**UNITEDSTATES****SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20006**

**FORM 10-K**

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

**For the fiscal year endedDecember 31, 2006**

**Commission File Number 0-51678**

**COMMUNITYVALLEY BANCORP**

(Exact name of registrant as specified in itscharter)

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

 

**(530) 899-2344**

Registrant’s telephone number, including areacode

Securities registered pursuant to Section 12(b) ofthe Act: **Common Stock, No Par Value**

Securities registered pursuant to Section 12(g) ofthe Act: **None**

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Indicate by check mark if theregistrant is a well-known seasoned issuer, as defined in Rule 405 of theSecurities Act. Yes  o    No  x

Indicateby check mark if the registrant is not required to file reports pursuant toSection 13 or Section 15(d) of the Exchange Act.

Yes  o    No  x

Indicate by check mark whether the Registrant (1) has filed all reportsrequired to be 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 to suchfiling requirements for the past 90 days.

Yes  x    No  o

Check if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof Registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendment tothis form 10-K. o

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

 

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

As of June 30, 2006, the aggregate market value of the voting stock heldby non-affiliates of the Registrant was approximately $82.4 million, based onthe sales price reported to the Registrant on that date of $17.00 per share.

Shares of Common Stock held by each officer and director and each personowning more than five percent of the outstanding Common Stock have beenexcluded in that such persons may be deemed to be affiliates. Thisdetermination of the affiliate status is not necessarily a conclusivedetermination for other purposes.

The number of shares of Common Stock of the registrant outstanding as ofFebruary 28, 2007 was 7,476,133.

**DOCUMENTS INCORPORATED BYREFERENCE**

Portions of the Proxy Statement relating to the Annual Meeting ofShareholders to be held on May 31, 2007, are incorporated by reference intoPart III of this Report.

 

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

 

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**PART I**

**Item 1.    Business**

**ForwardLooking 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**

**TheCompany**

Community ValleyBancorp (the “Company”) is a California corporation registered as a financialholding company under the Financial Holding Company Act of 1956, as amended (the “BHC Act”), and isheadquartered in Chico, California. The Company was incorporated in July, 2001and acquired all of the outstanding shares of Butte Community Bank (the “Bank”)in May, 2002. The Company’s principal subsidiary is the Bank. The Company alsohas a subsidiary in the name of Community Valley Bancorp Trust I, which wasformed in December, 2002 solely to facilitate the issuance of capital trustpass-through securities. The Company also has an insurance subsidiary in thename of Community Valley Bancorp Insurance Agency, LLC (subsequently changed toButte Community Insurance Agency, LLC) which was formed in December 2004 toprovide a full service insurance agency offering all lines of coverage. TheCompany exists primarily for the purpose of holding the stock of the Bank andof such other subsidiaries as it may acquire or establish.

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

At December 31,2006, the Company had consolidated assets of $550.0 million, deposits of $484.9million and shareholders’ equity of $45.7 million.

The Company’sAdministrative Offices have moved to the new headquarters located at 1360 EastLassen Avenue, Chico, California and its telephone number is (530) 899-2344.References herein to the “Company” include the Company and the Bank, unless thecontext indicates otherwise.

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, www.communityvalleybancorp.com through the reports link, assoon as reasonably practicable after the Company files such documents with theSEC. The Company’s filings are also available through the SEC’s website atwww.sec.gov.

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**The Bank**

Butte CommunityBank was incorporated under the laws of the State of California on May 11, 1990and commenced operations as a California state-chartered commercial bank onDecember 14, 1990. The Bank’s Administrative Office is located at 1360 EastLassen Avenue, Chico, California. The Bank is an insured bank under the FederalDeposit Insurance Act up to the maximum limits thereof. The Bank is not amember of the Federal Reserve System. At December 31, 2006, the Bank hadapproximately $549.6 million in assets, $442.3 million in loans and $488.4million in deposits.

We operate sevenfull-service branch offices in four Butte County communities, one full-servicebranch office in Sutter County, two full-service branches in Tehama County, onefull-service branch in Yuba County, one full-service branch in Colusa County,one full-service branch 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                     |   | Red  Bluff |   | Red Bluff Branch  10 Gilmore Rd         |
|            |   |                                                 |   |       |   |                                    |
|            |   |                                                 |   |       |   |                                    |
| 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,Data Processing, Call Center and Bank Card Center are located at 1390 RidgewoodDrive, Chico. Our Real Estate Loan Center and Central Note Department are locatedat 1360 East Lassen Avenue, Chico.  Wealso have specialized credit centers for agricultural lending and constructionand real estate lending within a number of these branch offices. Thesefacilities are located in the cities of Chico, Paradise, and Oroville in ButteCounty, the city of Yuba City in Sutter County, The cities of Red Bluff andCorning in Tehama County, the city of Marysville in Yuba County, the city ofColusa in Colusa County, the city of Citrus Heights in Sacramento County, andthe city of Redding in Shasta County.

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Throughout thehistory of Butte Community Bank, our growth has been exclusively byestablishing de novo full-service branch offices and credit centers in variouslocations in California’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 two other significant dimensions which surround this coreof retail community banking: Agricultural lending, and real estate financing (both construction andlong term).

The AgriculturalCredit Centers located in Yuba City, Chico, and Red Bluff provide a completeline of credit services in support of the agricultural activities which are keyto the continued economic development of the communities we serve. “Ag lending”clients include a full range of individual farming customers and small businessfarming organizations.

The Bank CardCenter, 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 offices with real estate lending specialists. Theseofficers are responsible for a complete line of land acquisition anddevelopment loans, construction loans for residential and commercialdevelopment, and the origination of multifamily credit facilities. Secondarymarket services are provided through the Bank’s affiliations with Fannie Maeand various non-governmental programs. The Bank services these real estateloans sold on the secondary market, and as of year end the portfolio serviced wasin excess of $152 million. We also have an orientation toward Small BusinessAdministration lending and have been designated as a Preferred Lender since1998. The Bank’s SBA program generated approximately $5.3 million in loansduring the past year. It is anticipated that loans under this program will bean increasing segment of our loan portfolio over the next few years.  In September, 2006 a lender with SBAexpertise was hired to work out of the Loan Office in Citrus Heights.  The Bank was also recognized as the numberone USDA Business and Industry (B&I) Lender in the nation during 2006having originated fifteen loans totaling more than $46 million. The primarypurpose of the B&I program is to stimulate the local economy, createadditional employment, attract additional commercial investment capital andsupport potential growth in tax revenue, which will improve the quality of lifefor rural residents.

As ofDecember 31, 2006, the principal areas in which we directed our lendingactivities, and the percentage of our total loan portfolio for which each ofthese areas was responsible, were as follows: (i) agricultural loans (6%); (ii)commercial and industrial (including SBAand B&I) loans (15%); (iii) realestate loans (commercial and construction) (69%); (iv) consumer loans (10%).

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 ofDecember 31, 2006, we had 34,021 deposit accounts with balances totalingapproximately $488 million, compared to 30,097 deposit accounts with balancestotaling approximately $434 million at December 31, 2005. 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 offerother products 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.

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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 $10,000 at December 31, 2006, 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 2006, with the downturn in the real estate market, thesebalances decreased.   Management believesthis relationship to be very secure and does not anticipate this businessleaving the Bank.

For non-depositservices, we have a strategic alliance with Linsco Private Ledger FinancialServices. Through this arrangement, our registered and licensed representativesprovide Bank customers with convenient access to annuities, insurance products,mutual funds, and a full range of investment products which are not FDIC insured.They conduct business from all of our full service offices.

We do not believethere is a significant demand for additional trust services in our serviceareas, and we do not operate or have any present intention to seek authority tooperate a Trust Department. We believe that the cost of establishing andoperating such a department would not be justified by the potential income tobe gained there from.

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 nopatents or licenses (other than licenses required by appropriate bankregulatory agencies), franchises, or concessions. The Bank is not dependent ona single customer or group of related customers for a material portion of itsdeposits, nor is a material portion of the Bank’s loans concentrated within asingle industry or group of related industries. There has been no materialeffect upon the Bank’s capital expenditures, earnings, or competitive positionas a result of Federal, state, or local environmental regulation.

**RecentDevelopments**

On May 19, 2006the Company filed applications with the California Department of FinancialInstitutions and the Federal Deposit Insurance Corporation for permission torelocate its branch office in the city of Red Bluff. This branch subsequentlyopened on June 26, 2006.

On June 22, 2006the Company filed applications with the California Department of FinancialInstitutions and the Federal Deposit Insurance Corporation for permission torelocate its branch office in the city of Redding.  This branch subsequently opened on July 31,2006.

On September 12,2006 the Company filed applications with the California Department of FinancialInstitutions and the Federal Deposit Insurance Corporation for permission torelocate its branch office in the city of Marysville.  This branch subsequently opened for businesson October 30, 2006.

On August 30, 2006the Company filed applications with the California Department of FinancialInstitutions and the Federal Deposit Insurance Corporation to relocate itsbranch office in the city of Corning. This branch was subsequently opened onNovember 20, 2006.

**Competition**

The bankingbusiness in California generally, and specifically in our market areas, ishighly competitive with respect to virtually all products and services and hasbecome increasingly more so in recent years. The

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industry continuesto consolidate and strong, unregulated competitors have entered banking marketswith focused products targeted at highly profitable customer segments. Manylargely unregulated competitors are able to compete across geographicboundaries and provide customers increasing access to meaningful alternativesto banking services in nearly all significant products. These competitivetrends are likely to continue.

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 total capitalization,such banks also have substantially higher lending limits than we do.

In addition toother banks, competitors include savings institutions, credit unions, andnumerous non-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 alsointensified due to recently enacted federal and state interstate banking laws,which permit banking organizations to expand geographically, and the Californiamarket has been particularly attractive to out-of-state institutions. TheFinancial Modernization Act, which, effective March 11, 2000, has made itpossible for full affiliations to occur between banks and securities firms,insurance companies, and other financial companies, is also expected tointensify competitive conditions.

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

For many years, wehave countered this increasing competition by providing our own style of community-oriented,personalized service. We rely upon local promotional activity, personalcontacts by our officers, directors, employees, and shareholders, automated24-hour banking, and the individualized service which we can provide throughour flexible policies. In addition, to meet the needs of customers withelectronic access requirements, the Company has embraced the electronic age andinstalled telephone banking and personal computer and internet banking withbill payment capabilities. This high tech and high touch approach allows theindividual to customize the Bank’s contact methodologies to their particularpreference. Moreover, for customers whose loan demands exceed our legal lendinglimit, we attempt to arrange for such loans on a participation basis withcorrespondent banks. We also assist our customers in obtaining from ourcorrespondent banks other services that the Bank may not offer.

Our credit cardbusiness is subject to an even higher level of competitive pressure than ourgeneral banking business. There are a number of major banks and credit cardissuers that are able to finance often highly successful advertising campaignswith which 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.

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**Employees**

As of December 31,2006 the Company had 191 full-time and 115 part-time employees. On a full timeequivalent basis, the Company’s staff level was 263 at December 31, 2006, ascompared to 241 at December 31, 2005. None of our employees is concurrentlyrepresented by a union or covered by a collective bargaining agreement.Management of the Company believes its employee relations are satisfactory.

**Regulationand Supervision**

The Company andthe Bank are subject to significant regulation by federal and state regulatoryagencies. The following discussion of statutes and regulations is only a briefsummary and does not purport to be complete. This discussion is qualified inits entirety by reference to such statutes and regulations. No assurance can begiven that such statutes or regulations will not change in the future.

**TheCompany**

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 FederalReserve Board has by regulation determined certain activities in which afinancial holding company may or may not conduct business. A financial holdingcompany must engage, with certain exceptions, in the business of banking ormanaging or controlling banks or furnishing services to or performing servicesfor its subsidiary banks. The permissible activities and affiliations ofcertain bank holding companies have recently been expanded. (See “FinancialModernization Act” 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 andgrowth of 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.

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**CapitalAdequacy Requirements**

The Company andthe Bank are subject to the regulations of the Federal Reserve Board and theFDIC, respectively, governing capital adequacy. Those regulations incorporateboth risk-based and leverage capital requirements. Each of the federalregulators has established risk-based and leverage capital guidelines for thebanks or bank holding companies it regulates, which set total capitalrequirements and define capital in terms of “core capital elements,” or Tier 1capital; and “supplemental capital elements,” or Tier 2 capital. Tier 1 capitalis generally defined as the sum of the core capital elements less goodwill andcertain other deductions, notably the unrealized net gains or losses (after taxadjustments) on available for sale investment securities carried at fair marketvalue. The following items are defined as core capital elements: (i) commonshareholders’ equity; (ii) trust preferred securities are a form of long-termborrowing that currently qualifies as Tier 1 capital not to exceed 25% ofpro-forma Tier 1 capital; (iii) qualifying non-cumulative perpetual preferredstock and related surplus (not to exceed 25% of pro-forma Tier 1 capital); and(iv) minority interests in the equity accounts of consolidated subsidiaries.Supplementary capital elements include: (i) allowance for loan and lease losses (but not more than 1.25% of aninstitution’s risk-weighted assets); (ii) perpetual preferred stock and relatedsurplus not qualifying as core capital; (iii) hybrid capital instruments,perpetual debt and mandatory convertible debt instruments; and (iv) termsubordinated debt and intermediate-term preferred stock and related surplus.The maximum amount of supplemental capital elements which qualifies as Tier 2capital is limited to 100% of Tier 1 capital, net of goodwill.

The minimumrequired ratio of qualifying total capital to total risk-weighted assets is8.0% (“Total Risk-Based Capital Ratio”), at least one half of which must be inthe form of Tier 1 capital, and the minimum required ratio of Tier 1 capital tototal risk-weighted assets is 4.0% (“Tier 1 Risk-Based Capital Ratio”).Risk-based capital ratios are calculated to provide a measure of capital thatreflects the degree of risk associated with a banking organization’s operationsfor both transactions reported on the balance sheet as assets, andtransactions, such as letters of credit and recourse arrangements, which arerecorded as off-balance sheet items. Under the risk-based capital guidelines,the nominal dollar amounts of assets and credit-equivalent amounts of off-balancesheet items are multiplied by one of several risk adjustment percentages, whichrange from 0% for assets with low credit risk, such as certain U. S. Treasurysecurities, to 100% for assets with relatively high credit risk, such asbusiness loans. As of December 31, 2006 and 2005, the Bank’s TotalRisk-Based Capital Ratios were 11.1% and 11.3%, respectively and itsTier 1 Risk-Based Capital Ratios were 10.0% and 10.1%, respectively. As ofDecember 31, 2006 and 2005, the Company’s Total Risk-Based Capital was 11.9%and 12.5% respectively, and its Tier 1 Risk-Based Capital Ratio was 10.7% and11.4% respectively. The risk-based capital requirements also take into accountconcentrations of credit (i.e., relatively large proportions of loans involvingone 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-basedcapital regulations also include exposure to interest rate risk as a factorthat the regulators will consider in evaluating a bank’s capital adequacy.Interest rate risk is the exposure of a bank’s current and future earnings andequity capital arising from adverse movements in interest rates. While interestrisk is inherent in a bank’s role as financial intermediary, it introducesvolatility to bank earnings and to the economic value of the bank.

The FDIC and theFederal Reserve Board also require the maintenance of a leverage capital ratiodesigned to supplement the risk-based capital guidelines. Banks and bankholding companies that have received the highest rating of the five categoriesused by regulators to rate banks and are not anticipating or experiencing anysignificant growth must maintain a ratio of Tier 1 capital (net of allintangibles) to adjusted total assets (“Leverage Capital Ratio”) of at least3%. All other institutions are required to maintain a leverage ratio of atleast 100 to 200 basis points above the 3% minimum, for a minimum of 4% to 5%.Pursuant to federal regulations, banks must maintain capital levelscommensurate with the level of risk to which they are exposed, including thevolume and severity of problem loans, and federal regulators may, however, sethigher capital requirements when a bank’s particular circumstances warrant. Asof December 31, 2006 and 2005, the Bank’s Leverage Capital Ratios were 9.0%and 8.8%, respectively. As of December 31, 2006 and 2005, the Company’sleverage capital ratios were 10.1% and 9.8%, respectively,

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exceeding regulatoryminimums. At December 31, 2006 and 2005 the Company met all of its capitaladequacy guidelines and the Bank was considered “well capitalized” under theprompt corrective action provisions. See Part II, Item 7, Management’sDiscussion and Analysis of Financial Condition and Results of Operation —Liquidity and Market Risk Management.

