities werenot registered under the Securities Act in reliance on the exemption set forthin Section 4(2) thereof. The Subordinated Debt Securities were issuedto the Trust in consideration for the receipt of the net proceeds raised by theTrust from the sale of $8,000,000 in principal amount of the Trust’s Fixed RateCapital Trust Pass-through Securities (the “Trust Preferred Securities”).Sandler O’Neill & Partners, L.P. acted as the placement agent inconnection with the offering of the Trust Preferred Securities.  The sale of the Trust Preferred Securitieswas part of a larger transaction arranged by Sandler O’Neill &Partners, L.P. pursuant to which the Trust Preferred Securities were depositedinto a special purpose vehicle along with similar securities issued by a numberof other banks and the special purpose vehicle then issued its securities tothe public (the “Pooled Trust Preferred Securities”). The Pooled TrustPreferred 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.

 

26

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

 

The “selected financialdata” which follows has been derived from the audited Consolidated FinancialStatements of the Company and other data from our internal accounting system.The selected financial data should be read in conjunction with the auditedConsolidated Financial Statements and Notes thereto, and Management’sDiscussion and Analysis of Financial Condition and Results of Operations inItem 7 below. Statistical information below is generally based on average dailyamounts.

 

**SelectedFinancial Data**

 

 
| ** **                                                 | ** ** | **As of December 31,** | ** ** |
|------------------------------------------------------------|------------|-----------------------------|------------|
| **(dollars in thousands, except per share data)**          | ** ** | **2007**                    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Income  Statement Summary**                              | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest income                                            |       | $                           | 43,223     |   | $ | 40,814 |   | $ | 32,438 |   | $ | 24,980 |   | $ | 21,517 |   |
| Interest expense                                           |       | $                           | 13,889     |   | $ | 9,532 |   | $ | 5,331 |   | $ | 4,056 |   | $ | 4,396 |   |
| Net interest  income before provision for loan losses      |       | $                           | 29,334     |   | $ | 31,282 |   | $ | 27,107 |   | $ | 20,924 |   | $ | 17,121 |   |
| Provision /  credit for loan losses                        |       | $                           | (16        | ) | $ | 775 |   | $ | 825 |   | $ | 790 |   | $ | 655 |   |
| Non-interest  income                                       |       | $                           | 8,475      |   | $ | 6,769 |   | $ | 6,711 |   | $ | 6,019 |   | $ | 5,950 |   |
| Non-interest  expense                                      |       | $                           | 26,927     |   | $ | 25,023 |   | $ | 20,824 |   | $ | 16,740 |   | $ | 13,818 |   |
| Income before  provision for income taxes                  |       | $                           | 10,898     |   | $ | 12,253 |   | $ | 12,169 |   | $ | 9,413 |   | $ | 8,598 |   |
| Provision for  income taxes                                |       | $                           | 4,439      |   | $ | 5,102 |   | $ | 4,971 |   | $ | 3,803 |   | $ | 3,329 |   |
| Net Income                                                 |       | $                           | 6,459      |   | $ | 7,151 |   | $ | 7,198 |   | $ | 5,610 |   | $ | 5,269 |   |
|                                                       |       |                        |       |   |   |   |   |   |   |   |   |
| **Balance  Sheet Summary**                                 | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total loans, net                                           |       | $                           | 441,350    |   | $ | 442,251 |   | $ | 401,221 |   | $ | 339,174 |   | $ | 270,231 |   |
| Allowance for  loan losses                                 |       | $                           | (5,232     | ) | $ | (5,274 | ) | $ | (4,716 | ) | $ | (4,381 | ) | $ | (3,587 | ) |
| Investment  securities held to maturity                    |       | $                           | 1,596      |   | $ | 1,777 |   | $ | 2,295 |   | $ | 2,582 |   | $ | 3,823 |   |
| Investment  securities available for sale                  |       | $                           | 4,668      |   | $ | 3,350 |   | $ | 4,381 |   | $ | 4,379 |   | $ | 502 |   |
| Interest-bearing  deposits in banks                        |       | $                           | 4,250      |   | $ | 2,278 |   | $ | 6,636 |   | $ | 8,715 |   | $ | 7,925 |   |
| Cash and due  from banks                                   |       | $                           | 31,714     |   | $ | 20,558 |   | $ | 18,988 |   | $ | 21,778 |   | $ | 26,205 |   |
| Federal funds  sold & other                       |       | $                           | 54,290     |   | $ | 42,070 |   | $ | 29,015 |   | $ | 46,440 |   | $ | 50,605 |   |
| Premises and  equipment, net                               |       | $                           | 17,905     |   | $ | 15,359 |   | $ | 11,221 |   | $ | 9,027 |   | $ | 8,554 |   |
| Total  interest-earning assets                             |       | $                           | 506,154    |   | $ | 491,726 |   | $ | 443,548 |   | $ | 401,290 |   | $ | 333,086 |   |
| Total assets                                               |       | $                           | 580,620    |   | $ | 550,037 |   | $ | 494,777 |   | $ | 449,675 |   | $ | 386,723 |   |
| Total  interest-bearing deposits                           |       | $                           | 423,417    |   | $ | 407,868 |   | $ | 350,682 |   | $ | 318,266 |   | $ | 274,048 |   |
| Total deposits                                             |       | $                           | 500,991    |   | $ | 484,856 |   | $ | 434,018 |   | $ | 399,059 |   | $ | 342,511 |   |
| Total  liabilities                                         |       | $                           | 529,646    |   | $ | 504,310 |   | $ | 453,222 |   | $ | 415,144 |   | $ | 356,774 |   |
| Total  shareholders’ equity                           |       | $                           | 50,974     |   | $ | 45,726 |   | $ | 41,555 |   | $ | 34,531 |   | $ | 29,949 |   |
|                                                       |       |                        |       |   |   |   |   |   |   |   |   |
| **Per  Share Data (1)**                                    | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic earnings  per share                                  |       | $                           | 0.87       |   | $ | 0.98 |   | $ | 1.00 |   | $ | 0.79 |   | $ | 0.75 |   |
| Diluted earnings  per share                                |       | $                           | 0.85       |   | $ | 0.93 |   | $ | 0.95 |   | $ | 0.74 |   | $ | 0.71 |   |
| Book value per  weighted average share                     |       | $                           | 6.81       |   | $ | 6.28 |   | $ | 5.80 |   | $ | 4.86 |   | $ | 4.26 |   |
| Cash dividends                                             |       | $                           | 0.32       |   | $ | 0.26 |   | $ | 0.16 |   | $ | 0.16 |   | $ | 0.16 |   |
|                                                       |       |                        |       |   |   |   |   |   |   |   |   |
| Weighted average  common shares outstanding, basic         |       | 7,416,874                   |       | 7,279,969 |   | 7,166,258 |   | 7,112,386 |   | 7,025,290 |   |
|                                                       |       |                        |       |   |   |   |   |   |   |   |   |
| Weighted average  common shares outstanding, diluted       |       | 7,611,959                   |       | 7,661,045 |   | 7,611,704 |   | 7,601,092 |   | 7,430,518 |   |
|                                                       |       |                        |       |   |   |   |   |   |   |   |   |
| **Key  Operating Ratios:**                                 |       |                        |       |   |   |   |   |   |   |   |   |
| **Performance  Ratios:**                                   |       |                        |       |   |   |   |   |   |   |   |   |
| Return on  Average Equity (2)                              |       | 13.22                       | %          | 15.99 | % | 18.82 | % | 17.20 | % | 19.07 | % |
| Return on  Average Assets (3)                              |       | 1.13                        | %          | 1.38 | % | 1.51 | % | 1.34 | % | 1.44 | % |
| Net Interest  Margin (4)                                   |       | 5.68                        | %          | 6.62 | % | 6.32 | % | 5.70 | % | 5.32 | % |
| Dividend Payout  Ratio (5)                                 |       | 36.74                       | %          | 26.47 | % | 15.93 | % | 20.28 | % | 20.67 | % |
| Equity to Assets  Ratio (6)                                |       | 8.78                        | %          | 8.64 | % | 8.02 | % | 7.82 | % | 7.54 | % |
| Net Loans to  Total Deposits at Period End                 |       | 47.74                       | %          | 91.21 | % | 92.44 | % | 84.99 | % | 78.90 | % |
| **Asset Quality  Ratios:**                                 |       |                        |       |   |   |   |   |   |   |   |   |
| Non Performing  Loans to Total Loans                       |       | 0.06                        | %          | 0.51 | % | 0.00 | % | 0.03 | % | 0.02 | % |
| Nonperforming  Assets to Total Loans and Other Real Estate |       | 0.06                        | %          | 0.51 | % | 0.00 | % | 0.03 | % | 0.02 | % |
| Net Charge-offs  to Average Loans                          |       | 0.00                        | %          | 0.02 | % | 0.00 | % | 0.00 | % | 0.03 | % |
| Allowance for  Loan Losses to Net Loans at Period End      |       | 1.17                        | %          | 1.18 | % | 1.16 | % | 1.16 | % | 1.19 | % |
|                                                       |       |                        |       |   |   |   |   |   |   |   |   |
| **Capital  Ratios:**                                       |       |                        |       |   |   |   |   |   |   |   |   |
| Tier 1 Capital  to Adjusted Total Assets                   |       | 11.5                        | %          | 10.1 | % | 9.8 | % | 9.5 | % | 9.9 | % |
| Tier 1 Capital  to Total Risk-Weighted Assets              |       | 13.1                        | %          | 10.9 | % | 11.4 | % | 11.3 | % | 12.2 | % |
| Total Capital to  Total Risk-Weighted Assets               |       | 14.1                        | %          | 11.9 | % | 12.5 | % | 12.5 | % | 13.3 | % |

----

(1)          All per sharedata and the average number of shares outstanding have been retroactivelyrestated on a split-adjusted basis.

 

27

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(2)          Net incomedivided by average shareholders’ equity.

(3)          Net incomedivided by average total assets.

(4)          Net interestincome divided by average earning assets.

(5)          Dividendsdeclared per share divided by net income per share.

(6)          Average equitydivided by average total assets.

 

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

 

This discussion presentsManagement’s analysis of the financial condition as of December 31, 2007and 2006 and results of operations of the Company for each of the years in thethree-year period ended December 31, 2007. The discussion should be readin conjunction with the Consolidated Financial Statements of the Company andthe Notes related thereto presented elsewhere in this Form 10-K AnnualReport (see Item 8).

 

*Statements contained in thisreport that are not purely historical are forward looking statements within themeaning of Section 21E of the Securities Exchange Act of 1934 as amended,including the Company’s expectations, intentions, beliefs, or strategiesregarding the future. All forward-looking statements concerning economicconditions, rates of growth, rates of income or values as may be included inthis document are based on information available to the Company on the datenoted, and the Company assumes no obligation to update any such forward-lookingstatements. It is important to note that the Company’s actual results couldmaterially differ from those in such forward-looking statements. Factors thatcould cause actual results to differ materially from those in suchforward-looking statements are fluctuations in interest rates, inflation,government regulations, economic conditions, customer disintermediation andcompetitive product and pricing pressures in the geographic and business areasin which the Company conducts its operations.*

 

**Critical Accounting Policies**

 

*General*

 

TheCompany’s significant accounting principles are described in Note 1 of theconsolidated financial statements and are essential to understanding Management’sDiscussion and Analysis of Results of Operations and Financial Condition.Community Valley Bancorp’s consolidated financial statements are prepared inaccordance with accounting principles generally accepted in the United Statesof America (GAAP). The financial information contained within our statementsis, to a significant extent, financial information that is based on measures ofthe financial effects of transactions and events that have already occurred.Some of the Company’s accounting principles require significant judgment toestimate values of assets or liabilities. In addition, certain accountingprinciples require significant judgment in applying the complex accountingprinciples to transactions to determine the most appropriate treatment. Thefollowing is a summary of the more judgmental and complex accounting estimatesand principles.

 

*Allowance for Loan Losses (ALL)*

 

The allowance for loan losses is management’s bestestimate of the probable losses that may be sustained in our loan portfolio.The allowance is based on two basic principles of accounting:  (1) SFAS No.5 which requires that lossesbe accrued when they are probable of occurring and estimable and (2) SFAS No. 114,which requires that losses be accrued on impaired loans based on thedifferences between the value of collateral, present value of future cash flowsor values that are observable in the secondary market and the loan balance.

 

The Company performs periodic and systematicdetailed evaluations of its lending portfolio to identify and estimate theinherent risks and assess the overall collectibility. These evaluations includegeneral conditions such as the portfolio composition, size and maturities ofvarious segmented portions of the portfolio such as secured, unsecured,construction, and Small Business Administration (“SBA”).  Additional factors include concentrations ofborrowers, 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 SFAS No. 5 portion of the ALL based onthe segmentation of its portfolio. For those segments 

 

28

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thatrequire an ALL, the Company estimates loan losses on a monthly basis based uponits ongoing loan review process and analysis of loan performance. The Companyfollows a systematic and consistently applied approach to select the most appropriateloss measurement methods and support its conclusions and rationale with writtendocumentation. One method of estimating loan losses for groups of loans isthrough the application of loss rates to the groups’ aggregate loan balances.Such rates typically reflect historical loss experience for each group ofloans, adjusted for relevant economic factors over a defined period of time.The Company evaluates and modifies its loss estimation model as needed toensure that the resulting loss estimate is consistent with GAAP.

 

For individually impairedloans, SFAS No. 114 provides guidance on the acceptable methods to measureimpairment. Specifically, SFAS No. 114 states that when a loan isimpaired, the Company should measure impairment based on the present value ofexpected future principal and interest cash flows discounted at the loan’seffective interest rate, except that as a practical expedient, a creditor maymeasure impairment based on a loan’s observable market price or the fair valueof collateral, if the loan is collateral dependent. When developing theestimate of future cash flows for a loan, the Company considers all availableinformation reflecting past events and current conditions, including the effectof existing environmental factors.

 

*Loan Sales and Servicing*

 

The Company originates government guaranteed loansand mortgage loans that may be sold in the secondary market. The amounts ofgains recorded on sales of loans and the initial recording of servicing assetsand interest only (I/O) strips is based on the estimated fair values of therespective components. In recording the initial value of the servicing assetsand the fair value of the I/O strips receivable, the Company uses estimateswhich are made based on management’s expectations of future prepayment anddiscount rates. Servicing assets are amortized over the estimated life of therelated loan. I/O strips are not significant at December 31, 2007. Theseprepayment and discount rates were based on current market conditions andhistorical performance of the various pools of serviced loans. If actualprepayments with respect to sold loans occur more quickly than projected thecarrying value of the servicing assets may have to be adjusted through a chargeto earnings.

 

*Stock-Based Compensation*

 

On January 1,2006, the Company adopted Statement of Financial Accounting Standards No. 123(R),*Share Based Payment* (“SFAS 123(R)”). Under SFAS No.123(R),compensation expense is recognized for options granted prior to the adoptiondate in an amount equal to the fair value of the unvested amounts over theirremaining vesting period, based on the grant date fair value estimated inaccordance with SFAS No. 123, *Accounting for Stock BasedCompensation* and compensation expense for all share based payments grantedafter adoption based on the grant date fair values estimated in accordance withSFAS No. 123(R) . The estimates of the grant date fair values arebased on an option pricing model that uses assumptions based on the expectedoption life, the level of estimated forfeitures, expected stock volatility andthe risk-free interest rate. The calculation of the fair value of share basedpayments is by nature inexact, and represents management’s best estimate of thegrant date fair value of the share based payments. See Note 1 to the auditedConsolidated Financial Statements in Item 8 of this Annual Report.

 

*Revenue Recognition*

 

TheCompany’s primary source of revenue is interest income, which is the differencebetween the interest income it receives on interest-earning assets and theinterest expense it pays on interest-bearing liabilities, and (ii) feeincome, which includes fees earned on deposit services, income from SBAlending, electronic-based cash management services, mortgage brokerage feeincome and merchant credit card processing services. Interest income isrecorded on an accrual basis. Note 1 to the Consolidated Financial Statementsoffers an explanation of the process for determining when the accrual ofinterest income is discontinued on an impaired loan.

 

*Income Taxes*

 

TheCompany accounts for income taxes under the asset and liability method. Underthe asset and liability method, deferred tax assets and liabilities arerecognized for the future tax consequences attributable to differences betweenthe financial statement carrying amounts of existing assets and liabilities andtheir respective tax bases. Deferred tax assets 

 

29

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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.

 

The provisions ofFinancial Accounting Standards Board (FASB) Interpretation No. 48, *Accounting for Uncertainty in Income Taxes*(FIN 48) have been applied to all tax positions of the Company as of January 1,2007.  FIN 48 prescribes a recognitionthreshold and measurement standard for the financial statement recognition andmeasurement of an income tax position taken or expected to be taken in a taxreturn.    Only tax positions that metthe more-likely-than-not recognition threshold on January 1, 2007 wererecognized or continue to be recognized upon adoption.  The benefit of a tax position is recognizedin the financial statements in the period during which, based on all availableevidence, management believes it is more likely than not that the position willbe sustained upon examination, including the resolution of appeals orlitigation processes, if any.  Tax positions taken are not offset oraggregated with other positions.  Taxpositions that meet the more-likely-than-not recognition threshold are measuredas the largest amount of tax benefit that is more than 50 percent likely ofbeing realized upon settlement with the applicable taxing authority.  The portion of the benefits associated withtax positions taken that exceeds the amount measured as described above isreflected as a liability for unrecognized tax benefits in the accompanyingbalance sheet along with any associated interest and penalties that would bepayable to the taxing authorities upon examination.  Interest expense and penalties associated withunrecognized tax benefits are classified as income tax expense in theconsolidated statement of income.

 

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

######  

For 2007, net income was$6.46 million, compared to the $7.15 million earned in 2006 and net income of$7.2 million in 2005. Net income per diluted share was $.85 for 2007, ascompared to $.93 during 2006 and $.95 in 2005. The Company’s Return on AverageAssets (“ROAA”) was 1.13% and Return on Average Equity (“ROAE”) was 13.22% in2007, as compared to 1.38% and 15.99%, respectively, in 2006 and 1.51% and18.82%, respectively, for 2005.

 

The downward movement inrates of 100 basis points by the FOMC (Federal Open Market Committee), duringthe third and fourth quarter of 2007 had a negative impact on the net interestmargin. Net interest income decreased by $1.9 million from 2006 to 2007 due toslower growth of earning assets and a change in the mix of both earning assetsto higher relative levels of Federal funds sold and in interest bearingliabilities to higher interest bearing accounts.  The downturn in the real estate market had anegative effect on our construction loan business and the resulting mortgageloans that in the past had resulted in substantial gains when sold on thesecondary market. However, the Company was able to sell several USDA Businessand Industry guaranteed loans and SBA loans for substantial gains during 2007.Increases in non interest expenses are, primarily related to salaries andemployee benefits and increased occupancy costs from the two new branchesopened in the third quarter in Anderson and Redding.

 

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

######  

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

 

We monitor asset anddeposit levels, developments and trends in interest rates, liquidity, capitaladequacy and marketplace opportunities. We respond to all of these to protect and maximize income while managingrisks within acceptable levels as set by the Company’s policies.  In additional 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 regularreports to the Board of Directors.  Boardapproval is obtained for major actions or the occasional exception to policy.

 

30

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

######  

The Company earns incomefrom two primary sources. The first is net interest income brought about byincome from the successful deployment of earning assets less the costs ofinterest-bearing liabilities. The second is non-interest income, whichgenerally comes from customer service charges and fees, but can also resultfrom non-customer sources such as gains on loan sales. The majority of theCompany’s non-interest expenses are operating costs which relate to providing afull range of banking services to our customers.

 

Net interest income,which is simply total interest income (including fees) less total interestexpense, was $29.3 million in 2007 compared to $31.3 million and $27.1 millionin 2006 and 2005, respectively. This represents a decrease of 6.2% in 2007 from2006 and an increase of 15.5% in 2006 over 2005. The amount by which interestincome exceeds interest expense depends on several factors. Among those factorsare yields on earning assets, the cost of interest-bearing liabilities, therelative volume of total earning assets and total interest-bearing liabilities,and the mix of products which comprise the Company’s earning assets, deposits,and other interest-bearing liabilities. Change in the amount and mix ofinterest-earning assets and interest-bearing liabilities is referred to as “volumechange.”  Change in interest rates earnedon assets and rates paid on deposits and other borrowed funds is referred to as“rate change.”

 

The Volume and RateVariances table which follows sets forth the dollar amount of changes ininterest earned and paid for each major category of interest-earning assets andinterest-bearing liabilities and the amount of change attributable to changesin average balances (volume) or changes in average interest rate. Thecalculation is as follows: the change dueto increase or decrease in volume is equal to the increase or decrease in theaverage balance times the prior period’s rate. The change due to an increase ordecrease in the rate is equal to the increase or decrease in the average ratetimes the current period’s balance. The variances attributable to boththe volume and rate changes have been allocated to the change in rate.

 
| ** **                             | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------------|------------|-----------------------------------|------------|
| ** **                             | ** ** | **2007 over 2006**                | ** ** | **2006 over 2005** | ** ** |
| ** **                             | ** ** | **Increase (decrease) due to:**   | ** ** | **Increase (decrease) due to:** | ** ** |
| ** **                             | ** ** | **Volume**                        | ** ** | **Rate** | ** ** | **Net** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Net** | ** ** |
| **Earning Assets:**               | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loans                                  |       | $                                 | 1,058      |   | $ | (331 | ) | $ | 728 |   | $ | 4,916 |   | $ | 3,682 |   | $ | 8,598 |   |
| Federal funds sold                     |       | 1,685                             |       | (56 | ) | 1,629 |   | (405 | ) | 308 |   | (97 | ) |
| Investment securities:                 |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                                |       | (14                               | )          | 62 |   | 48 |   | (48 | ) | 30 |   | (18 | ) |
| Tax-exempt (1)                         |       | —                            |       | (1 | ) | (0 | ) | (45 | ) | (1 | ) | (46 | ) |
| Interest bearing deposits in banks     |       | (77                               | )          | 80 |   | 4 |   | (106 | ) | 45 |   | (61 | ) |
| Total                                  |       | 2,653                             |       | (245 | ) | 2,408 |   | 4,312 |   | 4,064 |   | 8,376 |   |
|                                   |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| **Interest-bearing liabilities:** | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest bearing deposits:             |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| NOW and MMDA  deposits                 |       | (294                              | )          | 21 |   | (273 | ) | (53 | ) | 578 |   | 525 |   |
| Savings deposits                       |       | 676                               |       | 2,554 |   | 3,230 |   | 6 |   | 150 |   | 156 |   |
| Time deposits                          |       | 62                                |       | 1,037 |   | 1,099 |   | 1,482 |   | 1,878 |   | 3,360 |   |
| Total interest  bearing deposits       |       | 444                               |       | 3,612 |   | 4,056 |   | 1,435 |   | 2,606 |   | 4,041 |   |
|                                   |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Other borrowings                       |       | 369                               |       | (73 | ) | 296 |   | 17 |   | 142 |   | 159 |   |
| Total Interest  bearing liabilities    |       | 813                               |       | 3,539 |   | 4,352 |   | 1,452 |   | 2,748 |   | 4,200 |   |
| Net interest margin/income             |       | $                                 | 1,840      |   | $ | (3,784 | ) | $ | (1,944 | ) | $ | 2,860 |   | $ | 1,316 |   | $ | 4,176 |   |

----

(1)          Yields on taxexempt income have not been computed on a tax equivalent basis.

 

31

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The Company’s netinterest margin is its net interest income expressed as a percentage of averageearning assets. The Company’s net interest margin for 2007 was 5.68% a decreaseof 94 basis points from the 6.62% reported in 2006. For the year 2005, thismargin was 6.32%. The following Distribution, Rate and Yield table shows, foreach of the past three years, the rates earned on each component of the Company’sinvestment and loan portfolio and the rates paid on each segment of the Company’sinterest bearing liabilities. That same table also shows the Company’s averagedaily balances for each principal category of assets, liabilities andshareholders’ equity, the amount of interest income or interest expense, andthe average yield or rate for each category of interest-earning asset andinterest-bearing liability along with the net interest margin for each of thereported periods.

** **

**Distribution,Rate & Yield**

 
| ** **                                           | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                           | ** ** | **2007 (a)**                     | ** ** | **2006 (a)** | ** ** | **2005 (a)** | ** ** |
| ** **                                           | ** ** | **Avg**                          | ** ** | ** ** | ** ** | **Average** | ** ** | **Avg** | ** ** | ** ** | ** ** | **Average** | ** ** | **Avg** | ** ** | ** ** | ** ** | **Average** | ** ** |
| **(In thousands, except  percentages)**              | ** ** | **Balance**                      | ** ** | **Interest** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| **Assets**                                           | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Investments:                                         |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Federal funds sold                                   |       | $                                | 51,358     |   | $ | 2,475 |   | 4.82 | % | $ | 17,164 |   | $ | 846 |   | 4.93 | % | $ | 30,066 |   | $ | 943 |   | 3.14 | % |
| Taxable                                              |       | 4,053                            |       | 229 |   | 5.66 | % | 4,403 |   | 181 |   | 4.12 | % | 5,793 |   | 199 |   | 3.45 | % |
| Non-taxable (1)                                      |       | 1,377                            |       | 65 |   | 4.70 | % | 1,370 |   | 65 |   | 4.74 | % | 2,289 |   | 111 |   | 4.85 | % |
| Interest bearing deposits in banks                   |       | 2,509                            |       | 182 |   | 7.24 | % | 4,409 |   | 178 |   | 4.04 | % | 7,918 |   | 239 |   | 3.02 | % |
| Total investments                                    |       | 59,297                           |       | 2,951 |   | 4.98 | % | 27,346 |   | 1,270 |   | 4.65 | % | 46,066 |   | 1,492 |   | 3.24 | % |
| Loans:                                               |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Agricultural                                         |       | 30,832                           |       | 2,818 |   | 9.14 | % | 28,129 |   | 2,578 |   | 9.17 | % | 25,388 |   | 2,032 |   | 8.00 | % |
| Commercial                                           |       | 70,732                           |       | 7,242 |   | 10.24 | % | 67,608 |   | 6,655 |   | 9.84 | % | 63,051 |   | 5,827 |   | 9.24 | % |
| Real estate                                          |       | 307,430                          |       | 26,472 |   | 8.61 | % | 307,921 |   | 27,167 |   | 8.82 | % | 263,141 |   | 20,967 |   | 7.97 | % |
| Consumer                                             |       | 48,039                           |       | 3,740 |   | 7.79 | % | 41,461 |   | 3,144 |   | 7.58 | % | 31,079 |   | 2,120 |   | 6.82 | % |
| Total loans                                          |       | 457,033                          |       | 40,272 |   | 8.81 | % | 445,119 |   | 39,544 |   | 8.88 | % | 382,659 |   | 30,946 |   | 8.09 | % |
| Total earning assets (2)                             |       | 516,330                          |       | 43,223 |   | 8.37 | % | 472,465 |   | 40,814 |   | 8.64 | % | 428,725 |   | 32,438 |   | 7.57 | % |
| Non earning assets                                   |       | 56,122                           |       |   |   |   |   | 45,159 |   |   |   |   |   | 48,167 |   |   |   |   |   |
| Average total assets                                 |       | $                                | 572,452    |   |   |   |   |   | $ | 517,624 |   |   |   |   |   | $ | 476,892 |   |   |   |   |   |
|                                                 |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities & Shareholders’ Equity** | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest bearing deposits:                           |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| NOW                                                  |       | $                                | 116,403    |   | $ | 919 |   | 0.79 | % | $ | 137,358 |   | $ | 1,210 |   | 0.88 | % | $ | 143,250 |   | $ | 934 |   | 0.65 | % |
| Savings                                              |       | 113,913                          |       | 3,567 |   | 3.13 | % | 37,893 |   | 337 |   | 0.89 | % | 36,759 |   | 181 |   | 0.49 | % |
| Money market                                         |       | 32,440                           |       | 631 |   | 1.94 | % | 40,066 |   | 616 |   | 0.88 | % | 41,795 |   | 368 |   | 0.88 | % |
| TDOAs and IRAs                                       |       | 7,632                            |       | 343 |   | 4.49 | % | 6,537 |   | 242 |   | 3.70 | % | 6,434 |   | 183 |   | 2.84 | % |
|                                                 |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Certificates of  deposit < $100,000               |       | 77,341                           |       | 3,655 |   | 4.73 | % | 78,661 |   | 3,242 |   | 4.12 | % | 54,005 |   | 1,510 |   | 2.80 | % |
|                                                 |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Certificates of  deposit > $100,000               |       | 74,230                           |       | 3,656 |   | 4.93 | % | 72,513 |   | 3,061 |   | 4.22 | % | 47,417 |   | 1,492 |   | 3.15 | % |
| Total interest bearing deposits                      |       | 421,959                          |       | 12,771 |   | 3.03 | % | 373,028 |   | 8,708 |   | 2.33 | % | 329,660 |   | 4,668 |   | 1.42 | % |
| Borrowed Funds:                                      |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other borrowings                                     |       | 13,523                           |       | 1,118 |   | 8.27 | % | 9,334 |   | 824 |   | 8.81 | % | 9,095 |   | 663 |   | 7.29 | % |
| Total borrowed  funds                                |       | 13,523                           |       | 1,118 |   | 8.27 | % | 9,334 |   | 824 |   | 8.81 | % | 9,095 |   | 663 |   | 7.29 | % |
| Total interest  bearing liabilities                  |       | 435,482                          |       |   | 13,889 |   | 3.19 | % | 382,362 |   | 9,532 |   | 2.49 | % | 338,755 |   | 5,331 |   | 1.57 | % |
| Demand deposits                                      |       | 81,860                           |       |   |   |   |   | 83,427 |   |   |   |   |   | 89,325 |   |   |   |   |   |
| Other liabilities                                    |       | 6,251                            |       |   |   |   |   | 7,112 |   |   |   |   |   | 10,560 |   |   |   |   |   |
| Total liabilities                                    |       | 523,593                          |       |   |   |   |   | 472,901 |   |   |   |   |   | 438,640 |   |   |   |   |   |
| Shareholders’ equity                            |       | 48,859                           |       |   |   |   |   | 44,723 |   |   |   |   |   | 38,252 |   |   |   |   |   |
| Average liabilities and equity                       |       | $                                | 572,452    |   |   |   |   |   | $ | 517,624 |   |   |   |   |   | $ | 476,892 |   |   |   |   |   |
|                                                 |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest income & margin (3)            |       |                             |       | $ | 29,334 |   | 5.68 | % |   |   | $ | 31,282 |   | 6.62 | % |   |   | $ |  27,107 |   | 6.32 | % |

----

(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)   Non-accrual loans have beenincluded in total loans for purposes of total earning assets.