**PromptCorrective Action Provisions**

Federal lawrequires each federal banking agency to take prompt corrective action toresolve the problems of insured financial institutions, including but notlimited to those that fall below one or more prescribed minimum capital ratios.The federal banking agencies have by regulation defined the following fivecapital categories: “well capitalized” (Total Risk-Based Capital Ratio of 10%;Tier 1 Risk-Based Capital Ratio of 6%; and Leverage Ratio of 5%); “adequatelycapitalized” (Total Risk-Based Capital Ratio of 8%; Tier 1 Risk-Based CapitalRatio of 4%; and Leverage Ratio of 4%) (or 3% if the institution receives thehighest rating from its primary regulator); “undercapitalized” (TotalRisk-Based Capital Ratio of less than 8%; Tier 1 Risk-Based Capital Ratio ofless than 4%; or Leverage Ratio of less than 4%) (or 3% if the institutionreceives the highest rating from its primary regulator); “significantlyundercapitalized” (Total Risk-Based Capital Ratio of less than 6%; Tier 1Risk-Based Capital Ratio of less than 3%; or Leverage Ratio less than 3%); and “criticallyundercapitalized” (tangible equity to total assets less than 2%). A bank may betreated as though it were in the next lower capital category if after noticeand the opportunity for a hearing, the appropriate federal agency finds anunsafe or unsound condition or practice so warrants, but no bank may be treatedas “critically undercapitalized” unless its actual capital ratio warrants suchtreatment.

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

In addition tomeasures taken under the prompt corrective action provisions, insured banks maybe subject to potential actions by the federal regulators for unsafe or unsoundpractices in conducting their businesses or for violations of any law, rule,regulation or any condition imposed in writing by the agency or any writtenagreement with the agency. Enforcement actions may include the issuance ofcease and desist orders, termination of insurance of deposits (in the case of abank), the imposition of civil money penalties, the issuance of directives toincrease capital, formal and informal agreements, or removal and prohibitionorders against “institution-affiliated” parties.

**Safetyand Soundness Standards**

The federalbanking agencies 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.

**Premiumsfor Deposit Insurance**

The FDICregulations also implement a risk-based premium system, whereby insureddepository institutions are required to pay insurance premiums depending ontheir risk classification. Under this system, institutions such as the Bankwhich are insured by the Bank Insurance Fund (“BIF”) are

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categorized intoone of three capital categories (well capitalized, adequately capitalized, andundercapitalized) and one of three supervisory categories based on federalregulatory evaluations. The three supervisory categories are: financially soundwith only a few minor weaknesses (Group A), demonstrates weaknesses that couldresult in significant deterioration (Group B), and poses a substantialprobability of loss (Group C). The capital ratios used by the FDIC to definewell capitalized, adequately capitalized and undercapitalized are the same inthe FDIC’s prompt corrective action regulations. The current BIF baseassessment rates (expressed as cents per $100 of deposits) are summarized asfollows:
| ** **              | ** ** | **Group A** | ** ** | **Group B** | ** ** | **Group C** | ** ** |
|-------------------------|------------|------------------|------------|------------------|------------|------------------|------------|
|                    |       |             |       |             |       |             |       |
| Well Capitalized        |       | 0                |       | 3                |       | 17               |       |
| Adequately  Capitalized |       | 3                |       | 10               |       | 24               |       |
| Undercapitalized        |       | 10               |       | 24               |       | 27               |       |

 

In addition, BIFmember banks (such as the Bank) must pay an amount which fluctuates but iscurrently 1.22 basis points, or cents per $100 of insured deposits, toward theretirement of the Financing Corporation bonds issued in the 1980’s to assist inthe recovery of the savings and loan industry.

**Dividends**

The Company isentitled to receive dividends, when and as declared by its subsidiary banks’Boards of Directors. Those dividends may come from funds legally available forthose dividends, as specified and limited by the California Financial Code andthe U.S. Code. Under the California Financial Code, funds available for cashdividends by a California-chartered bank are restricted to the lesser of:(i)the bank’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) the bank’sretained earnings; (ii) net income for the bank’s last preceding fiscal year;or (iii) net income for the bank’s current fiscal year. If the DFI determinesthat the shareholders’ equity of the bank paying the dividend is not adequateor that the payment of the dividend would be unsafe or unsound for the bank,the DFI may order the bank not to pay the dividend.

It is alsopossible, depending upon its financial condition and other factors, that aregulatory agency could assert that the payment of dividends or other paymentsmight, under some circumstances, constitute an unsafe or unsound practice andthereby prohibit such payments.

CaliforniaCorporations Code Section 500 allows the Company to pay a dividend to itsshareholders only to the extent that it has retained earnings and, after thedividend, 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, theFRB’s policy regarding dividends provides that a bank holding company shouldnot pay cash dividends exceeding its net income or which can only be funded inways that weaken the bank holding company’s financial health, such as byborrowing. The FRB also possesses enforcement powers over bank holdingcompanies and their non-bank subsidiaries to prevent or remedy actions thatrepresent unsafe or unsound practices or violations of applicable statutes andregulations.

**TransactionsWith Affiliates**

The Company andany of its subsidiaries and certain related interests are deemed to beaffiliates of its subsidiary banks within the meaning of Sections 23A and 23Bof the Federal Reserve Act. Under those terms, loans by a subsidiary bank toaffiliates, investments by them in affiliates’ stock, and taking affiliates’stock as collateral for loans to any borrower is limited to 10% of theparticular banking subsidiary’s capital, in the case of any one affiliate, andis limited to 20% of the banking subsidiary’s capital, in the case of allaffiliates. In addition, such transactions must be on terms and conditions thatare consistent with safe and sound banking practices; in particular, a bank andits subsidiaries generally may not purchase from an

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affiliate alow-quality asset, as defined in the Federal Reserve Act. These restrictionsalso prevent a bank holding company and its other affiliates from borrowingfrom a banking subsidiary of the bank holding company unless the loans aresecured by marketable collateral of designated amounts. The Company and itssubsidiary banks are also subject to certain restrictions with respect toengaging in the underwriting, public sale and distribution of securities.

**RecentLegislation**

From time to timelegislation is enacted which has the effect of increasing the cost of doingbusiness and changing the competitive balance between banks and other financialand non-financial institutions. Various federal laws enacted over the pastseveral years have provided, among other things, for:

·                  the maintenance of mandatory reserves withthe Federal Reserve Bank on deposits by depository institutions;

·                  the phasing-out of the restrictions on theamount of interest which financial institutions may pay on certain types ofaccounts; and

·                  the authorization of various types of newdeposit accounts, such as “NOW” accounts, “Money Market Deposit” accounts and “SuperNOW” accounts, designed to be competitive with money market mutual funds andother types of accounts and services offered by various financial andnon-financial institutions.

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

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

**CommunityReinvestment Act**

The Bank issubject to certain requirements and reporting obligations involving CommunityReinvestment Act (“CRA”) activities. The CRA generally requires the federalbanking agencies to evaluate the record of a financial institution in meetingthe credit needs of its local communities, including low and moderate incomeneighborhoods. The CRA further requires the agencies to take a financialinstitution’s record of meeting its community credit needs into account whenevaluating applications for, among other things, domestic branches,consummating mergers or acquisitions, or holding company formations. Inmeasuring a bank’s compliance with its CRA obligations, the regulators utilizea performance-based evaluation system which bases CRA ratings on the bank’s actuallending service and investment performance, rather than on the extent to whichthe institution conducts needs assessments, documents community outreachactivities or complies with other procedural requirements. In connection withits assessment of CRA performance, the FDIC assigns a rating of “outstanding,” “satisfactory,”“needs to improve” or “substantial noncompliance.”  The Bank was last examined for CRA compliancein January 2004 and received a “satisfactory” CRA Assessment Rating.

###### **OtherConsumer Protection Laws and Regulations**

The bankregulatory agencies are increasingly focusing attention on compliance withconsumer protection laws and regulations. Examination and enforcement hasbecome intense, and banks have been advised to

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carefully monitor compliancewith various consumer protection laws and their implementing regulations. Thefederal Interagency 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.

**InterstateBanking 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 been permittedto merge with a bank in another state without the need for explicit state lawauthorization. However, states were given the ability to prohibit interstatemergers with banks in their own state by “opting-out” (enacting statelegislation applying equality to all out-of-state banks prohibiting suchmergers) prior to June 1, 1997.

Since 1995,adequately capitalized and managed bank holding companies have been permittedto acquire banks located in any state, subject to two exceptions: first, anystate may still prohibit bank holding companies from acquiring a bank which isless than five years old; and second, no interstate acquisition can be consummatedby a bank 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 mayestablish and operate de novo branches in any state in which the bank does notmaintain a branch if that state has enacted legislation to expressly permit allout-of-state banks 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 changeseffected by Interstate Banking Act and California laws have increasedcompetition in the environment in which the Bank operates to the extent thatout-of-state financial institutions directly or indirectly enter the Bank’smarket areas. It appears that the Interstate Banking Act has contributed to theaccelerated consolidation of the banking industry. While many largeout-of-state banks have already entered the California market as a result ofthis legislation, it is not possible to predict the precise impact of this legislationon the Bank and the Company and the competitive environment in which theyoperate.

**FinancialModernization Act**

Effective March11, 2000 the Gramm-Leach-Bliley Act eliminated most barriers to affiliationsamong banks and securities firms, insurance companies, and other financialservice providers, and enabled full affiliations to occur between suchentities. This legislation permits bank holding companies to become “financialholding companies” and thereby acquire securities firms and insurance companiesand engage in other activities that are financial in nature. A bank holdingcompany may become a financial holding company if each of its subsidiary banksis well capitalized under the FDICIA prompt corrective action provisions, iswell managed, 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 CVB Insurance Agency.

TheGramm-Leach-Bliley Act defines “financial in nature” to include securitiesunderwriting, dealing and market making; sponsoring mutual funds and investmentcompanies; insurance underwriting and agency; merchant banking activities; andactivities that the Board has determined to be closely related to banking. A

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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.

TheGramm-Leach-Bliley Act also imposes significant new requirements on the sharingof customer information between financial institutions. The Company hasresponded to these new restrictions.

The Company andthe Bank must file periodic reports with the various regulators to keep theminformed of their financial condition and operations as well as theircompliance with all the various regulations. Three regulatory agencies - theFederal Reserve Bank of San Francisco for the Company, and the FDIC and theCalifornia Department of Financial Institutions - conduct periodic examinationsof the Company and the Bank to verify their reporting is accurate and toascertain that they are in compliance with regulations.

A banking agencymay take action against a financial holding company or a bank should it findthe financial institution has failed to maintain adequate capital. This actionhas usually 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-OxleyAct**

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 internal controlsover financial reporting, evaluate the design and effectiveness of thosecontrols, 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.

**RegulatoryCapital Treatment of Equity Investments.**

In December of2001 and 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-financialcompanies under the legal authorities specified in the final rules. Amongothers, these include the merchant banking authority granted by theGramm-Leach-Bliley Act and the authority to invest in small business investmentcompanies (“SBICs”) granted by the Small Business Investment Act. Coveredequity investments will be subject to a series of marginal Tier 1 capitalcharges, with the size of the charge increasing as the organization’s level ofconcentration in equity investments increases. The highest marginal chargespecified in the final rules requires a 25 percent deduction from Tier 1capital for covered investments that aggregate more than 25 percent of anorganization’s Tier 1 capital. Equity investments through SBICs will be exemptfrom the new charges to the extent such investments, in the aggregate, do notexceed 15 percent of the banking organization’s Tier 1 capital. Grandfatheredinvestments made by state banks under section 24(f) of the Federal DepositInsurance Act also are exempted from coverage.

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**OtherPending and Proposed Legislation**

Other legislativeand regulatory initiatives which could affect the Company, the Bank and thebanking industry in general are pending, and additional initiatives may beproposed or introduced before the United States Congress, the Californialegislature and other governmental bodies in the future. Such proposals, ifenacted, may further alter the structure, regulation and competitiverelationship among financial institutions, and may subject the Bank toincreased regulation, disclosure and reporting requirements. In addition, thevarious banking regulatory agencies often adopt new rules and regulations toimplement and enforce existing legislation. It cannot be predicted whether, orin what form, any such legislation or regulations may be enacted or the extentto which the business of the Company or the Bank would be affected thereby.

**Recent Accounting Pronouncements**

 

*Accountingfor Servicing of Financial Assets*

 

In March 2006, the FinancialAccounting Standards Board (FASB) issued Statement No. 156 (SFAS 156), *Accounting for Servicing of Financial Assets – AnAmendment of FASB Statement No. 140*.  SFAS 156 requires that all separatelyrecognized servicing assets and servicing liabilities be initially measured atfair value, if practicable, and permits, but does not require, the subsequentmeasurement of servicing assets and servicing liabilities at fair value.  Under SFAS 156, an entity can electsubsequent fair value measurement of its servicing assets and servicingliabilities by class.  An entity shouldapply the requirements for recognition and initial measurement of servicingassets and servicing liabilities prospectively to all transactions after theeffective date. SFAS 156 permits an entity to reclassify certainavailable-for-sale securities to trading securities provided that they areidentified in some manner as offsetting the entity's exposure to changes infair value of servicing assets or servicing liabilities subsequently measuredat fair value.  The provisions of SFAS156 are effective for an entity as of the beginning of its first fiscal yearthat begins after September 15, 2006 and the Bank adopted these provisionson January 1, 2007.  Management does notexpect the adoption of SFAS 156 to have a material impact on the Bank'sfinancial position or results of operations. 

 

*Accounting for Uncertainty inIncome Taxes*

 

In July 2006,, the FASB issued Interpretation No. 48, *Accounting for Uncertainty in Income Taxes – aninterpretation of FASB Statement 109*(FIN 48).   FIN 48clarifies the accounting for uncertainty in income taxes recognized in acompany's financial statements in accordance with FASB Statement No. 109, *Accounting for Income Taxes*.  The Company presently recognizes income taxpositions based on management’s estimate of whether it is reasonably possiblethat a liability has been incurred for unrecognized income tax benefits byapplying FASB Statement No. 5, *Accountingfor Contingencies*.  FIN 48prescribes a comprehensive model for recognizing, measuring, presenting anddisclosing in the financial statements tax positions taken or expected to betaken in a tax return. 

 

Theprovisions of FIN 48 will be effective for the Company on January 1, 2007 andare to be applied to all tax positions upon initial application of thisstandard. Only tax positions that meet the more-likely-than-not recognitionthreshold at the effective date may be recognized or continue to be recognizedupon adoption. 

 

Thecumulative effect of applying the provisions of FIN 48, if any, will bereported as an adjustment to the opening balance of retained earnings for hefiscal year of adoption.  Management doesnot expect the adoption to have a material impact on the Company’s financialposition or results of operations.

  

*Considering theEffects of Prior Year Misstatements*

* *

In September 2006, the Securities andExchange Commission published Staff Accounting Bulleting No. 108 *Considering the Effects of Prior Year Misstatementswhen Quantifying Misstatements in Current Year Financial Statements*. The interpretations in this Staff Accounting Bulleting are being issued toaddress diversity in practice in quantifying financial statement misstatementsand the potential under current practice to build up improper amounts on thebalance sheet.  This guidance will apply to the first fiscal year endingafter November 15, 2006, or December 31, 2006 for the Company.  Theadoption of SAB 108 did not  have a materialimpact on the Company’s  financialposition, results of operations or cash flows and no cumulative adjustment wasrequired.

 

*Fair Value Measurements*

 

In September 2006, the FASB issued StatementNo. 157 (SFAS 157), *Fair ValueMeasurements*. SFAS 157 defines fair value, establishes a frameworkfor measuring fair value and expands disclosures about fair valuemeasurements.  SFAS 157 applies wheneverother standards require (or permit) assets or liabilities to be measured atfair value but does not expand the use of fair value in any newcircumstances.  In this standard, theFASB clarifies the principle that fair value should be based on the assumptionsmarket 

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participants would use when pricing the asset orliability.  In support of this principle,SFAS 157 establishes a fair value hierarchy that prioritizes the informationused to develop those assumptions.  Theprovisions of SFAS 157 are effective for financial statements issued for fiscalyears beginning after November 15, 2007 and interim periods within thosefiscal years.  The provisions should be appliedprospectively, except for certain specifically identified financialinstruments.  Management does not expectthe adoption of SFAS 157 to have a material impact to the Bank's financialposition or result of operations.

 

* *

*Accounting for Purchases of LifeInsurance*

 

InSeptember 2006, the FASB ratified the consensuses reached by theEmerging Issues Task Force (the Task Force) on Issue No. 06-5 (EITF 06-5) *Accounting for the Purchases of Life Insurance –Determining the Amount that Could be Realized in Accordance with FASB TechnicalBulletin No. 85-4* (FTB 85-4). FTB 85-4 indicates that the amount of the asset included in the balancesheet for life insurance contracts within its scope should be "the amountthat could be realized under the insurance contract as of the date of thestatement of financial position." Questions arose in applying the guidance in FTB 85-4 to whether"the amount that could be realized" should consider 1) anyadditional amounts included in the contractual terms of the insurance policyother than the cash surrender value and 2) the contractual ability to surrenderall of the individual-life policies (or certificates in a group policy) at thesame time.  EITF 06-5 determined that"the amount that could be realized" should 1) consider any additionalamounts included in the contractual terms of the policy and 2) assume thesurrender of an individual-life by individual-life policy (or certificate bycertificate in a group policy).  Anyamount that is ultimately realized by the policy holder upon the assumedsurrender of the final policy (or final certificate in a group policy) shall beincluded in the "amount that could be realized."  An entity should apply the provisions of EITF06-5 through either a change in accounting principle through acumulative-effect adjustment to retained earnings as of the beginning of theyear of adoption or a change in accounting principle through retrospectiveapplication to all prior periods.  Theprovisions of EITF 06-5 are effective for fiscal years beginning afterDecember 15, 2006.  Management hasnot yet completed its evaluation of the impact that EITF 06-5 will have.

* *

*Accounting for Deferred Compensationand Postretirement Benefit Aspects of Endorsement Split-Dollar Life InsuranceArrangements*

 

In September 2006, theFASB ratified the consensuses reached by the Task Force on Issue No. 06-4(EITF 06-4) *Accounting for DeferredCompensation and Postretirement Benefit Aspects of Endorsement Split-DollarLife Insurance Arrangements*. A question arose when an employer enters into an endorsementsplit-dollar life insurance arrangement related to whether the employer shouldrecognize a liability for the future benefits or premiums to be provided to theemployee.  EITF 06-4 indicates that anemployer should recognize a liability for future benefits and that a liabilityfor the benefit obligation has not been settled through the purchase of anendorsement type policy. An entity should apply the provisions of EITF 06-4either through a change in accounting principle through a cumulative-effectadjustment to retained earnings as of the beginning of the year of adoption ora change in accounting principle through retrospective application to all priorperiods.  The provisions of EITF 06-4 areeffective for fiscal years beginning after December 15, 2007.  Management has not yet completed itsevaluation of the impact that EITF 06-4 will have.

 

**Item 1a. Risk Factors**

This discussionand analysis provides insight into Management’s assessment of the operatingtrends over the last several years and its expectations for 2007. Suchexpressions of expectations are not historical in nature and are “forward-lookingstatements” within the meaning of the Private Securities Litigation Reform Actof 1995. Forward-looking statements are subject to risks and uncertainties thatmay cause actual future results to differ materially from those expressed inany forward-looking statement. Such risks and uncertainties with respect to theCompany include:

·                  increasedcompetitive pressure among financial services companies;

·                  changesin the interest rate environment reducing interest margins or increasinginterest rate risk;

·                  deteriorationin general economic conditions, internationally, nationally or in the State ofCalifornia;

·                  theoccurrence of future events such as the terrorist acts of September 11, 2001;

·                  theavailability of sources of liquidity at a reasonable cost; and

·                  legislativeor regulatory changes adversely affecting the business in which the Companyengages.

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**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, GeneralMotors and various software developers. Similar competition is faced forcommercial financial products from insurance companies and investment bankers.Community banks, including the Company, attempt to offset this trend bydeveloping 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.

**EconomicConditions**

Beginning in thesummer of 2004 the Fed began raising its target rate and by year end it hadincreased by 1.25% to 5.25%. Throughout 2005 the Fed continued to increase itstarget rate and by year end it reached 7.25%. During 2006 the target rate wasincreased 25 basis points four times ending on June 29, 2006 at 8.25% where itremained through the end of the year. These changes impacted the Company as marketrates for loans, investments and deposits respond to the Fed’s actions. Themost significant economic factors impacting the Company in the last three yearshave been the healthy economic expansion during 2004 and 2005 and the gradualreal estate slow down in 2006. A significant portion of our total loan portfoliois related to real estate obligations, particularly residential real estateloans. Our local economies continue to grow and prosper but we are experiencingstabilization in the rapid pace of people moving into our service areas. Thesmaller towns in close proximity to Chico such as Orland and Oroville arecontinuing to grow due to the lower cost of land acquisition for new housing.The areas around Redding such as Cottonwood and Anderson are also experiencingmodest growth.

**RiskManagement**

The Company seesthe process 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.

Some of the risksfaced by 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.

**ManagingOur Growth**

Our Company’stotal assets increased from $495 million at December 31, 2005 to $550 millionat December 31, 2006. Management’s intention is to leverage the Company’scurrent infrastructure to sustain the momentum achieved in 2006, 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.

**TheImpact of Changes in Assets and Liabilities to Net Interest Income and NetInterest Margin**

The Company earnsincome from two sources. The primary source is from the management of itsfinancial assets and liabilities and the second is from charging fees forservices provided. The first source involves functioning as a **financial intermediary**, that is, the Company accepts fundsfrom depositors or obtains funds from other creditors and then either lends thefunds to borrowers or invests those funds in securities or other financialinstruments. Income is earned as a spread between the interest earned from theloans or investments and the interest paid on the deposits and otherborrowings. The second source, fee income, is discussed in other sections ofthis analysis, specifically in “Noninterest Revenue.”

16

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**Changesin Net Interest Income and Net Interest Margin**

**Netinterest 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 compared withthe interest rate paid on those interest-bearing deposits and liabilities.

**Netinterest 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.

**TheAllowance for Loan Losses May Not Cover 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:

·                  industrystandards;

·                  historicalexperience with our loans;

·                  evaluationof qualitative factors such as loan concentrations and local economicconditions;

·                  regularreviews of the quality, mix and size of the overall loan portfolio;

·                  regularreviews of delinquencies; and

·                  thequality of the collateral underlying our loans;

·                  loan impairment.

We maintain anallowance for 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 Department of Financial Institutions, as part of theirsupervisory functions, periodically review our allowance for loan losses. Suchagencies 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 havebeen submitted to the registrant by the staff of the Securities ExchangeCommission.

**Item 2.    Properties**

The followingproperties (real properties and/or improvements thereon) are owned by theCompany and are unencumbered. In the opinion of Management, all properties areadequately covered by insurance.

On June 1, 2005,Community Valley Bancorp entered into a short term, unsecured note payable in aprincipal amount of $800,000 in conjunction with the purchase of real property.The interest rate on the note at December 31, 2005 was 4.5%. The note was paidin full on January 4, 2006. This real property is a 19,000 square foot buildingin Chico that serves as the corporate administrative headquarters and also housesother service departments. The remodeling of this building was completed at theend of January 2007 and is now fully occupied.

17

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| **Location**                                                                                                                             | ** ** | **Use of Facilities**           | ** ** | **Square Feet of  Office Space** | ** ** | **Land and  Building  Cost** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------|------------|
| 672 Pearson Road  Paradise, California  (Opened December 1990)                                                                           |       | Branch  Office                            |       | 4,200                                           |       | $                                 | 612,261    |   |
|                                                                                                                                     |       |                                      |       |                                            |       |                              |       |
| 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  (Opened May 1998)                                                                                |       | Central  Services/  Information  Services |       | 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  (building remodeled, occupancy  January 2007)                                               |       | Administration  Credit Services           |       | 19,000                                          |       | $                                 | 1,143,000  |   |

 

18

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The followingfacilities are leased by the Company:
|                                                                          | ** ** | **Use of**                   | ** ** | **Square Feet of** | ** ** | **Monthly Rent**        | ** ** | **Term of** | ** **     |
|--------------------------------------------------------------------------|------------|-----------------------------------|------------|------------------------------|------------|------------------------------|------------|------------------|----------------|
| **Location**                                                             | ** ** | **Facilities**                    | ** ** | **Office Space**        | ** ** | **as of 12/31/06** | ** ** | **Lease**        | ** **     |
|                                                                     |       |                              |       |                         |       |                         |       |             |           |
| 14001 Lakeridge CircleMagalia, California                                |       | Branch  Office                    |       | 600                          |       | $                            | 570        |             | 3/31/2008      | (1) |
|              |       |                              |       |                         |       |                         |       |             |           |
| 237 West East Ave.  Chico, California  land lease only                   |       | Branch  Office                    |       |                         |       | $                            | 3,958      |             | 10/31/2028     | (2) |
|              |       |                              |       |                         |       |                         |       |             |           |
| 900 Mangrove Ave.Chico, California                                       |       | Branch  Office                    |       | 6,000                        |       | $                            | 6,786      |             | 9/30/2011      | (3) |
|              |       |                              |       |                         |       |                         |       |             |           |
| 6653 Clark Road  Paradise, California                                    |       | Branch  Office                    |       | 4,640                        |       | $                            | 5,170      |             | 3/31/2013      | (4) |
|              |       |                              |       |                         |       |                         |       |             |           |
| 2951 Churn Creek RdRedding, California                                   |       | Branch  Office                    |       | 15,000                       |       | $                            | 9,300      |             | 6/30/2011      | (5) |
|              |       |                              |       |                         |       |                         |       |             |           |
| 5959 Greenback #450  Citrus Heights, California                          |       | Loan  Office                      |       | 1,315                        |       | $                            | 2,109      |             | 7/31/2009      | (6) |
|              |       |                              |       |                         |       |                         |       |             |           |
| 936 Mangrove Ave.Chico, California                                       |       | General  Offices                  |       | 6,000                        |       | $                            | 4,602      |             | 2/28/2013      | (7) |
|              |       |                              |       |                         |       |                         |       |             |           |
| 84 Belle Mill Rd  Red Bluff CA                                           |       | Branch  office                    |       | 3,825                        |       | $                            | 5,164      |             | 5/31/2007      | (8) |
|              |       |                              |       |                         |       |                         |       |             |           |
| 904 B StreetMarysville CA                                                |       | Branch  office                    |       | 4,742                        |       | $                            | 10,670     |             | 10/31/2016     | (9) |
|              |       |                              |       |                         |       |                         |       |             |           |
| 1017 Bridge St  Colusa CA                                                |       | Branch  office                    |       | 1,500                        |       | $                            | 1,300      |             | 2/28/2014      | (10) |
|              |       |                              |       |                         |       |                         |       |             |           |
| 1010 Spruce StreetGridley CA                                             |       | Loan  Office                      |       | 960                          |       | $                            | 900        |             | month to month |   |
|                                                                     |       |                              |       |                         |       |                         |       |             |           |
| 950 Hwy 99W  Corning CA                                                  |       | Branch  office                    |       | 5,300                        |       | $                            | 13,250     |             | 10/31/2016     | (11) |
|              |       |                              |       |                         |       |                         |       |             |           |
| 1335 Hilltop DrRedding CAland lease only                                 |       | Branch  office under construction |       |                         |       | $                            | 6,250      |             | 2/28/2021      | (12) |

 

Additionally, theBank has five remote ATM locations. The amount of monthly rent at theselocations is minimal.

19

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(1) This is the termination date of the current 5-year lease.  The Company also has two renewal options forfive years each.

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

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

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

(5) This is the termination date of the current 10-year lease.  The Company has two renewal options for fiveyears each. 

(6) This is the termination date of the current 3-year lease. The Companydoes not have renewal options on this property. 

(7) This is the termination date of the current 10-year lease.  The Company also has one renewal option forten years. 

(8) This is the termination date of the current 3-year lease.  The Company has one renewal option for threeyears.

(9) This is the termination date of the current 10-year lease.  The Company has two renewal options for fiveyears each.

(10) This is the termination date of thecurrent 10-year lease.  The Company doesnot have renewal options on this property.

(11) This is the termination date of thecurrent 20 year lease.  The Company doesnot have renewal options on this property.

(12) This is the termination date of the current 15 year landlease.  The Company has three renewaloptions for five years each. 

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

From time to time,the Company 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 Mattersto a Vote of Security Holders**

No matters weresubmitted to a vote of our shareholders’ during the fourth quarter of thefiscal year ended December 31, 2006.

**PART II**

**Item 5.****    Market for Registrants Common Equityand Related Shareholder Matters and Issuer Purchases of Equity Securities**

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

Community ValleyBancorp was previously listed on the Nasdaq OTC Bulletin Board starting June17, 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 & Arnett Inc., SanFrancisco, 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 thatfollows shows the total return performance of the Company as compared to theRussell 3000 and the SNL $100 million to $500 million peer group of banks overthe past five years.

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***CommunityValleyBancorp***
| ** **                               | ** ** | **Period Ending** | ** ** |
|------------------------------------------|------------|------------------------|------------|
| **Index**                                | ** ** | **12/31/01**           | ** ** | **12/31/02** | ** ** | **12/31/03** | ** ** | **12/31/04** | ** ** | **12/31/05** | ** ** | **12/31/06** | ** ** |
| Community Valley  Bancorp                |       | 100.00                 |       | 112.34 |   | 151.83 |   | 210.29 |   | 218.39 |   | 235.18 |   |
| Russell 3000                             |       | 100.00                 |       | 78.46 |   | 102.83 |   | 115.11 |   | 122.16 |   | 141.35 |   |
| SNL $100M-$500M OTC-BB  & Pink Banks |       | 100.00                 |       | 119.95 |   | 162.94 |   | 196.93 |   | 218.70 |   | 239.40 |   |

 

21

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The followingtable summarizes trades of the Company setting forth the approximate high andlow sales 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. The stock prices andapproximate trading volumes and cash dividends have been adjusted to giveeffect to the four-for-three stock split issued in March 2004 and thetwo-for-one stock split issued in May 2005.
|                        | ** ** | ** **                                               | ** ** | **Approximate** | ** ** |
|------------------------|------------|----------------------------------------------------------|------------|-----------------|------------|
| ** **             | ** ** | **Sale Price of the Company’s** | ** ** | **Trading**     | ** ** |
| **Calendar**           | ** ** | **Common Stock**                                    | ** ** | **Volume**      | ** ** |
| **Quarter Ended** | ** ** | **High**                                                 | ** ** | **Low**         | ** ** | **Shares** | ** ** |
| March 31, 2005         |       | 14.59                                                    |       | 12.85           |       | 135,200 |   |
| June 30, 2005          |       | 15.27                                                    |       | 13.26           |       | 322,700 |   |
| September 30,  2005    |       | 15.41                                                    |       | 13.92           |       | 186,500 |   |
| December 31,  2005     |       | 15.00                                                    |       | 13.21           |       | 80,600 |   |
| 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 |   |

 

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

On March 6, 2007there were approximately 557 shareholders of record of the Company.