 

32

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

(4)          Yields andamounts earned on loans include loan fees of $1,936,000, $2,450,000 and$2,453,000 for the years ended December 31, 2007, 2006 and 2005respectively.

 

During 2007, the Company’snet interest margin declined primarily as a result of the change in the mix inearning assets from slower growth in the loan portfolio and the change in mixof interest bearing liabilities particularly savings. Average investments,primarily Federal funds sold, increased by 117% as loan growth, on an averagebasis, only increased by 2.7%.    Thiscombination resulted in an overall decrease of 94 basis points in net theinterest margin. On an average basis, the rates on loans decreased by 7 basispoints resulting in a decrease in interest income of $331thousand. Thisdecrease in rates was offset by the increase in the average volume of loans of$11.9 million that generated an additional $1.1 million in loan relatedinterest income. On an average basis, the rate on investments increased by 33basis points resulting in an increase in interest income of $85 thousand, thiswas augmented by the increase in average volume of investment securities of $32million which resulted in an increase in interest income of $1.6 million.  Overall, interest income on earning assetsincreased by $2.4 million.

 

A large portion of theBank’s loans carry variable rates and re-price immediately, versus a large baseof core deposits which are generally slower to re-price. Interest expenseincreased in 2007 as rates increased and the Company’s mix of deposits changedfrom transaction based lower rate demand deposits to a higher rate savingsproduct introduced late in 2006 called a liquid certificate of deposit.  The average rates paid on interest bearingdeposits for 2007 was 3.03% compared to 2.33% in 2006 and 1.42% in 2005. Thechanges in deposit rates in 2007 compared to 2006 were primarily due to thecompetitive pricing environment and the changes in interest rates brought on byFederal Reserve Board actions as discussed previously. The average rates thatare paid on deposits generally trail behind these money market rate changes fortwo reasons: (1) financial institutions do not try to change deposit rateswith 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 individualaccounts. Only new accounts and those that mature and are renewed will bear thenew rate. The average balances of interest bearing liabilities of $435,482,000were $53,120,000 (13.9%) higher in 2007 than 2006.  Rates paid on interest bearing liabilitiesincreased 70 basis points from 2006 to 2007. On an average basis, NOW account deposits were down $21 million, savingsaccount deposits were up $76 million, money market account deposits were down$7.6 million and certificate of deposit balances were up $1.5 million.  Average non-interest bearing demand depositsbalances decreased by $1.6 million from 2006 to 2007.

 

From 2006 to 2007, theCompany’s average loan portfolio grew by approximately $11.9 million, or 2.7%,building on the growth of $62 million, or 16.3% from 2005 to 2006. The earningson that growth, net of associated funding costs, are a significant contributorto net interest income. During 2007, the loan portfolio averaged 80.4% of totalassets, while for 2006 and 2005 such balances represented 86% and 80.2%,respectively, of average assets.

 

Based on current economicconditions, the Company expects moderate to aggressive decreases in the ratespaid on interest-bearing liabilities and rates earned on both the investmentand loan portfolio during 2008. In order to fund the loan portfolio growthanticipated in 2008, it is anticipated that the Company’s net interest marginwill experience more compression as the lag period on time deposits repricingwill not keep up with the amount of variable rate loans that reprice with eachrate adjustment.

 

###### **Non-interest Income and Non-interest Expense**

######  

For the year 2007,non-interest income increased 1,706,000 or (25.2%) to $8,475,000 as compared to$6,769,000 for 2006. Non interest income in 2005 was $6,711,000. The primarytraditional sources of non-interest income for the Company are service chargeson deposit accounts, gains on the sale of loans, loan servicing income,alternative investment fees earned on the sales of non-deposit investmentproducts, merchant credit card fees, and earnings from changes in the cashsurrender value of bank owned life insurance. Service charges on depositaccounts and loan sales income in 2007 accounted for 40.4% and 17.8%,respectively, of total non-interest income, as compared to 39.7% and 23.3%,respectively, for 2006 and 35% and 26.9%, respectively, for 2004. Loanservicing income, alternative investment fees, merchant credit card fees, andearning from cash surrender value of bank owned life insurance for 2007 were4.7%, 4.2%, 4.8%, and 4.5% respectively, of total non-interest income, ascompared to 6.8%, 5.2%, 5.6%, 

 

33

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and 4.9% respectively,for 2006 and 7.2%, 7.8%, 5.8%, and 4.4% respectively, for 2005.  Other non-interest income represented 23.7%,14.6%, and 13% respectively in 2007, 2006, and 2005.

 

The primary source ofnon-interest income during 2007 was from service charges on deposit accountswhich increased by $736,000.  This wasfollowed by other non-interest income which increased $1,024,000 largely due tothe one time pre tax gain of $730,000 realized in the third quarter of 2007from the sale of mortgage servicing rights. The increase in service charges ondeposit accounts was primarily a result of the fees charged on additionaldeposit accounts opened during the year, and the overdraft privilege depositproduct which on a year over year basis increased $650,000. Gains on sales ofloan decreased $72,000 from $1,578,000 in 2006 to $1,506,000 in 2007. This wasa result of the lower volume of loans sold during 2007. The real estate markethas softened in most of the areas we serve which has resulted in more homes forsale thereby creating an environment more advantageous to the buyer than theseller.  The areas in and around ourprimary service area in Chico, California are not experiencing the extremedownturn in residential real estate values in the same manner as some of themore populous areas of California. According to the Chico Association of Realtors, the median sale price ofa single family home was $335,000 in 2005, $336,000 in 2006, and $325,000 in2007, a drop of just 3% while the decrease statewide was 11.9%.  The biggest change in the Chico area was howlong it took the average house to sell. In 2005, a single family home stayed on the market for 52 days; in 2006,63 days, and in 2007, 81 days.

 

The loan portfolio alsoincludes loans which are 75% to 90% guaranteed by the Small BusinessAdministration (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, RBSand FSA government guaranteed loans being serviced by the Company increased by27% from 2006 to 2007. The reduction in loan servicing income of $62,000 from$457,000 in 2006 to $381,000 in 2007 was due to the sale of the mortgage loanportfolio discussed above.

 

Alternative investmentfees earned on the sales of non-deposit investment products increased by $4,000in 2007 compared to 2006 primarily as a result of more sales throughout theyear.

 

Merchant credit card feesincreased $22 thousand from $381 thousand in 2006, to $403 thousand in 2007.Through more aggressive marketing efforts of this product, management expectsincome from this area to increase somewhat in 2008.

 

A ratio that is used tocompare the Company’s expenses to those of other financial institutions is theoperating efficiency ratio.  This ratiotakes into account the fact 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 70.6% for 2007, 65.8% for 2006, and 61.6% for 2005 ascompared to the 55% and lower ratios of certain major financial institutions,it is expected that this focus will continue for the foreseeable future.

 

The Company’s totalnon-interest expense increased to $26.9 million in 2007, as compared to $25.2million in 2006, and $20.9 million in 2005.

 

Salaries and employeebenefits increased $205,000 or 1.3% from 2006 to 2007.   Included within salaries and benefits areactual salaries, bonuses, commissions, retirement benefits, payroll taxes, andstock option expense.  This increaseresulted from normal cost of living raises. The increase in salaries and benefits in 2006 compared to 2005 was$2,290,000 or 25.7%. Full time equivalent employees decreased to 260 at December 31,2007 from 263 at December 31, 2006 which was an increase from 240 at December 31,2005. Benefit costs and employer taxes increased commensurate with thesalaries. It is management’s opinion that the Company can achieve significantgrowth in loans and deposits with the current level of staffing.

 

34

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Occupancy and equipmentexpenses were $4,221,000, an increase of $741,000 or 21.3% when compared to the2006 total of $3,480,000. Much of the increase in occupancy expense was relatedto the additional depreciation of $446,000 primarily related to the newheadquarters building as well as furniture, fixtures and equipment for the new Anderson and Reddingbranches which opened in the third quarter of 2007. The increase in occupancyexpenses in 2006 compared to 2005 was $511,000 or 18%.

 

The majority of theincrease in professional services costs of $329,000 from 2006 to 20076 relatesto outsourcing our internal audit work and the process of complying withSarbanes-Oxley 404. The increase in 2006 compared to 2005 was due tooutsourcing of the internal audit work and the implementation process ofSarbanes-Oxley 404 compliance. Advertising and marketing expenses increased by 13.9% in 2007 from 2006after increasing by 60% in 2006 from 2005 as we promoted the new branches.

 

Expenses representingtelephone and data communications, postage and mail, stationery and supplies,director fees and retirement accruals, advertising and promotion, and otherexpenses totaled $5,319,000 for 2007 compared to $4,931,000 in 2006 and$4,651,000 in 2005, an increase of 7.9% and 6.0% on a year over year basis.Management considers this increase in expenses commensurate with the growth ofthe Company.

 

The Company has two sharebased compensation plans. On January 1, 2006, the Company adoptedStatement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-BasedPayment,” which requires the Company to measure the cost of employees servicesreceived in exchange for an award of equity instruments based on the grant datefair value of the award.  The Companyelected to use the modified prospective transition method of adoption such thatSFAS No. 123(R) applies to the unvested portion of previously issuedawards, new awards and to awards modified, repurchased or canceled after theadoption date.  Accordingly, commencing January 1,2006, the Company recognized stock-based compensation for all current awardgrants and for the unvested portion of previous award grants that are expectedto vest based on the grant date fair value. Prior to 2006, the Company accounted for stock-based compensation awardsunder Accounting Principles Board Opinion No. 25 intrinsic value method,under which no compensation expense was recognized because all historicaloptions granted were at an exercise price equal to the market value of theCompany’s stock on the grant date. Financial statements prior to adoption have not been adjusted to reflectfair value stock-based compensation expense under SFAS No. 123(R).

 

As a result of adoptingSFAS 123(R), the Company’s income before provision for income taxes and netincome for the year ended December 31, 2007 are $139,000 and $123,000,respectively, and for the year ended December 31, 2006 are $175,000 and$163,000, respectively, lower than if it had continued to account forshare-based compensation under APB 25. Basic and diluted earnings per share forthe year ended December 31, 2007 would have been $.89 and $.87,respectively, without the adoption of SFAS 123(R) compared to $.87 and$.85, respectively, as reported. Basic and diluted earnings per share for theyear ended December 31, 2006 would have been $1.00 and $.95, respectively,without the adoption of SFAS 123(R) compared to $.98 and $.93,respectively, as reported.

 

There were no significantchanges in the valuation methods or types of awards or terms made by theCompany subsequent to the adoption of SFAS No. 123(R) and nocumulative effect adjustments were made at adoption to the financialstatements.

 

As of December 31,2007, there was $174,000 of total unrecognized compensation cost related tonon-vested share-based compensation arrangements granted under the Plans.  The cost is expected to be recognized over aweighted average period of 2.0 years. See Notes 1 and 11 to the audited Consolidated Financial Statements inItem 8.

 

35

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| ** **                                                       | ** ** | **2007**   | ** ** | **% of Total** | ** ** | **2006**   | ** ** | **% of Total** | ** ** | **2005**   | ** ** | **% of Total** | ** ** |
|------------------------------------------------------------------|------------|------------|------------|----------------|------------|------------|------------|----------------|------------|------------|------------|----------------|------------|
| **Non-interest income:**                                         | ** ** | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** | ** **     | ** ** |
| Service charges on deposit accounts                              |       | $          | 3,422      |           | 37.17      | %          | $          | 2,686          |       | 39.68      | %          | $              | 2,351      |   | 35.03 | % |
| Gain on sale of loans                                            |       | 1,506      |       | 16.36          | %          | 1,578      |       | 23.31          | %          | 1806       |       | 26.91          | %          |
| Loan servicing income                                            |       | 395        |       | 4.29           | %          | 457        |       | 6.75           | %          | 481        |       | 7.17           | %          |
| Alternative investment fees                                      |       | 354        |       | 3.85           | %          | 350        |       | 5.17           | %          | 520        |       | 7.75           | %          |
| Merchant card processing fees                                    |       | 403        |       | 4.38           | %          | 381        |       | 5.63           | %          | 390        |       | 5.81           | %          |
| Earnings from  cash surrender value of bank owned life insurance |       | 383        |       | 4.16           | %          | 330        |       | 4.88           | %          | 294        |       | 4.38           | %          |
| Gain on sale of mortgage servicing assets                        |       | 730        |       | 7.93           | %          | —     |       | 0.00           | %          | —     |       | 0.00           | %          |
| Other                                                            |       | 2,012      |       | 21.86          | %          | 987        |       | 14.58          | %          | 869        |       | 12.95          | %          |
| Total  non-interest income                                       |       | $          | 9,205      |           | 100.00     | %          | $          | 6,769          |       | 100.00     | %          | $              | 6,711      |   | 100.00 | % |
| As a percentage  of average earning assets                       |       | 1.78       | %          |           |       | 1.43       | %          |           |       | 1.57       | %          |           |       |
|                                                             |       |       |       |           |       |       |       |           |       |       |       |           |       |
| **Non-interest expense:**                                        | ** ** | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** | ** **     | ** ** | ** ** | ** ** | ** **     | ** ** |
|  Salaries and  employee benefits                            |       | $          | 15,630     |           | 58.57      | %          | $          | 15,425         |       | 61.64      | %          | $              | 12,270     |   | 58.64 | % |
| Occupancy and equipment                                          |       | 4,221      |       | 15.82          | %          | 3,480      |       | 13.91          | %          | 2,969      |       | 14.19          | %          |
| Professional fees                                                |       | 1,516      |       | 5.68           | %          | 1,187      |       | 4.74           | %          | 1,035      |       | 4.95           | %          |
| Telephone and postage                                            |       | 594        |       | 2.23           | %          | 630        |       | 2.52           | %          | 580        |       | 2.77           | %          |
| Stationery and supply costs                                      |       | 828        |       | 3.10           | %          | 601        |       | 2.40           | %          | 545        |       | 2.60           | %          |
| Director fees and retirement accrual                             |       | 482        |       | 1.81           | %          | 450        |       | 1.80           | %          | 469        |       | 2.24           | %          |
| Advertising and promotion                                        |       | 752        |       | 2.82           | %          | 660        |       | 2.64           | %          | 412        |       | 1.97           | %          |
| Other                                                            |       | 2,663      |       | 9.98           | %          | 2,590      |       | 10.35          | %          | 2,645      |       | 12.64          | %          |
| Total  non-interest expense                                      |       | $          | 26,686     |           | 100.00     | %          | $          | 25,023         |       | 100.00     | %          | $              | 20,925     |   | 100.00 | % |
| As a percentage  of average earning assets                       |       | 5.17       | %          |           |       | 5.30       | %          |           |       | 4.88       | %          |           |       |

 

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

######  

Credit risk is inherentin the business of making loans. The Company sets aside an allowance for loanlosses through charges to earnings. The charges are shown in the incomestatements as provisions for loan losses, and specifically identifiable andquantifiable losses are immediately charged off against the allowance.

 

The Company’s provisionsfor loan losses and undisbursed commitments in 2007, 2006, and 2005 were$225,000, $775,000, and $825,000 respectively. The amounts allocated to theprovision and the undisbursed commitments were $(16,000) and $241,000respectively for 2006, $638,000 and $137,000 for 2005 and $724,000 and $101,000for 2004.  The loan loss provision isdetermined by conducting a monthly evaluation of the adequacy of the Company’sallowance for loan losses, and charging the shortfall, if any, to the currentmonth’s expense. This has the effect of creating variability in the amount andfrequency of charges to the Company’s earnings. The procedures for monitoringthe adequacy of the allowance, as well as detailed information concerning theallowance itself, are included below under “Allowance for Loan Losses.”

 

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

######  

As indicated in Note 13in the Notes to the Consolidated Financial Statements, the provision for incometaxes 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, and is in essence the actual current incometax liability. Some items of income and expense are recognized in differentyears for tax purposes than when applying accounting principles generallyaccepted in the United States of America, however, leading to differencesbetween the Company’s actual tax liability and the amount accrued for thisliability based on book income. These temporary timing differences comprise thedeferred portion of the Company’s tax provision.

 

Most of the Company’stemporary differences involve recognizing more expenses in its financialstatements than it has been allowed to deduct for tax purposes, and thereforethe Company normally carries a net deferred tax asset on its books. At December 31,2007, the Company’s $5.8 million net deferred tax asset was primarily due totemporary differences in the reported allowance for loan losses, deferredcompensation, and future benefit of state tax deduction offset by the temporarydifferences related to certain deferred tax liabilities.

 

36

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

######  

The following discussionof the financial condition of the Company is grouped into earning assets,comprised of loans and investments; non-earning assets, comprised of cash anddue from banks, premises and equipment and other assets; liabilities,consisting of deposits and other borrowings; capital resources; and liquidityand market risk. Each section provides details where applicable on volume,rates of change, and significance relative to the overall activities of theCompany.

 

A comparison between thesummary year-end balance sheets for 2003 through 2007 was presented previouslyin the table of Selected Financial Data (see Item 6 above). As indicated inthat table, the Company’s total assets, loans, deposits, and shareholders’equity have grown each year for the past four years, with asset growth, interms of total dollars, most pronounced in 2004 when the Company grew by $63million, or 16.3%.  This was followed bygrowth in the Company’s total assets during 2005 of $45 million or 10% andgrowth in the Company’s total assets during 2006 of approximately $55 million,or 11.2% and growth in the Company’s total assets during 2007 of approximately$30 million, or 5.6%.

 

Late in 2006 the Companybegan offering a savings product which we called a liquid certificate ofdeposit. It was developed as an alternative to traditional certificates ofdeposit which had accounted for nearly all of the deposit growth the Companyexperienced during 2006.  This productwas very popular during 2007 as we found many customers deciding to exchangesome of the earnings on  the higher ratecertificates of deposit for the liquidity feature of the lower rate liquidcertificate of deposit.  As a result, themix of our core deposit base changed during 2007 as NOW and Money Marketaccount balances, on an average basis, declined by 18% and 23% respectivelywhile savings balances, including the liquid certificate of deposits, increasedby 200% and certificates of deposit balances remained relativelyunchanged.  The weighted average rate ofour certificates of deposit was 4.81% compared to 3.13% for the savingsproducts.  Had the deposit growth in 2007come from the traditional certificates of deposit as it had in 2006, ourinterest expense would have been approximately $1.3 million higher.

 

Deposit interest ratesgradually increased through 2007 before declining in the fourth quarter.  On an average basis, deposits increased $48.9million while the average rates paid on all interest bearing deposits increasedby 70 basis points.     Throughout 2007deposit growth was achieved in our newer markets in Red Bluff, Marysville,Corning,  Redding, and Anderson. Webelieve this will be the case again in 2008 but we are optimistic that our moreseasoned branches will be able to increase market share.

 

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

######  

The Company offers a widevariety of loan types and terms to customers along with very competitivepricing and quick delivery of the credit decision. The Company’s loan portfoliorepresents the single largest portion of invested assets, substantially greaterthan the investment portfolio or any other asset category. At December 31,2007, gross loans represented 77.1% of total assets, as compared to 81.5% and82.3% at December 31, 2006 and 2005, respectively. By the end of thefourth quarter of 2007our loan balances had declined by $28 million from whathad been reported at September 30, 2007, as several large relationshipspaid their loans off. The quality and diversification of the Company’s loanportfolio are important considerations when reviewing the Company’s results ofoperations.

 

The Selected FinancialData table in Item 6 reflects the net amount of loans outstanding at December 31stfor each year between 2003 and 2007. The Loan Distribution table which followssets forth the amount and composition of the Company’s total loans outstandingin each category at the dates indicated.

 

37

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**Loan Distribution**

(dollars in thousands)

 
| ** **                    | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|------------------|------------|
| ** **                    | ** ** | **2007**         | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Agriculture                   |       | $                | 25,367     |   | $ | 25,745 |   | $ | 24,803 |   | $ | 22,177 |   | $ | 20,820 |   |
| Commercial                    |       | 77,680           |       | 65,241 |   | 61,162 |   | 58,662 |   | 57,739 |   |
| Real estate- commercial       |       | 208,531          |       | 208,102 |   | 173,449 |   | 146,876 |   | 111,249 |   |
| Real estate- construction     |       | 81,891           |       | 105,449 |   | 111,130 |   | 90,643 |   | 63,345 |   |
| Installment                   |       | 53,801           |       | 43,789 |   | 36,501 |   | 26,219 |   | 21,698 |   |
|                          |       | 447,270          |       | 448,326 |   | 407,045 |   | 344,577 |   | 274,851 |   |
|                          |       |             |       |   |   |   |   |   |   |   |   |
| Deferred loan fees, net       |       | (688             | )          | (801 | ) | (1,108 | ) | (1,022 | ) | (1,033 | ) |
| Allowance for loan losses     |       | (5,232           | )          | (5,274 | ) | (4,716 | ) | (4,381 | ) | (3,587 | ) |
|                          |       | $                | 441,350    |   | $ | 442,251 |   | $ | 401,221 |   | $ | 339,174 |   | $ | 270,231 |   |
|                          |       |             |       |   |   |   |   |   |   |   |   |
| **Percentage of Total Loans** | ** ** | ** **       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Agriculture                   |       | 5.67             | %          | 5.74 | % | 6.09 | % | 6.44 | % | 7.58 | % |
| Commercial                    |       | 17.37            | %          | 14.55 | % | 15.03 | % | 17.02 | % | 21.01 | % |
| Real estate- commercial       |       | 46.62            | %          | 46.42 | % | 42.61 | % | 42.63 | % | 40.48 | % |
| Real estate- construction     |       | 18.31            | %          | 23.52 | % | 27.30 | % | 26.31 | % | 23.05 | % |
| Installment                   |       | 12.03            | %          | 9.77 | % | 8.97 | % | 7.60 | % | 7.89 | % |
|                          |       | 100.00           | %          | 100.00 | % | 100.00 | % | 100.00 | % | 100.00 | % |
|                          |       |             |       |   |   |   |   |   |   |   |   |

 

As reflected in the LoanDistribution table, aggregate loan balances have increased $171 million, or63%, over the last four years. The largest percentage of growth over that fouryear period and continuing in 2007 was in Installment loans which grew by $10million in 2007 and 148% over the past four years.  The largest dollar volume increase duringthat that four year period was in commercial real estate which grew by $97.3million or 87%.

 

Loan growth in theCompany’s immediate market has been oriented toward loans secured by realestate, commercial loans, including Small Business Administration loans, aswell as consumer loans. As a result, these areas have comprised the majorportion of the Company’s loan growth over the past few years. During 2007 loanssecured by real estate declined by $23 million, or 7.4%, and commercial loansgrew by $12.4 million, or 19%. Installment loans increased by $10 million, or 22.9%.  Loans secured by real estate and commercialloans comprised 64.9% and 17.4%, respectively, of the Bank’s total loanportfolio at December 31, 2007.

 

The Company’s commercialloans are centered in locally oriented commercial activities in the marketswhere the Company has a presence. Additionally, the Company has a GovernmentLending Division dedicated to its SBA product and its Business and Industry(B&I) Guaranteed Loan Program. For the fiscal year ended September 30,2007, the Company was named the number one USDA Business and Industry lender inthe entire United States for number of loans made by originating 20 loanstotaling more than $30million. The Company is also designated as an SBAPreferred Lender, which means it has the authority to underwrite and approveSBA loans locally. This recognition lends credence to the Company’s success inmeeting the needs of smaller business owners in the communities in which theCompany conducts its banking activities.

 

Consistent with theoverall growth in loans, the most significant shift in the loan portfolio mixover the past four years has been in loans secured by commercial real estate,which increased from 40.5% of total loans at the end of 2003 to 46.6% of totalloans at the end of 2007. Real estate lending is an important part of theCompany’s focus, and even though this segment of loans did not increase in 2007it is likely to remain so for the immediate future. Commercial loans decreasedto 17.4% of total loan balances by the end of 2007 from 21.1% at the end of2002, and agricultural loans decreased during the same period to 5.7% of thetotal loan balances from 7.6%. The decline in the percentage of agriculturalloans to total loans over the last few years has been due to the growth in theother lending areas outpacing the growth in the agricultural lending.Agricultural borrowing relationships have remained consistent year after yearand we have not substantially expanded this part of our business.  Installment loans have increased from 7.9% ofthe portfolio in 2003 to 12% of total loans at the end of 2007.

 

38

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Another important aspectof the Company’s loan business has been that of residential real estate loanswhich were generated internally by the real estate mortgage loan department andthen sold in the secondary market to government sponsored enterprises or otherlong-term lenders. The Company has consistently been among the largest realestate mortgage lenders in Butte County for the past several years. During2007, the Company originated and sold aggregate balances of approximately $39million of such loans, a $13 million decrease from the $52 million originatedand sold in 2006. In September, 2007 the Company sold the servicing rights tothe mortgage loans it was servicing for the Federal National MortgageAssociation (FNMA).

 

In the normal course ofbusiness, the Company makes commitments to extend credit as long as there areno violations of any condition established in the contractual arrangement.Total outstanding commitments to extend credit were $184 million at December 31,2007 as compared to $186 million at December 31, 2006. These commitmentsrepresented 41% of outstanding gross loans at December 31, 2007 and December 31,2006, respectively. The Company’s stand-by letters of credit at December 31,2007 were $6.7 million and $5.1 million at December 31, 2006, respectively,which represented approximately 3.5% and 2.7% of total commitments outstandingat the end of 2007 and 2006. It is not anticipated that all of thesecommitments or stand-by letters of credit will fund.