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

As a financialholding company 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 paidcash dividends quarterly totaling $1.9 million or $0.26 per share in 2006 and$1.1 million or $0.16 per share in 2005, representing 27% and 16%, respectivelyof the 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 todeclare and pay dividends of no more than 40% of its previous years net incometo shareholders. However, no assurance can be given that the Bank’s and theCompany’s future earnings and/or growth expectations in any given year willjustify the payment of such a dividend.

The ability of theBank’s Board of Directors to declare cash dividends is also limited bystatutory and regulatory restrictions which restrict the amount available forcash dividends depending upon the earnings, financial condition and cash needsof the Bank, as well as general business conditions. A detailed discussion islocated in Item 1 above.

22

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

The Board of Directorsapproved a plan to repurchase up to $3,000,000 of the outstanding common stockof the Company in 2003. 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 2005 and2003, no shares of the Company’s common stock were repurchased. During 2004, 38,470shares of the Company’s common stock were repurchased for $502,000.  During 2006, 143,950 shares were repurchasedfor $2,498,000.

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

The following chart sets forth information for thefiscal year ended December 31, 2006, regarding equity based compensation plansof 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     |       | 719,183                                                                                                                                               |       | $                                                                                                                 | 8.65       |                                                                                                                                                                                                              | 66,877     |   |
|                                                        |       |                                                                                                                                                  |       |                                                                                                              |       |                                                                                                                                                                                                              |       |
| Equity compensation plans not approved by security  holders |       | None                                                                                                                                                  |       | None                                                                                                              |       | None                                                                                                                                                                                                              |       |
|                                                        |       |                                                                                                                                                  |       |                                                                                                              |       |                                                                                                                                                                                                              |       |
| Total                                                       |       | 719,183                                                                                                                                               |       | $                                                                                                                 | 8.65       |                                                                                                                                                                                                              | 66,877     |   |

 

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

On December 19,2002, the Company issued an aggregate of $8,248,000 in principal amount of itsFloating Rate Junior Subordinated Deferrable Interest Debentures due 2032 (the “SubordinatedDebt Securities”). All of the Subordinated Debt Securities were issued toCommunity Valley Trust I, a Delaware statutory business trust and awholly-owned but unconsolidated subsidiary of the Company (the “Trust”). TheSubordinated Debt Securities were not registered under the Securities Act inreliance on the exemption set forth in Section 4(2) thereof. The SubordinatedDebt Securities were issued to the Trust in consideration for the receipt ofthe net proceeds (approximately $7.75 million) raised by the Trust from thesale of $8,000,000 in principal amount of the Trust’s Floating Rate CapitalTrust Pass-through Securities (the “Trust Preferred Securities”). Bear Stearns& Co. Inc. acted as the placement agent in connection with the offering ofthe Trust Preferred Securities for aggregate commissions of $240,000 payable bythe Trust. The sale of the Trust Preferred Securities was part of a largertransaction arranged by Bear Stearns & Co. pursuant to which the TrustPreferred Securities were deposited into a special purpose vehicle along withsimilar securities issued by a number of other banks and the special purposevehicle then issued its securities to the public (the “Pooled Trust PreferredSecurities”). The Pooled Trust Preferred Securities were sold by Bear Stearns& Co. Inc. only (i) to those entities Bear Stearns & Co. Inc.reasonably believed were qualified institutional  buyers (as defined in Rule 144A under theSecurities Act), (ii) to “accredited investors” (as defined in Rule 501(a)(1),(2), (3) or (7) or Regulation D promulgated under the Securities

23

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Act) or (iii) inoffshore transactions in compliance with Rule 903 of Regulation S under theSecurities Act. The Trust Preferred Securities were not registered under theSecurities Act in reliance on exemptions set forth in Rule 144A, Regulation Dand Regulation S, as applicable.

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

The “selectedfinancial data” for 2006 which follows is derived from the audited ConsolidatedFinancial Statements of the Company and other data from our internal accountingsystem. The selected financial data should be read in conjunction with theaudited Consolidated 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.

24

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**Selected Financial Data**
| ** **                                                 | ** ** | **As of December 31,**                                           | ** ** |
|------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **(Dollars in thousands, except per share data)** | ** ** |
| ** **                                                 | ** ** | **2006**                                                                        | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Income Statement Summary**                     |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Interest income                                            |       | $                                                                               | 40,814     |   | $ | 32,438 |   | $ | 24,980 |   | $ | 21,517 |   | $ | 18,977 |   |
| Interest expense                                           |       | $                                                                               | 9,532      |   | $ | 5,331 |   | $ | 4,056 |   | $ | 4,396 |   | $ | 4,774 |   |
| Net interest income  before provision for loan losses      |       | $                                                                               | 31,282     |   | $ | 27,107 |   | $ | 20,924 |   | $ | 17,121 |   | $ | 14,203 |   |
| Provision for loan  losses                                 |       | $                                                                               | 775        |   | $ | 825 |   | $ | 790 |   | $ | 655 |   | $ | 603 |   |
| Non-interest income                                        |       | $                                                                               | 6,769      |   | $ | 6,711 |   | $ | 6,019 |   | $ | 5,950 |   | $ | 6,164 |   |
| Non-interest expense                                       |       | $                                                                               | 25,023     |   | $ | 20,824 |   | $ | 16,740 |   | $ | 13,818 |   | $ | 12,539 |   |
| Income before provision  for income taxes                  |       | $                                                                               | 12,253     |   | $ | 12,169 |   | $ | 9,413 |   | $ | 8,598 |   | $ | 7,225 |   |
| Provision for income  taxes                                |       | $                                                                               | 5,102      |   | $ | 4,971 |   | $ | 3,803 |   | $ | 3,329 |   | $ | 2,375 |   |
| Net Income                                                 |       | $                                                                               | 7,151      |   | $ | 7,198 |   | $ | 5,610 |   | $ | 5,269 |   | $ | 4,850 |   |
|                                                       |       |                                                                            |       |   |   |   |   |   |   |   |   |
| **Balance Sheet Summary**                                  | ** ** | ** **                                                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total loans, net                                           |       | $                                                                               | 442,251    |   | $ | 401,221 |   | $ | 339,174 |   | $ | 270,231 |   | $ | 229,699 |   |
| Allowance for loan  losses                                 |       | $                                                                               | (5,274     | ) | $ | (4,716 | ) | $ | (4,381 | ) | $ | (3,587 | ) | $ | (3,007 | ) |
| Investment securities  held to maturity                    |       | $                                                                               | 1,777      |   | $ | 2,295 |   | $ | 2,582 |   | $ | 3,823 |   | $ | 2,873 |   |
| Investment securities  available for sale                  |       | $                                                                               | 3,350      |   | $ | 4,381 |   | $ | 4,379 |   | $ | 502 |   | $ | 514 |   |
| Interest-bearing  deposits in banks                        |       | $                                                                               | 2,278      |   | $ | 6,636 |   | $ | 8,715 |   | $ | 7,925 |   | $ | 4,061 |   |
| Cash and due from banks                                    |       | $                                                                               | 20,558     |   | $ | 18,988 |   | $ | 21,778 |   | $ | 26,205 |   | $ | 15,621 |   |
| Federal funds sold                                         |       | $                                                                               | 42,070     |   | $ | 29,015 |   | $ | 46,440 |   | $ | 50,605 |   | $ | 57,410 |   |
| Other real estate                                          |       | $                                                                               | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Premises and equipment,  net                               |       | $                                                                               | 15,359     |   | $ | 11,221 |   | $ | 9,027 |   | $ | 8,554 |   | $ | 6,653 |   |
| Total interest-earning  assets                             |       | $                                                                               | 491,726    |   | $ | 443,548 |   | $ | 401,290 |   | $ | 333,086 |   | $ | 294,557 |   |
| Total assets                                               |       | $                                                                               | 550,037    |   | $ | 494,777 |   | $ | 449,675 |   | $ | 386,723 |   | $ | 337,483 |   |
| Total interest-bearing  deposits                           |       | $                                                                               | 407,868    |   | $ | 350,682 |   | $ | 318,266 |   | $ | 274,048 |   | $ | 243,092 |   |
| Total deposits                                             |       | $                                                                               | 484,856    |   | $ | 434,018 |   | $ | 399,059 |   | $ | 342,511 |   | $ | 297,981 |   |
| Total liabilities                                          |       | $                                                                               | 504,310    |   | $ | 453,222 |   | $ | 415,144 |   | $ | 356,774 |   | $ | 312,103 |   |
| Total shareholders’  equity                           |       | $                                                                               | 45,726     |   | $ | 41,555 |   | $ | 34,531 |   | $ | 29,949 |   | $ | 25,380 |   |
| **Per Share Data****(1)**                                  | ** ** | ** **                                                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic earnings per  share                                  |       | $                                                                               | 0.98       |   | $ | 1.00 |   | $ | 0.79 |   | $ | 0.75 |   | $ | 0.70 |   |
| Dilute earnings per  share                                 |       | $                                                                               | 0.93       |   | $ | 0.95 |   | $ | 0.74 |   | $ | 0.71 |   | $ | 0.66 |   |
| Book value per weighted  average share                     |       | $                                                                               | 6.28       |   | $ | 5.80 |   | $ | 4.86 |   | $ | 4.26 |   | $ | 3.67 |   |
| Cash Dividends                                             |       | $                                                                               | 0.26       |   | $ | 0.16 |   | $ | 0.16 |   | $ | 0.16 |   | $ | 0.13 |   |
| Weighted Average Common  Shares Outstanding, Basic         |       | 7,279,969                                                                       |       | 7,166,258 |   | 7,112,386 |   | 7,025,290 |   | 6,922,230 |   |
| Weighted Average Common  Shares Outstanding, Diluted       |       | 7,661,045                                                                       |       | 7,611,704 |   | 7,601,092 |   | 7,430,518 |   | 7,279,858 |   |
|                                                       |       |                                                                            |       |   |   |   |   |   |   |   |   |
| **Key Operating Ratios:**                                  | ** ** | ** **                                                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Performance  Ratios:**                                   | ** ** | ** **                                                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Return on  Average Equity(2)                               |       | 15.99                                                                           | %          | 18.82 | % | 17.20 | % | 19.07 | % | 20.82 | % |
| Return on  Average Assets (3)                              |       | 1.38                                                                            | %          | 1.51 | % | 1.34 | % | 1.44 | % | 1.69 | % |
| Net Interest  Margin (4)                                   |       | 6.62                                                                            | %          | 6.32 | % | 5.70 | % | 5.32 | % | 5.52 | % |
| Dividend Payout  Ratio (5)                                 |       | 26.47                                                                           | %          | 15.93 | % | 20.28 | % | 20.67 | % | 17.84 | % |
| Equity to Assets  Ratio (6)                                |       | 8.64                                                                            | %          | 8.02 | % | 7.82 | % | 7.54 | % | 8.12 | % |
| Net Loans to  Total Deposits at Period End                 |       | 91.21                                                                           | %          | 92.44 | % | 84.99 | % | 78.90 | % | 77.09 | % |
| **Asset  Quality Ratios:**                                 | ** ** | ** **                                                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Non Performing  Loans to Total Loans                       |       | 0.51                                                                            | %          | 0.00 | % | 0.03 | % | 0.02 | % | 25.00 | % |
| Nonperforming  Assets to Total Loans and Other Real Estate |       | 0.51                                                                            | %          | 0.00 | % | 0.03 | % | 0.02 | % | 0.22 | % |
| Net Charge-offs  to Average Loans                          |       | 0.02                                                                            | %          | 0.00 | % | 0.00 | % | 0.03 | % | 0.00 | % |
| Allowance for  Loan Losses to Net Loans at Period End      |       | 1.18                                                                            | %          | 1.16 | % | 1.16 | % | 1.19 | % | 1.16 | % |
|                                                       |       |                                                                            |       |   |   |   |   |   |   |   |   |
| **Capital  Ratios:**                                       | ** ** | ** **                                                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Tier 1 Capital  to Adjusted Total Assets                   |       | 10.1                                                                            | %          | 9.8 | % | 9.5 | % | 9.9 | % | 10.4 | % |
| Tier 1 Capital  to Total Risk-Weighted Assets              |       | 10.9                                                                            | %          | 11.4 | % | 11.3 | % | 12.2 | % | 12.8 | % |
| Total Capital to Total  Risk-Weighted Assets               |       | 11.9                                                                            | %          | 12.5 | % | 12.5 | % | 13.3 | % | 14.0 | % |

 

25

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

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

(3)          Net income divided by average total assets.

(4)          Net interest income divided by average earningassets.

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

(6)          Average equity divided by average total assets.

**Item 7.****    Management’s Discussionand Analysis of Financial Condition and Results of Operations**

This discussionpresents Management’s analysis of the financial condition as of December 31,2006 and 2005 and results of operations of the Company for each of the years inthe three-year period ended December 31, 2006. The discussion should be read inconjunction with the Consolidated Financial Statements of the Company and theNotes related thereto presented elsewhere in this Form 10-K Annual Report (seeItem 8).

*Statementscontained in this report that are not purely historical are forward looking statementswithin the meaning of Section 21E of the Securities Exchange Act of 1934 asamended, including the Company’s expectations, intentions, beliefs, orstrategies regarding the future. All forward-looking statements concerningeconomic conditions, rates of growth, rates of income or values as may beincluded in this document are based on information available to the Company onthe date noted, and the Company assumes no obligation to update any suchforward-looking statements. It is important to note that the Company’s actualresults could materially differ from those in such forward-looking statements.Factors that could 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.*

**CriticalAccounting Policies**

*General*

The Company’s significant accounting principles aredescribed in Note 1 of the consolidated financial statements and are essentialto understanding Management’s Discussion and Analysis of Results of Operationsand Financial Condition. Community Valley Bancorp’s consolidated financialstatements are prepared in accordance with accounting principles generallyaccepted in the United States of America (GAAP). The financial informationcontained within our statements is, to a significant extent, financialinformation that is based on measures of the financial effects of transactionsand events that have already occurred. Some of the Company’s accountingprinciples require significant judgment to estimate values of assets orliabilities. In addition, certain accounting principles require significantjudgment in applying the complex accounting principles to transactions todetermine the most appropriate treatment. The following is a summary of themore judgmental and complex accounting estimates and principles.

*Allowancefor Loan Losses (ALL)*

The allowance for loanlosses is management’s best estimate of the probable losses that may besustained in our loan portfolio. The allowance is based on two basic principlesof accounting:  (1) SFAS No.5 whichrequires that losses be accrued when they are probable of occurring andestimable and (2) SFAS No. 114, which requires that losses be accrued onimpaired loans based on the differences between the value of collateral,present value of future cash flows or values that are observable in thesecondary market and the loan balance.

The Company performsperiodic and systematic detailed evaluations of its lending portfolio toidentify and estimate the inherent risks and assess the overall collectibility.These evaluations include general conditions such as the portfolio composition,size and maturities of various segmented portions of the portfolio such assecured, unsecured, construction, and Small Business Administration (“SBA”).

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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 on thesegmentation of its portfolio. For those segments that require an ALL, theCompany estimates loan losses on a monthly basis based upon its ongoing loanreview process and analysis of loan performance. The Company follows asystematic 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 individuallyimpaired loans, SFAS No. 114 provides guidance on the acceptable methodsto measure impairment. Specifically, SFAS No. 114 states that when a loanis impaired, the Company should measure impairment based on the present valueof expected 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.

*LoanSales and Servicing*

The Company originatesgovernment guaranteed loans and mortgage loans that may be sold in thesecondary market. The amounts of gains recorded on sales of loans and theinitial recording of servicing assets and interest only (I/O) strips is basedon the estimated fair values of the respective components. In recording theinitial value of the servicing assets and the fair value of the I/O stripsreceivable, the Company uses estimates which are made based on management’sexpectations of future prepayment and discount rates. Servicing assets areamortized over the estimated life of the related loan. I/O strips are notsignificant at December 31, 2006. These prepayment and discount rates werebased on current market conditions and historical performance of the variouspools of serviced loans. If actual prepayments with respect to sold loans occurmore quickly than projected the carrying value of the servicing assets may haveto be adjusted through a charge to earnings.