 

Approximately one half ofthe loans held by the Company have floating rates of interest tied to theCompany’s base lending rate or to another market rate indicator so that theymay be re-priced as interest rates change. The same interest rate and liquidityrisks that apply to securities are also applicable to lending activity.Fixed-rate loans are subject to market risk: they decline in value as interest rates rise. The Company’s loans thathave fixed rates generally have relatively short maturities or amortizemonthly, which effectively lessens the market risk. The table in Note 16 to theconsolidated financial statements shows that at December 31, 2007, thedifference in the carrying amount of loans, i.e., their face value, is about $3.3 million or .75 % more than their fair value. At the end of 2006, thecarrying amount of loans was about $3.5 million or .80% more than the fairvalue.

 

Because the Company isnot involved with chemicals or toxins that might have an adverse effect on theenvironment, its primary exposure to environmental legislation is through itslending activities. The Company’s lending procedures include steps to identifyand monitor this exposure to avoid any significant loss or liability related toenvironmental regulations.

 

**Loan Maturities**

 

The following LoanMaturity table shows the amounts of total loans outstanding as of December 31,2007, which, based on remaining scheduled repayments of principal, are duewithin one year, after one year but less than five years, and in more than fiveyears. (Non-accrual loans are intermixed within each category.)

 
| **(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               |       | $                      | 14,007     |                    | $          | 9,873                 |       | $         | 1,487      |                                      | $          | 25,367                                 |       | $ | — |   | $ | 11,360 |   |
| Commercial                 |       | 24,949                 |       | 14,349                  |       | 38,382                |       | 77,680    |       | 5,352                                     |       | 47,379                                 |       |
| Real estate - commercial   |       | 105,373                |       | 91,055                  |       | 12,103                |       | 208,531   |       | 2,059                                     |       | 101,099                                |       |
| Real estate - construction |       | 76,687                 |       | 5,045                   |       | 159                   |       | 81,891    |       | —                                    |       | 5,204                                  |       |
| Installment                |       | 5,564                  |       | 44,951                  |       | 3,286                 |       | 53,801    |       | —                                    |       | 48,237                                 |       |
|                       |       |                   |       |                    |       |                  |       |      |       |                                      |       |                                   |       |
| Total                      |       | $                      | 226,580    |                    | $          | 165,273               |       | $         | 55,417     |                                      | $          | 447,270                                |       | $ | 7,411 |   | $ | 213,279 |   |

 

This schedule,which aggregates contractual principal repayments by time period, can be usedin combination with the Investment Maturities table in the Investment Securitiessection and the Deposit Maturities table in the Deposits section to identifytime periods with potential liquidity exposure. The referenced maturityschedules do not convey a complete picture of the Company’s re-pricing exposureor interest rate risk, however. For details on the re-pricing characteristicsof the Company’s balance sheet and a more comprehensive discussion of theCompany’s sensitivity to changes in interest rates, see the “Liquidity andMarket Risk” section.

 

39

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

######  

Banks have generallysuffered their most severe earnings declines as a result of customers’inability to generate sufficient cash flow to service their debts, or as aresult of the downturns in national and regional economies which have broughtabout declines in overall property values. In addition, certain investmentswhich the Company may purchase have the potential of becoming less valuable asthe conditions change in the obligor’s financial capacity to repay, based onregional economies or industry downturns. As a result of these types offailures, an institution may suffer asset quality risk, and may lose theability to obtain full repayment of an obligation to the Company. Since loansare the most significant assets of the Company and generate the largest portionof revenues, the Company’s management of asset quality risk is focusedprimarily on loan quality.

 

The Company achieves acertain level of loan quality by establishing a sound credit plan, whichincludes defining goals and objectives and devising and documenting creditpolicies 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 granting procedures,training, risk management techniques, and familiarity with our loan customersas well as the relative diversity and geographic concentration of our loanportfolio.

 

As a multi-community,independent bank headquartered in and serving Butte County (with a smallerpresence in each of Colusa, Sutter, Sacramento, Shasta, Tehama, and Yubacounties); the Company has mitigated its risk to any one segment of theseNorthern Sacramento Valley markets. The Company’s asset quality continues to beexcellent with delinquency ratios at low levels. The Company is optimistic thatthe local and regional economy will continue to perform, but no assurance canbe given that this performance will in fact continue.

 

From time to time,Management has reason to believe that certain borrowers may not be able torepay their loans within the parameters of the present repayment term, eventhough, in some cases, the loans are current at the time. These loans areregarded as potential problem loans, and a portion of the allowance is assignedand/or allocated, as discussed below, to cover the Company’s exposure to losswould the borrowers indeed fail to perform according to the terms of the notes.This class of loans does not include loans in a nonaccrual status or 90 days ormore delinquent but still accruing, which are shown in the table below.

 

Non-performing assets arecomprised of loans on non-accrual status, loans 90 days or more past due andstill accruing interest, loans restructured where the terms of repayment havebeen renegotiated resulting in a deferral of interest or principal and otherreal estate (“ORE”). Loans are generally placed on non-accrual status when theybecome 90 days past due as to principal or interest. Loans may be restructuredby management when a borrower has experienced some change in financial statuscausing an inability to meet the original repayment terms and where the Companybelieves the borrower will eventually overcome those circumstances and repaythe loan in full. ORE consists of properties acquired by foreclosure or similarmeans that management intends to offer for sale.

 

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 continuously pursued.

 

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.

 

40

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**Non-performing Assets**

(dollars in thousands)

 
| ** **                                                               | ** ** | **As of December 31,** | ** ** |
|--------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                               | ** ** | **2007**               | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Nonaccrual Loans:**                                                    | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Agricultural                                                             |       | $                      | —     |   | $ | — |   | $ | — |   | $ | 17 |   | $ | — |   |
| Commercial and Industrial                                                |       | $                      | —     |   | $ | 1,502 |   | $ | — |   | $ | — |   | $ | 46 |   |
| **Real Estate**                                                          | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Secured by  Commercial/Professional Office                               |       | $                      | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Properties  Including Construction and Development                       |       | $                      | 233        |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Secured by  Residential Properties                                       |       | $                      | 20         |   | $ | 780 |   | $ | — |   | $ | 84 |   | $ | — |   |
| Secured by  Farmland                                                     |       | $                      | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Consumer Loans                                                           |       | $                      | —     |   | $ | — |   | $ | 9 |   | $ | — |   | $ | 8 |   |
| **SUBTOTAL**                                                             |       | $                      | 253        |   | $ | 2,282 |   | $ | 9 |   | $ | 101 |   | $ | 54 |   |
|                                                                     |       |                   |       |   |   |   |   |   |   |   |   |
| Other Real Estate (OREO)                                                 |       | $                      | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Total non-performing Assets                                              |       | $                      | 253        |   | $ | 2,282 |   | $ | 9 |   | $ | 101 |   | $ | 54 |   |
| Restructured Loans                                                       |       | N/A                    |       | N/A |   | N/A |   | N/A |   | N/A |   |
| Non-performing loans as % of total gross loans                           |       | 0.06                   | %          | 0.51 | % | 0.00 | % | 0.03 | % | 0.02 | % |
| Non-performing  assets as a % of total gross loans and other real estate |       | 0.06                   | %          | 0.51 | % | 0.00 | % | 0.03 | % | 0.02 | % |

 

Total non-performingbalances were $253,000 at the end of 2007, which consisted of two real estateloans. The first one was a vacant lot secured by a first deed of trust in theamount of $233,000 which the Company eventually obtained through foreclosureand is attempting to sell.  The otherloan was an equity line of credit secured by a second deed of trust on a singlefamily residence in the amount of $20,000.  Other than the loans included as non-performing assets at December 31,2007, the company has not identified any potential problem loans that would resultin any loan being included as a non-performing asset at a future date.

 

###### **Allowancefor Loan Losses**

######  

The allowance for loanlosses is established through a provision for loan losses based on management’sevaluation of known and inherit risk in our loan portfolio. The allowance isincreased by provisions charged against current earnings and reduced by netcharge-offs. Loans are charged off when they are deemed to be uncollectible;recoveries are generally recorded only when cash payments are received subsequentto the charge off. The following table summarizes the activity in the allowancefor loan losses for the past five years.

 

41

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**Allowance For Loan Losses**

(In thousands, except forpercentages)
| ** **                                                      | ** ** | **As of December 31,** | ** ** |
|-----------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                      | ** ** | **2007**               | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Balances:**                                                   | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Average loans outstanding during period                         |       | $                      | 456,818    |   | $ | 445,119 |   | $ | 382,659 |   | $ | 313,912 |   | $ | 254,682 |   |
| Gross loans outstanding at end of period.                       |       | $                      | 446,582    |   | $ | 448,326 |   | $ | 407,045 |   | $ | 344,577 |   | $ | 274,851 |   |
|                                                            |       |                   |       |   |   |   |   |   |   |   |   |
| **Allowance for Loan Losses:**                                  | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Allowance for  possible loan losses at beginning of period      |       | $                      | 5,274      |   | $ | 4,716 |   | $ | 4,000 |   | $ | 3,587 |   | $ | 3,007 |   |
| Adjustments                                                     |       | $                      | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Provision charged to expense                                    |       | $                      | 225        |   | $ | 775 |   | $ | 824 |   | $ | 790 |   | $ | 655 |   |
|                                                            |       |                   |       |   |   |   |   |   |   |   |   |
| Loans charge-offs                                               |       |                   |       |   |   |   |   |   |   |   |   |
| Agricultural                                                    |       | $                      | 2          |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Commercial &  industrial loans                              |       | $                      | 13         |   | $ | 42 |   | $ | — |   | $ | 11 |   | $ | 77 |   |
| Real estate                                                     |       | $                      | 8          |   | $ | 31 |   | $ | — |   | $ | — |   | $ | — |   |
| Consumer                                                        |       | $                      | 3          |   | $ | 9 |   | $ | 9 |   | $ | 12 |   | $ | 4 |   |
| Credit card loans                                               |       | $                      | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Total                                                           |       | $                      | 26         |   | $ | 82 |   | $ | 9 |   | $ | 23 |   | $ | 81 |   |
|                                                            |       |                   |       |   |   |   |   |   |   |   |   |
| Recoveries                                                      |       |                   |       |   |   |   |   |   |   |   |   |
| Agricultural                                                    |       | $                      | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Commercial                                                      |       | $                      | —     |   | $ | 2 |   | $ | 1 |   | $ | 15 |   | $ | — |   |
| Real estate                                                     |       | $                      | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Consumer                                                        |       | $                      | —     |   | $ | — |   | $ | — |   | $ | 12 |   | $ | 6 |   |
| Credit card  loans                                              |       | $                      | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Total                                                           |       | $                      | —     |   | $ | 2 |   | $ | 1 |   | $ | 27 |   | $ | 6 |   |
| Net loan charge-offs                                            |       | $                      | 26         |   | $ | 80 |   | $ | 8 |   | $ | (4 | ) | $ | 75 |   |
| Allowance for unfunded loan commitments                         |       | $                      | (241       | ) | $ | (137 | ) | $ | (100 | ) | $ | (381 | ) | $ | — |   |
| Allowance for loan losses at end of period                      |       | $                      | 5,232      |   | $ | 5,274 |   | $ | 4,716 |   | $ | 4,000 |   | $ | 3,587 |   |
|                                                            |       |                   |       |   |   |   |   |   |   |   |   |
| **Ratios:**                                                     | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loan  charge-offs to average loans                          |       | 0.00                   | %          | 0.02 | % | 0.00 | % | 0.00 | % | 0.03 | % |
| Allowance for  loan losses to gross loans at end of period      |       | 1.17                   | %          | 1.18 | % | 1.16 | % | 1.16 | % | 1.31 | % |
| Allowance for  loan losses to non-performing loans              |       | 2067.98                | %          | 231.11 | % | 52411.11 | % | 3960.40 | % | 6642.59 | % |
| Net charge-offs  to allowance for loan losses at end of period  |       | 0.50                   | %          | 1.52 | % | 0.17 | % | (0.10 | )% | 2.09 | % |
| Net loan  charge-offs to provision charged to operating expense |       | 11.56                  | %          | 10.32 | % | 0.97 | % | (0.51 | )% | 11.45 | % |

 

We employ a systematicmethodology for determining the allowance for loan losses that includes amonthly review process and monthly adjustment of the allowance. Our processincludes a periodic review of individual loans that have been specificallyidentified as problem loans or have characteristics which could lead toimpairment, as well as detailed reviews of other loans (either individually orin pools). While this methodology utilizes historical and other objectiveinformation, the establishment of the allowance for loan losses and theclassification of loans are, to some extent, based on management’s judgment andexperience.

 

Our methodologyincorporates a variety of risk considerations, both quantitative andqualitative, in establishing an allowance for loan losses that managementbelieves is appropriate at each reporting date. Quantitative factors include 

 

42

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our historical lossexperience, delinquency and charge-off trends, collateral values, changes innon-performing loans, and other factors. Quantitative factors also incorporateknown information about individual loans, including borrowers’ sensitivity tointerest rate movements and borrowers’ sensitivity to quantifiable externalfactors including commodity prices as well as acts of nature (freezes,earthquakes, fires, etc.) that occur in a particular period.

 

Qualitative factorsinclude the general economic environment in Northern California and, in particular,in our markets wherein we monitor the state of the agriculture industry andother key industries in the Northern Sacramento Valley. The way a particularloan might be structured, the extent and nature of waivers of existing loanpolicies, loan concentrations and the rate of portfolio growth are otherqualitative factors that are considered.

 

Our methodology is, andhas been, consistently followed. However, as we add new products, increase incomplexity, and expand our geographic coverage, we expect to enhance ourmethodology to keep pace with the size and complexity of the loan portfolio. Onan ongoing basis we engage outside firms to independently assess ourmethodology, and to perform independent credit reviews of our loan portfolio.The FDIC and the California Department of Financial Institutions review theallowance for loan losses as an integral part of the examination processes.Management believes that our current methodology is appropriate given our sizeand level of complexity. Further, management believes that the allowance forloan losses is adequate as of December 31, 2007 to cover known andinherent risks in the loan portfolio. However, fluctuations in credit quality,or changes in economic conditions or other factors could cause management toincrease or decrease the allowance for loan losses as necessary.

 

The following tableprovides a summary of the allocation of the allowance for loan losses forspecific loan categories at the dates indicated. The allocation presentedshould not be interpreted as an indication that charges to the allowance forloan losses will be incurred in these amounts or proportions, or that theportion of the allowance allocated to each loan category represents the totalamounts available for charge-offs that may occur within these categories. Theunallocated portion of the allowance for loan losses and the total allowance isapplicable to the entire loan portfolio.

 

**Allocationof Loan Loss Allowance**

(dollars in thousands)

 
| ** **                        | ** ** | **As of  December 31,** | ** ** |
|-----------------------------------|------------|-------------------------|------------|
| ** **                        | ** ** | **2007**                | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                        | ** ** | ** **              | ** ** | **% Total  (1)** | ** ** | ** ** | ** ** | **% Total  (1)** | ** ** | ** ** | ** ** | **% Total  (1)** | ** ** | ** ** | ** ** | **% Total  (1)** | ** ** | ** ** | ** ** | **% Total  (1)** | ** ** |
| ** **                        | ** ** | **Amount**              | ** ** | **Loans** | ** ** | **Amount** | ** ** | **Loans** | ** ** | **Amount** | ** ** | **Loans** | ** ** | **Amount** | ** ** | **Loans** | ** ** | **Amount** | ** ** | **Loans** | ** ** |
| Agricultural                      |       | $                       | 313        |   | 5.89 | % | $ | 219 |   | 5.74 | % | $ | 200 |   | 6.09 | % | $ | 244 |   | 6.44 | % | $ | 179 |   | 7.58 | % |
| Commercial                        |       | $                       | 631        |   | 16.13 | % | $ | 626 |   | 14.55 | % | $ | 1,123 |   | 15.03 | % | $ | 690 |   | 17.02 | % | $ | 1,258 |   | 21.01 | % |
| Real Estate                       |       | $                       | 4,628      |   | 65.95 | % | $ | 4,172 |   | 69.94 | % | $ | 3,488 |   | 69.91 | % | $ | 3,027 |   | 68.93 | % | $ | 1,815 |   | 63.52 | % |
| Installment Loans                 |       | $                       | 520        |   | 12.03 | % | $ | 876 |   | 9.77 | % | $ | 386 |   | 8.97 | % | $ | 420 |   | 7.61 | % | $ | 335 |   | 7.89 | % |
| Reserve for  Unfunded Commitments |       | $                       | (860       | ) |   |   | $ | (619 | ) |   |   | $ | (481 | ) |   |   | $ | (381 | ) |   |   |   |   |   |   |
| **TOTAL**                         |       | $                       | 5,232      |   | 100.00 | % | $ | 5,274 |   | 100.00 | % | $ | 4,716 |   | 100.00 | % | $ | 4,000 |   | 100.00 | % | $ | 3,587 |   | 100.00 | % |

 

----

(1) Representspercentage of loans in category to total loans.

 

At December 31, 2007, the Company’s allowance forloan losses was $5.3 million. The loan loss and undisbursed commitmentprovisions in 2007, 2006, and 2005 totaled $225,000, $775,000, and $825,000,respectively. Over the past five years, net charge-offs have averaged $37,000.The Company ended 2007 with net loan losses of $25,000, compared to net lossesof $80,000 during 2006.

 

**Other Loan Portfolio Information**

 

Loan Concentrations: The concentration profile of the Company’s loans is discussed in Note 10to the accompanying Consolidated Financial Statements.

 

43

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Loan Sales and ServicingRights:  The Company sells or brokers some of theloans it originates through the SBA and FMHA B&I programs. Some of theloans are sold “servicing released” and the purchaser takes over the collectionof the payments. However, some are sold with “servicing retained” and theCompany continues to receive the payments from the borrower and forwards thefunds to the purchaser. The Company earns a fee for this service. The sales aremade without recourse, that is, the purchaser cannot look to the Company in theevent the borrower does not perform according to the terms of the note. Whenloans are sold, a portion of the sale is attributed to the right to receive thefee for servicing and this value is recorded as a separate servicing asset.Servicing rights are amortized over the expected term of the related servicingincome.  At December 31, 2007 and2006, the amortized cost of these assets was $1,104,000 and $872,000respectively.

 

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

######  

The investment securitiesportfolio had a carrying value of $6.3 million at December 31, 2007. TheCompany classified its investments into two categories: “held-to-maturity”, and“available-for-sale”. The Company does not have any investments classified astrading. The held-to-maturity portfolio consists only of investments that theCompany has both the intention and ability to hold until maturity, to be soldonly in the event of concerns with an issuer’s creditworthiness, a change intax law that eliminates their tax exempt status or other infrequent situationsas permitted under GAAP. Given the small and non complex nature of theportfolio, management does not rely heavily on these investments as a source offunds for growth in the loan portfolio.

 

Securities pledged ascollateral on repurchase agreements, public deposits and for other purposes asrequired or permitted by law were $4,360,000 as of December 31, 2007 and$3,357,000 as of December 31, 2006.

 

The total investmentportfolio increased in 2007 to $6.3 million at the end of the year from $5.1million at December 31, 2006. The Company’s investment portfolio iscomposed primarily of:  (1) U.S.Treasury and Agency issues for liquidity and pledging; and (2) state,county and municipal obligations which provide tax free income and pledgingpotential. The distribution of these groups within the overall portfolioremained relatively consistent.   TheU.S. Treasury and Agency issues continue to be the largest portion of the totalportfolio at 78%, up from 73% at the end of 2006. Municipal issues comprised22% of total investments at the end of 2007, down from 27% at the end of 2006.

 

The following InvestmentPortfolio table reflects the amortized cost and fair market values for thetotal portfolio for each of the categories of investments for the past threeyears.

 

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 $54.3 million and $42million as of December 31, 2007 and December 31, 2006.

 

**Investment Portfolio**

(dollarsin thousands)

 
| ** **                                 | ** ** | **As of December 31,** | ** ** |
|--------------------------------------------|------------|------------------------|------------|
| ** **                                 | ** ** | **2007**               | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                 | ** ** | **Amortized Cost**     | ** ** | **Fair   Market   Value** | ** ** | **Amortized Cost** | ** ** | **Fair   Market   Value** | ** ** | **Amortized Cost** | ** ** | **Fair   Market   Value** | ** ** |
| **Available for sale**                     | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| US Government  Agencies & Corporations |       | $                      | 3,282      |   | $ | 3,287 |   | $ | 1,977 |   | $ | 1,961 |   | $ | 3,009 |   | $ | 2,964 |   |
| State &  political subdivisions        |       | 1,357                  |       | 1,381 |   | 1,357 |   | 1,389 |   | 1,356 |   | 1,380 |   |
| **Total available for sale**               |       | 4,639                  |       | 4,668 |   | 3,334 |   | 3,350 |   | 4,365 |   | 4,344 |   |
| **Held to maturity**                       | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| US Government  Agencies & Corporations |       | 1,596                  |       | 1,602 |   | 1,777 |   | 1,759 |   | 2,332 |   | 2,296 |   |
| **Total Investment Securities**            |       | $                      | 6,235      |   | $ | 6,270 |   | $ | 5,111 |   | $ | 5,109 |   | $ | 6,697 |   | $ | 6,640 |   |

 

 

44

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The investment maturitiestable below summarizes the maturity of the Company’s investment securities andtheir weighted average yields at December 31, 2007. Expected remainingmaturities may differ from remaining contractual maturities because obligorsmay have the right to repay certain obligations with or without penalties.

 

**Investment Maturities**

(dollars in thousands)

 
| ** **                                 | ** ** | **As of December 31, 2007** | ** ** |
|--------------------------------------------|------------|-----------------------------|------------|
| ** **                                 | ** ** | **Within One   Year**       | ** ** | **After One But Witihin Five Years** | ** ** | **After Five   Years But** | ** ** | **After Ten   Years** | ** ** | **Total** | ** ** |
| ** **                                 | ** ** | **Amount**                  | ** ** | **Yield** | ** ** | **Amount** | ** ** | **Yield** | ** ** | **Amount** | ** ** | **Yield** | ** ** | **Amount** | ** ** | **Yield** | ** ** | **Amount** | ** ** | **Yield** | ** ** |
| **Available for sale**                     | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| US Government  agencies & corporations |       | —                      |       |   |   | 2,009 |   | 4.96 | % | 1,278 |   | 4.96 | % | — |   |   |   | 3,287 |   | 4.96 | % |
| State &  political subdivsions         |       | —                      |       | — |   | — |   |   |   | — |   |   |   | 1,381 |   | 7.14 | % | 1,381 |   | 7.14 | % |
| **Total  available for sale**              |       | $                           | —     |   |   |   | $ | 2,009 |   | 4.96 | % | $ | 1,278 |   | 4.96 | % | $ | 1,381 |   | 7.14 | % | $ | 4,668 |   | 5.60 | % |
| **Held to Maturity**                       | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| US Government  agencies & corporations |       | 1,000                       |       | 3.15 | % | 522 |   | 4.08 | % | 74 |   | 6.00 | % | — |   |   |   | 1,596 |   | 3.58 | % |
| **Total  investment securities**           |       | $                           | 1,000      |   | 3.15 | % | $ | 2,531 |   | 4.78 | % | $ | 1,352 |   | 5.01 | % | $ | 1,381 |   | 7.14 | % | $ | 6,264 |   | 5.09 | % |

 

 

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

######  

Cash on hand and balancesdue from correspondent banks represent the major portion of the Company’snon-earning assets. At December 31, 2007 these areas comprised 5.5% oftotal assets, as compared to 3.7% of total assets at December 31, 2006.The Company strives to maintain vault cash at a level consistent with thewithdrawal needs of the customers. The vault cash amount for December 31,2007 was $4.1 million.

 

The Company’s operatingbranches lie within the Federal Reserve Bank (FRB) of San Francisco’sresponsibility area of check clearing activities, while the Company’s itemprocessing activities are performed in Chico. As a result of the FederalReserve Banks’ new Check 21 services the Company is taking advantage ofquicker clearing times to offset time zone and geography challenges and improveavailability. With traditional paper check clearing, all non-local and countryitems in the 12th District receive availability that is at least oneday deferred. Under the new 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. Pacific through 9:00 a.m.Pacific time, image cash letters enable institutions on the West Coast toreduce the clearing time of many high value East Coast items by at least onebusiness day, thereby increasing funds available for investment and reducingrisk.

 

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

######  

Premises and equipmentare stated at cost less accumulated depreciation and amortization. Depreciationis charged to income over the estimated useful lives of the assets andleasehold improvements are amortized over the terms of the related lease, orthe estimated useful lives of the improvements, whichever is shorter.Depreciation expense was $2,108,000 for the year ended December 31, 2007as compared to $1,662,000 during 2006 and $1,574,000 during 2005. The followingpremises and equipment table reflects the balances by major category of fixedassets:

 

45

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**Premises & Equipment**

(dollarsin thousands)

 
| ** **               | ** ** | **As of December 31,** | ** ** |
|--------------------------|------------|------------------------|------------|
| ** **               | ** ** | **2007**               | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **               | ** ** | **Cost**               | ** ** | **Accumulated Depreciation** | ** ** | **Net Book Value** | ** ** | **Cost** | ** ** | **Accumulated Depreciation** | ** ** | **Net Book Value** | ** ** | **Cost** | ** ** | **Accumulated Depreciation** | ** ** | **Net Book Value** | ** ** |
| Land                     |       | $                      | 2,176      |   | $ | — |   | $ | 2,176 |   | $ | 2,176 |   | $ | — |   | $ | 2,176 |   | $ | 2,176 |   | $ | — |   | $ | 2,176 |   |
| Buildings                |       | 12,927                 |       | 2,069 |   | 10,858 |   | 8,713 |   | 1,714 |   | 6,999 |   | 6,908 |   | 1,425 |   | 5,483 |   |
| Leasehold Improvements   |       | 2,485                  |       | 849 |   | 1,636 |   | 2,258 |   | 555 |   | 1,703 |   | 994 |   | 386 |   | 608 |   |
| Construction in progress |       | 31                     |       | — |   | 31 |   | 2,368 |   | — |   | 2,368 |   | 622 |   | — |   | 622 |   |
| Furniture and Equipment  |       | 9,867                  |       | 6,663 |   | 3,203 |   | 8,282 |   | 6,169 |   | 2,113 |   | 7,384 |   | 5,052 |   | 2,332 |   |
| **Total**                |       | $                      | 27,486     |   | $ | 9,581 |   | $ | 17,905 |   | $ | 23,797 |   | $ | 8,438 |   | $ | 15,359 |   | $ | 18,084 |   | $ | 6,863 |   | $ | 11,221 |   |

 

 

The net book value of theCompany’s premises and equipment increased by $2,546,000 in 2007, primarily dueto the full year depreciation of the new corporate administrative headquartersbuilding in Chico that was completed in January of 2007 and the newbranches in Anderson and Redding that were opened in the third quarter of2007.  As a percentage of total assets,the Company’s premises and equipment was 3.1%, at the end of 2007, 2.8% at the endof 2006 and 2.3% at the end of 2005.

 

###### **Deposits**

######  

The composition and costof the Company’s deposit base are important components in analyzing the Company’snet interest margin and balance sheet liquidity characteristics, both of whichare discussed in greater detail in other sections herein. Net interest marginis improved to the extent that growth in deposits can be concentrated inhistorically lower-cost core deposits, namely non-interest-bearing demand, NOWaccounts, savings accounts and money market deposit accounts. Liquidity isimpacted by the volatility of deposits or other funding instruments, or inother words their propensity to leave the institution for rate-related or otherreasons. Potentially, the most volatile deposits in a financial institution arelarge certificates of deposit, which generally mean time deposits with balancesexceeding $100,000. Because these deposits (particularly when consideredtogether with a customer’s other specific deposits) may exceed FDIC insurancelimits, depositors may select shorter maturities to offset perceived riskelements associated with deposits over $100,000.  Certificates of deposits exceeding $100,000represented 14.7% of average total deposits in 2007, 15.9% in 2006 and 11.3% in2005.  While the total of these depositshas been stable over the past three years, the Company’s community-orienteddeposit gathering activities in Butte, Colusa, Shasta, Sutter, Tehama, and Yubacounties have engendered a less volatile than usual base of depositorcertificates over $100,000.

 

The Company’s totaldeposit volume increased to $501 million at the end of 2007, as compared to$485 million at the end of 2006. Deposit growth of $16 million was achievedduring 2007, primarily as a result of the full year of operations for thebranches opened in 2006 and the new branches opened in 2007. The mix of thedeposits changed from 2006 to 2007 as the growth was realized in savingsthrough our liquid certificate of deposit product rather than the lower costcore deposit accounts (demand deposits, NOW, money market). We expect depositrates to be lower in 2008, and our focus will be to attract deposits at thelowest cost possible to fund our loan growth and maintain a reasonable netinterest margin in 2008.

 

The scheduled maturity distributionof the Company’s time deposits, including IRA accounts as of December 31,2007 was as follows:

 

46

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**Deposit Maturity Distribution**

(dollars in thousands)

 
| ** **                                   | ** ** | **As of December 31, 2007**  | ** ** |
|----------------------------------------------|------------|------------------------------|------------|
| ** **                                   | ** ** | **Three   months or   less** | ** ** | **Three to   twelve   months** | ** ** | **One to   three   years** | ** ** | **Over   three   years** | ** ** | **Total** | ** ** |
| Time  Certificates of Deposits < $100,000 |       | $                            | 20,099     |   | $ | 54,599 |   | $ | 2,863 |   | $ | 405 |   | $ | 77,966 |   |
| Other Time  Deposits > $100,000           |       | $                            | 18,854     |   | $ | 60,815 |   | $ | 1,029 |   | $ | 870 |   | $ | 81,568 |   |
| TOTAL                                        |       | $                            | 38,953     |   | $ | 115,414 |   | $ | 3,892 |   | $ | 1,275 |   | $ | 159,534 |   |
|                                         |       |                         |       |   |   |   |   |   |   |   |   |

 

 

**Notes Payable and OtherBorrowings**

 

The Company has $15million in unsecured borrowing arrangements with two of its correspondent banksto meet short-term liquidity needs. There were no borrowings outstanding underthese arrangements at December 31, 2007 and 2006.

 

The following summarizesthe note payable to the Company’s subsidiary grantor trust at December 31,2007:

 

| ** **                                                                                                                                                                                                                                                                                                                     | ** ** | **(Dollars in  thousands)**   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------|
| Subordinated debentures due to Community Valley  Bancorp Trust I with interest adjusted and payable quarterly based on 3month  Libor plus 3.30% to a maximum of 12.5% (8.0% at December 31, 2007),  redeemable beginning December 31, 2007, due December 31, 2032                                               |       | $                                  | 8,248 |
|                                                                                                                                                                                                                                                                                                                           |       |                               |
| ** **                                                                                                                                                                                                                                                                                                                     | ** ** | **(Dollars in    thousands)** |
| Subordinated debentures due to Community Valley  Bancorp Trust II with interest fixed and payable quarterly based on the 5  year swap rate benchmark of 5.57% plus 1.57% Libor for the first 5 years;  then converting to 3-month LIBOR plus 1.57% for remaining term, beginning  July 10, 2007, due October 1, 2037 |       | $                                  | 8,248 |

 

The Company hasguaranteed, on a subordinated basis, distributions and other payments due onthe trust preferred securities issued by the subsidiary grantor trust. Interestexpense recognized by the Company for the years ended December 31, 2007,2006 and 2005 related to the junior subordinated debentures was $1,024,000,$733,000 and $592,000, respectively. These junior subordinated debenturescurrently qualify as Tier 1 capital when determining regulatory risk-basedcapital ratios.

 

On April 28, 2006the ESOP obtained financing through a $1.3 million unsecured line of creditfrom another financial institution with the Company acting as the guarantor.The note has a variable interest rate, based on an independent index, and amaturity date of April 10, 2014. At December 31, 2007, the interestrate was 7.5%. Advances on the line of credit totaled $1,093,000, $1,217,000 atDecember 31, 2007 and 2006, respectively. A summary of the activity inthis line of credit follows.

 

47

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| ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                  | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005**   | ** ** |
| **ESOP Note Payable**                       |       |       |       |       |       |       |       |
| **(dollars in thousands)**                  |       |       |       |       |       |       |       |
|                                        |       |       |       |       |       |       |       |
| Balance at December 31                      |       | $          | 1,092      |       | $          | 1,217      |       | $ | 981 |   |
|                                        |       |       |       |       |       |       |       |
| Average amount outstanding                  |       | $          | 1,150      |       | $          | 1,068      |       | $ | 865 |   |
|                                        |       |       |       |       |       |       |       |
| Maximum amount outstanding at any month end |       | $          | 1,215      |       | $          | 1,142      |       | $ | 1,080 |   |
|                                        |       |       |       |       |       |       |       |
| Average interest rate for the year          |       | 8.08       | %          | 7.94       | %          | 6.13       | %          |

 

 
| ** **                                  | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Other Note Payable**                      |       |     |       |     |       |     |       |
| **(dollars in thousands)**                  |       |     |       |     |       |     |       |
|                                        |       |     |       |     |       |     |       |
| Balance at December 31                      |       | $        | —     |     | $          | —   |       | $ | 800 |   |
|                                        |       |     |       |     |       |     |       |
| Average amount outstanding                  |       | $        | —     |     | $          | —   |       | $ | 465 |   |
|                                        |       |     |       |     |       |     |       |
| Maximum amount outstanding at any month end |       | $        | —     |     | $          | —   |       | $ | 800 |   |
|                                        |       |     |       |     |       |     |       |
| Average interest rate for the year          |       | 0.00     | %          | 0.00     | %          | 4.50     | %          |
|                                        |       |     |       |     |       |     |       |

 

 

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

######  

At December 31,2007, the Company had total shareholders equity of $51 million, comprised of$9.5 million in common stock, and $41.5 million in retained earnings. Totalshareholders equity at the end of 2006 was $45.7 million. Net income hasprovided $21 million in capital over the last three years, of which $5.5million or approximately 26% was distributed in dividends. The retention ofearnings has been the Company’s main source of capital since 1990, however theCompany issued $8.2 million in Subordinated Debentures in 2002 and 2007, theproceeds of which are considered Tier 1 capital for regulatory purposes butlong-term debt in accordance with GAAP.

 

The Company paidquarterly cash dividends totaling $2,425,000 or $.32 per share in 2007 and$1,933,000 or $.26 per share in 2005, representing 37.5% and 27%, respectivelyof the prior year’s earnings.  Since thesecond quarter of 2001, the Company has adhered to a policy of paying quarterlycash dividends totaling about 22.5% of the prior year’s net earnings to theextent consistent with general considerations of safety and soundness, providedthat such payments do not adversely affect the Bank’s or the Company’sfinancial condition and are not overly restrictive to its growth capacity. The Companyanticipates paying dividends in the future consistent with the general dividendpolicy as described above. 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.

 

The Company uses avariety of measures to evaluate capital adequacy. Management reviews variouscapital measurements on a monthly basis and takes appropriate action to ensurethat such measurements are within established internal and external guidelines.The external guidelines, which are issued by the FDIC, establish arisk-adjusted ratio relating capital to different categories of assets and offbalance sheet exposures. There are two categories of capital under the FDIC guidelines:Tier 1 and Tier 2 Capital. Tier 1 Capital includes common shareholders’ equityand the proceeds from the issuance of trust-preferred securities (subject tothe limitations previously discussed), less goodwill and certain otherdeductions, notably the unrealized net gains or losses (after tax adjustments)on securities available for sale, which are carried at fair market value. Tier2 Capital includes preferred stock and certain types of debt equity, which theCompany does not hold, as well as the allowance for loan losses, subject tocertain limitations. (For a more detailed definition, see “Item 1,Business-Supervision and Regulation — Capital Adequacy Requirements” herein.)

 

48

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At December 31, 2007,the Company had a Tier 1 risk based capital ratio of 13.1%, a total capital torisk-weighted assets ratio of 14.1%, and a leverage ratio of 11.6%. The Companyhad a Tier 1 risk-based capital ratio of 10.9%, a total risk-based capitalratio of 11.9%, and a leverage ratio of 10.1% at December 31, 2006. Note11 of the Notes to Consolidated Financial Statements provides more detailedinformation concerning the Company’s capital amounts and ratios as of December 31,2007 and 2006.

 

At the current time, theBank is considered “well capitalized” under the Prompt Corrective Actionstandards. It is anticipated that the current level of capital will allow theCompany to grow and remain well capitalized, although no assurance can be giventhat this will be the case.

 

****Off-Balance Sheet Itemsand Contractual Obligations****

 

TheCompany has certain ongoing commitments under operating leases. See Note 10 tothe consolidated financial statements at Item 8 of this report for the terms.These commitments do not significantly impact operating results. As of December 31,2007 commitments to extend credit and stand-by-letters of credit were theCompany’s only financial instruments with off-balance sheet risk. Loancommitments decreased to $184 million at December 31, 2007 from $186million at December 31, 2006. Stand-by-letters of credit increasedslightly to $6.7 million from $5.1 million over the same period.  The commitments and stand-by letters ofcredit represent 43% of the total loans outstanding at year-end 2007 versus 42%at December 31, 2006.

 

The following chart summarizes certain contractual obligations of the Company as of December 31, 2007:

 
| ** **                    | ** ** | **Less than   1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than   5 years** | ** ** | **Total** | ** ** |
|-------------------------------|------------|------------------------|------------|---------------|------------|---------------|------------|-------------------------|------------|-----------|------------|
|                          |       |                   |       |          |       |          |       |                    |       |      |       |
| Subordinated debenture        |       | $                      | 8,248      |          | $          | —        |       | $                       | —     |      | $          | 8,248 |   | $ | 16,496 |   |
| Operating lease obligations   |       | 929                    |       | 1,830         |       | 1,574         |       | 7,524                   |       | 11,857    |       |
| Deferred compensation         |       | —                 |       | —        |       | —        |       | 5,119                   |       | 5,119     |       |
| Supplemental retirement plans |       | 119                    |       | 380           |       | 416           |       | 1,125                   |       | 2,040     |       |
| Notes payable                 |       | —                 |       | —        |       | —        |       | 1,092                   |       | 1,092     |       |
| Total contractual obligations |       | $                      | 9,296      |          | $          | 2,210         |       | $                       | 1,990      |      | $          | 23,108 |   | $ | 36,604 |   |

 

----

| (1) | These  amounts represent the accrued liabilities as of December 31, 2007 under  the Company’s deferred compensation and supplemental retirement plans. See  Note 15 to the consolidated financial statements at Item 8 of this report for  additional information related to the Company’s deferred compensation and  supplemental retirement plan liabilities. The subordinated debenture in the  less than 1 year column was subsequently redeemed in January 2008. |
|-----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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

######  

The Company must addresson a 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.

 

Liquidity refers to theCompany’s ability to maintain a cash flow adequate to fund operations, and tomeet obligations and other commitments in a timely and cost-effective fashion.At various times the Company requires funds to meet short-term cashrequirements brought about by loan growth or deposit outflows, the purchase ofassets, or liability repayments. To manage liquidity needs properly, cashinflows must be timed to coincide with anticipated outflows, or sufficientliquidity resources must be available to meet varying demands. The Companymanages its own liquidity in such a fashion as to be able to meet unexpectedsudden changes in levels of its assets or deposit liabilities, withoutmaintaining excessive amounts of on-balance sheet liquidity. Excess balancesheet liquidity can negatively impact the interest margin.

 

49

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An integral part of theCompany’s ability to manage its liquidity position appropriately is provided bythe Company’s large base of core deposits, which were generated by offeringtraditional banking services in the communities in its service area and whichhave, historically, been a very stable source of funds.

 

Additionally, the Companymaintains $15 million in unsecured borrowing arrangements with two of itscorrespondent banks. The Company also has the ability to raise deposits throughvarious deposit brokers, sell investment securities, or sell loans if requiredfor liquidity purposes.

 

Market risk arises fromchanges in interest rates, exchange rates, commodity prices and equity prices.The Company’s market risk exposure is primarily that of interest rate risk, andit has risk management policies to monitor and limit earnings and balance sheetexposure to changes in interest rates. The Company does not engage in thetrading of financial instruments.

 

The principal objectiveof 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.

 

Modeling software is usedby the Company for asset/liability management in order to simulate the effectsof potential interest rate changes on the Company’s net interest margin. Thesesimulations can also provide both static and dynamic information on theprojected fair market values of the Company’s financial instruments underdiffering interest rate assumptions. The simulation program utilizes specificindividual loan and deposit maturities, embedded options, rates and re-pricingcharacteristics to determine the effects of a given interest rate change on theCompany’s interest income and interest expense. Rate scenarios consisting ofkey rate and yield curve projections are run against the Company’s investment,loan, deposit and borrowed funds portfolios. These rate projections can beshocked (an immediate and sustained change in rates, up or down), ramped (anincremental 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 15%, 30%, and 45% and 12.5%, 25%, and 37.5% respectively upon applicationof interest rate shocks of 100 bp, 200 bp, and 300 bp as compared to a baserate scenario. As of December 31, 2007, the Company had the followingestimated net interest margin sensitivity profile:

 
| ** **                  | ** ** | **Immediate  Change in Rate** | ** ** | **Immediate  Change in Rate** | ** ** | **Immediate  Change in Rate** | ** ** |
|-----------------------------|------------|-------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| ** **                  | ** ** | **+100 bp**                   | ** ** | **-100 bp**                   | ** ** | **+200 bp**                   | ** ** | **-200 bp** | ** ** | **+300 bp** | ** ** | **-300 bp** | ** ** |
| Net  Interest Income Change |       | $                             | 1,765,000  |                          | $          | (1,692,000                    | )          | $ | 3,510,000 |   | $ | (3,847,000 | ) | $ | 5,230,000 |   | $ | (5,981,000 | ) |
|                             |            |                               |            |                               |            |                               |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

The above profileillustrates that if there were an immediate increase of 200 basis points ininterest rates, the Company’s annual net interest income would likely increaseby about $3,510,000, or approximately 12.8%. Likewise, if there were animmediate downward adjustment of 200 basis points in interest rates, theCompany’s net interest income would likely decrease by approximately$3,847,000, or 14%, over the next year.

 

The results for theCompany’s December 31, 2007, balances indicate that the Company’s netinterest income at risk over a one-year period and net economic value at riskfrom 2% shocks are within normal expectations for such sudden changes.

 

The amount of change isbased on the profiles of each loan and deposit class, which include the rate,the likelihood of prepayment or repayment, whether its rate is fixed orfloating, the maturity of the instrument, and the particular circumstances ofthe customer. The quantification of the change in economic value is somewhatapparent in Note 16, Fair Value of Financial Instruments, in the consolidatedfinancial statements; however such values change over time based on certainassumptions about interest rates and likely changes in the yield curve.

 

50

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**Selected Quarterly Financial Data**

(Dollars in thousands,except per share data)

 
| **2007 Quarter**                                     | ** ** | **1st** | ** ** | **2nd** | ** ** | **3rd** | ** ** | **4th** | ** ** |
|------------------------------------------------------|------------|---------|------------|---------|------------|---------|------------|---------|------------|
|                                                 |       |    |       |    |       |    |       |    |       |
| Interest income                                      |       | $       | 10,615     |    | $          | 10,960  |       | $       | 11,128     |   | $ | 10,520 |   |
| Net interest income                                  |       | $       | 7,234      |    | $          | 7,497   |       | $       | 7,581      |   | $ | 7,022 |   |
| Net interest income  after provision for loan losses |       | $       | 7,159      |    | $          | 7,497   |       | $       | 7,506      |   | $ | 6,947 |   |
|                                                 |       |    |       |    |       |    |       |    |       |
| Net income                                           |       | $       | 1,250      |    | $          | 1,642   |       | $       | 2,179      |   | $ | 1,388 |   |
|                                                 |       |    |       |    |       |    |       |    |       |
| Net income per share,  basic                         |       | $       | 0.17       |    | $          | 0.22    |       | $       | 0.29       |   | $ | 0.19 |   |
|                                                 |       |    |       |    |       |    |       |    |       |
| Net income per share,  diluted                       |       | $       | 0.17       |    | $          | 0.22    |       | $       | 0.29       |   | $ | 0.18 |   |
|                                                 |       |    |       |    |       |    |       |    |       |
| Dividends declared                                   |       | $       | 0.08       |    | $          | 0.08    |       | $       | 0.08       |   | $ | 0.08 |   |

 
| **2006 Quarter**                                     | ** ** | **1st** | ** ** | **2nd** | ** ** | **3rd** | ** ** | **4th** | ** ** |
|------------------------------------------------------|------------|---------|------------|---------|------------|---------|------------|---------|------------|
|                                                 |       |    |       |    |       |    |       |    |       |
| Interest income                                      |       | $       | 9,268      |    | $          | 10,117  |       | $       | 10,670     |   | $ | 10,759 |   |
| Net interest income                                  |       | $       | 7,541      |    | $          | 7,901   |       | $       | 8,109      |   | $ | 7,731 |   |
| Net interest income  after provision for loan losses |       | $       | 7,316      |    | $          | 7,676   |       | $       | 7,884      |   | $ | 7,631 |   |
|                                                 |       |    |       |    |       |    |       |    |       |
| Net income                                           |       | $       | 1,749      |    | $          | 2,110   |       | $       | 1,733      |   | $ | 1,559 |   |
|                                                 |       |    |       |    |       |    |       |    |       |
| Net income per share,  basic                         |       | $       | 0.24       |    | $          | 0.29    |       | $       | 0.24       |   | $ | 0.21 |   |
|                                                 |       |    |       |    |       |    |       |    |       |
| Net income per share,  diluted                       |       | $       | 0.23       |    | $          | 0.27    |       | $       | 0.23       |   | $ | 0.20 |   |
|                                                 |       |    |       |    |       |    |       |    |       |
| Dividends declared                                   |       | $       | 0.05       |    | $          | 0.06    |       | $       | 0.07       |   | $ | 0.08 |   |

 

 

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

 

The information requireby Item 7a of Form 10-K is contained in the Liquidity and Market RiskManagement section of Item 7 — Managements Discussion and Analysis of FinancialCondition and Results of Operations.

 

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

 

The financial statementsbegin on page 59 of this report.

 

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

 

There were no changes ordisagreements with Accountants for the year 2007.

 

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

#  

As of the end of theperiod covered by this report, we conducted an evaluation, under thesupervision and with the participation of our Chief Executive Officer and ChiefFinancial Officer, of our disclosure controls and procedures (as

 

51

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defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934).  Based on thisevaluation, our Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures are effective to ensure thatinformation required to be disclosed by us in reports that we file or submitunder the Exchange Act is recorded, processed, summarized and reported withinthe time periods specified in Securities and Exchange Commission rules andforms.  There was no change in our internal control over financialreporting during our most recently completed fiscal quarter that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

 

**Item 9b.Other Information**

 

**PART III**

 

**Item10. Directors and Executive Officers and Corporate Governance**

 

The information requiredby Item 10 of Form 10-K is incorporated by reference to the informationcontained in the Company’s Proxy Statement for the 2008 Annual Meeting ofShareholders which will be filed pursuant to Regulation 14A.

 

**Item11. Executive Compensation**

 

The information requiredby Item 11 of Form 10-K is incorporated by reference to the informationcontained in the Company’s Proxy Statement for the 2008 Annual Meeting ofShareholders which will be filed pursuant to Regulation 14A.

 

**Item12. Security Ownership of Certain Beneficial Owners and Management and RelatedStockholder Matters**

 

The information requiredby Item 12 of Form 10-K is incorporated by reference to the informationcontained in the Company’s Proxy Statement for the 2008 Annual Meeting of Shareholderswhich will be filed pursuant to Regulation 14A.

 

**Item 13.****        ****Certain Relationships andRelated Transactions and Director Independence**

 

The information requiredby Item 13 of Form 10-K is incorporated by reference to the informationcontained in the Company’s Proxy Statement for the 2008 Annual Meeting ofShareholders which will be filed pursuant to Regulation 14A.

 

**Item 14.****        ****Principal Accountant Feesand Services**

 

The information requiredby Item 14 of Form 10-K is incorporated by reference to the informationcontained in the Company’s Proxy Statement for the 2008 Annual Meeting ofShareholders which will be filed pursuant to Regulation 14A.

 

**PART IV**

 

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

 

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

 

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

 

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

 

52

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|   | I.   |   | Report of Independent  Registered Public Accounting Firm                                                             |
|--------|------|--------|----------------------------------------------------------------------------------------------------------------------|
|   | II.  |   | Consolidated Balance  Sheet - December 31, 2007 and 2006                                                        |
|   | III. |   | Consolidated Statement  of Income - Years Ended December 31, 2007, 2006 and 2005                                |
|   | IV.  |   | Consolidated Statement  of Changes in Shareholders’ Equity - Years Ended December 31, 2007, 2006  and 2005 |
|   | V.   |   | Consolidated Statement  of Cash Flows - Years Ended December 31, 2007, 2006 and 2005                            |
|   | VI.  |   | Notes to the  Consolidated Financial Statements                                                                      |

 

**(2)**        **Financial Statement Schedules**

 

Schedules to the financialstatements are omitted because the required information is not applicable orbecause the required information is presented in the Company’s ConsolidatedFinancial Statements or related notes.

 

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

 

53

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**SIGNATURES**

 

Pursuant to therequirements 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: March 12, 2008 |   | **COMMUNITY VALLEY BANCORP** |
|----------------------------|--------|------------------------------|
|                       |   | a California corporation     |
|                       |   |                         |
|                       |   | By                           | */s/ Keith C. Robbins* |   |
|                       |   |                         | Keith C. Robbins |
|                       |   |                         | President and Chief Executive Officer |
|                       |   |                         |
|                       |   | By                           | */s/ John F. Coger* |   |
|                       |   |                         |   | John F. Coger |
|                       |   |                         |   | Executive Vice President   Chief Financial Officer and   Chief Operating Officer |
|                            |        |                              |  |  |  |  |  |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant and in thecapacities and on the dates indicated.

 
| **Signature**           | ** ** | **Title** | ** **                        | **Date** |
|-------------------------|------------|-----------|-----------------------------------|----------|
|                    |       |      |                              |     |
| */s/ M. Robert Ching*   |       |      | Director                          |     | March 12, 2008 |
| M. Robert Ching         |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ John F. Coger*     |       |      | Executive Vice President, CFO/COO |     | March 12, 2008 |
| John F. Coger           |       |      | and Director                      |     |   |
|                    |       |      |                              |     |   |
| */s/Eugene B. Even*     |       |      | Director                          |     | March 12, 2008 |
| Eugene B. Even          |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ John D. Lanam*     |       |      | Director                          |     | March 12, 2008 |
| John D. Lanam           |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ Donald W. Leforce* |       |      | Chairman of the Board             |     | March 12, 2008 |
| Donald W. Leforce       |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ Charles Mathews*   |       |      | Director                          |     | March 12, 2008 |
| Charles Mathews         |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ Ellis L. Matthews* |       |      | Director                          |     | March 12, 2008 |
| Ellis L. Matthews       |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ Luther McLaughlin* |       |      | Director                          |     | March 12, 2008 |
| Luther McLaughlin       |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ Robert L. Morgan*  |       |      | Director                          |     | March 12, 2008 |
| Robert L. Morgan        |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ Keith C. Robbins*  |       |      | President, Chief Executive        |     | March 12, 2008 |
| Keith C. Robbins        |       |      | Officer and Director              |     |   |
|                    |       |      |                              |     |   |
| */s/ James S. Rickards* |       |      | Director and                      |     | March 12, 2008 |
| James S. Rickards       |       |      | Corporate Secretary               |     |   |
|                    |       |      |                              |     |   |
| */s/ Gary B. Strauss*   |       |      | Director                          |     | March 12, 2008 |
| Gary B. Strauss         |       |      | Vice Chairman                     |     |   |
|                    |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ Hubert Townshend*  |       |      | Director                          |     | March 12, 2008 |
| Hubert Townshend        |       |      |                              |     |   |

 

54

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| **Exhibit** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                    |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**  | ** ** | **Document  Description**                                                                                                                                                                                                                                                                                                                                     |
|        |       |                                                                                                                                                                                                                                                                                                                                                          |
| (3.1)       |       | Articles of  Incorporation incorporated by reference from the Company’s Registration  Statement Form S-4EF, file #333-85950.                                                                                                                                                                                                                   |
| (3.2)       |       | Bylaws incorporated by  reference from the Company’s Registration Statement Form S-4EF, file #333-85950.                                                                                                                                                                                                                                       |
| (4.0)       |       | Specimen of Company’s  Common Stock Certificate incorporated by reference from the Company’s  Registration Statement Form S-4EF, file #333-85950.                                                                                                                                                                                         |
| (10.1)      |       | Employment Agreement  with Keith C Robbins dated April 27, 1995.  Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002.                                                                                                  |
| (10.1)1     |       | Amendment to Employment  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)      |       | Salary Continuation  Agreement dated April 14, 1998, and Amendment to Salary Continuation  Agreement dated January 10, 2002, for Keith C Robbins. Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002.                  |
| (10.2)1     |       | Amendment to Salary  Continuation Agreement of April 14, 1998 for Keith C Robbins dated January 1,  2004  Incorporated by reference to the Company’s Annual Report on Form 10-K  for the period ended December 31, 2003, filed with the Commission on March 20,  2004.                                                     |
| (10.2)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.                                                                               |
| (10.3)      |       | Executive Supplemental  Retirement Plan dated August 1, 2000, and Amendment to Executive  Supplement Retirement Plan dated January 10, 2002, for Keith C Robbins.  Incorporated by reference to the Company’s Quarterly Report on Form 10-Q  for the period ended June 30, 2002, filed with the Commission on August 14,  2002. |
| (10.4)      |       | 1997 Stock Option  Agreement for Keith C Robbins dated May 1, 1997. Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002.                                                                                                     |
| (10.5)      |       | 2000 Stock Option  Agreement for Keith C Robbins dated March 14, 2000. Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002.                                                                                                  |
| (10.6)      |       | Employment Agreement  with John F Coger dated April 27, 1995. Incorporated by reference to the  Company’s Quarterly Report on Form 10-Q for the period ended June 30,  2002, filed with the Commission on August 14, 2002.                                                                                                           |
| (10.7)      |       | Salary Continuation  Agreement dated April 14, 1998, and Amendment to Salary Continuation  Agreement dated January 10, 2002, for John F Coger. Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002.                     |
| (10.7)1     |       | Amendment to Salary  Continuation Agreement of April 14, 1998 for John F Coger dated January 1,  2004.  Incorporated by reference to the Company’s Annual Report on Form 10-K  for the period ended December 31, 2003, filed with the Commission on March 20,  2004.                                                  |
| (10.8)      |       | Executive Supplemental  Retirement Plan dated August 1, 2000, and Amendment to Executive  Supplement Retirement Plan dated January 10, 2002, for John F Coger.  Incorporated by reference to the Company’s Quarterly Report on Form 10-Q  for the period ended June 30, 2002, filed with the Commission on August 14,  2002.    |
| (10.9)      |       | 2000 Stock Option  Agreement for John F. Coger dated March 14, 2000 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002                                                                                                      |
| (10.10)     |       | 1997 Stock Option  Agreement for M. Robert Ching dated May 1, 1997 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002                                                                                                       |
| (10.11)     |       | 2000 Stock Option  Agreement for M Robert Ching dated May 1, 2000. Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002.                                                                                                      |

 

55

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| (10.12) |   | 1997 Stock Option  Agreement for Eugene B. Even dated May 1, 1997 Incorporated by reference  to the Company’s Quarterly Report on Form 10-Q for the period ended June 30,  2002, filed with the Commission on August 14, 2002        |
|---------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (10.13) |   | 2000 Stock Option  Agreement for Eugene B Even dated May 1, 2000. Incorporated by reference  to the Company’s Quarterly Report on Form 10-Q for the period ended June 30,  2002, filed with the Commission on August 14, 2002.       |
| (10.14) |   | 1997 Stock Option  Agreement for John D Lanam dated May 1, 1997. Incorporated by reference  to the Company’s Quarterly Report on Form 10-Q for the period ended June 30,  2002, filed with the Commission on August 14, 2002.        |
| (10.15) |   | 2000 Stock Option  Agreement for John D Lanam dated May 1, 2000. Incorporated by reference  to the Company’s Quarterly Report on Form 10-Q for the period ended June 30,  2002, filed with the Commission on August 14, 2002.        |
| (10.16) |   | 1997 Stock Option  Agreement for Donald W Leforce dated May 1, 1997. Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002.    |
| (10.17) |   | 2000 Stock Option  Agreement for Donald W. Leforce dated May 1, 2000 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002     |
| (10.18) |   | 1997 Stock Option  Agreement for Ellis L. Matthews dated May 1, 1997 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002     |
| (10.19) |   | 2000 Stock Option  Agreement for Ellis L. Matthews dated May 1, 2000 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002     |
| (10.20) |   | 1997 Stock Option  Agreement for Robert L Morgan dated May 1, 1997 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002.      |
| (10.21) |   | 2000 Stock Option  Agreement for Robert L. Morgan dated May 1, 2000 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002      |
| (10.22) |   | 1997 Stock Option Agreement  for James S Rickards dated May 1, 1997. Incorporated by reference to the  Company’s Quarterly Report on Form 10-Q for the period ended June 30,  2002, filed with the Commission on August 14, 2002.    |
| (10.23) |   | 2000 Stock Option  Agreement for James S. Rickards dated May 1, 2000 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002     |
| (10.24) |   | 1997 Stock Option  Agreement for Gary B. Strauss dated May 1, 1997 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002       |
| (10.25) |   | 2000 Stock Option  Agreement for Gary B Strauss dated May 1, 2000. Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002.      |
| (10.26) |   | 1997 Stock Option  Agreement for Hubert I. Townshend dated May 1, 1997 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002   |
| (10.27) |   | 2000 Stock Option  Agreement for Hubert I. Townshend dated May 1, 2000 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002   |
| (10.28) |   | Director Deferred Fee  Agreement for M. Robert Ching dated April 8, 1998 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002 |
| (10.29) |   | Director Retirement  Agreement for M. Robert Ching dated April 14, 1998 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002  |

 

56

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| (10.30) |   | Director Retirement  Agreement for Eugene B. Even dated April 14, 1998 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002                                                                               |
|---------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (10.31) |   | Director Retirement  Agreement for John D Lanam dated April 14, 1998. Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002.                                                                               |
| (10.32) |   | Director Deferred Fee  Agreement for Donald W. Leforce dated April 14, 1998 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002                                                                          |
| (10.33) |   | Director Retirement  Agreement for Donald W. Leforce dated April 14, 1998 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002                                                                            |
| (10.34) |   | Director Retirement  Agreement for Ellis L Matthews dated April 14, 1998. Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002.                                                                           |
| (10.35) |   | Director Retirement  Agreement for Robert L. Morgan dated April 14, 1998 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002                                                                             |
| (10.36) |   | Director Retirement  Agreement James S. Rickards dated April 14, 1998 Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002                                                                                |
| (10.37) |   | Director Retirement  Agreement for Gary B Strauss dated April 14, 1998. Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002.                                                                             |
| (10.38) |   | Director Retirement  Agreement for Hubert I Townshend dated April 14, 1998. Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002.                                                                         |
| (10.39) |   | Lease agreement between  Butte Community Bank and Anna Laura Schilling Trust dated March 20,  2001, related to 900 Mangrove Ave, Chico, California. Incorporated by  reference to the Company’s Quarterly Report on Form 10-Q for the period  ended June 30, 2002, filed with the Commission on August 14, 2002. |
| (10.40) |   | 2000 Stock Option Agreement  for Charles J Mathews dated October 21, 2003 Incorporated by reference  to the Company’s Annual Report on Form 10-K for the period ended December 31,  2005, filed with the Commission on March 14, 2006.                                                                           |
| (10.41) |   | 2000 Stock Option  Agreement for Luther W McLaughlin dated March 10, 2003. Incorporated by  reference to 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, BCB Insurance Agency, Community Valley Trust I,  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                                                                                                                                                                                                                                                                               |
|    |   |                                                                                                                                                                                                                                                                                                                                      |
| (99.2)  |   | 1997 Stock Option Plan  is incorporated by reference from the Company’s Registration Statement Form S-8,  filed August 14, 2002.                                                                                                                                                                                           |
| (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.                                                                                                        |

 

57

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(b) Reports on Form 8-K

 

OnJanuary 26, 2007 the Company issued a press release announcing earningsfor the fourth quarter and year ending December 31, 2006.