*Stock-BasedCompensation*

On January 1, 2006, the Company adopted Statement ofFinancial Accounting Standards No. 123(R),*Share Based Payment*(“SFAS 123(R)”). Under SFAS No.123(R), compensation expense is recognized foroptions granted prior to the adoption date in an amount equal to the fair valueof the unvested amounts over their remaining vesting period, based on the grantdate fair value estimated in accordance with SFAS No. 123, *Accountingfor Stock Based Compensation* and compensation expense for all share based payments granted afteradoption based on the grant date fair values estimated in accordance with SFASNo. 123(R) . The estimates of the grant date fair values are based on an optionpricing model that uses assumptions based on the expected option life, thelevel of estimated forfeitures, expected stock volatility and the risk-freeinterest rate. The calculation of the fair value of share based payments is bynature inexact, and represents management’s best estimate of the grant datefair value of the share based payments. See Note 1 to the audited ConsolidatedFinancial Statements in Item 8 of this Annual Report.

*RevenueRecognition*

The Company’s primary source of revenue is interestincome, which is the difference between the interest income it receives oninterest-earning assets and the interest expense it pays on interest-bearingliabilities, and (ii) fee income, which includes fees earned on depositservices, income from SBA lending, electronic-based cash management services,mortgage brokerage fee income and merchant credit card processing services.Interest income is recorded on an accrual basis. Note 1 to the ConsolidatedFinancial Statements offers an explanation of the process for determining whenthe accrual of interest income is discontinued on an impaired loan.

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*IncomeTaxes*

The Company accounts for income taxes under the assetand liability method. Under the asset and liability method, deferred tax assetsand liabilities are recognized for the future tax consequences attributable to differencesbetween the financial statement carrying amounts of existing assets andliabilities and their respective tax bases. Deferred tax assets and liabilitiesare measured using currently enacted tax rates applied to such taxable incomein the years in which those temporary differences are expected to be recoveredor settled. The effect on deferred tax assets and liabilities of a change intax rates is recognized in income in the period that includes the enactmentdate. If future income should prove non-existent or less than the amount ofdeferred tax assets within the tax years to which they may be applied, theasset may not be realized and our net income will be reduced.

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

For 2006, netincome was $7.15 million, compared to the $7.20 million earned in 2005 and netincome of $5.61 million in 2004. Net income per diluted share was $.93 for2006, as compared to $.95 during 2005 and $.74 in 2004. The Company’s Return onAverage Assets (“ROAA”) was 1.38% and Return on Average Equity (“ROAE”) was15.99% in 2006, as compared to 1.51% and 18.82%, respectively, in 2005 and1.34% and 17.20%, respectively, for 2004.

The upwardmovement in rates of 100 basis points by the FOMC (Federal Open MarketCommittee), during the first half of 2006 helped the Company achieve a betternet interest margin on a year over year basis. Net interest income, generatedby a higher level of average earning assets, increased by $4.2 million from2005 to 2006. Moreover, the relatively stable long-term market rates allowedthe Company to maintain a steady volume of mortgage loans, which we were ableto sell at substantial gains. The Company was also able to sell several USDABusiness and Industry guaranteed loans and SBA loans for substantial gains.Offsetting these increases in income was increased non interest expenses,primarily related to salaries and employee benefits and increased occupancycosts from the full year impact in 2006 of the branches and loan productionoffices opened in 2005.

###### **Resultsof 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 increase 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.

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

The Company earnsincome from two primary sources. The first is net interest income brought aboutby income 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 interestincome, which is simply total interest income (including fees) less totalinterest expense, was $31.3 million in 2006 compared to $27.1 million and $20.9million in 2005 and 2004, respectively. This

28

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represents anincrease of 15.5% in 2006 over 2005 and an increase of 29.7% in 2005 over 2004.The amount by which interest income exceeds interest expense depends on severalfactors. Among those factors are yields on earning assets, the cost ofinterest-bearing liabilities, the relative volume of total earning assets andtotal interest-bearing liabilities, and the mix of products which comprise theCompany’s earning assets, deposits, and other interest-bearing liabilities.Change in the amount and mix of interest-earning assets and interest-bearingliabilities is referred to as “volume change.” Change in interest rates earned on assets and rates paid on deposits andother borrowed funds is referred to as “rate change.”

The Volume andRate Variances 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,** | ** ** |
|------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                     | ** ** | **2006 over 2005**                | ** ** | **2005 over 2004** | ** ** |
| ** **                                     | ** ** | **Increase(decrease) due to**     | ** ** | **Increase(decrease) due to** | ** ** |
| **Volume & Rate Variances** | ** ** | **Volume**                                  | ** ** | **Rate** | ** ** | **Net** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Net** | ** ** |
| **(dollars in thousands)**                     | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Earning Assets:**                            |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Loans                                          |       | $                                           | 4,916      |   | $ | 3,682 |   | $ | 8,598 |   | $ | 5,201 |   | $ | 1,701 |   | $ | 6,902 |   |
| Federal funds sold                             |       | $                                           | (405       | ) | $ | 308 |   | $ | (97 | ) | $ | (111 | ) | $ | 566 |   | $ | 455 |   |
| Investment Securities:                         |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                                        |       | $                                           | (48        | ) | $ | 30 |   | $ | (18 | ) | $ | 40 |   | $ | 9 |   | $ | 49 |   |
| Non-taxable(1)                                 |       | $                                           | (45        | ) | $ | (1 | ) | $ | (46 | ) | $ | 65 |   | $ | (8 | ) | $ | 57 |   |
| Deposits in banks                              |       | $                                           | (106       | ) | $ | 45 |   | $ | (61 | ) | $ | (26 | ) | $ | 21 |   | $ | (5 | ) |
| Total earning  assets                          |       | $                                           | 4,312      |   | $ | 4,064 |   | $ | 8,376 |   | $ | 5,169 |   | $ | 2,289 |   | $ | 7,458 |   |
|                                           |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| **Interest-Bearing Liabilities**               |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  deposits:                    |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
|                                           |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Demand -  interest bearing                     |       | $                                           | (53        | ) | $ | 578 |   | $ | 525 |   | $ | 69 |   | $ | 138 |   | $ | 207 |   |
| Savings Accounts                               |       | $                                           | 6          |   | $ | 150 |   | $ | 156 |   | $ | 36 |   | $ | (1 | ) | $ | 35 |   |
| Certificates of  Deposit                       |       | $                                           | 1,482      |   | $ | 1,878 |   | $ | 3,360 |   | $ | 502 |   | $ | 339 |   | $ | 841 |   |
| Total interest  bearing deposits               |       | $                                           | 1,435      |   | $ | 2,606 |   | $ | 4,041 |   | $ | 607 |   | $ | 476 |   | $ | 1,083 |   |
| Borrowed funds:                                |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Other Borrowings                               |       | $                                           | 17         |   | $ | 142 |   | $ | 159 |   | $ | 8 |   | $ | 184 |   | $ | (1 | ) |
| Total Borrowed  Funds                          |       | $                                           | 17         |   | $ | 142 |   | $ | 159 |   | $ | 8 |   | $ | 184 |   | $ | 192 |   |
| Total Interest  Bearing Liabilities            |       | $                                           | 1,452      |   | $ | 2,748 |   | $ | 4,200 |   | $ | 615 |   | $ | 660 |   | $ | 1,275 |   |
| **Net  Interest Margin/Income**                |       | $                                           | 2,860      |   | $ | 1,316 |   | $ | 4,176 |   | $ | 4,554 |   | $ | 1,629 |   | $ | 6,183 |   |

 

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(1)          Yields on tax exempt income have not been computed on a tax equivalentbasis.

The Company’s netinterest margin is its net interest income expressed as a percentage of averageearning assets. The Company’s net interest margin for 2006 was 6.62% anincrease of 30 basis points from the 6.32% reported in 2005. For the year 2004,this margin was 5.70%. The following Distribution, Rate and

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Yield table shows,for each of the past three years, the rates earned on each component of theCompany’s investment and loan portfolio and the rates paid on each segment ofthe Company’s interest bearing liabilities. That same table also shows theCompany’s average daily balances for each principal category of assets,liabilities and shareholders’ equity, the amount of interest income or interestexpense, and the average yield or rate for each category of interest-earningasset and interest-bearing liability along with the net interest margin foreach of the reported periods.

**Distribution, Rate & Yield**
| ** **                                           | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                           | ** ** | **2006(a)**                                | ** ** | **2005(a)** | ** ** | **2004(a)** | ** ** |
| **(dollars in thousands)**                 | ** ** | **Average  Balance**                       | ** ** | **Income/  Expense** | ** ** | **Average  Rate** | ** ** | **Average  Balance** | ** ** | **Income/  Expense** | ** ** | **Average  Rate** | ** ** | **Average  Balance** | ** ** | **Income/  Expense** | ** ** | **Average  Rate** | ** ** |
| **Assets**                                           |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Investments:                                         |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Federal Funds Sold                                   |       | $                                          | 17,164     |   | $ | 846 |   | 4.93 | % | $ | 30,066 |   | $ | 943 |   | 3.14 | % | $ | 38,945 |   | $ | 488 |   | 1.25 | % |
| Taxable                                              |       | $                                          | 4,403      |   | $ | 181 |   | 4.12 | % | $ | 5,793 |   | $ | 199 |   | 3.45 | % | $ | 4,575 |   | $ | 151 |   | 3.30 | % |
| Non-taxable(1)                                       |       | $                                          | 1,370      |   | $ | 65 |   | 4.74 | % | $ | 2,289 |   | $ | 111 |   | 4.85 | % | $ | 1,039 |   | $ | 54 |   | 5.20 | % |
| Deposits in Banks                                    |       | $                                          | 4,409      |   | $ | 178 |   | 4.04 | % | $ | 7,918 |   | $ | 239 |   | 3.02 | % | $ | 8,862 |   | $ | 244 |   | 2.75 | % |
| Total  Investments                                   |       | $                                          | 27,346     |   | $ | 1,270 |   | 4.65 | % | $ | 46,066 |   | $ | 1,492 |   | 3.24 | % | $ | 53,421 |   | $ | 937 |   | 1.75 | % |
| Loans:                                               |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Agricultural                                         |       | $                                          | 28,129     |   | $ | 2,578 |   | 9.17 | % | $ | 25,388 |   | $ | 2,032 |   | 8.00 | % | $ | 26,287 |   | $ | 1,909 |   | 7.26 | % |
| Commercial                                           |       | $                                          | 67,608     |   | $ | 6,655 |   | 9.84 | % | $ | 63,051 |   | $ | 5,827 |   | 9.24 | % | $ | 60,261 |   | $ | 4,996 |   | 8.29 | % |
| Real Estate                                          |       | $                                          | 307,920    |   | $ | 27,167 |   | 8.82 | % | $ | 263,141 |   | $ | 20,967 |   | 7.97 | % | $ | 203,675 |   | $ | 15,579 |   | 7.65 | % |
| Consumer                                             |       | $                                          | 41,461     |   | $ | 3,144 |   | 7.58 | % | $ | 31,079 |   | $ | 2,120 |   | 6.82 | % | $ | 23,689 |   | $ | 1,559 |   | 6.58 | % |
| Total Loans                                          |       | $                                          | 445,119    |   | $ | 39,544 |   | 8.88 | % | $ | 382,659 |   | $ | 30,946 |   | 8.09 | % | $ | 313,912 |   | $ | 24,043 |   | 7.66 | % |
| Total Earning Assets(2)                              |       | $                                          | 472,465    |   | $ | 40,814 |   | 8.64 | % | $ | 428,725 |   | $ | 32,438 |   | 7.57 | % | $ | 367,333 |   | $ | 24,980 |   | 6.80 | % |
| Non-Earning Assets                                   |       | $                                          | 45,159     |   |   |   |   |   | $ | 48,167 |   |   |   |   |   | $ | 49,825 |   |   |   |   |   |
| **Total  Assets**                                    |       | $                                          | 517,624    |   |   |   |   |   | $ | 476,892 |   |   |   |   |   | $ | 417,158 |   |   |   |   |   |
| **Liabilities and Shareholders’  Equity**       |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-Bearing  Deposits:                          |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| NOW                                                  |       | $                                          | 137,358    |   | $ | 1,210 |   | 0.88 | % | $ | 143,250 |   | $ | 934 |   | 0.65 | % | $ | 136,612 |   | $ | 811 |   | 0.59 | % |
| Savings                                              |       | $                                          | 37,893     |   | $ | 337 |   | 0.89 | % | $ | 36,759 |   | $ | 181 |   | 0.49 | % | $ | 29,463 |   | $ | 145 |   | 0.49 | % |
| Money Market                                         |       | $                                          | 40,066     |   | $ | 616 |   | 0.88 | % | $ | 41,795 |   | $ | 368 |   | 0.88 | % | $ | 37,820 |   | $ | 284 |   | 0.75 | % |
| TDOA’s, and IRA’s                          |       | $                                          | 6,537      |   | $ | 242 |   | 3.70 | % | $ | 6,434 |   | $ | 183 |   | 2.84 | % | $ | 6,895 |   | $ | 177 |   | 2.57 | % |
| Certificates of Deposit  < $100,000               |       | $                                          | 78,661     |   | $ | 3,242 |   | 4.12 | % | $ | 54,005 |   | $ | 1,510 |   | 2.80 | % | $ | 45,681 |   | $ | 1,032 |   | 2.26 | % |
| Certificates of Deposit  > $100,000               |       | $                                          | 72,513     |   | $ | 3,061 |   | 4.22 | % | $ | 47,417 |   | $ | 1,492 |   | 3.15 | % | $ | 36,854 |   | $ | 1,136 |   | 3.08 | % |
| Total  Interest-Bearing Deposits                     |       | $                                          | 373,028    |   | $ | 8,708 |   | 2.33 | % | $ | 329,660 |   | $ | 4,668 |   | 1.42 | % | $ | 293,325 |   | $ | 3,585 |   | 1.22 | % |
| Borrowed Funds:                                      |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other Borrowings                                     |       | $                                          | 9,334      |   | $ | 824 |   | 8.81 | % | $ | 9,095 |   | $ | 663 |   | 7.29 | % | $ | 8,935 |   | $ | 471 |   | 5.27 | % |
| Total Borrowed  Funds                                |       | $                                          | 9,334      |   | $ | 824 |   | 8.81 | % | $ | 9,095 |   | $ | 663 |   | 7.29 | % | $ | 8,935 |   | $ | 471 |   | 5.27 | % |
| Total Interest  Bearing Liabilities                  |       | $                                          | 382,362    |   | $ | 9,532 |   | 2.49 | % | $ | 338,755 |   | $ | 5,331 |   | 1.57 | % | $ | 302,260 |   | $ | 4,056 |   | 1.34 | % |
| Demand Deposits                                      |       | $                                          | 83,427     |   |   |   |   |   | $ | 89,325 |   |   |   |   |   | $ | 77,225 |   |   |   |   |   |
| Other Liabilities                                    |       | $                                          | 7,112      |   |   |   |   |   | $ | 10,560 |   |   |   |   |   | $ | 5,066 |   |   |   |   |   |
| Shareholders’ Equity                            |       | $                                          | 44,723     |   |   |   |   |   | $ | 38,252 |   |   |   |   |   | $ | 32,607 |   |   |   |   |   |
| **Total Liabilities and  Shareholders’ Equity** |       | $                                          | 517,624    |   |   |   |   |   | $ | 476,892 |   |   |   |   |   | $ | 417,158 |   |   |   |   |   |
|                                                 |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest Income/Earning  Assets                      |       |                                       |       |   |   | 8.64 | % |   |   |   |   | 7.57 | % |   |   |   |   | 6.80 | % |
| Interest  Expense/Earning Assets                     |       |                                       |       |   |   | 2.02 | % |   |   |   |   | 1.24 | % |   |   |   |   | 1.10 | % |
| **Net Interest Margin(3)**                           |       |                                       |       | $ | 31,282 |   | 6.62 | % |   |   | $ | 27,107 |   | 6.32 | % |   |   | $ | 20,924 |   | 5.70 | % |

 

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

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

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

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

(4)          Yields and amounts earned on loans includeloan fees of $2,450,000, $2,453,000 and $2,303,000 for the years ended December31, 2006, 2005 and 2004 respectively.