 

OnMarch 16, 2007 the company issued a press release announcing the paymentof a five cent dividend to shareholders of record as of March 31, 2007.The payment date for the dividend was April 28, 2007.

 

OnApril 5, 2007 the Company issued a press release announcing approval of aplan to repurchase up to $6 million of the outstanding common stock of theCompany.

 

OnApril 18, 2006 the Company issued a press release announcing earnings for thefirst quarter of 2007.

 

OnJune 22, 2007 the Company issued a press release announcing the payment ofan eight cent dividend to shareholders of record as of June 29, 2007. Thepayment date for the dividend was July 27, 2007.

 

OnJuly 23, 2007 the Company issued a press release announcing second quarter2007 earnings.

 

OnSeptember 21, 2007 the Company issued a press release announcing thepayment of an eight cent dividend to shareholders of record as of September 28,2007. The payment date for the dividend was October 26, 2007.

 

OnOctober 19, 2007 the Company issued a press release announcing thirdquarter 2007 earnings.

 

OnDecember 21, 2007 the Company issued a press release announcing thepayment of a eight cent dividend to shareholders of record as of December 31,2007. The payment date for the dividend was January 25, 2008.

 

58

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** **

**COMMUNITY VALLEY BANCORP AND SUBSIDIARIES**

** **

**CONSOLIDATEDFINANCIAL STATEMENTS**

 

**AS OFDECEMBER 31, 2007 AND 2006**

 

**AND FORTHE YEARS ENDED**

 

**DECEMBER 31,2007, 2006 AND 2005**

 

**AND**

 

**REPORT OFINDEPENDENT REGISTERED**

 

**PUBLICACCOUNTING FIRM**

 

 

59

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**REPORT OF MANAGEMENT ON INTERNALCONTROL OVER FINANCIAL REPORTING**

 

Under the supervision and with the participation of our management,including our Chief Executive Officer and Chief Financial Officer, we conductedan evaluation of our disclosure controls and procedures, as such term isdefined under Rules 13a-15(f) and 15d-15(f) under the ExchangeAct.  Based on this evaluation, our ChiefExecutive Officer and Chief Financial Officer concluded that our disclosurecontrols and procedures were effective as of December 31, 2007.

 

Management is responsible for establishing and maintaining adequateinternal control over financial reporting at the Company.  Or internal control over financial reportingis a process designed under the supervision of the Chief Executive Office andChief Financial Officer to provide reasonable assurance regarding thereliability of financial reporting and preparation of the Company’s financialstatements for external reporting purposes in accordance with accountingprinciples generally accepted in the United States of America.  A company’s internal control over financialreporting includes policies and procedures that (1) pertain to themaintenance 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 andexpenditures are being made only in accordance with authorizations ofmanagement and the directors of the company; and (3) provide reasonableassurance regarding prevention or timely detection of unauthorized acquisition,use, or disposition of the company’s assets that could have a material effecton the company’s financial statements.

 

Because of its inherent limitations, internal control over financialreporting may not prevent or detect misstatements.  Also, projections of any evaluation ofeffectiveness to future periods are subject to risk that controls may becomeinadequate because of changes in conditions, or that the degree of compliancewith the policies or procedures may deteriorate.

 

As of December 31, 2007, the Company carried out an evaluation,under the supervision and with the participation of the Company’s management,including the Company’s Chief Executive Officer and Chief Financial Officer, ofthe effectiveness 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 “*Internal Control—IntegratedFramework*,” issued by the Committee of Sponsoring Organizations ofthe Treadway Commission (‘COSO).

 

Based on this evaluation, management concluded that as of December 31,2007, the Company’s internal control over financial reporting was effective.

 

Perry-Smith LLP, the independent registered public accounting firm thataudited the Company’s consolidated financial statements included in this annualreport, has issued a report appearing on page A-4, which expresses anunqualified opinion on the Company’s internal control over financial reportingas of December 31, 2007.

 
|                               |   |
|------------------------------------|--------|
| /s/ Keith C Robbins                |   |
| Keith C. Robbins                   |   |
| President, Chief Executive Officer |   |
|                               |   |
| /s/ John F Coger                   |   |
| John F Coger                       |   |
| Executive Vice President, CFO/COO  |   |

 

March 12, 2008

 

60

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

TheBoard of Directors and Shareholders

CommunityValley Bancorp

 

We have audited CommunityValley Bancorp and subsidiaries (the “Company”) internal control over financialreporting as of December 31, 2007, based on criteria established in *Internal Control—Integrated Framework*issuedby the Committee of Sponsoring Organizations of the Treadway Commission (the “COSOcriteria”). The Company’s management is responsible for maintaining effectiveinternal control over financial reporting and for its assessment of theeffectiveness of internal control over financial reporting included in theaccompanying Report of Management on Internal Control Over Financial Reporting.Our responsibility is to express an opinion the Company’s internal control overfinancial reporting based on our audit.

 

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether effective internal control overfinancial reporting was maintained in all material respects. Our audit includedobtaining an understanding of internal control over financial reporting,assessing the risk that a material weakness exists, and testing and evaluatingthe design and operating effectiveness of internal control based on theassessed risk.  Our audit also included  performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion.

 

A company’s internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with accountingprinciples generally accepted in the United States of America. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with accounting principles generallyaccepted in the United States of America, and that receipts and expenditures ofthe company are being made only in accordance with authorizations of managementand directors of the company; and (3) provide reasonable assuranceregarding prevention or timely detection of unauthorized acquisition, use, ordisposition of the company’s assets that could have a material effect on thefinancial statements.

 

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequate becauseof changes in conditions, or that the degree of compliance with the policies orprocedures may deteriorate.

 

In our opinion, CommunityValley Bancorp and subsidiaries maintained, in all material respects, effectiveinternal control over financial reporting as of December 31, 2007, isfairly stated, in all material respects, based on the COSO criteria.

 

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated balance sheet of Community Valley Bancorp andsubsidiaries as of December 31, 2007 and 2006, and the relatedconsolidated statements of income, changes in shareholders’ equity and cashflows for each of the years in the three-year period ended December 31,2007 and our report dated March 12, 2008 expressed an unqualified opinion.

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

 

Sacramento, California

March 12, 2008

 

61

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# ***REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM***

 

The Board of Directors andShareholders

Community Valley Bancorp

 

We have audited theaccompanying consolidated balance sheet of Community Valley Bancorp andsubsidiaries as of December 31, 2007 and 2006, and the relatedconsolidated statements of income, changes in shareholders’ equity and cashflows for each of the years in the three-year period ended December 31,2007. These consolidated financial statements are the responsibility of theCompany’s management. Our responsibility is to express an opinion on theseconsolidated financial statements based on our audits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan andperform the audits to obtain reasonable assurance about whether theconsolidated financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audits provide a reasonable basis for our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of Community ValleyBancorp and subsidiaries as of December 31, 2007 and 2006 and theconsolidated results of their operations and their cash flows for each of theyears in the three-year period ended December 31, 2007, in conformity withaccounting principles generally accepted in the United States of America.

 

We have alsoaudited, in accordance with the standards of the Public Company AccountingOversight Board (United States), Community Valley Bancorp and subsidiaries’internal control over financial reporting as of December 31, 2007, basedon criteria established in *InternalControl-Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission and our report dated March 12,2008 expressed an unqualified opinion on the effectiveness of Community ValleyBancorp and subsidiaries’ internal control over financial reporting.

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

 

Sacramento, California

March 12, 2008

 

62

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**COMMUNITYVALLEY BANCORP AND SUBSIDIARIES**

 

**CONSOLIDATED BALANCE SHEET**

 

**December 31, 2007 and 2006**

 
| ** **                                                                                                                                                    | ** ** | **2007**    | ** **  | **2006**    | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|-------------|-------------|------------|
| **ASSETS**                                                                                                                                                    | ** ** | ** **  | ** **  | ** **  | ** ** |
|                                                                                                                                                          |       |        |        |        |       |
| Cash and due from banks                                                                                                                                       |       | $           | 31,714,000  |        | $          | 20,558,000 |   |
| Federal funds sold and  other                                                                                                                                 |       | 54,290,000  |        | 42,070,000  |       |
| Total cash &  cash equivalents                                                                                                                            |       | 86,004,000  |        | 62,628,000  |       |
|                                                                                                                                                          |       |        |        |        |       |
| Interest-bearing  deposits in banks                                                                                                                           |       | 4,250,000   |        | 2,278,000   |       |
| Loans held for sale at  lower of cost or market                                                                                                               |       | —      |        | 790,000     |       |
| Investment Securities                                                                                                                                         |       |        |        |        |       |
| Available-for-sale,  at fair value                                                                                                                            |       | 4,668,000   |        | 3,350,000   |       |
| Held-to-maturity,  at cost                                                                                                                                    |       | 1,596,000   |        | 1,777,000   |       |
| Loans, less  allowance for loan losses of $5,232,000 at December 31, 2007 and $ 5,274,000  at December 31, 2006                                          |       | 441,350,000 |        | 442,251,000 |       |
| Premises and equipment,  net                                                                                                                                  |       | 17,905,000  |        | 15,359,000  |       |
| Bank owned life  insurance                                                                                                                                    |       | 10,201,000  |        | 9,798,000   |       |
| Accrued interest  receivable and other assets                                                                                                                 |       | 14,646,000  |        | 11,806,000  |       |
| Total assets                                                                                                                                                  |       | $           | 580,620,000 |        | $          | 550,037,000 |   |
| ** **                                                                                                                                                    | ** ** | ** **  | ** **  | ** **  | ** ** |
| **LIABILITIES  AND SHAREHOLDERS' EQUITY**                                                                                                                     | ** ** | ** **  | ** **  | ** **  | ** ** |
|                                                                                                                                                          |       |        |        |        |       |
| Deposits:                                                                                                                                                     |       |        |        |        |       |
| Non-interest  bearing                                                                                                                                         |       | $           | 77,574,000  |        | $          | 76,988,000 |   |
| Interest bearing                                                                                                                                              |       | 423,417,000 |        | 407,868,000 |       |
| Total deposits                                                                                                                                                |       | 500,991,000 |        | 484,856,000 |       |
|                                                                                                                                                          |       |        |        |        |       |
| ESOP note payable                                                                                                                                             |       | 1,093,000   |        | 1,217,000   |       |
| Junior subordinated  debentures                                                                                                                               |       | 16,496,000  |        | 8,248,000   |       |
| Accrued interest  payable and other liabilities                                                                                                               |       | 11,066,000  |        | 9,989,000   |       |
| Total  liabilities                                                                                                                                            |       | $           | 529,646,000 |        | $          | 504,310,000 |   |
| ** **                                                                                                                                                    | ** ** | ** **  | ** **  | ** **  | ** ** |
| Commitments and  contingencies                                                                                                                                |       |        |        |        |       |
|                                                                                                                                                          |       |        |        |        |       |
| Shareholders' equity                                                                                                                                          |       |        |        |        |       |
| Common stock -  no par value; 20,000,000 shares authorized; issued and outstanding -  7,607,908 shares at December 31, 2007 and 7,394,664 at December 31,2006 |       | 10,910,000  |        | 9,727,000   |       |
|                                                                                                                                                          |       |        |        |        |       |
| Unallocated ESOP  shares 126,590 shares at December 31, 2007 and 155,258 shares at December 31,  2006 (at cost)                                               |       | (1,407,000  | )           | (1,514,000  | )          |
| Retained  earnings                                                                                                                                            |       | 41,454,000  |        | 37,505,000  |       |
| Accumulated  other comprehensive income, net of taxes                                                                                                         |       | 17,000      |        | 9,000       |       |
|                                                                                                                                                          |       |        |        |        |       |
| Total  shareholders' equity                                                                                                                                   |       | 50,974,000  |        | 45,727,000  |       |
| Total  liabilities and shareholders' equity                                                                                                                   |       | $           | 580,620,000 |        | $          | 550,037,000 |   |

 

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

 

63

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**COMMUNITYVALLEY BANCORP AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENT OF INCOME**

 

**For theYears Ended December 31, 2007, 2006 and 2005**

 
| ** **                                            | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|-------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Interest income:                                      |       |       |       |       |       |       |       |
| Interest and  fees on loans                           |       | $          | 40,272,000 |       | $          | 39,544,000 |       | $ | 30,946,000 |   |
| Interest on  Federal funds sold and other             |       | 2,475,000  |       | 846,000    |       | 943,000    |       |
| Interest on  deposits in banks                        |       | 182,000    |       | 178,000    |       | 239,000    |       |
| Interest on  investment securities:                   |       |       |       |       |       |       |       |
| Taxable                                               |       | 229,000    |       | 181,000    |       | 199,000    |       |
| Exempt from  Federal income tax                       |       | 65,000     |       | 65,000     |       | 111,000    |       |
| Total interest  income                                |       | 43,223,000 |       | 40,814,000 |       | 32,438,000 |       |
| ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest expense:                                     |       |       |       |       |       |       |       |
| Interest expense  on deposits                         |       | 12,771,000 |       | 8,708,000  |       | 4,668,000  |       |
| Interest expense  on junior subordinated debentures   |       | 1,024,000  |       | 733,000    |       | 592,000    |       |
| Interest expense  on notes payble                     |       | 94,000     |       | 91,000     |       | 71,000     |       |
| Total interest  expense                               |       | 13,889,000 |       | 9,532,000  |       | 5,331,000  |       |
| Net interest  income before provision for loan losses |       | 29,334,000 |       | 31,282,000 |       | 27,107,000 |       |
| Provision for loan losses                             |       | (16,000    | )          | 638,000    |       | 724,000    |       |
| Net interest  income after provision for loan losses  |       | 29,350,000 |       | 30,644,000 |       | 26,383,000 |       |
|                                                  |       |       |       |       |       |       |       |
| Non-interest income:                                  |       |       |       |       |       |       |       |
| Service charges  and fees                             |       | 3,422,000  |       | 2,686,000  |       | 2,351,000  |       |
| Gain on sale of  loans                                |       | 1,506,000  |       | 1,578,000  |       | 1,806,000  |       |
| Loan servicing  income                                |       | 395,000    |       | 457,000    |       | 481,000    |       |
| Other                                                 |       | 3,152,000  |       | 2,048,000  |       | 2,073,000  |       |
| Total non-interest income:                            |       | 8,475,000  |       | 6,769,000  |       | 6,711,000  |       |
|                                                  |       |       |       |       |       |       |       |
| Non-interest expenses:                                |       |       |       |       |       |       |       |
| Salaries and  employee benefits                       |       | 15,630,000 |       | 15,425,000 |       | 12,270,000 |       |
| Occupancy and  Equipment                              |       | 4,221,000  |       | 3,480,000  |       | 2,969,000  |       |
| Other                                                 |       | 7,076,000  |       | 6,255,000  |       | 5,686,000  |       |
| Total  non-interest expense                           |       | 26,927,000 |       | 25,160,000 |       | 20,925,000 |       |
|                                                  |       |       |       |       |       |       |       |
| Income before  provision for income taxes             |       | 10,898,000 |       | 12,253,000 |       | 12,169,000 |       |
|                                                  |       |       |       |       |       |       |       |
| Provision for income taxes                            |       | 4,439,000  |       | 5,102,000  |       | 4,971,000  |       |
|                                                  |       |       |       |       |       |       |       |
| Net income                                            |       | $          | 6,459,000  |       | $          | 7,151,000  |       | $ | 7,198,000 |   |
|                                                  |       |       |       |       |       |       |       |
| Basic earnings per share                              |       | $          | 0.87       |       | $          | 0.98       |       | $ | 1.00 |   |
| Diluted earnings per share                            |       | $          | 0.85       |       | $          | 0.93       |       | $ | 0.95 |   |
|                                                  |       |       |       |       |       |       |       |
| Cash dividends per share                              |       | $          | 0.32       |       | $          | 0.26       |       | $ | 0.16 |   |

 

 

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

 

64

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

#### ** **

**CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’EQUITY**

 

**For theYears Ended December 31, 2007, 2006 and 2005**

 
| ** **                                                                           | ** ** | **Common Stock** | ** ** | **Unallocated** | ** ** | **Retained**    | ** ** | **Accumulated Other  Comprehensive** | ** ** | **Total  Shareholders'**      | ** ** | **Comprehensive** | ** ** |
|--------------------------------------------------------------------------------------|------------|------------------|------------|-----------------|------------|-----------------|------------|--------------------------------------|------------|-------------------------------|------------|-------------------|------------|
| ** **                                                                           | ** ** | **Shares**       | ** ** | **Amont**       | ** ** | **ESOP shares** | ** ** | **Earnings**                         | ** ** | **Income / (Loss)** | ** ** | **Equity**        | ** ** | **Income** | ** ** |
| Balance, January  1, 2005                                                            |       | 7,273,582        |       | $               | 7,862,000  |            | $          | (1,144,000                           | )          | $                             | 27,802,000 |              | $          | 11,000 |   | $ | 34,531,000 |   |   |   |
|                                                                                 |       |             |       |            |       |            |       |                                 |       |                          |       |              |       |   |   |
| Comprehensive  income                                                                |       |             |       |            |       |            |       |                                 |       |                          |       |              |       |   |   |
| Net income                                                                           |       |             |       |            |       |            |       | 7,198,000                            |       |                          |       | 7,198,000         |       | 7,198,000 |   |
| Other  comprehensive loss:                                                           |       |             |       |            |       |            |       |                                 |       |                          |       |              |       |   |   |
|                                                                                 |       |             |       |            |       |            |       |                                 |       |                          |       |              |       |   |   |
| Net change in  unrealized gains (losses) on available-for-sale investment securities |       |             |       |            |       |            |       |                                 |       | (24,000                       | )          | (24,000           | )          | (24,000 | ) |
| Total  comprehensive income                                                          |       |             |       |            |       |            |       |                                 |       |                          |       |              |       | 7,174,000 |   |
|                                                                                 |       |             |       |            |       |            |       |                                 |       |                          |       |              |       |   |   |
| Exercise of stock  options and related tax benefit                                   |       | 134,465          |       | 1,039,000       |       |            |       |                                 |       |                          |       | 1,039,000         |       |   |   |
| Amortization of  stock compensation - ESOP shares                                    |       |             |       | 150,000         |       | 101,000         |       |                                 |       |                          |       | 251,000           |       |   |   |
| Shares acquired  or redeemed by ESOP                                                 |       |             |       |            |       | (348,000        | )          |                                 |       |                          |       | (348,000          | )          |   |   |
| Cash dividends-  $0.16 per share                                                     |       |             |       |            |       |            |       |                                 |       |                          |       |              |       |   |   |
| share                                                                                |       |             |       |            |       |            |       | (1,092,000                           | )          |                          |       | (1,092,000        | )          |   |   |
| Balance, December  31, 2005                                                          |       | 7,408,047        |       | 9,051,000       |       | (1,391,000      | )          | 33,908,000                           |       | (13,000                       | )          | 41,555,000        |       |   |   |
|                                                                                 |       |             |       |            |       |            |       |                                 |       |                          |       |              |       |   |   |
| Comprehensive  income                                                                |       |             |       |            |       |            |       |                                 |       |                          |       |              |       |   |   |
| Net income                                                                           |       |             |       |            |       |            |       | 7,151,000                            |       |                          |       | 7,151,000         |       | 7,151,000 |   |
| Other  comprehensive income:                                                         |       |             |       |            |       |            |       |                                 |       |                          |       |              |       |   |   |
|                                                                                 |       |             |       |            |       |            |       |                                 |       |                          |       |              |       |   |   |
| Net change in  unrealized gains (losses) on available-for-sale investment securities |       |             |       |            |       |            |       |                                 |       | 22,000                        |       | 22,000            |       | 22,000 |   |
| Total  comprehensive income                                                          |       |             |       |            |       |            |       |                                 |       |                          |       |              |       | 7,173,000 |   |
|                                                                                 |       |             |       |            |       |            |       |                                 |       |                          |       |              |       |   |   |
| Exercise of stock  options and related tax benefit                                   |       | 130,567          |       | 1,000,000       |       |            |       |                                 |       |                          |       | 1,000,000         |       |   |   |
| Amortization of  stock compensation– ESOP shares                                |       |             |       | 378,000         |       | 231,000         |       |                                 |       |                          |       | 609,000           |       |   |   |
|                                                                                 |       |             |       |            |       |            |       |                                 |       |                          |       |              |       |   |   |
| Shares acquired  or redeemed by ESOP                                                 |       |             |       |            |       | (354,000        | )          |                                 |       |                          |       | (354,000          | )          |   |   |
| Stock based  compensation  expense                                              |       |             |       | 175,000         |       |            |       |                                 |       |                          |       | 175,000           |       |   |   |
| Cash dividends-  $.26 per share                                                      |       |             |       |            |       |            |       | (1,933,000                           | )          |                          |       | (1,933,000        | )          |   |   |
| Repurchase and  retirement of  common stock                                     |       | (143,950         | )          | (877,000        | )          |            |       | (1,621,000                           | )          |                          |       | (2,498,000        | )          |   |   |
| Balance, December  31, 2006                                                          |       | 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 |   |   |   |

 

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

 

65

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**COMMUNITYVALLEY BANCORP AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENT OF CASH FLOWS**

 