30

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During 2006, theCompany’s net interest margin improved primarily as a result of the growth andchange in the mix in earning assets. Average investments decreased asmaturities and growth in deposits were used to fund the increase in averageloans.  This combination contributed toan overall increase in net interest margin. On an average basis, the rates onloans increased by 79 basis points resulting in an increase in interest incomeof $3.7 million. This increase in rates was augmented by the increase in theaverage volume of loans of $62 million that generated an additional $4.9million in loan related interest income. On an average basis, the rates oninvestments increased by 141 basis points resulting in an increase in interestincome of $382 thousand, however this was more than offset by the decrease inthe average volume of investment securities of $18.7 million which resulted ina decrease in interest income of $604 thousand. Overall interest income on earning assets increased by $8.4 million.

A large portion ofthe Bank’s loans carry variable rates and re-price immediately, versus a largebase of core deposits which are generally slower to re-price. Interest expenseincreased in 2006 as rates increased and the Company’s mix of deposits changedfrom transaction based lower rate demand deposits to higher rate certificatesof deposit.  The average rates paid oninterest bearing deposits for 2006 was 2.33% compared to 1.42% in 2005 and1.22% in 2004. The changes in rates in 2006 compared to 2005 were primarily dueto the changes in interest rates brought on by Fed actions as discussedpreviously. The average rates that are paid on deposits generally trail behindthese money market rate changes for two reasons: (1) financial institutions donot try to change deposit rates with each small increase or decrease inshort-term rates; and (2) with time deposit accounts, even when new offering ratesare established, the average rates paid during the year are a blend of the ratepaid on individual accounts. Only new accounts and those that mature and arerenewed will bear the new rate. On an average basis, NOW account deposits weredown $5.9 million, savings account deposits were up $1.1 million, money marketaccount deposits were down $1.7 million and certificate of deposit balanceswere up $49.8 million. Average non interest bearing demand deposits balancesdecreased by $6.9 million or 8.4%, from 2005 to 2006.

From 2005 to 2006,the Company’s average loan portfolio grew by approximately $62 million, or16.3%, building on the growth of $69 million, or 21.9% from 2004 to 2005. Theearnings on that growth, net of associated funding costs, are a significantcontributor to net interest income. Additionally, loan balances, which are thehighest yielding component of the Company’s earning assets, increased during2006 as a portion of the Company’s average asset base. During 2006, the loanportfolio averaged 86% of total assets, while for 2005 and 2004 such balancesrepresented 80.2% and 75.3%, respectively, of average assets.

Based on theseindications and current economic conditions, the Company expects moderateincreases in the rates paid on interest-bearing liabilities and rates earned onboth the investment and loan portfolio during 2007. In order to fund the loanportfolio growth anticipated in 2007, it is anticipated that the Company’s netinterest margin will experience some compression as we will have to pay higherrates on deposits to attract the funds necessary for that growth. Net interestincome should increase if loans grow as planned even if the loan growth isfunded by higher priced deposits. However, no assurance can be given that thiswill, in fact, occur.

###### **Non-interestIncome and Non-interest Expense**

For the year 2006,non-interest income increased slightly by $58,000 or (.86%) to $6,769,000 ascompared to $6,711,000 for 2005. Non interest income in 2004 was $6,018,000.The primary traditional sources of non-interest income for the Company areservice charges on deposit accounts, gains on the sale of loans, loan servicingincome, alternative investment fees earned on the sales of non-depositinvestment products and merchant credit card fees. Service charges on depositaccounts and loan sales income in 2006 accounted for 39.7% and 23.3%,respectively, of total non-interest income, as compared to 35% and 27.8%,

31

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respectively, for2005 and 34.7% and 30.3%, respectively, for 2004. Loan servicing income,alternative investment fees and merchant credit card fees for 2006 were 6.8%,5.2% and 5.6% respectively, of total non-interest income, as compared to 6.3%,7.7% and 5.8%, respectively, for 2005 and 6.4%, 7.1% and 5.1%, respectively,for 2004.

The primary sourceof non-interest income during 2006 was from service charges on deposit accountsfollowed by the gain recognized on the sale of loans. The increase in servicecharges on deposit accounts was primarily a result of the fees charged onadditional deposit accounts opened during the year, and the overdraft privilegedeposit product which on a year over year basis increased $320,000. Loan salesincome decreased $228,000 from $1,806,000 in 2005 to $1,578,000 in 2006. Thiswas a result of the lower volume of mortgage loans sold during 2006. Mortgageloan activity was still vigorous in 2005 and fees derived from the sale ofthese loans increased from 2004. The real estate market has softened in most ofthe areas we serve which has resulted in more homes for sale thereby creatingan environment more advantageous to the buyer than the seller.

The loan portfolioalso includes loans which are 75% to 90% guaranteed by the Small BusinessAdministration (SBA), U.S. Department of Agriculture, Rural Business-CooperativeService (RBS) and Farm Services Agency (FSA). The guaranteed portion of theseloans may be sold to a third party, with the Company retaining the unguaranteedportion. The Company generally receives a premium in excess of the adjustedcarrying value of the loan at the time of sale.

The portfolio ofreal estate loans being serviced by the Company declined by 3% from 2005 to2006. The portfolio of SBA, RBS and FSA government guaranteed loans beingserviced by the Company declined by 1.8% from 2005 to 2006. These reductionsresulted in a decrease in loan servicing income of $24,000 from $481,000 in2005 to $457,000 in 2006.

Alternativeinvestment fees earned on the sales of non-deposit investment productsdecreased by $170,000 in 2006 compared to 2005 primarily as a result of fewersales throughout the year.

Merchant creditcard fees declined by $9,000 from $390 thousand in 2005, to $381 thousand in2006. Through more aggressive marketing efforts of this product, managementexpects income from this area to increase somewhat in 2007.

Aratio that is used to compare the Company’s expenses to those of otherfinancial institutions is the operating efficiency ratio.  This ratio takes into account the fact thatfor many financial institutions some of their income is not asset-based, it isbased on fees for services provided rather than income earned from a spreadbetween the interest earned on assets and interest paid on liabilities.  The operating efficiency ratio measures whatportion of each dollar of net revenue is spent earning that revenue.  With a portion of the Company’s revenuescoming from such areas as the Insurance Agency, Payroll Services and MerchantServices, i.e., from programs that require operating expenses to run but arenot related to assets on the Company’s balance sheet, management focuses moreon this ratio than the operating expense to assets ratio.    The Company is increasingly focused onenhancing its fee income. Based on the Company’s efficiency ratio of 65.8% for2006, 61.6% for 2005, and 62.1% for 2004 as compared to the 55% and lowerratios of certain major financial institutions, it is expected that this focuswill continue for the foreseeable future.

The Company’stotal non-interest expense increased to $25.2 million in 2006, as compared to$20.9 million in 2005, and $16.8 million in 2004.

The largest dollarincrease in non-interest expense was in salaries and employee benefits, whichincreased by $3,155,000, or 25.7% from 2005 to 2006. Included within salariesand benefits are actual salaries, bonuses, commissions, retirement benefits,payroll taxes, and stock option expense. This increase resulted from normal cost of living raises, and salariespaid to employees for a full year during 2006 at the Corning branch whichopened in March, 2005 and the Redding branch which opened in September, 2005.We also opened a Loan Production Office in the city of Gridley in July, 2005.Staffing additions made during the year as the Company continued to grow alsocontributed to the increase. The increase in salaries and benefits in 2005compared to 2004 was $2,290,000 or 22.9%. Full time equivalent employeesincreased to 263 at December 31, 2006 from 240 at December 31, 2005 and 204 atDecember 31, 2004. Benefit costs

32

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and employer taxesincreased commensurate with the salaries. It is management’s opinion that theCompany can achieve significant growth in loans and deposits with the currentstaff, however increases in staffing are expected during 2007 as the Companymoves forward with the planned addition of a second full service branch inRedding and Yuba City and a full service branch in Anderson. The Redding andAnderson branches are scheduled to open at the end of the second quarter withthe Yuba City branch due to open during the third quarter.

Occupancy andequipment expenses were $3,480,000, an increase of $511,000 or 17.2% whencompared to the 2005 total of $2,969,000. Much of the increase in occupancyexpense was related to furniture, fixtures and equipment for the relocation tothe new Red Bluff, Redding, Marysville and Corning branches opened during 2006.The lease agreements and remodeling costs associated with these offices, alsoadded to the year over year increase. The increase in occupancy expenses in2005 compared to 2004 was $444,000 or 18%.

The majority ofthe increase in professional services costs of $152,000 from 2005 to 2006relates to outsourcing audit work and the process of implementingSarbanes-Oxley 404 compliance. The increase in 2005 compared to 2004 was due tooutsourcing of audit work and the application process for the Company to jointhe NASDAQ exchange.  Advertising andmarketing expenses increased by 60% in 2006 from 2005 after increasing by 36%in 2005 from 2004 as we promoted the new branches and the four branch relocationsto new facilities.

Expensesrepresenting telephone and data communications, postage and mail, stationeryand supplies, director fees and retirement accruals, advertising and promotion,and other expenses totaled $4,931,000 for 2006 compared to $4,651,000 in 2005and $3,657,000 in 2004, an increase of 6.0% and 27.2% on a year over yearbasis. Management considers this increase in expenses commensurate with thegrowth of the Company.

The Company has two sharebased compensation plans.  In 2006, theCompany adopted Statement of Financial Accounting Standards No. 123(R), *Share-Based Payment* (SFAS 123(R)), using the modifiedprospective application transition method. Prior to January 1, 2006, the Company accounted for these plans underthe recognition and measurement principles of APB Opinion No. 25, *Accounting for Stock Issued to Employees*, and relatedInterpretations (APB 25).  No stock-basedcompensation cost is reflected in net income prior to January 1, 2006, as alloptions granted under these plans had an exercise price equal to the marketvalue of the underlying common stock on the date of the grant.  As a result of adopting SFAS 123(R), theCompany’s income before provision for income taxes and net income for the yearended December 31, 2006 are $175,000 and $163,000, respectively, lower than ifit had continued to account for share-based compensation under APB 25.  Basic and diluted earnings per share for theyear ended December 31, 2006 would have been $.02 higher without the adoptionof SFAS 123(R). Results for prior periods have not been restated.

The Company bases thefair value of the options previously granted on the date of grant using aBlack-Scholes option pricing model that uses assumptions based on expectedoption life, the level of estimated forfeitures, expected stock volatility andthe risk-free interest rate.  Stockvolatility is based on the historical volatility of the Company’s stock.  The risk-free rate is based on the U.S.Treasury yield curve and the expected term of the options.  The “simplified” method described in SECStaff Accounting Bulletin No. 107 was used to determine the expected term ofthe Bank’s options in 2006 and 2005.

There were no significantchanges in the valuation methods or types of awards or terms made by the Companysubsequent to the adoption of SFAS No. 123(R) and no cumulative effectadjustments were made to the financial statements.

As of December 31, 2006,there was $391,000 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 2.33 years. See Notes 1 and 11 to the audited Consolidated Financial Statements inItem 8.

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**NonInterest Income/Expense**

(dollars in thousands, unaudited)
| ** **                                                       | ** ** | **2006** | ** ** | **% of Total** | ** ** | **2005** | ** ** | **% of Total** | ** ** | **2004** | ** ** | **% of Total** | ** ** |
|------------------------------------------------------------------|------------|----------|------------|--------------------------|------------|----------|------------|--------------------------|------------|----------|------------|--------------------------|------------|
| NON-INTEREST  INCOME:                                            |       |     |       |                     |       |     |       |                     |       |     |       |                     |       |
| Service charges  on deposit accounts                             |       | $        | 2,686      |                     | 39.68      | %        | $          | 2,351                    |       | 35.03    | %          | $                        | 2,086      |   | 34.66 | % |
| Gain on sale of  loans                                           |       | $        | 1,578      |                     | 23.31      | %        | $          | 1,806                    |       | 26.91    | %          | $                        | 1,637      |   | 27.20 | % |
| Loan servicing  income                                           |       | $        | 457        |                     | 6.75       | %        | $          | 481                      |       | 7.17     | %          | $                        | 571        |   | 9.49 | % |
| Alternative  investment fees                                     |       | $        | 350        |                     | 5.17       | %        | $          | 520                      |       | 7.75     | %          | $                        | 428        |   | 7.11 | % |
| Merchant card  processing fees                                   |       | $        | 381        |                     | 5.63       | %        | $          | 390                      |       | 5.81     | %          | $                        | 337        |   | 5.60 | % |
| Earnings from  cash surrender value of bank owned life insurance |       | $        | 330        |                     | 4.88       | %        | $          | 294                      |       | 4.38     | %          | $                        | 284        |   | 4.72 | % |
| Other                                                            |       | $        | 987        |                     | 14.58      | %        | $          | 869                      |       | 12.95    | %          | $                        | 675        |   | 11.22 | % |
| Total non-interest income                                        |       | $        | 6,769      |                     | 100.00     | %        | $          | 6,711                    |       | 100.00   | %          | $                        | 6,018      |   | 100.00 | % |
| As a percentage of average earning assets                        |       |     |       | 1.43                     | %          |     |       | 1.57                     | %          |     |       | 1.64                     | %          |
|                                                             |       |     |       |                     |       |     |       |                     |       |     |       |                     |       |
| NON-INTEREST  EXPENSES:                                          |       |     |       |                     |       |     |       |                     |       |     |       |                     |       |
| Salaries and  employee benefits                                  |       | $        | 15,425     |                     | 61.64      | %        | $          | 12,270                   |       | 58.64    | %          | $                        | 9,980      |   | 59.42 | % |
| Occupancy and  equipment                                         |       | $        | 3,480      |                     | 13.91      | %        | $          | 2,969                    |       | 14.19    | %          | $                        | 2,525      |   | 15.03 | % |
| Professional fees                                                |       | $        | 1,187      |                     | 4.74       | %        | $          | 1,035                    |       | 4.95     | %          | $                        | 633        |   | 3.77 | % |
| Telephone and  postage                                           |       | $        | 630        |                     | 2.52       | %        | $          | 580                      |       | 2.77     | %          | $                        | 511        |   | 3.04 | % |
| Stationery &  supply costs                                   |       | $        | 601        |                     | 2.40       | %        | $          | 545                      |       | 2.60     | %          | $                        | 521        |   | 3.10 | % |
| Director fees  and retirement accrual                            |       | $        | 450        |                     | 1.80       | %        | $          | 469                      |       | 2.24     | %          | $                        | 408        |   | 2.43 | % |
| Advertising and  promotion                                       |       | $        | 660        |                     | 2.64       | %        | $          | 412                      |       | 1.97     | %          | $                        | 302        |   | 1.80 | % |
| Other                                                            |       | $        | 2,590      |                     | 10.35      | %        | $          | 2,645                    |       | 12.64    | %          | $                        | 1,915      |   | 11.40 | % |
| Total non-interest expense                                       |       | $        | 25,023     |                     | 100.00     | %        | $          | 20,925                   |       | 100.00   | %          | $                        | 16,795     |   | 100.00 | % |
| As a % of  average earning assets                                |       |     |       | 5.30                     | %          |     |       | 4.88                     | %          |     |       | 4.57                     | %          |

 

###### **Provisionfor Loan Losses**

Credit risk isinherent in the business of making loans. The Company sets aside an allowancefor loan losses through charges to earnings. The charges are shown in theincome statements as provisions for loan losses, and specifically identifiableand quantifiable losses are immediately charged off against the allowance.