**For theYears Ended December 31, 2007, 2006 and 2005**

 
| **(dollars in thousands)**                                                         | ** ** | **2007**    | ** **  | **2006**    | ** ** | **2005**     | ** ** |
|------------------------------------------------------------------------------------|------------|-------------|-------------|-------------|------------|--------------|------------|
|                                                                               |       |        |        |        |       |         |       |
| Cash flows from operating activities:                                              |       |        |        |        |       |         |       |
| Net income                                                                         |       | $           | 6,459,000   |        | $          | 7,151,000    |       | $ | 7,198,000 |   |
| Adjustments to reconcile net income to net cash provided  by operating activities: |       |        |        |        |       |         |       |
| Provision for loan losses                                                          |       | (16,000     | )           | 638,000     |       | 724,000      |       |
| (Increase) decrease in deferred loan origination costs                             |       | (113,000    | )           | (307,000    | )          | 86,000       |       |
| Depreciation, amortization, and accretion, net                                     |       | 2,100,000   |        | 1,671,000   |       | 1,556,000    |       |
| Increase in cash surrender value of bank-owned life  insurance, net                |       | (403,000    | )           | (331,000    | )          | (294,000     | )          |
| Non-cash compensation expense associated with the  ESOP                            |       | 172,000     |        | 609,000     |       | 251,000      |       |
| Stock based compensation                                                           |       | 139,000     |        | 175,000     |       | —       |       |
| Excess tax benefit from exercise of stock-based compensation  awards               |       | (428,000    | )           | (489,000    | )          | —       |       |
| Loss (gain) on disposition of Bank premises and  equipment                         |       | 28,000      |        | —      |       | (31,000      | )          |
| Net decrease (increase) in loans held for sale                                     |       | 790,000     |        | 1,407,000   |       | (707,000     | )          |
| (Increase) decrease in accrued interest receivable  and other assets               |       | (1,805,000  | )           | 94,000      |       | 871,000      |       |
| Increase in accrued interest payable and other liabilities                         |       | 1,060,000   |        | 519,000     |       | 1,767,000    |       |
| Provision for deferred income taxes                                                |       | (612,000    | )           | (1,050,000  | )          | (1,331,000   | )          |
| Net cash provided by operating activities                                          |       | 7,371,000   |        | 10,087,000  |       | 10,090,000   |       |
|                                                                               |       |        |        |        |       |         |       |
| Cash flows from investing activities:                                              |       |        |        |        |       |         |       |
| Purchase of held-to-maturity investment securities                                 |       | —      |        | —      |       | (1,234,000   | )          |
| Purchase of available-for-sale investment securities                               |       | (3,437,000  | )           | —      |       | (2,008,000   | )          |
| Proceeds from matured or called available-for-sale  investment securities     |       | 2,000,000   |        | 1,000,000   |       | 2,027,000    |       |
| Proceeds from matured or called held-to-maturity  investment securities       |       | —      |        | 246,000     |       | 1,119,000    |       |
| Proceeds from principal payments on  available-for-sale investment sercurities     |       | 133,000     |        | 31,000      |       | —       |       |
| Proceeds from principal payments on held-to-maturity  investment securities        |       | 175,000     |        | 300,000     |       | 358,000      |       |
| Net (increase) decrease in interest-bearing deposits  in banks                     |       | (1,972,000  | )           | 4,358,000   |       | 2,079,000    |       |
| Net decrease (increase) in loans                                                   |       | 1,030,000   |        | (41,361,000 | )          | (62,477,000  | )          |
| Premiums paid for life insurance policies                                          |       | —      |        | (1,020,000  | )          | (1,450,000   | )          |
| Purchases of premises and equipment                                                |       | (4,712,000  | )           | (5,820,000  | )          | (3,802,000   | )          |
| Proceeds from sale of premises and equipment                                       |       | 43,000      |        | 20,000      |       | 65,000       |       |
| Net cash used in investing activities                                              |       | (6,740,000  | )           | (42,246,000 | )          | (65,323,000  | )          |
|                                                                               |       |        |        |        |       |         |       |
| Cash flows from financing activities:                                              |       |        |        |        |       |         |       |
| Net increase in demand, interest-bearing and savings  deposits                     |       | 27,408,000  |        | 2,597,000   |       | 17,561,000   |       |
| Net increase (decrease) in time deposits                                           |       | (11,273,000 | )           | 48,241,000  |       | 17,398,000   |       |
| (Repayment) proceeds from note payable                                             |       | —      |        | (800,000    | )          | 800,000      |       |
| Proceeds from ESOP note payable                                                    |       | —      |        | 354,000     |       | 348,000      |       |
| Repayments of ESOP note payable                                                    |       | (124,000    | )           | (119,000    | )          | (199,000     | )          |
| Purchase of unallocated ESOP shares                                                |       | —      |        | (354,000    | )          | (348,000     | )          |
| Proceeds from exercise of stock options, including tax  benefit                    |       | 1,104,000   |        | 1,000,000   |       | 527,000      |       |
| Payment of cash dividends                                                          |       | (2,408,000  | )           | (1,637,000  | )          | (1,069,000   | )          |
| Repurchase and retirement of common stock                                          |       | (210,000    | )           | (2,498,000  | )          | —       |       |
| Proceeds from issuance of junior subordinated debentures                           |       | 8,248,000   |        | —      |       | —       |       |
| Net cash provided by financing activities                                          |       | 22,745,000  |        | 46,784,000  |       | 35,018,000   |       |
|                                                                               |       |        |        |        |       |         |       |
| Increase (decrease) in cash and cash equivalents                                   |       | 23,376,000  |        | 14,625,000  |       | (20,215,000  | )          |
|                                                                               |       |        |        |        |       |         |       |
| Cash and cash equivalents at beginning of year                                     |       | 62,628,000  |        | 48,003,000  |       | 68,218,000   |       |
|                                                                               |       |        |        |        |       |         |       |
| Cash and cash equivalents at end of period                                         |       | $           | 86,004,000  |        | $          | 62,628,000   |       | $ | 48,003,000 |   |
|                                                                               |       |        |        |        |       |         |       |
| Supplemetal disclosure of cash flow information:                                   |       |        |        |        |       |         |       |
|                                                                               |       |        |        |        |       |         |       |
| Cash paid during the year for:                                                     |       |        |        |        |       |         |       |
| Interest                                                                           |       | $           | 13,940,000  |        | $          | 9,147,000    |       | $ | 5,158,000 |   |
| Income taxes                                                                       |       | $           | 4,665,000   |        | $          | 6,064,000    |       | $ | 5,780,000 |   |
|                                                                               |       |        |        |        |       |         |       |
| Non-cash investing activities:                                                     |       |        |        |        |       |         |       |
| Net change in unrealized gains on available-for- sale  investment securities       |       | $           |  8,000 |        | $          |  22,000 |       | $ |  (24,000 | ) |
|                                                                               |       |        |        |        |       |         |       |
| Non-cash financing activities:                                                     |       |        |        |        |       |         |       |
| Release of unallocated ESOP shares                                                 |       | $           | 107,000     |        | $          | 231,000      |       | $ | 101,000 |   |
| Accrual of cash dividend declared                                                  |       | $           | 609,000     |        | $          | 592,000      |       | $ | 296,000 |   |
|                                                                                    |            |             |             |             |            |              |            |  |  |  |  |  |  |

 

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

 

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** **

**COMMUNITY VALLEY BANCORP ANDSUBSIDIARIES**

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**1.             SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES**

 

General

 

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

 

Founded in 1990,the Bank is a state-chartered financial institution with fifteen branches ineleven cities including Anderson, Chico, Colusa, Corning, Magalia, Marysville,Oroville, Paradise, Redding, Red Bluff, and Yuba City and loan productionoffices in Citrus Heights and Gridley. The Bank provides traditional depositand lending services including commercial and construction loans, governmentguaranteed loans such as those available from the USDA and SBA, merchantservices and investment services.

 

On December 19,2002, Community Valley formed a wholly-owned subsidiary, Community ValleyBancorp Trust I and on July 10, 2007 formed a wholly-owned subsidiary,Community Valley Bancorp Trust II (the “Trusts”), both of which are Delawarestatutory business trusts, for the purpose of issuing trust preferredsecurities (see Notes 9 and 18).

 

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

 

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

 

SegmentInformation

 

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

 

Principles ofConsolidation

 

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

 

For financialreporting purposes, the Company’s investment in the Trust of $496,000 (seeNotes 9 and 18) is accounted for under the equity method and is included inaccrued interest receivable and other assets on the consolidated balance sheet.The junior subordinated debentures issued and guaranteed by the Company andheld by the Trusts are reflected as debt in the Company’s consolidated balancesheet.

 

Stock Splits

 

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

 

Reclassifications

 

Certainreclassifications have been made to prior years’ balances to conform toclassifications used in 2007.

 

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Use of Estimates

 

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

 

Cash and Cash Equivalents

 

For purposes ofthe consolidated statement of cash flows, cash and cash equivalents includecash and due from banks and Federal funds sold and other interest-bearingdeposits in banks with maturities of less than 90 days at acquisition.  Federal funds are generally sold for one-dayperiods.

 

InvestmentSecurities

 

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.

 

Managementdetermines the appropriate classification of its investments at the time ofpurchase and may only change the classification in certain limitedcircumstances. All transfers between categories are accounted for at fairvalue. As of December 31, 2007 and 2006 the Company did not have anyinvestment securities classified as trading and there were no transfers ofsecurities between categories.

 

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

 

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

 

Loans

 

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

 

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

 

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

 

The Companymay acquire loans through a business combination or a purchase for whichdifferences may exist between the contractual cash flows and the cashflows expected to be collected due, at least in part, to credit quality. Whenthe Company acquires such loans, the yield that may be accreted(accretable yield) is limited to the excess of the Company’s estimate ofundiscounted cash flows expected to be collected over the Company’s initialinvestment in the loan. The excess of contractual cash flows over cash flowsexpected to be collected may not be recognized as an adjustment to yield,loss, or a valuation allowance. Subsequent increases in cash flows expected tobe collected generally should be recognized prospectively through adjustment ofthe loan’s yield over its remaining life. Decreases in cash flows expected tobe collected should be recognized as an impairment. The Company may not “carryover” or create a valuation allowance in the initial accounting for loansacquired under these circumstances. At December 31, 2007 and 2006, therewere no such loans being accounted for under this policy.

 

Loans Held forSale, Loan Sales and Servicing Rights

 

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

 

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

 

Any servicingassets in excess of the contractually specified servicing fees have beenreclassified at fair value as an interest-only (IO) strip receivable andtreated like an available-for-sale security. The servicing asset, net of anyrequired valuation allowance, and IO strip receivable are included in accruedinterest and other assets. At December 31, 2007 and 2006, IO strips werenot significant.

 

*GovernmentGuaranteed Loans*

 

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

 

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

 

The Companyserviced SBA, RBS and FSA government guaranteed loans for others totaling$100,822,000 and $79,675,000 as of December 31, 2007 and 2006,respectively.

 

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*MortgageLoans*

 

The Companyoriginates mortgage loans that are either held in the Company’s loan portfolioor sold in the secondary market. Loans held for sale are carried at the lowerof cost or market value. Market value is determined by the specificidentification method as of the balance sheet date or the date which thepurchasers have committed to purchase the loans. At the time the loan is sold,the related right to service the loan is either retained, with the Companyrecognizing 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 Companyserviced loans for the Federal National Mortgage Association (FNMA) totaling$152,618,000 as of December 31, 2006. In September 2007 the Company sold the servicing rights for thisportfolio of loans and continues to originate and sell mortgage loans withservicing released.

 

*ParticipationLoans*

 

The Company alsoserviced loans which it has participated with other financial institutionstotaling $5,543,000 and $10,118,000 as of December 31, 2007 and 2006,respectively.

 

## Allowance for LoanLosses

##  

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

 

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

 

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

 

The allowance forloan losses is established through a provision for loan losses which is chargedto expense. Additions to the allowance for loan losses are expected to maintainthe adequacy of the total allowance after loan losses and loan growth. Theallowance for loan losses at December 31, 2007 and 2006 reflectsmanagement’s estimate of possible losses in the portfolio.

 

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

##### ** **

The Companymaintains a separate allowance for losses related to undisbursed loancommitments. Management estimates the amount of probable losses by applying theloss factors used in the allowance for loan loss methodology to an estimate ofthe expected usage and applies the factor to the unused portion of undisbursedlines of credit. The allowance totaled $860,000 and $619,000 at December 31,2007 and 2006, respectively, and is included in accrued interest payable andother liabilities on the balance sheet.

 

Premises and Equipment

 

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

 

The Company evaluatespremises and equipment for financial impairment as events or changes incircumstances 

 

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indicate that thecarrying amount of such assets may not be fully recoverable.

 

Income Taxes

 

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

 

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

 

Accounting forUncertainty in Income Taxes

 

On January 1,2007, the Company adopted Financial Accounting Standards Board (“FASB”)Interpretation No. 48, *Accounting forUncertainty in Income Taxes* (“FIN 48”).  FIN 48 clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial statementsin accordance with FASB Statement No. 109, *Accounting for Income Taxes*. FIN 48 prescribes a recognition threshold and measurement standard forthe financial statement recognition and measurement of an income tax positiontaken or expected to be taken in a tax return. In addition, FIN 48 provides guidance on derecognition,classification, interest and penalties, accounting in interim periods,disclosure and transition.

 

Theprovisions of FIN 48 have been applied to all tax positions of the Companyas of January 1, 2007.  Only taxpositions that met the more-likely-than-not recognition threshold on January 1,2007 were recognized or continue to be recognized upon adoption.  The Company previously recognized income taxpositions based on management’s estimate of whether it was reasonably possiblethat a liability had been incurred for unrecognized income tax benefits byapplying FASB Statement No. 5, *Accountingfor Contingencies*.  Theadoption of FIN 48 did not have a material impact on the Company’sfinancial position, results of operations or cash flows.

 

When tax returns arefiled, it is highly certain that some positions taken would be sustained uponexamination by the taxing authorities, while others are subject to uncertaintyabout the merits of the position taken or the amount of the position that wouldbe ultimately sustained.  The benefit ofa tax position is recognized in the financial statements in the period duringwhich, based on all available evidence, management believes it is more likelythan not that the position will be sustained upon examination, including theresolution of appeals or litigation processes, if any.  Tax positionstaken are not offset or aggregated with other positions.  Tax positions that meet themore-likely-than-not recognition threshold are measured as the largest amountof tax benefit that is more than 50 percent likely of being realized uponsettlement with the applicable taxing authority.  The portion of the benefits associated withtax positions taken that exceeds the amount measured as described above isreflected as a liability for unrecognized tax benefits in the accompanyingbalance sheet along with any associated interest and penalties that would bepayable to the taxing authorities upon examination.

 

Interest expense andpenalties associated with unrecognized tax benefits are classified as incometax expense in the consolidated statement of income.

 

Earnings Per Share

 

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

 

Comprehensive Income

 

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

 

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comprehensiveincome (loss) are presented in the consolidated statement of changes inshareholders’ equity.

 

Stock-Based Compensation

 

The Company issues stockoptions under two shareholder approved stock-based compensation plans, theCommunity Valley Bancorp 1997 and 2000 Stock Option Plans.  The Plans do not provided for the settlementof awards in cash and new shares are issued upon exercise of the options.  The plans require 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; however,nonstatutory options granted during 1997 vested immediately. Under the 1997plan, 22,674 shares of common stock remain reserved for issuance to employeesand directors, and the related options are exercisable until their expiration.However, no new options will be granted under this plan. Under the Company’s2000 stock option plan, 454,247shares of common stock remain reserved forissuance to employees and directors, of which 73,877 shares are available forfuture grants.

 

On January 1, 2006,the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R),“Share-Based Payment,” which requires the Company to measure the cost ofemployees services received in exchange for an award of equity instrumentsbased on the grant date fair value of the award.  The Company elected to use the modifiedprospective transition method of adoption such that SFAS No. 123R appliesto the unvested portion of previously issued awards, new awards and to awardsmodified, repurchased or canceled after the adoption date.  Accordingly, commencing January 1, 2006,the Company recognized stock-based compensation for all current award grantsand for the unvested portion of previous award grants that are expected to vestbased on the grant date fair value. Prior to 2006, the Company accounted for stock-based compensation awardsunder Accounting Principles Board Opinion No. 25 intrinsic value method,under which no compensation expense was recognized because all historicaloptions granted were at an exercise price equal to the market value of theCompany’s stock on the grant date.  Priorperiod financial statements have not been adjusted to reflect fair valuestock-based compensation expense under SFAS No. 123R.

 

As a result of adoptingSFAS 123(R), the Company’s income before provision for income taxes and netincome for the year ended December 31, 2007 are $139,000 and $123,000,respectively, and for the year ended December 31, 2006 are $175,000 and$163,000, respectively, lower than if it had continued to account forshare-based compensation under APB 25. Basic and diluted earnings per share forthe year ended December 31, 2007 would have been $.89 and $.87,respectively, without the adoption of SFAS 123(R) compared to $.87 and$.85, respectively, as reported. Basic and diluted earnings per share for theyear ended December 31, 2006 would have been $1.00 and $.95, respectively,without the adoption of SFAS 123 (R) compared to $.98 and $.93,respectively, as reported. 

 

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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 was used to determinethe expected term of the Company’s options for 2007 and 2006.  The risk free interest rate for the expectedterm of the option is based on U.S. Treasury yield curve in effect at the timeof the grant.  The expected dividendsyield was determined based on the budgeted cash dividends of the Company at thetime of the grant.  In addition to theseassumptions, management makes estimates regarding pre-vesting forfeitures thatwill impact total compensation expense recognized under the Plan.

 

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

 
| ** **                                                      | ** ** | **2007**  | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|-----------------------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| Expected volatility                                             |       | 46.85     | %          | 11.54     | %          | 12.38     | %          |
| Risk-free interes t rate                                        |       | 4.5       | %          | 4.6       | %          | 4.0       | %          |
| Expected option life                                            |       | 7.5 years |       | 7.5 years |       | 7.5 years |       |
| Expected dividend yield                                         |       | 2.70      | %          | 1.47      | %          | 1.11      | %          |
| Weighted average fair value of options granted  during the year |       | $         | 6.02       |      | $          | 3.75      |       | $ | 3.25 |   |
|                                                                 |            |           |            |           |            |           |            |  |  |  |

 

The followingtable illustrates the effect on net income and earnings per share for the yearended December 31, 2005 as if the Company had applied the fair valuerecognition provisions of SFAS No. 123 to options granted under theCompany’s stock option plan:

 
| ** **                                                                                                                               | ** ** | **2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Net income, as  reported                                                                                                                 |       | $        | 7,198,000  |   |
| Deduct: Total  stock-based compensation expense determined under the fair value based method  for all awards, net of related tax effects |       | 353,000  |       |
|                                                                                                                                     |       |     |       |
| Pro forma net  income                                                                                                                    |       | $        | 6,845,000  |   |
|                                                                                                                                     |       |     |       |
| Basic earnings  per share- as reported                                                                                                   |       | $        | 1.00       |   |
| Basic earnings  per share- pro forma                                                                                                     |       | $        | 0.95       |   |
|                                                                                                                                     |       |     |       |
| Diluted earnings  per share- as reported                                                                                                 |       | $        | 0.95       |   |
| Diluted earnings  per share- pro forma                                                                                                   |       | $        | 0.90       |   |

 

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Impact of NewFinancial Accounting Standards

 

*Fair Value Measurements*

 

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement No. 157 (SFAS 157), *Fair Value Measurements*.  SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.  SFAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances.  In this standard, the FASB clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability.  In support of this principle, SFAS 157 establishes a fair value hierarchy that prioritizes the information used to develop those assumptions.  The provisions of SFAS 157 are effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years.  The provisions should be applied prospectively, except for certain specifically identified financial instruments.  The Company adopted SFAS 157 on January 1, 2008 and management does not believe its adoption will have a material impact on the Company’s financial position, results of operations or cash flows.

 

*The Fair Value Option for Financial Assets and Financial Liabilities*

 

In February 2007,the FASB issued Statement No. 159 (SFAS 159), *The FairValue Option for Financial Assets and Financial Liabilities — Including anAmendment of FASB Statement No. 115.*  This standard permits an entity to choose tomeasure many financial instruments and certain other items at fair value atspecified election dates.  The entitywill report unrealized gains and losses on items for which the fair valueoption has been elected in earnings at each subsequent reporting date.  The fair value option (a) may be appliedinstrument by instrument, with a few exceptions, such as investments otherwiseaccounted for by the equity method, (b) is irrevocable (unless a newelection date occurs), and (c) is applied only to entire instruments andnot to portions of instruments.  TheCompany adopted SFAS 159 on January 1, 2008 and management did not electthe fair value option for any of its financial instruments.

 

*Accounting for Business Combinations*

 

In December 2007,the FASB issued Statement of Financial Accounting Standards No. 141(revised 2007), *Business Combinations*(“SFASNo. 141R”).  SFAS No. 141(R),among other things, establishes principles and requirements for how theacquirer in a business combination (i) recognizes and measures in itsfinancial statements the identifiable assets acquired, the liabilities assumed,and any noncontrolling interest in the acquired business, (ii) recognizesand measures the goodwill acquired in the business combination or a gain from abargain purchase, and (iii) determines what information to disclose toenable users of the financial statements to evaluate the nature and financialeffects of the business combination.  TheCompany is required to adopt SFAS No. 141(R) for all businesscombinations for which the acquisition date is on or after January 1,2009.  Earlier adoption isprohibited.  This standard will changethe accounting treatment for business combinations on a prospective basis.

 

   **2.          INVESTMENT SECURITIES**

 

The amortized costand estimated fair value of investment securities at December 31, 2007 and2006 consisted of the following:

 
| ** **                                        | ** ** | **2007**      | ** ** |
|---------------------------------------------------|------------|---------------|------------|
| ** **                                        | ** ** | ** **    | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                                        | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Estimated** | ** ** |
| **Available for Sale**                            | ** ** | **Cost**      | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Fair Value** | ** ** |
| Debt securities:                                  |       |          |       |   |   |   |   |   |   |
| U.S. Government  agencies                         |       | $             | 3,282,000  |   | $ | 17,000 |   | $ | (12,000 | ) | $ | 3,287,000 |   |
| Obligations of  states and political subdivisions |       | 1,357,000     |       | 24,000 |   | — |   | 1,381,000 |   |
|                                              |       | $             | 4,639,000  |   | $ | 41,000 |   | $ | (12,000 | ) | $ | 4,668,000 |   |

 

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| ** **                                        | ** ** | **2006**      | ** ** |
|---------------------------------------------------|------------|---------------|------------|
| ** **                                        | ** ** | ** **    | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                                        | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Estimated** | ** ** |
| ** **                                        | ** ** | **Cost**      | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Fair Value** | ** ** |
| Debt securities:                                  |       |          |       |   |   |   |   |   |   |
| U.S. Government  agencies                         |       | $             | 1,977,000  |   | — |   | $ | (16,000 | ) | $ | 1,961,000 |   |
| Obligations of  states and political subdivisions |       | 1,357,000     |       | 32,000 |   | — |   | 1,389,000 |   |
|                                              |       | $             | 3,334,000  |   | 32,000 |   | $ | (16,000 | ) | $ | 3,350,000 |   |

 

Net unrealizedgains on available-for-sale investment securities totaling $29,000 and  $16,000 were recorded, net of $12,000 and$7,000 in tax expenses, respectively, as accumulated other comprehensive  income within shareholders’ equity at December 31,2007 and 2006, respectively. There were no sales or transfers ofavailable-for-sale investment securities for the years ended December 31,2007, 2006 and 2005.

 
| ** **                | ** ** | **2007**      | ** ** |
|---------------------------|------------|---------------|------------|
| ** **                | ** ** | ** **    | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Estimated** | ** ** |
| **Held to Maturity**      | ** ** | **Cost**      | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Fair Value** | ** ** |
| Debt securities:          |       |          |       |   |   |   |   |   |   |
| U.S. Government  agencies |       | $             | 1,596,000  |   | $ | 7,000 |   | $ | (1,000 | ) | $ | 1,602,000 |   |
|                      |       |          |       |   |   |   |   |   |   |
|                      |       | **2006**      |       |
|                      |       | ** **    |       | **Gross** |   | **Gross** |   |   |   |
|                      |       | **Amortized** |       | **Unrealized** |   | **Unrealized** | ** ** | **Estimated** |   |
|                      |       | **Cost**      |       | **Gains** |   | **Losses** | ** ** | **Fair  Value** |   |
| Debt securities:          |       |          |       |   |   |   |   |   |   |
| U.S. Government  agencies |       | $             | 1,777,000  |   | $ | 3,000 |   | $ | (21,000 | ) | $ | 1,759,000 |   |

 

There were nosales or transfers of held-to-maturity investment securities for the yearsended December 31, 2007, 2006 and 2005.

 

75

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Investmentsecurities with unrealized losses at December 31, 2007 and 2006 aresummarized and classified according to the duration of the loss period asfollows:

 
| ** **                | ** ** | **2007**                 | ** ** |
|---------------------------|------------|--------------------------|------------|
| ** **                | ** ** | **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 |       | $                        | —     |   | $ | — |   | $ | 1,837,000 |   | $ | (13,000 | ) | $ | 1,837,000 |   | $ | (13,000 | ) |
|                      |       |                     |       |   |   |   |   |   |   |   |   |   |   |
|                      | ** ** | **2006**                 | ** ** |
|                      | ** ** | **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 |       | $                        | 1,981,000  |   | $ | (19,000 | ) | $ | 1,484,000 |   | $ | (18,000 | ) | $ | 3,465,000 |   | $ | (37,000 | ) |

 

 

U.S. GovernmentAgencies

 

At December 31,2007, the Company held ten U.S. Government agency securities of which one wasin a loss position for less than twelve months and two were in a loss positionand had been in a loss position for twelve months or more.  The unrealized losses on the Company’sinvestments in direct obligations of U.S. government agencies were caused byinterest rate increases.  The contractualterms of this investment do not permit the issuer to settle the security at aprice less than the amortized cost of the investment.  Because the decline in market value isattributable to changes in interest rates and not credit quality, and becausethe Company has the ability and intent to hold this investment until a recoveryof fair value, which may be maturity, the Company does not consider thisinvestment to be other-than-temporarily impaired at December 31, 2007.

 

The amortized costand estimated fair value of investment securities at December 31, 2007, bycontractual maturity, are shown below. Expected maturities will differ fromcontractual maturities because the issuers of securities may have theright to call or prepay obligations with or without prepayment penalties.

 
| ** **                                                | ** ** | **Available for Sale** | ** ** | **Held to Maturity**      | ** ** |
|-----------------------------------------------------------|------------|------------------------|------------|---------------------------|------------|
| ** **                                                | ** ** | **Amortized Cost**     | ** ** | **Estimated  Fair Value** | ** ** | **Amortized Cost** | ** ** | **Estimated  Fair Value** | ** ** |
|                                                      |       |                   |       |                      |       |   |   |   |   |
| Within one year                                           |       | $                      | —     |                      | $          | — |   | $ | 1,000,000 |   | $ | 999,000 |   |
| After one year through five years                         |       | 2,000,000              |       | 2,009,000                 |       | — |   | — |   |
| After five years through ten years                        |       | —                 |       | —                    |       | — |   | — |   |
| After ten years                                           |       | 1,357,000              |       | 1,381,000                 |       | — |   | — |   |
|                                                      |       |                   |       |                      |       |   |   |   |   |
|                                                      |       | 3,357,000              |       | 3,390,000                 |       | 1,000,000 |   | 999,000 |   |
|                                                      |       |                   |       |                      |       |   |   |   |   |
| Investment securities not due at a single maturity  date: |       |                   |       |                      |       |   |   |   |   |
| SBA pools                                                 |       | 1,282,000              |       | 1,278,000                 |       | 596,000 |   | 603,000 |   |
|                                                      |       |                   |       |                      |       |   |   |   |   |
|                                                      |       | $                      | 4,639,000  |                      | $          | 4,668,000 |   | $ | 1,596,000 |   | $ | 1,602,000 |   |

 

Investmentsecurities with amortized costs totaling $4,357,000 and $3,357,000 and fairvalues totaling $4,389,000 and $3,370,000 were pledged to secure publicdeposits and treasury, tax and loan accounts at December 31, 2007 and2006, respectively.

 

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**3.   LOANSAND ALLOWANCE FOR LOAN LOSSES**

 

Outstanding loansare summarized as follows:

 
| ** **                | ** ** | **December 31,** | ** **  |
|---------------------------|------------|------------------|-------------|
| ** **                | ** ** | **2007**         | ** **  | **2006** | ** ** |
| Real estate:              |       |             |        |   |   |
| Mortgage                  |       | $                | 208,531,000 |   | $ | 208,102,000 |   |
| Construction              |       | 81,891,000       |        | 105,449,000 |   |
| Commercial                |       | 77,680,000       |        | 65,241,000 |   |
| Agriculture               |       | 25,367,000       |        | 25,745,000 |   |
| Installment               |       | 53,801,000       |        | 43,789,000 |   |
|                      |       |             |        |   |   |
| Total loans               |       | 447,270,000      |        | 448,326,000 |   |
|                      |       |             |        |   |   |
| Deferred loan fees, net   |       | (688,000         | )           | (801,000 | ) |
| Allowance for loan losses |       | (5,232,000       | )           | (5,274,000 | ) |
|                      |       |             |        |   |   |
| Total net loans           |       | $                | 441,350,000 |   | $ | 442,251,000 |   |

 

Changes in theallowance for loan losses were as follows:

 
| ** **                               | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------|------------|-----------------------------|------------|
| ** **                               | ** ** | **2007**                    | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                     |       |                        |       |   |   |   |   |
| Balance, beginning of year               |       | $                           | 5,274,000  |   | $ | 4,716,000 |   | $ | 4,000,000 |   |
| Provision charged/credited to operations |       | (16,000                     | )          | 638,000 |   | 724,000 |   |
| Losses charged to allowance              |       | (26,000                     | )          | (82,000 | ) | (9,000 | ) |
| Recoveries                               |       | —                      |       | 2,000 |   | 1,000 |   |
|                                     |       |                        |       |   |   |   |   |
| Balance, end of  year                    |       | $                           | 5,232,000  |   | $ | 5,274,000 |   | $ | 4,716,000 |   |

 

At December 31,2007 and 2006, nonaccrual loans totaled $253,000 and $2,282,000, which wereconsidered impaired loans. A valuation allowance of $20,000 and $12,000 wasallocated to these loans in 2007 and 2006 respectively.  The average recorded investment in impairedloans for the years ended December 31, 2007 and 2006 was $110,000 and $1,616,000, respectively.  Interestforegone on nonaccrual loans totaled $10,000 for the year ended December 31,2007, $106,000 for 2006 and $1,000 for 2005. Interest recognized for cashpayment received on nonaccrual loans was not significant for the years ended December 31,2007, 2006 and 2005, respectively.

 

The Company didnot hold any real estate acquired by foreclosure at December 31, 2007 or2006.

 

Salaries andemployee benefits totaling $1,189,000, $1,246,000 and $1,766,000 have beendeferred as loan origination costs for the years ended December 31, 2007,2006 and 2005, respectively.