The Company’sprovisions for loan losses and undisbursed commitments in 2006, 2005, and 2004were $775,000, $825,000, and $790,000 respectively. The amounts allocated tothe provision and the undisbursed commitments were $638,000 and $137,000respectively for 2006, $724,000 and $101,000 for 2005 and $734,000 and $56,000for 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.”

###### **IncomeTaxes**

As indicated inNote 13 in the Notes to the Consolidated Financial Statements, the provisionfor income taxes is the sum of two components, the provision for current taxesand deferred 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

34

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purposes than whenapplying accounting principles generally accepted in the United States ofAmerica, however, leading to differences between the Company’s actual taxliability and the amount accrued for this liability based on book income. Thesetemporary timing differences comprise the deferred portion of the Company’s taxprovision.

Most of theCompany’s temporary differences involve recognizing more expenses in itsfinancial statements than it has been allowed to deduct for tax purposes, andtherefore the Company normally carries a net deferred tax asset on its books.At December 31, 2006, the Company’s $5.2 million net deferred tax asset wasprimarily due to temporary differences in the reported allowance for loanlosses, deferred compensation, and future benefit of state tax deduction offsetby the temporary differences related to certain deferred tax liabilities.

###### **FinancialCondition**

The followingdiscussion of the financial condition of the Company is grouped into earningassets, comprised of loans and investments; non-earning assets, comprised ofcash and due 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 comparisonbetween the summary year-end balance sheets for 2002 through 2006 was presentedpreviously in the table of Selected Financial Data (see Item 6 above). Asindicated in that table, the Company’s total assets, loans, deposits, andshareholders’ equity have grown each year for the past four years, with assetgrowth, in terms of total dollars, most pronounced in 2004 when the Companygrew by $63 million, or 16.3%.  This wasfollowed by growth in the Company’s total assets during 2005 of $45 million or10% and growth in the Company’s total assets during 2006 of approximately $55million, or 11.2%.

The mix ofdeposits in NOW, money market and savings average balances changed very littlefrom 2005 to 2006 declining by $5.5 million or 3%.  As interest rates gradually increased through2006 the growth in deposits was primarily in certificates of deposit.  These balances increased by $49.9 millionwhile the average rates paid on all interest bearing deposits increased by 91basis points.  In the third quarter ourloan volume peaked which resulted in the Company obtaining brokered depositsfrom the wholesale market.  Thesebrokered deposits also contributed to the increase in average rates paid forthe year.  Throughout 2006 deposit growthwas achieved in our newer markets in Red Bluff, Marysville, Corning andRedding. We believe this will be the case again in 2007 as we have relocatedall of these branches from their less desirable storefront environment to freestanding buildings with drive-up lanes. As mentioned previously construction is underway for a second fullservice branch in Redding and for a new branch in Anderson.  When opened in the second quarter of 2007,these two branches will complement the existing branch in Redding in gatheringmore deposits.   The opening in the thirdquarter of 2007of a second branch in Yuba City will cover more of the southernsection and will be located in a shopping center on Highway 99.

###### **LoanPortfolio**

The Company offersa wide variety 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 31,2006, gross loans represented 81.5% of total assets, as compared to 82.3% and76.4% at December 31, 2005 and 2004, respectively. The quality anddiversification of the Company’s loan portfolio are important considerationswhen reviewing the Company’s results of operations.

The Selected FinancialData table in Item 6 reflects the net amount of loans outstanding at December31st for each year between 2002 and 2006. The LoanDistribution table which follows sets forth the amount and composition of theCompany’s total loans outstanding in each category at the dates indicated.

35

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**Loan Distribution**
| ** **                           | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------|------------|---------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| **(dollars in thousands)** | ** ** | **As of December 31,** | ** ** |
| ** **                           | ** ** | **2006**                              | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** |
| Agricultural                         |       | $                                     | 25,745     |       | $          | 24,803     |       | $          | 22,177     |       | $          | 20,820 |   | $ | 18,935 |   |
| Commercial                           |       | $                                     | 65,241     |       | $          | 61,162     |       | $          | 58,662     |       | $          | 57,739 |   | $ | 48,661 |   |
| Real estate –  commercial       |       | $                                     | 208,102    |       | $          | 173,449    |       | $          | 146,876    |       | $          | 111,249 |   | $ | 82,057 |   |
| Real estate –  construction     |       | $                                     | 105,449    |       | $          | 111,130    |       | $          | 90,643     |       | $          | 63,345 |   | $ | 64,565 |   |
| Installment                          |       | $                                     | 43,789     |       | $          | 36,501     |       | $          | 26,219     |       | $          | 21,698 |   | $ | 19,325 |   |
| ** **                           |       | $                                     | 448,326    |       | $          | 407,045    |       | $          | 344,577    |       | $          | 274,851 |   | $ | 233,543 |   |
| ** **                           | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Deferred loan  origination fees, net |       | $                                     | (801       | )          | $          | (1,108     | )          | $          | (1,022     | )          | $          | (1,033 | ) | $ | (837 | ) |
| Allowance for  loan losses           |       | $                                     | (5,274     | )          | $          | (4,716     | )          | $          | (4,381     | )          | $          | (3,587 | ) | $ | (3,007 | ) |
|                                 |       | $                                     | 442,251    |       | $          | 401,221    |       | $          | 339,174    |       | $          | 270,231 |   | $ | 229,699 |   |
|                                 |       |                                  |       |       |       |       |       |       |       |       |       |
| **Percentage  of Total Loans**       | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Agricultural                         |       | 5.74                                  | %          | 6.09       | %          | 6.44       | %          | 7.58       | %          | 8.11       | %          |
| Commercial                           |       | 14.55                                 | %          | 15.03      | %          | 17.02      | %          | 21.01      | %          | 20.84      | %          |
| Real Estate –  commercial       |       | 46.42                                 | %          | 42.61      | %          | 42.63      | %          | 40.48      | %          | 35.13      | %          |
| Real Estate –  construction     |       | 23.52                                 | %          | 27.30      | %          | 26.31      | %          | 23.05      | %          | 27.65      | %          |
| Installment                          |       | 9.77                                  | %          | 8.97       | %          | 7.60       | %          | 7.88       | %          | 8.27       | %          |
|                                 |       | 100.00                                | %          | 100.00     | %          | 100.00     | %          | 100.00     | %          | 100.00     | %          |

 

As reflected inthe Loan Distribution table, aggregate loan balances have increased $212million, or 92%, over the last four years. The largest percentage of growth andlargest dollar volume increase during that that four year period and during2006 was in commercial real estate which grew by $126 million or 153% and $34.6million or 20% respectively.

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 2006 loanssecured by real estate grew by $29 million, or 10.2%, and commercial loans grewby $4.1 million, or 6.7%.  Consumer loansincreased by $7.3 million, or 20%.  Loanssecured by real estate and commercial loans comprised 69.9% and 14.6%,respectively, of the Bank’s total loan portfolio at December 31, 2006.

The Company’scommercial loans are centered in locally oriented commercial activities in themarkets where the Company has a presence. Additionally, the Company has aGovernment Lending Division dedicated to its SBA product and its Business andIndustry (B&I) Guaranteed Loan Program. For the fiscal year ended September30, 2006, the Company was named the number one USDA Business and Industrylender in the entire United States by originating over $46 million in loans.The Company is also designated as an SBA Preferred Lender, which means it hasthe authority to underwrite and approve SBA loans locally. This recognitionlends credence to the Company’s success in meeting the needs of smallerbusiness owners in the communities in which the Company conducts its bankingactivities.

Consistent withthe overall growth in loans, the most significant shift in the loan portfoliomix over the past four years has been in loans secured by commercial realestate, which increased from 35.1% of total loans at the end of 2002 to 46.4%of total loans at the end of 2006. Real estate lending is an important part ofthe Company’s focus, and is likely to remain so for the immediate future.Commercial loans declined to just 14.6% of total loan balances by the end of2006 from 20.8% at the end of 2002, and agricultural loans decreased during thesame period to 5.7% of the total loan balances from 8.1%. The decline in thepercentage of agricultural loans to total loans over the last few years hasbeen due to the growth in the other

36

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lending areasoutpacing the growth in the agricultural lending. Agricultural borrowingrelationships have remained consistent year after year and we have notsubstantially expanded this part of our business.

Another importantaspect of the Company’s loan business has been that of residential real estateloans which were generated internally by the real estate mortgage loandepartment and then sold in the secondary market to government sponsoredenterprises or other long-term lenders. The Company has consistently been amongthe largest real estate mortgage lenders in Butte County for the past severalyears. During 2006, the Company originated and sold aggregate balances ofapproximately $52 million of such loans, a $26 million decrease from the $78million originated and sold in 2005. The Company services the mortgage loanssold to the Federal National Mortgage Association (FNMA). As of December 31,2006, aggregate balances of $153 million were being serviced down slightly fromthe $157 million at the end of 2005.

In the normalcourse of business, the Company makes commitments to extend credit as long asthere are no violations of any condition established in the contractualarrangement. Total outstanding commitments to extend credit were $186 millionat December 31, 2006 as compared to $201 million at December 31, 2005. Thesecommitments represented 41% of outstanding gross loans at December 31, 2006and 49% at December 31, 2005, respectively. The Company’s stand-by letters ofcredit at December 31, 2006 and 2005 were $5.1 million and $4.9 million,respectively, which represented approximately 2.7% and 2.4% of totalcommitments outstanding at the end of 2006 and 2005. It is not anticipated thatall of these commitments or stand-by letters of credit will fund.

Approximately onehalf of the loans held by the Company have floating rates of interest tied tothe Company’s base lending rate or to another market rate indicator so thatthey may be re-priced as interest rates change. The same interest rate andliquidity risks that apply to securities are also applicable to lendingactivity. Fixed-rate loans are subject to market risk:  they decline in value as interest rates rise.The Company’s loans that have fixed rates generally have relatively shortmaturities or amortize monthly, which effectively lessens the market risk. Thetable in Note 16 to the consolidated financial statements shows that atDecember 31, 2006, the difference in the carrying amount of loans, i.e., theirface value, is about $ 3.5 million or .80 % less than their fair value. At theend of 2005, the fair value of loans was about $1.7 million or .42% less thanthe carrying amount.

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

**LoanMaturities**

The following LoanMaturity table shows the amounts of total loans outstanding as of December 31,2006, 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.)

**Loan Maturity**

(dollarsin thousands)
| ** **                  | ** ** | ** **       | ** ** | ** **       | ** ** | ** ** | ** ** | ** ** | ** ** | **Floating**       | ** ** | **Fixed**          | ** ** |
|-----------------------------|------------|------------------|------------|------------------|------------|------------|------------|------------|------------|--------------------|------------|--------------------|------------|
| ** **                  | ** ** | **One**          | ** ** | **One**          | ** ** | **Over**   | ** ** | ** ** | ** ** | **rate:**          | ** ** | **rate:**          | ** ** |
| ** **                  | ** ** | **year or** | ** ** | **to five** | ** ** | **five**   | ** ** | ** ** | ** ** | **due after** | ** ** | **due after** | ** ** |
| ** **                  | ** ** | **less**         | ** ** | **years**        | ** ** | **years**  | ** ** | **Total**  | ** ** | **one year**  | ** ** | **one year**  | ** ** |
| Agricultural                |       | $                | 16,232     |             | $          | 8,782      |       | $          | 731        |               | $          | 25,745             |       | $ | — |   | $ | 9,513 |   |
| Commercial                  |       | $                | 32,887     |             | $          | 3,251      |       | $          | 29,103     |               | $          | 65,241             |       | $ | 2,671 |   | $ | 29,683 |   |
| Real Estate -  Commercial   |       | $                | 99,746     |             | $          | 100,600    |       | $          | 7,756      |               | $          | 208,102            |       | $ | 113 |   | $ | 108,243 |   |
| Real Estate -  Construction |       | $                | 103,360    |             | $          | 2,089      |       | $          | —     |               | $          | 105,449            |       | $ | — |   | $ | 2,089 |   |
| Installment                 |       | $                | 4,176      |             | $          | 38,528     |       | $          | 1,085      |               | $          | 43,789             |       | $ | — |   | $ | 39,613 |   |
|                        |       |             |       |             |       |       |       |       |       |               |       |               |       |
| TOTAL                       |       | $                | 256,401    |             | $          | 153,250    |       | $          | 38,675     |               | $          | 448,326            |       | $ | 2,784 |   | $ | 189,141 |   |

 

37

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

###### **Non-performingAssets**

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

As amulti-community, independent bank headquartered in and serving Butte County(with a smaller presence in each of Colusa, Sutter, Sacramento, Shasta, Tehama,and Yuba counties); the Company has mitigated its risk to any one segment ofthese Northern Sacramento Valley markets. The Company’s asset quality continuesto be excellent with delinquency ratios at low levels. The Company isoptimistic that the local and regional economy will continue to perform, but noassurance can be 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 assetsare comprised of loans on non-accrual status, loans 90 days or more past dueand still accruing interest, loans restructured where the terms of repaymenthave been renegotiated resulting in a deferral of interest or principal andother real estate (“ORE”). Loans are generally placed on non-accrual statuswhen they become 90 days past due as to principal or interest. Loans may berestructured by management when a borrower has experienced some change infinancial status causing an inability to meet the original repayment terms andwhere the Company believes the borrower will eventually overcome thosecircumstances and repay the loan in full. ORE consists of properties acquiredby foreclosure or similar means that management intends to offer for sale.

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

The followingtable provides information with respect to components of the Company’snon-performing assets at the date indicated. The Company has not had any loans90 days past due and still accruing interest in any periods presented.

**Non-performingAssets**

(dollars inthousands)
| ** **                                         | ** ** | **As of December 31,** | ** ** |
|----------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                         | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Nonaccrual  Loans:**                             | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Agricultural                                       |       | $                                     | —     |   | $ | — |   | $ | 17 |   | $ | — |   | $ | — |   |
| Commercial and  Industrial                         |       | $                                     | 1,502      |   | — |   |   |   | $ | 46 |   | $ | 134 |   |
| Real Estate                                        |       |                                  |       |   |   |   |   |   |   |   |   |
| Secured by  Commercial/Professional Office         |       | $                                     | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Properties  Including Construction and Development |       | $                                     | —     |   | $ | — |   | $ | — |   | $ | — |   |   |   |
| Secured by  Residential Properties                 |       | $                                     | 780        |   | $ | — |   | $ | 84 |   | $ | — |   | $ | — |   |
| Secured by  Farmland                               |       | $                                     | —     |   | $ | — |   | $ | — |   |   |   | $ | 460 |   |
| Consumer Loans                                     |       | $                                     |       |   | 9 |   |   |   | $ | 8 |   | $ | — |   |
| **SUBTOTAL**                                       |       | $                                     | 2,282      |   | $ | 9 |   | $ | 101 |   | $ | 54 |   | $ | 594 |   |
|                                               |       |                                  |       |   |   |   |   |   |   |   |   |
| Other Real  Estate (ORE)                           |       | $                                     | —     |   | $ | — |   | $ | — |   | $ | — |   |   |   |
| Total  non-performing Assets                       |       | $                                     | 2,282      |   | $ | 9 |   | $ | 101 |   | $ | 54 |   | $ | 594 |   |
| Restructured  Loans                                |       | N/A                                   |       | N/A |   | N/A |   | N/A |   | N/A |   |
| Non-performing  loans as  % of total gross loans   |       | 0.51                                  | %          | 0.00 | % | 0.03 | % | 0.02 | % | 0.25 | % |
| Non-performing  assets as a  % of total gross      |       |                                  |       |   |   |   |   |   |   |   |   |
| loans and other real  estate                       |       | 0.51                                  | %          | 0.00 | % | 0.03 | % | 0.02 | % | 0.22 | % |

 

Totalnon-performing balances were $2,282,000 at the end of 2006, which consisted ofa commercial loan for $1.6 million for an industrial building on which theCompany has an 80% guarantee from the USDA, and two residential properties. Asof March 9, 2007 the Company has completed foreclosure on all three of theseproperties and has reclassified them as ORE. We have a buyer for the $1.6 million industrial building and have enteredinto escrow with an anticipated close by March 31, 2007.   There was no ORE outstanding at December 31,2006, 2005 or 2004. Other than the loans included as non-performing assets atDecember 31, 2006, the company has not identified any potential problem loansthat would result in any loan being included as a non-performing asset at afuture date.