 

77

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**4.**                                      ACCRUED INTEREST RECEIVABLE AND OTHERASSETS

 

Accrued interestreceivable and other assets consisted of the following:

 
| ** **                  | ** ** | **December 31,** | ** ** |
|-----------------------------|------------|------------------|------------|
| ** **                  | ** ** | **2007**         | ** ** | **2006** | ** ** |
|                        |       |             |       |   |   |
| Accrued interest receivable |       | $                | 3,657,000  |   | $ | 4,197,000 |   |
| Deferred tax assets, net    |       | 5,831,000        |       | 5,225,000 |   |
| Loan servicing assets       |       | 1,104,000        |       | 872,000 |   |
| Prepaid expenses            |       | 1,439,000        |       | 1,270,000 |   |
| Other                       |       | 2,615,000        |       | 242,000 |   |
|                        |       |             |       |   |   |
|                        |       | $                | 14,646,000 |   | $ | 11,806,000 |   |

 

Originatedmortgage servicing assets totaling $232,000, $208,000 and $142,000 wererecognized during the years ended December 31, 2007, 2006 and 2005,respectively.  Amortization of mortgageservicing assets totaled $330,000, $409,000 and $417,000 for the years ended December 31,2007, 2006 and 2005, respectively.  Inthe third quarter of 2007 the Company sold the mortgage servicing rights for aone time pre tax gain of $730,000.

 

**5.**                                      PREMISES AND EQUIPMENT

 

Premises andequipment consisted of the following:

 
| ** **                                     | ** ** | **December 31,** | ** ** |
|------------------------------------------------|------------|------------------|------------|
| ** **                                     | ** ** | **2007**         | ** ** | **2006** | ** ** |
|                                           |       |             |       |   |   |
| Land                                           |       | $                | 2,176,000  |   | $ | 2,176,000 |   |
| Buildings and improvements                     |       | 12,927,000       |       | 8,713,000 |   |
| Furniture, fixtures, and equipment             |       | 9,867,000        |       | 8,282,000 |   |
| Leasehold Improvements                         |       | 2,485,000        |       | 2,258,000 |   |
| Construction in progress                       |       | 31,000           |       | 2,368,000 |   |
|                                           |       |             |       |   |   |
| ** **                                     |       | 27,486,000       |       | 23,797,000 |   |
| ** **                                     | ** ** | ** **       | ** ** | ** ** | ** ** |
| Less accumulated depreciation and amortization |       | 9,581,000        |       | 8,438,000 |   |
| ** **                                     | ** ** | ** **       | ** ** | ** ** | ** ** |
| ** **                                     |       | 17,905,000       |       | 15,359,000 |   |
|                                                |            |                  |            |  |  |  |  |

 

Depreciation andamortization included in occupancy and equipment expense totaled $2,108,000,$1,662,000 and $1,574,000 for the years ended December 31, 2007, 2006 and2005 respectively.

 

Subsequent to December 31,2007 the Company completed a sale-lease back of seven of its properties (seeNote 18).

 

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**6.**                                      INTEREST-BEARING DEPOSITS

 

Interest-bearingdeposits consisted of the following:

 
| ** **                     | ** ** | **December 31,** | ** **  |
|--------------------------------|------------|------------------|-------------|
| ** **                     | ** ** | **2007**         | ** **  | **2006** | ** ** |
|                           |       |             |        |   |   |
| Savings                        |       | $                | 111,394,000 |   | $ | 73,913,000 |   |
| Money market                   |       | 37,053,000       |        | 37,783,000 |   |
| NOW accounts                   |       | 115,436,000      |        | 125,912,000 |   |
| Individual retirement accounts |       | 7,933,000        |        | 7,387,000 |   |
| Time, $100,000 or more         |       | 79,606,000       |        | 76,577,000 |   |
| Other time                     |       | 71,995,000       |        | 86,296,000 |   |
|                           |       |             |        |   |   |
|                           |       | $                | 423,417,000 |   | $ | 407,868,000 |   |

 

Aggregate annualmaturities of time deposits at December 31, 2007 are as follows:

 
| **Year Ending December 31,** | ** ** | ** ** | ** **  |
|------------------------------|------------|------------|-------------|
|                         |       |       |        |
| 2008                         |       | $          | 147,628,000 |   |
| 2009                         |       | 1,395,000  |        |
| 2010                         |       | 1,511,000  |        |
| 2011                         |       | 278,000    |        |
| 2012                         |       | 789,000    |        |
|                         |       |       |        |
|                         |       | $          | 151,601,000 |   |

 

 

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

 

| ** **                     | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------|------------|-----------------------------|------------|
| ** **                     | ** ** | **2007**                    | ** ** | **2006** | ** ** | **2005** | ** ** |
|                           |       |                        |       |   |   |   |   |
| Savings                        |       | $                           | 3,567,000  |   | $ | 337,000 |   | $ | 181,000 |   |
| Money market                   |       | 631,000                     |       | 616,000 |   | 368,000 |   |
| NOW accounts                   |       | 919,000                     |       | 1,210,000 |   | 934,000 |   |
| Individual retirement accounts |       | 343,000                     |       | 242,000 |   | 183,000 |   |
| Time, $100,000 or more         |       | 3,729,000                   |       | 3,061,000 |   | 1,492,000 |   |
| Other time                     |       | 3,582,000                   |       | 3,242,000 |   | 1,510,000 |   |
|                           |       |                        |       |   |   |   |   |
|                           |       | $                           | 12,771,000 |   | $ | 8,708,000 |   | $ | 4,668,000 |   |

 

 

**7.**                                      SHORT-TERM BORROWING ARRANGEMENTS

 

The Company has$15,000,000 in unsecured borrowing arrangements with two of its correspondentbanks to meet short-term liquidity needs. There were no borrowings outstandingunder these arrangements at December 31, 2007 and 2006.

 

**8.**                                      NOTE PAYABLE

 

Employee StockOwnership Plan (ESOP) Note

 

The ESOP obtainedfinancing through a $1,300,000 unsecured line of credit from another financialinstitution with the Company acting as the guarantor (see Note 15). Thenote has a variable interest rate, based on an independent index, and amaturity date of April 10, 2014. At December 31, 2007, the interestrate was 7.5%. Advances on the line of credit totaled $1,093,000 and $1,217,000at December 31, 2007 and 2006 respectively.

 

**9.**                                      JUNIOR SUBORDINATED DEBENTURES

** **

Community Valley BancorpTrust I and II (CVB Trust I and II) are Delaware statutory business trustsformed by the Company for the sole purpose of issuing trust preferredsecurities 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, 2007, all of thetrust preferred securities that have been issued qualify as Tier 1 capital.

 

In December 2002,the Company issued to CVB Trust I Subordinated Debentures due December 31,2032. Simultaneously, CVB Trust I issued 8,000 floating rate trust preferredsecurities, with liquidation values of $1,000 per security, for gross proceedsof $8,000,000. The Subordinated Debentures represent the sole assets of theTrust. The Subordinated Debentures are redeemable by the Company, subject toreceipt by the Company of prior approval from the Federal Reserve Bank (FRB),if then required under applicable capital guidelines or policies of the FRB.The Company may redeem the Subordinated Debentures held by CVB Trust I on anyDecember 31st on or after December 31, 2007. The redemption priceshall be par plus accrued and unpaid interest, except in the case of redemptionunder a special event, which is defined in the debenture. The floating ratetrust preferred securities are subject to mandatory redemption to the extent ofany early redemption of the Subordinated Debentures and upon maturity of theSubordinated Debentures on December 31, 2032.

 

Holders of the trustpreferred securities are entitled to cumulative cash distributions on theliquidation amount of $1,000 per security. Interest rates on the trustpreferred securities and Subordinated Debentures are the same and are computedon a 360-day basis. The stated interest rate is the three-month LondonInterbank Offered Rate (LIBOR) plus 3.30% (8.00% at December 31, 2007)with a maximum rate of 12.5% annually, adjustable quarterly. CVB Trust I wasredeemed on January 7, 2008, see Note 18.

 

In July 2007, theCompany issued to CVB Trust II Subordinated Debentures due October 1,2037. Simultaneously, CVB Trust II issued 8,000 fixed rate trust preferredsecurities, with liquidation values of $1,000 per security, for gross proceedsof $8,000,000. The Subordinated Debentures represent the sole assets of theTrust. The Subordinated Debentures are redeemable by the Company, subject toreceipt by the Company of prior approval from the Federal 

 

80

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Reserve Bank(FRB), if then required under applicable capital guidelines or policies of theFRB. The Company may redeem the Subordinated Debentures held by CVB TrustII on any October 1st on or after October 1, 2012. The redemptionprice shall be par plus accrued and unpaid interest, except in the case ofredemption under a special event, which is defined in the debenture. The fixedrate trust preferred securities are subject to mandatory redemption to theextent of any early redemption of the Subordinated Debentures and upon maturityof 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%.

 

Interest expense recognized by the Company for theyears ended December 31, 2007, 2006 and 2005 related to the subordinateddebentures was $1,024,000, $733,000 and $592,000 respectively.  There were no deferred costs at December 31,2007.   The amount of deferred costs at December 31,2006 was $48,000.  The amortization ofthe deferred costs was $48,000 for each of the years ended December 31,2007, 2006 and 2005.

 

**10.**                               **COMMITMENTS AND CONTINGENCIES**

 

Leases

 

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

 
| **Year Ending  December 31,** | ** ** | **Minimum  Lease  Payments** | ** ** | **Minimum  Sublease  Rental  Income** | ** ** |
|-------------------------------|------------|------------------------------|------------|---------------------------------------|------------|
|                          |       |                         |       |                                  |       |
| 2008                          |       | $                            | 929,000    |                                  | $          | 316,000 |   |
| 2009                          |       | 913,000                      |       | 323,000                               |       |
| 2010                          |       | 917,000                      |       | 318,000                               |       |
| 2011                          |       | 853,000                      |       | 207,000                               |       |
| 2012                          |       | 721,000                      |       | 102,000                               |       |
| Thereafter                    |       | 7,524,000                    |       | 182,000                               |       |
|                          |       |                         |       |                                  |       |
|                          |       | $                            | 11,857,000 |                                  | $          | 1,448,000 |   |

 

Rental expenseincluded in occupancy and equipment expense totaled $1,027,000, $753,000 and$524,000 for the years ended December 31, 2007, 2006 and 2005,respectively. Sublease income included in occupancy expense totaled $321,000,$144,000 and $134,000 for the years ended December 31, 2007, 2006 and2005, respectively.

 

FinancialInstruments With Off-Balance-Sheet Risk

 

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

 

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

 

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

 
| ** **                   | ** ** | **December 31,** | ** **  |
|------------------------------|------------|------------------|-------------|
| ** **                   | ** ** | **2007**         | ** **  | **2006** | ** ** |
|                         |       |             |        |   |   |
| Commitments to extend credit |       | $                | 183,699,000 |   | $ | 186,299,000 |   |
| Standby letters of credit    |       | $                | 6,695,000   |   | $ | 5,139,000 |   |

 

 

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

 

Standby letters ofcredit are conditional commitments issued to guarantee the performance of acustomer to a third party. The credit risk involved in issuing standby lettersof credit is essentially the same as that involved in extending loans tocustomers. The fair value of the liability related to these standby letters ofcredit, which represents the fees received for issuing the guarantees, was notsignificant at December 31, 2007 and 2006. The Company recognizes these feesas revenues over the term of the commitment or when the commitment is used.

 

Commercial loancommitments and standby letters of credit represent approximately 17% of totalcommitments and are generally unsecured or secured by collateral other thanreal estate and have variable interest rates. Agricultural loan commitmentsrepresent approximately 12% of total commitments and are generally secured bycrop assignments, accounts receivable and farm equipment and have variableinterest rates. Real estate loan commitments represent approximately 46% oftotal commitments and are generally secured by property with a loan-to-valueratio not to exceed 80%. The majority of real estate commitments also havevariable interest rates. Personal lines of credit and home equity lines ofcredit represent the remaining 25% of total commitments and are generallyunsecured or secured by residential real estate and have both variable andfixed interest rates.

 

Concentrations ofCredit Risk

 

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

 

Although theCompany has a diversified loan portfolio, a substantial portion of its portfoliois secured by commercial and residential real estate. However, personal andbusiness income represents the primary source of repayment for a majority ofthese loans.

 

In addition, theCompany’s real estate and construction loans represent approximately 65% and70% of outstanding loans at December 31, 2007, and 2006 respectively.Collateral values associated with this lending concentration can varysignificantly based on the general level of interest rates and both local andregional economic conditions. In management’s opinion, although thisconcentration has no more than the normal risk of collection, a substantialdecline in the performance of the economy in general or a decline in realestate values in the Company’s primary market areas, in particular, could havean adverse impact on the collectibility of these loans.

 

Correspondent BankingAgreements

 

The Companymaintains funds on deposit with other federally insured financial institutionsunder correspondent banking agreements. Uninsured deposits totaled $1,460,000at December 31, 2007.

 

Federal Reserve Requirements

 

Banks are requiredto maintain reserves with the Federal Reserve Bank equal to a percentage oftheir reservable deposits less vault cash. The Bank’s vault cash fulfilled itsreserve requirement at December 31, 2007.

 

Contingencies

 

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

 

82

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consolidatedfinancial position or consolidated results of operations of the Company.

 

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

 

Dividends

 

The shareholders of the Company will be entitled toreceive dividends when and as declared by its Board of Directors, out of fundslegally available for the payment of dividends, as provided in the CaliforniaGeneral Corporation Law. The California general corporation law prohibits theCompany from paying dividends on its common stock unless: (i) its retainedearnings, immediately prior to the dividend payment, equals or exceeds theamount 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. In certain circumstances, the Company may berequired to obtain the prior approval of the Federal Reserve Board to makecapital distributions to shareholders of the Company.

 

The CaliforniaFinancial Code restricts the total dividend payment of any bank in any calendaryear to the lesser of (1) the bank’s retained earnings or (2) thebank’s net income for its last three fiscal years, less distributions made toshareholders during the same three-year period. At December 31, 2007,retained earnings of $15,358,000 were free of such restrictions. In additionthe Company’s ability to pay dividends is subject to certain covenantscontained in the indentures relating to Trust Preferred Securities issued bythe business trust (see Note 9).

 

Stock Repurchase Plan

 

The Board of Directorsapproved a plan to repurchase up to $6,000,000 of the outstanding common stockof the Company in 2007. Stock repurchases were made from time to time on theopen market or through privately negotiated transactions. The timing ofpurchases and the exact number of shares purchased was dependent on marketconditions. The share repurchase program did not include specific price targetsor timetables and could have been suspended at any time. During 2007,18,864 shares were repurchased for $210,000 at an average price of $11.15 pershare.

 

The Board ofDirectors approved a plan to repurchase up to $3,000,000 of the outstandingcommon stock of the Company in 2003. Stock repurchases were made from time totime on the open market or through privately negotiated transactions. Thetiming of purchases and the exact number of shares purchased was dependent onmarket conditions. The share repurchase program did not include specific pricetargets or timetables and could have been suspended at any time. During2006, 143,950 shares were repurchased for $2,498,000 at an average price of$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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Stock-Based Compensation

 

Stock option activity forthe years ended December 31, 2007, 2006 and 2005 is summarized as follows:

 
| ** **                             | ** ** | **2007**    | ** ** | **2006**                               | ** ** | **2005**    | ** ** |
|----------------------------------------|------------|-------------|------------|----------------------------------------|------------|-------------|------------|
| ** **                             | ** ** | **Options** | ** ** | **Weighted  average  Exercise  Price** | ** ** | **Options** | ** ** | **Weighted  average  Exercise  Price** | ** ** | **Options** | ** ** | **Weighted  average  Exercise  Price** | ** ** |
| Incentive Options                      |       |        |       |                                   |       |        |       |   |   | ** ** |   |   |   |
|                                   |       |        |       |                                   |       |        |       |   |   |   |   |   |   |
| Options  outstanding beginning of year |       | 438,196     |       | $                                      | 7.35       |        | 487,962    |   | $ | 6.76 |   | 551,348 |   | $ | 6.28 |   |
|                                   |       |        |       |                                   |       |        |       |   |   |   |   |   |   |
| Options granted                        |       | 1,000       |       | $                                      | 13.95      |        | 23,000     |   | $ | 17.17 |   | 30,000 |   | $ | 14.48 |   |
| Options exercised                      |       | (138,332    | )          | $                                      | 2.59       |        | (57,572    | ) | $ | 4.90 |   | (69,765 | ) | $ | 5.28 |   |
| Options  cancelled                     |       | (11,154     | )          | $                                      | 10.70      |        | (15,194    | ) | $ | 12.49 |   | (23,621 | ) | $ | 9.79 |   |
|                                   |       |        |       |                                   |       |        |       |   |   |   |   |   |   |
| Options  outstanding, end of year      |       | 289,710     |       | $                                      | 8.48       |        | 438,196    |   | $ | 7.35 |   | 487,962 |   | $ | 6.76 |   |
|                                   |       |        |       |                                   |       |        |       |   |   |   |   |   |   |
| Options  exercisable, end of year      |       | 229,240     |       | $                                      | 8.28       |        | 336,818    |   | $ | 5.65 |   | 352,016 |   | $ | 4.94 |   |
|                                   |       |        |       |                                   |       |        |       |   |   |   |   |   |   |
| Non-Qualified Options                  |       |        |       |                                   |       |        |       |   |   |   |   |   |   |
|                                   |       |        |       |                                   |       |        |       |   |   |   |   |   |   |
| Options  outstanding beginning of year |       | 280,987     |       | $                                      | 4.44       |        | 353,982    |   | $ | 4.17 |   | 414,682 |   | $ | 3.82 |   |
|                                   |       |        |       |                                   |       |        |       |   |   |   |   |   |   |
| Options granted                        |       | —      |       |                                   |       | —      |       |   |   | 4,000 |   | $ | 13.25 |   |
| Options  exercised                     |       | (93,776     | )          | $                                      | 3.39       |        | (72,995    | ) | $ | 3.13 |   | (64,700 | ) | $ | 2.45 |   |
|                                   |       |        |       |                                   |       |        |       |   |   |   |   |   |   |
| Options  outstanding, end of year      |       | 187,211     |       | $                                      | 4.93       |        | 280,987    |   | $ | 4.44 |   | 353,982 |   | $ | 4.17 |   |
|                                   |       |        |       |                                   |       |        |       |   |   |   |   |   |   |
| Options  exercisable, end of year      |       | 183,743     |       | $                                      | 4.83       |        | 277,021    |   | $ | 4.34 |   | 347,892 |   | $ | 4.04 |   |

 

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A summary of options outstanding at December 31, 2007 follows:

 
| **Range of Exercise Prices** | ** ** | **Number of  Options  Outstanding  December 31,  2007** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Number of  Options  Exercisable  December 31,  2007** | ** ** | **Number of  Options  Vested or  Expected to vest  December 31,  2007** | ** ** |
|---------------------------------------------|------------|-------------------------------------------------------------------|------------|-----------------------------------------------------|------------|-------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|
|                                        |       |                                                              |       |                                                |       |                                                              |       |                                                                              |       |
| Incentive Options                           |       |                                                              |       |                                                |       |                                                              |       |                                                                              |       |
|                                        |       |                                                              |       |                                                |       |                                                              |       |                                                                              |       |
| $2.29 - $4.53                               |       | 18,958                                                            |       | 1.3 years                                           |       | 18,958                                                            |       | n/a                                                                               |       |
| $4.54 - $7.12                               |       | 135,063                                                           |       | 3.8 years                                           |       | 135,063                                                           |       | n/a                                                                               |       |
| $7.13 - $12.36                              |       | 8,025                                                             |       | 5.4 years                                           |       | 5,357                                                             |       | 7,865                                                                             |       |
| $12.37 - $13.99                             |       | 80,664                                                            |       | 6.6 years                                           |       | 52,596                                                            |       | 79,051                                                                            |       |
| $14.00 - $17.80                             |       | 47,000                                                            |       | 7.9 years                                           |       | 17,266                                                            |       | 46,060                                                                            |       |
|                                        |       |                                                              |       |                                                |       |                                                              |       |                                                                              |       |
|                                        |       | 289,710                                                           |       |                                                |       | 229,240                                                           |       | 132,975                                                                           |       |
|                                        |       |                                                              |       |                                                |       |                                                              |       |                                                                              |       |
| Non-qualified Options                       |       |                                                              |       |                                                |       |                                                              |       |                                                                              |       |
|                                        |       |                                                              |       |                                                |       |                                                              |       |                                                                              |       |
| $4.71                                       |       | 179,475                                                           |       | 2.3 years                                           |       | 179,475                                                           |       | n/a                                                                               |       |
| $9.65                                       |       | 5,332                                                             |       | 5.8 years                                           |       | 4,264                                                             |       | 5,225                                                                             |       |
| $13.25                                      |       | 2,404                                                             |       | 7.2 years                                           |       | 4                                                                 |       | 2,356                                                                             |       |
|                                        |       |                                                              |       |                                                |       |                                                              |       |                                                                              |       |
|                                        |       | 187,211                                                           |       |                                                |       | 183,743                                                           |       | 7,581                                                                             |       |

 

The weighted averagegrant date fair value of options granted during the years ended December 31,2007, 2006 and 2005 was $6.02, $3.75, and $3.25.

 

The aggregate intrinsicvalue is calculated as the difference between the exercise price of theunderlying awards and the quoted price of the Company’s common stock foroptions that were in-the-money at December 31, 2007. The aggregate intrinsicvalue of options outstanding for the year ended December 31, 2007 was$1,616,000.  The intrinsic value ofoptions vested for the year ended December 31, 2007 was $1,615,000 and foroptions vested or expected to vest was $1,500. The intrinsic value of options exercised during the years ended December31, 2007, 2006 and 2005 totaled $1,663,000, $1,560,000 and $1,383,000,respectively.  The total fair value ofthe shares that vested during the years ended December 31, 2007, 2006 and 2005totaled $535,000, $175,000 and $390,000, respectively.

 

The compensation costcharged against income for stock options was $139,000 and $175,000 for the yearsended December 31, 2007 and 2006, respectively. Income tax benefits recognizedfor the years ended December 31, 2007 and 2006 totaled $428,000 and $489,000. Management’sestimate of expected forfeitures for the remaining non-vested options isapproximately 2% and is recognizing compensation costs only for those equityawards expected to vest.

 

At December 31, 2007, thetotal compensation cost related to non-vested stock option awards granted toemployees under the Company’s stock option plans but not yet recognized was $174,000.Stock option compensation expense is recognized on a straight-line basis overthe vesting period of the option. This cost is expected to be recognized over aweighted average remaining period of 2.0 years and will be adjusted forsubsequent changes in estimated

 

 

85

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forfeitures.

 

SFAS 123(R) requires thecash flows resulting from the tax benefits resulting from tax deductions inexcess of the compensation cost recognized for those options (excess taxbenefits) to be classified as a cash flow from financing activities in theconsolidated statement of cash flows. These excess tax benefits for the yearending December 31, 2007 and 2006 totaled $428,000 and $489,000,respectively.

 

Earnings Per Share

 

A reconciliation of the numerators and denominators of the basic anddiluted earnings per share computations is as follows:

 
| **For the  Year Ended**    | ** ** | **Net Income** | ** ** | **Weighted  Average  Number of  Shares  Outstanding** | ** ** | **Per Share  Amount** | ** ** |
|----------------------------|------------|----------------|------------|-------------------------------------------------------|------------|-----------------------|------------|
|                       |       |           |       |                                                  |       |                  |       |
| December 31, 2007          |       |           |       |                                                  |       |                  |       |
|                       |       |           |       |                                                  |       |                  |       |
| Basic earnings per share   |       | $              | 6,459,000  |                                                  | 7,416,874  |                  | $          | 0.87 |   |
|                       |       |           |       |                                                  |       |                  |       |
| Effect of dilutive stock   |       |           |       | 195,085                                               |       |                  |       |
|                       |       |           |       |                                                  |       |                  |       |
| Diluted earnings per share |       | $              | 6,459,000  |                                                  | 7,611,959  |                  | $          | 0.85 |   |
|                       |       |           |       |                                                  |       |                  |       |
| December 31, 2006          |       |           |       |                                                  |       |                  |       |
|                       |       |           |       |                                                  |       |                  |       |
| Basic earnings per share   |       | $              | 7,151,000  |                                                  | 7,279,969  |                  | $          | 0.98 |   |
|                       |       |           |       |                                                  |       |                  |       |
| Effect of dilutive stock   |       |           |       | 381,076                                               |       |                  |       |
|                       |       |           |       |                                                  |       |                  |       |
| Diluted earnings per share |       | $              | 7,151,000  |                                                  | 7,661,045  |                  | $          | 0.93 |   |
|                       |       |           |       |                                                  |       |                  |       |
| December 31, 2005          |       |           |       |                                                  |       |                  |       |
|                       |       |           |       |                                                  |       |                  |       |
| Basic earnings per share   |       | $              | 7,198,000  |                                                  | 7,166,258  |                  | $          | 1.00 |   |
|                       |       |           |       |                                                  |       |                  |       |
| Effect of dilutive stock   |       |           |       | 445,446                                               |       |                  |       |
|                       |       |           |       |                                                  |       |                  |       |
| Diluted earnings per share |       | $              | 7,198,000  |                                                  | 7,611,704  |                  | $          | 0.95 |   |

 

Stock options totaling118,000 were excluded from the computation of diluted earnings per share forthe year ended December 31, 2007 due to the stock options being consideredanti-dilutive.  All stock optionsoutstanding were included in the computation of diluted earnings per share forthe years ended December 31, 2006 and 2005 as none of those stock options wereconsidered anti-dilutive.

 

Regulatory Capital

 

The Company andthe Bank are subject to certain regulatory capital requirements administered bythe Board of Governors of the Federal Reserve System and the Federal DepositoryInsurance Corporation (FDIC). Failure to meet these minimum capital requirementscan initiate certain mandatory, and possibly additional discretionary, actionsby regulators that, if undertaken, could have a direct material effect on theCompany’s consolidated financial statements. Under capital adequacy guidelinesand the regulatory framework for prompt corrective action, the Bank must meetspecific capital guidelines that involve quantitative measures of their assets,liabilities and certain off-

 

 

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balance-sheetitems as calculated under regulatory accounting practices. The Company’s andthe Bank’s capital amounts and classifications are also subject to qualitativejudgments by the regulators about components, risk weightings and otherfactors.

 

Quantitativemeasures established by regulation to ensure capital adequacy require theCompany and the Bank to maintain minimum amounts and ratios of total and Tier 1capital to risk-weighted assets and of Tier 1 capital to average assets as setforth in the following table. Each of these components is defined in theregulations. Management believes that the Company and the Bank meet all theircapital adequacy requirements as of December 31, 2007 and 2006.

 

In addition, themost recent notification from the FDIC categorized the Bank as well capitalizedunder the regulatory framework for prompt corrective action. To be categorizedas well capitalized, the Bank must maintain minimum total risk-based, Tier 1risk-based and Tier 1 leverage ratios as set forth below. There are no conditionsor events since that notification that management believes have changed theBank’s category.

 
| ** **                                | ** ** | **Actual** | ** ** | **For Capital Adequacy  Purposes** | ** ** | **To Be Well Capitalized  Under Prompt  Corrective Action** | ** ** |
|-------------------------------------------|------------|------------|------------|------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                | ** ** | **Amount** | ** ** | **Ratio**                          | ** ** | **Minimum  Amount**                                         | ** ** | **Minimum  Ratio** | ** ** | **Minimum  Amount** | ** ** | **Minimum  Ratio** | ** ** |
| ** **                                | ** ** | ** ** | ** ** | ** **                         | ** ** | ** **                                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| December 31, 2007                         |       |       |       |                               |       |                                                        |       |   |   |   |   |   |   |
|                                      |       |       |       |                               |       |                                                        |       |   |   |   |   |   |   |
| Company:                                  |       |       |       |                               |       |                                                        |       |   |   |   |   |   |   |
| Total capital  (to risk-weighted assets)  |       | $          | 72,206,000 |                               | 14.1       | %                                                           | $          | 40,849,000 |   | 8.0 | % | n/a |   | n/a |   |
| Tier 1 capital  (to risk-weighted assets) |       | $          | 66,974,000 |                               | 13.1       | %                                                           | $          | 20,425,000 |   | 4.0 | % | n/a |   | n/a |   |
| Tier 1 capital  (to average assets)       |       | $          | 66,974,000 |                               | 11.6       | %                                                           | $          | 23,096,000 |   | 4.0 | % | n/a |   | n/a |   |
|                                      |       |       |       |                               |       |                                                        |       |   |   |   |   |   |   |
| Bank:                                     |       |       |       |                               |       |                                                        |       |   |   |   |   |   |   |
| Total capital  (to risk- weighted assets) |       | $          | 58,149,000 |                               | 11.4       | %                                                           | $          | 40,793,000 |   | 8.0 | % | $ | 50,991,000 |   | 10.0 | % |
| Tier 1 capital  (to risk-weighted assets) |       | $          | 52,917,000 |                               | 10.4       | %                                                           | $          | 20,397,000 |   | 4.0 | % | $ | 30,595,000 |   | 6.0 | % |
| Tier 1 capital  (to average assets)       |       | $          | 52,917,000 |                               | 9.3        | %                                                           | $          | 22,756,000 |   | 4.0 | % | $ | 28,445,000 |   | 5.0 | % |
| ** **                                | ** ** | ** ** | ** ** | ** **                         | ** ** | ** **                                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| December 21, 2006                         |       |       |       |                               |       |                                                        |       |   |   |   |   |   |   |
|                                      |       |       |       |                               |       |                                                        |       |   |   |   |   |   |   |
| Company:                                  |       |       |       |                               |       |                                                        |       |   |   |   |   |   |   |
| Total capital  (to risk-weighted assets)  |       | $          | 58,991,000 |                               | 11.9       | %                                                           | $          | 39,549,000 |   | 8.0 | % | n/a |   | n/a |   |
| Tier 1 capital  (to risk-weighted assets) |       | $          | 53,717,000 |                               | 10.9       | %                                                           | $          | 19,775,000 |   | 4.0 | % | n/a |   | n/a |   |
| Tier 1 capital  (to average assets)       |       | $          | 53,717,000 |                               | 10.1       | %                                                           | $          | 21,972,000 |   | 4.0 | % | n/a |   | n/a |   |
|                                      |       |       |       |                               |       |                                                        |       |   |   |   |   |   |   |
| Bank:                                     |       |       |       |                               |       |                                                        |       |   |   |   |   |   |   |
| Total capital  (to risk- weighted assets) |       | $          | 54,792,000 |                               | 11.1       | %                                                           | $          | 39,511,000 |   | 8.0 | % | $ | 49,387,000 |   | 10.0 | % |
| Tier 1 capital  (to risk-weighted assets) |       | $          | 49,518,000 |                               | 10.0       | %                                                           | $          | 19,756,000 |   | 4.0 | % | $ | 29,633,000 |   | 6.0 | % |
| Tier 1 capital  (to average assets)       |       | $          | 49,518,000 |                               | 9.0        | %                                                           | $          | 20,473,000 |   | 4.0 | % | $ | 25,591,000 |   | 5.0 | % |

 

 

 

87

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

** **

Other non-interest income consisted of the following:

 
| ** **                                                       | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                       | ** ** | **2007**                    | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                             |       |                        |       |   |   |   |   |
| Alternative investment fees                                      |       | $                           | 354,000    |   | $ | 350,000 |   | $ | 520,000 |   |
| Merchant card processing fees                                    |       | 403,000                     |       | 381,000 |   | 390,000 |   |
| Earnings from  Cash surrender value of bank owned life insurance |       | 383,000                     |       | 331,000 |   | 294,000 |   |
| Gain on sale of mortage servicing assets                         |       | 730,000                     |       | — |   | — |   |
| Other                                                            |       | 1,282,000                   |       | 986,000 |   | 869,000 |   |
|                                                             |       |                        |       |   |   |   |   |
|                                                             |       | $                           | 3,152,000  |   | $ | 2,048,000 |   | $ | 2,073,000 |   |

 

 

Other expenses consistedof the following:

 
| ** **                           | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------|------------|-----------------------------|------------|
| ** **                           | ** ** | **2007**                    | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                 |       |                        |       |   |   |   |   |
| Professional fees                    |       | $                           | 1,516,000  |   | $ | 1,269,000 |   | $ | 1,035,000 |   |
| Telephone and postage                |       | 594,000                     |       | 630,000 |   | 580,000 |   |
| Stationary and supplies              |       | 828,000                     |       | 710,000 |   | 545,000 |   |
| Advertising and promotion            |       | 752,000                     |       | 660,000 |   | 412,000 |   |
| Director fees and retirement accrual |       | 482,000                     |       | 450,000 |   | 469,000 |   |
| Other                                |       | 2,904,000                   |       | 2,536,000 |   | 2,645,000 |   |
|                                 |       |                        |       |   |   |   |   |
|                                 |       | $                           | 7,076,000  |   | $ | 6,255,000 |   | $ | 5,686,000 |   |

 

**13.****                               INCOMETAXES**

 

The provision forincome taxes for the years ended December 31, 2007, 2006 and 2005consisted of the following:

 
| ** **                  | ** ** | **Federal** | ** ** | **State** | ** ** | **Total**  | ** ** |
|-----------------------------|------------|-------------|------------|-----------|------------|------------|------------|
| 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 |   |
|                        |       |        |       |      |       |       |       |
| 2006                        |       |        |       |      |       |       |       |
|                        |       |        |       |      |       |       |       |
| Current                     |       | $           | 4,572,000  |      | $          | 1,580,000  |       | $ | 6,152,000 |   |
| Deferred                    |       | (820,000    | )          | (230,000  | )          | (1,050,000 | )          |
|                        |       |        |       |      |       |       |       |
| Provision for  income taxes |       | $           | 3,752,000  |      | $          | 1,350,000  |       | $ | 5,102,000 |   |
|                        |       |        |       |      |       |       |       |
| 2005                        |       |        |       |      |       |       |       |
|                        |       |        |       |      |       |       |       |
| Current                     |       | $           | 4,643,000  |      | $          | 1,659,000  |       | $ | 6,302,000 |   |
| Deferred                    |       | (992,000    | )          | (339,000  | )          | (1,331,000 | )          |
|                        |       |        |       |      |       |       |       |
| Provision for  income taxes |       | $           | 3,651,000  |      | $          | 1,320,000  |       | $ | 4,971,000 |   |

 

88

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Deferred tax assets (liabilities) are comprised of the following atDecember 31, 2007 and 2006:

 
| ** **                                                   | ** ** | **2007**   | ** ** | **2006**  | ** ** |
|--------------------------------------------------------------|------------|------------|------------|-----------|------------|
| Deferred tax assets:                                         |       |       |       |      |       |
| Allowance for  loan losses                                   |       | $          | 2,731,000  |      | $          | 2,585,000 |   |
| Deferred  compensation                                       |       | 3,090,000  |       | 2,714,000 |       |
| Future benefit  of state tax deduction                       |       | 388,000    |       | 507,000   |       |
| Premises and  equipment                                      |       | 635,000    |       | 336,000   |       |
| Stock based  compensation                                    |       | 23,000     |       | —    |       |
| Other                                                        |       | 12,000     |       | 27,000    |       |
|                                                         |       |       |       |      |       |
| Total deferred  tax assets                                   |       | 6,879,000  |       | 6,169,000 |       |
|                                                         |       |       |       |      |       |
| Deferred tax liabilities:                                    |       |       |       |      |       |
| Future liability  of state deferred tax assets               |       | (486,000   | )          | (436,000  | )          |
| Accrual to cash  - deferred loan costs                       |       | (177,000   | )          | (225,000  | )          |
| Prepaid expenses                                             |       | (255,000   | )          | (276,000  | )          |
| Unrealized loss  on available-for-sale investment securities |       | (13,000    | )          | (7,000    | )          |
| Other                                                        |       | (117,000   | )          | —    |       |
|                                                         |       |       |       |      |       |
| Total Deferred  tax liabilities                              |       | (1,048,000 | )          | (944,000  | )          |
|                                                         |       |       |       |      |       |
| Net deferred tax  assets                                     |       | $          | 5,831,000  |      | $          | 5,225,000 |   |

 

 

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

 

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

 
| ** **                                      | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------------|------------|
| ** **                                      | ** ** | **2007**                    | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                      | ** ** | **Amount**                  | ** ** | **Rate %** | ** ** | **Amount** | ** ** | **Rate %** | ** ** | **Amount** | ** ** | **Rate %** | ** ** |
|                                            |       |                        |       |   |   |   |   |   |   |   |   |   |   |
| Federal income  tax expense, at statutory rate  |       | $                           | 3,814,000  |   | 35.0 |   | $ | 4,289,000 |   | 35.0 |   | $ | 4,261,000 |   | 35.0 |   |
| State franchise  tax, net of Federal tax effect |       | 763,000                     |       | 7.0 |   | 877,000 |   | 7.2 |   | 871,000 |   | 7.2 |   |
| Tax-exempt  income from life insurance policies |       | (134,000                    | )          | (1.2 | ) | (116,000 | ) | (1.0 | ) | (99,000 | ) | (0.8 | ) |
| Other                                           |       | (4,000                      | )          | (0.0 | ) | 52,000 |   | 0.4 |   | (62,000 | ) | (0.6 | ) |
|                                            |       |                        |       |   |   |   |   |   |   |   |   |   |   |
|                                            |       | $                           | 4,439,000  |   | 40.8 |   | $ | 5,102,000 |   | 41.6 |   | $ | 4,971,000 |   | 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, 2004, and bystate and local taxing authorities for years ended before December 31,2003.  The Company determined theunrecognized tax benefit was not significant at December 31, 2007.

 

 

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** **

**14.****                              ****RELATED PARTY TRANSACTIONS**

 

During the normal course of business, the Company enters intotransactions with related parties, including Directors and executive officers.These transactions include borrowings with substantially the same terms,including rates and collateral, as loans to unrelated parties. The following isa summary of the aggregate activity involving related party borrowers during2006:

 

| Balance, January 1, 2007                                       |   | $          | 1,927,000 |   |
|----------------------------------------------------------------|--------|------------|-----------|--------|
|                                                           |   |       |      |
| Disbursements                                                  |   | 5,351,000  |      |
| Amounts repaid                                                 |   | (4,870,000 | )         |
|                                                           |   |       |      |
| Balance, December 31, 2007                                     |   | $          | 2,408,000 |   |
|                                                           |   |       |      |
| Undisbursed commitments to related parties, December  31, 2007 |   | $          | 1,423,000 |   |

 

 

The Company engages a related party for certainconstruction projects related to the Company’s buildings.  Total fees paid to this related party forconstruction activities for the year ended December 31, 2007 and 2006 were$624,000 and $1,488,000.

 

**15.****                              ****EMPLOYEE BENEFIT PLANS**

 

Salary Continuation andRetirement Plans

 

Salary continuation plans are in place for twelve 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, 2007, 2006 and 2005 totaled $944,000, $1,111,000and $741,000, respectively.

 

In connection with these plans, the Company purchased single premiumlife insurance policies with cash surrender values totaling $10,201,000 and$9,798,000 at December 31, 2007 and 2006, respectively. Income earned onthese policies, net of expenses, totaled $383,000, $331,000 and $294,000 forthe years ended December 31, 2007, 2006 and 2005, respectively.

 

Savings Plan

 

The Butte Community Bank 401(k) Savings Plancommenced January 1, 1993 and is available to employees meeting certainservice requirements. Under the plan, employees may defer a selectedpercentage of their annual compensation. The Bank may make a discretionarycontribution to the plan which would be allocated as follows:

 

·**                                         **A matching contribution to be determinedby the Board of Directors each plan year under which the Bank will match apercentage of each participant’s contribution.

 

·**                                         **A basic contribution that would beallocated in the same ratio as each participant’s contribution bears to totalcompensation.

 

There were no employer contributions for the yearsended December 31, 2007, 2006 or 2005.

 

Employee Stock OwnershipPlan

 

Under the Butte Community Bank Employee StockOwnership Plan (“ESOP”), employees who have been credited with at least 1,000hours of service during a twelve month period and who have attained age eighteenare eligible to participate. The ESOP has funded purchases of the Bank’s commonstock through a line of credit from another financial institution (see Note 8).The line of credit is repaid from discretionary contributions to the ESOPdetermined by the Bank’s Board of Directors. Annual contributions are limitedon a participant-by-participant basis to the lesser of $30,000 or twenty-fivepercent of the participant’s compensation for the year. Employee contributionsare not permitted.

 

90

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As a leveraged ESOP, interest expense is recognized onthe line of credit in the Company’s consolidated financial statements. Sharesare allocated on the basis of eligible compensation, as defined in the ESOPplan document, in the year of allocation. Benefits generally become 100% vestedafter seven years of credited service. Employees with at least three, but fewerthan seven, years of credited service receive a partial vesting according to asliding schedule. However, in the event of normal retirement, disability, ordeath, any unvested portion of benefits vests immediately.

 

As shares are purchased by the ESOP with proceeds fromthe line of credit, the Company records the cost of these unearned ESOP sharesas a contra-equity account. These amounts are shown as a reduction ofshareholders’ equity in the Company’s consolidated balance sheet. As the debtis repaid, the shares are released from unallocated ESOP shares in proportionto the debt service paid during the year and allocated to eligible employees.As shares are released from unallocated ESOP shares, the Company reportscompensation expense equal to the current market price of the shares, and theshares are recognized as outstanding for earnings per share computations.Benefits are distributed in the form of qualifying Company securities.However, the Company will issue a put option to each participant upondistribution of the securities which, if exercised, requires the Company topurchase the qualifying securities at fair market value.

 

During 2007, the ESOP did not purchase any shares of the Company’sstock.  During 2006 the ESOP purchased20,750 shares of the Company’s common stock at a cost of $354,000 using theproceeds from the line of credit to the ESOP. Interest expense of $94,000,$88,000 and $50,000 was recognized in connection with the line of credit duringthe years ended December 31, 2007, 2006 and 2005, respectively.

 

Compensation expense of $172,000, $609,000 and $251,000 was recognizedfor the years ended December 31, 2007, 2006 and 2005.

 

Allocated and unallocated ESOP shares at December 31,2007, 2006 and 2005, adjusted for stock splits, were as follows:

 
| ** **                       | ** ** | **2007** | ** ** | **2006** | ** ** | **2005**  | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|-----------|------------|
|                             |       |     |       |     |       |      |       |
| Allocated shares                 |       | 316,524  |       | 289,355  |       | 238,812   |       |
| Unallocated Shares               |       | 126,590  |       | 155,258  |       | 185,051   |       |
|                             |       |     |       |     |       |      |       |
| Total ESOP Shares                |       | 443,114  |       | 444,613  |       | 423,863   |       |
|                             |       |     |       |     |       |      |       |
| Fair value of unallocated shares |       | $        | 1,276,000  |     | $          | 2,344,000 |       | $ | 2,637,000 |   |
|                             |       |     |       |     |       |      |       |
|                                  |            |          |            |          |            |           |            |  |  |  |

 

 

**16.****                              ****DISCLOSURES ABOUT FAIR VALUE OFFINANCIAL INSTRUMENTS**

 

Estimated fair values are disclosed for financialinstruments for which it is practicable to estimate fair value. These estimatesare made at a specific point in time based on relevant market data andinformation about the financial instruments. These estimates do not reflect anypremium or discount that could result from offering the Company’s entireholdings of a particular financial instrument for sale at one time, nor do theyattempt to estimate the value of anticipated future business related to theinstruments. In addition, the tax ramifications related to the realization ofunrealized gains and losses can have a significant effect on fair valueestimates and have not been considered in any of these estimates.

 

Because no market exists for a significant portion ofthe Company’s financial instruments, fair value estimates are based onjudgments regarding current economic conditions, risk characteristics ofvarious financial instruments and other factors. These estimates are subjectivein nature and involve uncertainties and matters of significant judgment andtherefore cannot be determined with precision. Changes in assumptions couldsignificantly affect the fair values presented.

 

The following methods and assumptions were used by the Company toestimate the fair value of its financial instruments at December 31, 2007and 2006:

 

Cash and cash equivalents: Cash and cash equivalents include cashand due from banks Federal funds sold and certain short-term interest-bearingdeposits in banks and the carrying amount is estimated to be fair value.

 

Interest-bearing depositsin banks: Thefair values of interest-bearing deposits in banks are estimated by discounting 

 

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their future cash flows using rates at each reportingdate for instruments with similar remaining maturities offered by comparablefinancial institutions.

 

Investment securities: For investment securities, fair valuesare based on quoted market prices, where available. If quoted market prices arenot available, fair values are estimated using quoted market prices for similarsecurities and indications of value provided by brokers.

 

Loans: Fair values of loans held for sale areestimated using quoted market prices for similar loans or the amount thatpurchasers have committed to purchase the loans. For variable-rate loans thatreprice frequently with no significant change in credit risk, fair values arebased on carrying values.  The fairvalues for other loans are estimated using discounted cash flow analyses, usinginterest rates offered at each reporting date for loans with similar terms toborrowers of comparable creditworthiness adjusted for the allowance for loanlosses. The carrying amount of accrued interest receivable approximates itsfair value.

 

Other investments: Other investments includenon-marketable equity securities. The carrying value of these investmentsapproximates their fair value.

 

Bank owned life insurancepolicies: Thefair values of life insurance policies are based on cash surrender values ateach reporting date provided by the insurers.

 

Loan servicing assets: The fair value of servicing assets isestimated using projected cash flows, adjusted for the effects of anticipatedprepayments, using a market discount rate.

 

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 subordinateddebentures: Thefair value of the junior subordinated debentures was determined based on thecurrent market for like-kind instruments of a similar maturity and structure.

 

Commitments to extendcredit and standby letters of credit: Commitments to extend credit are primarily forvariable rate loans and standby letters of credit. For these commitments, thereis no difference between the committed amounts and their fair values. The fairvalue of the commitments at each reporting date was not significant and notincluded in the accompanying table.

 

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

 
| ** **                                                  | ** ** | **December 31, 2007** | ** **  | **December 31, 2006** | ** ** |
|-------------------------------------------------------------|------------|-----------------------|-------------|-----------------------|------------|
| ** **                                                  | ** ** | **Carrying   Amount** | ** **  | **Fair Value**        | ** ** | **Carrying   Amount** | ** ** | **Fair Value** | ** ** |
|                                                        |       |                  |        |                  |       |   |   |   |   |
| Financial assets:                                           |       |                  |        |                  |       |   |   |   |   |
| Cash and due  from banks                                    |       | $                     | 31,714,000  |                  | $          | 31,714,000 |   | $ | 20,558,000 |   | $ | 20,558,000 |   |
| Federal Funds  sold and other                               |       | 54,290,000            |        | 54,290,000            |       | 42,070,000 |   | 42,070,000 |   |
| Interest-bearing  deposits in banks                         |       | 4,250,000             |        | 4,285,000             |       | 2,278,000 |   | 2,277,000 |   |
| Loans held for  sale                                        |       | —                |        | —                |       | 790,000 |   | 800,000 |   |
| Investment  securities                                      |       | 6,264,000             |        | 6,270,000             |       | 5,127,000 |   | 5,109,000 |   |
| Loans                                                       |       | 441,350,000           |        | 438,055,000           |       | 442,251,000 |   | 438,757,000 |   |
| Other  investments                                          |       | 591,000               |        | 591,000               |       | 118,000 |   | 118,000 |   |
| Accrued interest  receivable                                |       | 3,657,000             |        | 3,657,000             |       | 4,197,000 |   | 4,197,000 |   |
| Cash surrender  value of Bank owned life insurance policies |       | 10,201,000            |        | 10,201,000            |       | 9,798,000 |   | 9,798,000 |   |
| Loan servicing  assets                                      |       | 1,104,000             |        | 1,104,000             |       | 872,000 |   | 872,000 |   |
|                                                        |       |                  |        |                  |       |   |   |   |   |
| Financial liabilities:                                      |       |                  |        |                  |       |   |   |   |   |
| Deposits                                                    |       | $                     | 500,991,000 |                  | $          | 501,437,000 |   | $ | 484,856,000 |   | $ | 470,917,000 |   |
| Notes payable                                               |       | 1,093,000             |        | 1,093,000             |       | 1,217,000 |   | 1,217,000 |   |
| Junior  subordinated debentures                             |       | 16,496,000            |        | 18,230,000            |       | 8,248,000 |   | 8,248,000 |   |
| Accrued interest  payable                                   |       | 985,000               |        | 985,000               |       | 1,037,000 |   | 1,037,000 |   |

 

 

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

 

**CONDENSEDBALANCE SHEET**

 

**December 31,2006 and 2005**

 
| ** **                                            | ** ** | **2007**   | ** ** | **2006**   | ** ** |
|-------------------------------------------------------|------------|------------|------------|------------|------------|
|                                                  |       |       |       |       |       |
| **ASSETS**                                            |
|                                                  |       |       |       |       |       |
| Cash and cash equivalents                             |       | $          | 12,326,000 |       | $          | 2,985,000 |   |
| Investment in bank subsidiary                         |       | 52,917,000 |       | 49,518,000 |       |
| Investment in non-bank subsidiary                     |       | 660,000    |       | 716,000    |       |
| Other assets                                          |       | 3,596,000  |       | 2,747,000  |       |
|                                                  |       |       |       |       |       |
| Total assets                                          |       | $          | 69,499,000 |       | $          | 55,966,000 |   |
|                                                  |       |       |       |       |       |
| **LIABILITIES  AND SHAREHOLDERS' EQUITY**             |
|                                                  |       |       |       |       |       |
| Liabilities:                                          |       |       |       |       |       |
| ESOP note  payable                                    |       | $          | 1,093,000  |       | $          | 1,217,000 |   |
| Junior  subordinated debentures                       |       | 16,496,000 |       | 8,248,000  |       |
| Other  liabilities                                    |       | 936,000    |       | 774,000    |       |
|                                                  |       |       |       |       |       |
| Total  liabilities                                    |       | 18,525,000 |       | 10,239,000 |       |
|                                                  |       |       |       |       |       |
| Shareholders' equity                                  |       |       |       |       |       |
| Common stock                                          |       | 10,910,000 |       | 9,727,000  |       |
| Unallocated ESOP  shares                              |       | (1,407,000 | )          | (1,514,000 | )          |
| Retained  earnings                                    |       | 41,454,000 |       | 37,505,000 |       |
| Accumulated  other comprehensive income, net of taxes |       | 17,000     |       | 9,000      |       |
|                                                  |       |       |       |       |       |
| Total  shareholders' equity                           |       | 50,974,000 |       | 45,727,000 |       |
|                                                  |       |       |       |       |       |
| Total  liabilities and shareholders' equity           |       | $          | 69,499,000 |       | $          | 55,966,000 |   |

 

 

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

 

**CONDENSEDSTATEMENT OF INCOME**

 

**For theYears Ended December 31, 2006, 2005 and 2004**

 
| ** **                                                    | ** ** | **2007**  | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|---------------------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
|                                                          |       |      |       |      |       |      |       |
| Income:                                                       |       |      |       |      |       |      |       |
| Dividends  declared by bank subsidiary                        |       | $         | 4,251,000  |      | $          | 3,039,000 |       | $ | 2,258,000 |   |
|                                                          |       |      |       |      |       |      |       |
| Expenses:                                                     |       |      |       |      |       |      |       |
| Professional  fees                                            |       | 367,000   |       | 347,000   |       | 231,000   |       |
| Interest expense                                              |       | 1,118,000 |       | 821,000   |       | 642,000   |       |
| Other expenses                                                |       | 380,000   |       | 790,000   |       | 374,000   |       |
|                                                          |       |      |       |      |       |      |       |
| Total expenses                                                |       | 1,865,000 |       | 1,958,000 |       | 1,247,000 |       |
|                                                          |       |      |       |      |       |      |       |
| Income before  equity in undistributed income of subsidiaries |       | 2,386,000 |       | 1,081,000 |       | 1,011,000 |       |
|                                                          |       |      |       |      |       |      |       |
| Equity in undistributed income of subsidiaries                |       | 3,335,000 |       | 5,416,000 |       | 5,707,000 |       |
|                                                          |       |      |       |      |       |      |       |
| Income before  income tax benefit                             |       | 5,721,000 |       | 6,497,000 |       | 6,718,000 |       |
|                                                          |       |      |       |      |       |      |       |
| Income tax benefit                                            |       | 738,000   |       | 654,000   |       | 480,000   |       |
|                                                          |       |      |       |      |       |      |       |
| Net Income                                                    |       | $         | 6,459,000  |      | $          | 7,151,000 |       | $ | 7,198,000 |   |
|                                                          |       |      |       |      |       |      |       |

 

 

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

 

**CONDENSEDSTATEMENT OF CASH FLOWS**

 

**For theYears Ended December 31, 2006, 2005 and 2004**

 
| ** **                                                                         | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash flows from operating activities:                                              |       |       |       |       |       |       |       |
| Net income                                                                         |       | $          | 6,459,000  |       | $          | 7,151,000  |       | $ | 7,198,000 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |       |       |       |       |       |       |
| Undistributed net income of subsidiary                                             |       | (3,335,000 | )          | (5,416,000 | )          | (5,707,000 | )          |
| Stock-based compensation                                                           |       | 139,000    |       | 175,000    |       | —     |       |
| (Increase) decrease in other assets                                                |       | (678,000   | )          | (54,000    | )          | 268,000    |       |
| Increase in other liabilities                                                      |       | 146,000    |       | 25,000     |       | 44,000     |       |
| Net cash provided by operating activities                                          |       | 2,731,000  |       | 1,881,000  |       | 1,803,000  |       |
|                                                                               |       |       |       |       |       |       |       |
| Cash flows from financing activities:                                              |       |       |       |       |       |       |       |
| Proceeds from ESOP note payable                                                    |       | —     |       | 354,000    |       | 348,000    |       |
| Repayment of ESOP note payable                                                     |       | (124,000   | )          | (119,000   | )          | (199,000   | )          |
| Proceeds from issuance of junior subordinated  debentures                          |       | 8,248,000  |       | —     |       | —     |       |
| Purchase of unallocated ESOP shares                                                |       | —     |       | (354,000   | )          | (348,000   | )          |
| Proceeds from exercise of stock options, including  tax benefit                    |       | 1,104,000  |       | 1,000,000  |       | 527,000    |       |
| Payment of cash dividends                                                          |       | (2,408,000 | )          | (1,637,000 | )          | (1,069,000 | )          |
| Repurchase of common stock                                                         |       | (210,000   | )          | (2,498,000 | )          | —     |       |
| Net cash used by financing activities                                              |       | 6,610,000  |       | (3,254,000 | )          | (741,000   | )          |
|                                                                               |       |       |       |       |       |       |       |
| Increase (decrease) in cash and cash equivalents                                   |       | 9,341,000  |       | (1,373,000 | )          | 1,062,000  |       |
|                                                                               |       |       |       |       |       |       |       |
| Cash and cash equivalents at beginning of year                                     |       | 2,985,000  |       | 4,358,000  |       | 3,296,000  |       |
|                                                                               |       |       |       |       |       |       |       |
| Cash and cash equivalents at end of year                                           |       | $          | 12,326,000 |       | $          | 2,985,000  |       | $ | 4,358,000 |   |

 

 

**18.****                              ****SUBSEQUENT EVENTS — TRUPS REPAY,SALE LEASEBACK, AND DIVIDEND**

 

Redemption of TrustPreferred Securities

 

In July 2007, the Company formed CVB Trust II andissued $8,000,000 in Trust Preferred Securities (see Note 9).  This was done in anticipation of redeemingthe $8,000,000 in callable Trust Preferred Securities issued by CVB Trust Iwhich was completed in January 2008. At December 31, 2007 the variable rate on the CVB Trust Isecurities was 8.0%.  CVB Trust II isfixed at 7.14% for the first five years.

 

Sale-Lease Back ofCertain Properties

 

In February 2008, the Company sold and simultaneouslyentered into long-term operating lease agreements on seven of its propertieswith proceeds from the sale of approximately $15.3 million and a net gain of$5.6 million which will be deferred and recognized over the 15 year term of theleases.

 

Dividend

 

On March 7, 2008, the Company declared a cashdividend of $0.08 per share.  The dividend is payable on April 25,2008 to holders of record at the close of business on March 31, 2008.

 

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