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

The allowance forloan losses is established through a provision for loan losses based onmanagement’s evaluation of known and inherit risk in our loan portfolio. Theallowance is increased by provisions charged against current earnings andreduced by net charge-offs. Loans are charged off when they are deemed to beuncollectible; recoveries are generally recorded only when cash payments arereceived subsequent to the charge off. The following table summarizes theactivity in the allowance for loan losses for the past five years.

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**Allowance For Loan Losses**

(dollars inthousands)
| ** **                                                          | ** ** | **As of December 31,** | ** ** |
|---------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                          | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Balances:**                                                       | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Average gross  loans outstanding during period                      |       | $                                     | 445,119    |   | $ | 382,659 |   | $ | 313,912 |   | $ | 254,682 |   | $ | 216,953 |   |
| Gross loans  outstanding at end of period                           |       | $                                     | 448,326    |   | $ | 407,045 |   | $ | 344,577 |   | $ | 274,851 |   | $ | 233,542 |   |
|                                                                |       |                                  |       |   |   |   |   |   |   |   |   |
| **Allowance  for Loan Losses:**                                     | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance at  beginning of period                                     |       | $                                     | 4,716      |   | $ | 4,000 |   | $ | 3,587 |   | $ | 3,007 |   | $ | 2,397 |   |
| Adjustments                                                         |       |                                  |       |   |   |   |   |   |   |   |   |
| Provision  Charged to Expense                                       |       | $                                     | 775        |   | $ | 824 |   | $ | 790 |   | $ | 655 |   | $ | 603 |   |
|                                                                |       |                                  |       |   |   |   |   |   |   |   |   |
| Loan Charge-offs                                                    |       |                                  |       |   |   |   |   |   |   |   |   |
| Agricultural                                                        |       |                                  |       |   |   |   |   |   |   |   |   |
| Commercial & Industrial Loans                                   |       | $                                     | 42         |   | $ | — |   | $ | 11 |   | $ | 77 |   | $ | — |   |
| Real Estate Loans                                                   |       | $                                     | 31         |   | $ | — |   | $ | — |   | $ | — |   | $ | 4 |   |
| Consumer Loans                                                      |       | $                                     | 9          |   | $ | 9 |   | $ | 12 |   | $ | 4 |   | $ | 3 |   |
| Credit Card Loans                                                   |       | $                                     | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Total                                                               |       | $                                     | 82         |   | $ | 9 |   | $ | 23 |   | $ | 81 |   | $ | 7 |   |
|                                                                |       |                                  |       |   |   |   |   |   |   |   |   |
| Recoveries                                                          |       |                                  |       |   |   |   |   |   |   |   |   |
| Agricultural                                                        |       | $                                     | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Commercial & Industrial Loans                                   |       | $                                     | 2          |   | $ | 1 |   | $ | 15 |   | $ | — |   | $ | 14 |   |
| Real Estate Loans                                                   |       | $                                     | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Consumer Loans                                                      |       | $                                     | —     |   | $ | — |   | $ | 12 |   | $ | 6 |   | $ | — |   |
| Credit Card Loans                                                   |       | $                                     | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Total                                                               |       | $                                     | 2          |   | $ | 1 |   | $ | 27 |   | $ | 6 |   | $ | 14 |   |
| Net Loan  Charge-offs                                               |       | $                                     | 80         |   | $ | 8 |   | $ | (4 | ) | $ | 75 |   | $ | (7 | ) |
| Reserve for  unfunded commitments                                   |       | $                                     | (137       | ) | $ | (100 | ) | (381 | ) |   |   |   |   |
| Balance at end  of period                                           |       | $                                     | 5,274      |   | $ | 4,716 |   | $ | 4,000 |   | $ | 3,587 |   | $ | 3,007 |   |
|                                                                |       |                                  |       |   |   |   |   |   |   |   |   |
| **Ratios:**                                                         | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net Loan  Charge-offs to Average Loans                              |       | 0.02                                  | %          | 0.00 | % | 0.00 | % | 0.03 | % | 0.05 | % |
| Allowance for  Loan Losses to Gross Loans at End of Period          |       | 1.18                                  | %          | 1.16 | % | 1.16 | % | 1.31 | % | 1.29 | % |
| Allowance for  Loan Losses to Non-Performing Loans                  |       | 231.11                                | %          | 52411.11 | % | 3960.40 | % | 6642.59 | % | 506.23 | % |
| Net Loan  Charge-offs to Allowance for Loan Losses at End of Period |       | 1.52                                  | %          | 0.17 | % | (0.10 | )% | 2.09 | % | (0.23 | )% |
| Net Loan Charge-offs to  Provision Charged to Operating Expense     |       | 10.32                                 | %          | 0.97 | % | (0.51 | )% | 11.45 | % | (1.16 | )% |

 

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

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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 includeour historical loss experience, delinquency and charge-off trends, collateralvalues, changes in non-performing loans, and other factors. Quantitativefactors also incorporate known information about individual loans, includingborrowers’ sensitivity to interest rate movements and borrowers’ sensitivity toquantifiable external factors including commodity prices as well as acts ofnature (freezes, earthquakes, fires, etc.) that occur in a particular period.

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

Our methodologyis, and has been, consistently followed. However, as we add new products,increase in complexity, and expand our geographic coverage, we expect toenhance our methodology to keep pace with the size and complexity of the loanportfolio. On an ongoing basis we engage outside firms to independently assessour methodology, and to perform independent credit reviews of our loanportfolio. The FDIC and the California Department of Financial Institutionsreview the allowance for loan losses as an integral part of the examinationprocesses. Management believes that our current methodology is appropriategiven our size and level of complexity. Further, management believes that theallowance for loan losses is adequate as of December 31, 2006 to cover knownand inherent risks in the loan portfolio. However, fluctuations in creditquality, or changes in economic conditions or other factors could causemanagement to increase or decrease the allowance for loan losses as necessary.

The followingtable provides 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,** | ** ** |
|-----------------------------------|------------|---------------------------------------|------------|
| ** **                        | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                        | ** ** | ** **                            | ** ** | **% Total  (1)** | ** ** | ** ** | ** ** | **% Total  (1)** | ** ** | ** ** | ** ** | **% Total  (1)** | ** ** | ** ** | ** ** | **% Total  (1)** | ** ** | ** ** | ** ** | **% Total  (1)** | ** ** |
| ** **                        | ** ** | **Amount**                            | ** ** | **Loans** | ** ** | **Amount** | ** ** | **Loans** | ** ** | **Amount** | ** ** | **Loans** | ** ** | **Amount** | ** ** | **Loans** | ** ** | **Amount** | ** ** | **Loans** | ** ** |
| Agricultural                      |       | $                                     | 219        |   | 5.74 | % | $ | 200 |   | 6.09 | % | $ | 244 |   | 6.44 | % | $ | 179 |   | 7.58 | % | $ | 146 |   | 8.11 | % |
| Commercial                        |       | $                                     | 626        |   | 14.55 | % | $ | 1,123 |   | 15.03 | % | $ | 690 |   | 17.02 | % | $ | 1,258 |   | 21.01 | % | $ | 735 |   | 20.84 | % |
| Real Estate                       |       | $                                     | 4,172      |   | 69.94 | % | $ | 3,488 |   | 69.91 | % | $ | 3,027 |   | 68.93 | % | $ | 1,815 |   | 63.52 | % | $ | 1,379 |   | 62.78 | % |
| Installment  Loans                |       | $                                     | 876        |   | 9.77 | % | $ | 386 |   | 8.97 | % | $ | 420 |   | 7.61 | % | $ | 335 |   | 7.89 | % | $ | 747 |   | 8.27 | % |
| Reserve for  Unfunded Commitments |       | $                                     | (619       | ) |   |   | $ | (481 | ) |   |   | $ | (381 | ) |   |   | $ | (325 | ) |   |   | $ | (256 | ) |   |   |
| **TOTAL**                         |       | $                                     | 5,274      |   | 100.00 | % | $ | 4,716 |   | 100.00 | % | $ | 4,000 |   | 100.00 | % | $ | 3,262 |   | 100.00 | % | $ | 2,751 |   | 100.00 | % |

 

----

(1) Represents percentageof loans in category to total loans.

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At December 31, 2006, the Company’s allowance for loanlosses was $5.3 million. The loan loss and undisbursed commitment provisions in2006, 2005, and 2004 totaled $775,000, $825,000, and $790,000, respectively.Over the past five years, net charge-offs have averaged $30,000. The Companyended 2006 with net loan losses of $80,000, compared to net losses of $8,000during 2005.

**OtherLoan Portfolio Information**

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

Loan Sales andMortgage Servicing Rights: The Company sells or brokers some of the fixed-rate single familymortgage loans it originates as well as other selected portfolio loans. Someare sold “servicing released” and the purchaser takes over the collection ofthe payments. However, most are sold with “servicing retained” and the Companycontinues to receive the payments from the borrower and forwards the funds tothe purchaser. The Company earns a fee for this service. The sales are madewithout 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.Mortgage servicing rights are amortized over the expected term of the relatedservicing income.  At December 31, 2006and 2005, the amortized cost of these assets was $872,000 and $1,073,000respectively.

###### **InvestmentPortfolio**

The investmentsecurities portfolio had a carrying value of $5.1 million at December 31, 2006.The Company classified its investments into two portfolios: “held-to-maturity”,and “available-for-sale”. The Company does not have any investments classifiedas trading. The held-to-maturity portfolio should consist only of investmentsthat the Company has both the intention and ability to hold until maturity, tobe sold only in the event of concerns with an issuer’s creditworthiness, achange in tax law that eliminates their tax exempt status or other infrequentsituations as permitted under GAAP. Given the small and non complex nature ofthe portfolio, management does not rely heavily on these investments as asource of funds for growth in the loan portfolio.

Securities pledgedas collateral on repurchase agreements, public deposits and for other purposesas required or permitted by law were $3,357,000 for both periods endingDecember 31, 2006 and 2005.

The totalinvestment portfolio decreased in 2006 to $5.1 million at the end of the yearfrom $6.7 million at December 31, 2005. The Company’s investment portfolio iscomposed primarily of:  (1) U.S.Treasury and Agency issues for liquidity and pledging; and (2) state, countyand municipal obligations which provide tax free income and pledging potential.The distribution of these groups within the overall portfolio remainedrelatively consistent as there were no purchases or sales in 2006. The U.S.Treasury and Agency issues continue to be the largest portion of the totalportfolio at 73%, down from 80% at the end of 2005. Municipal issues comprised27% of total investments at the end of 2006, up from 20% at the end of 2005.

The followingInvestment Portfolio table reflects the amortized cost and fair market valuesfor the total portfolio for each of the categories of investments for the pastthree years.

Federal funds sold comprise the remainder ofthe assets that are not invested in the securities portfolio or in the loanportfolio.  These are overnighttransactions that are highly liquid and are returned to the Company the nextday.  The Company sold $42 million and$29 million as of December 31, 2006 and December 31, 2005.

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**Investment Portfolio**

(dollars in thousands)
| ** **                                | ** ** | **As of December 31,** | ** ** |
|-------------------------------------------|------------|---------------------------------------|------------|
| ** **                                | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Investment Portfolio**             | ** ** | **Amortized**                         | ** ** | **Fair  Market** | ** ** | **Amortized** | ** ** | **Fair  Market** | ** ** | **Amortized** | ** ** | **Fair  Market** | ** ** |
| **(dollars in thousands)**      | ** ** | **Cost**                              | ** ** | **Value** | ** ** | **Cost** | ** ** | **Value** | ** ** | **Cost** | ** ** | **Value** | ** ** |
| **Held to maturity**            |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| US Government Agencies & Corporations |       | $                                     | 1,777      |   | $ | 1,759 |   | $ | 2,332 |   | $ | 2,296 |   | $ | 2,481 |   | $ | 2,482 |   |
| State & political subdivisions        |       |                                  |       |   |   |   |   |   |   | $ | 101 |   | $ | 101 |   |
| **Total  held to maturity**               |       | $                                     | 1,777      |   | $ | 1,759 |   | $ | 2,332 |   | $ | 2,296 |   | $ | 2,582 |   | $ | 2,583 |   |
| **Available  for sale**                   | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| US Government Agencies & Corporations |       | $                                     | 1,977      |   | $ | 1,961 |   | $ | 3,009 |   | $ | 2,964 |   | $ | 3,004 |   | $ | 3,002 |   |
| State & political subdivisions        |       | $                                     | 1,357      |   | $ | 1,389 |   | $ | 1,356 |   | $ | 1,380 |   | $ | 1,356 |   | $ | 1,377 |   |
| **Total  available for sale**             |       | $                                     | 3,334      |   | $ | 3,350 |   | $ | 4,365 |   | $ | 4,344 |   | $ | 4,360 |   | $ | 4,379 |   |
| **Total Investment Securities**           |       | $                                     | 5,111      |   | $ | 5,109 |   | $ | 6,682 |   | $ | 6,676 |   | $ | 6,942 |   | $ | 6,962 |   |

 

The investmentmaturities table below summarizes the maturity of the Company’s investmentsecurities and their weighted average yields at December 31, 2006. Expectedremaining maturities may differ from remaining contractual maturities becauseobligors may have the right to repay certain obligations with or withoutpenalties.

43

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**Investment Maturities**

(dollarsin thousands)
| ** **                                 | ** ** | **As of December 31, 2006** | ** ** |
|--------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                 | ** ** | **Within One  Year**                       | ** ** | **After One  But Within Five Years** | ** ** | **After Five Years But  Within Ten Years** | ** ** | **After Ten  Years** | ** ** | **Total** | ** ** |
| ** **                                 | ** ** | **Amount**                                      | ** ** | **Yield** | ** ** | **Amount** | ** ** | **Yield** | ** ** | **Amount** | ** ** | **Yield** | ** ** | **Amount** | ** ** | **Yield** | ** ** | **Amount** | ** ** | **Yield** | ** ** |
| **Held to  maturity**                      | ** ** | ** **                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| US Government  Agencies & Corporations |       |                                            |       |   |   | $ | 982 |   | 3.15 | % | $ | 678 |   | 4.08 | % | $ | 99 |   | 5.99 | % | $ | 1,760 |   | 3.67 | % |
| State &  political subdivisions        |       |                                            |       | — |   |   |   |   |   |   |   |   |   | — |   | — |   | — |   |   |   |
| **Total  held to maturity**                |       | $                                               |       |   | — |   | $ | 982 |   | 3.15 | % | $ | 678 |   | 4.08 | % | $ | 99 |   | 5.99 | % | $ | 1,760 |   | 3.67 | % |
| **Available  for sale**                    | ** ** | ** **                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| US Government  Agencies & Corporations |       | 998                                             |       | 3.22 | % |   |   |   |   | $ | 962 |   | 4.72 | % |   |   | — |   | $ | 1,960 |   | 3.96 | % |
| State &  political subdivisions        |       |                                            |       | — |   | — |   |   |   | — |   | — |   | $ | 1,389 |   | 4.74 | % | $ | 1,389 |   | 4.74 | % |
| **Total  available for sale**              |       | $                                               | 998        |   | 3.22 | % | $ |   |   |   |   | $ | 962 |   | 4.72 | % | $ | 1,389 |   | 4.74 | % | $ | 3,349 |   | 4.28 | % |
| **Total investment securities**            |       | $                                               | 998        |   | 3.22 | % | $ | 982 |   | 3.15 | % | $ | 1,640 |   | 4.46 | % | $ | 1,488 |   | 4.82 | % | $ | 5,109 |   | 4.07 | % |

 

###### **Cashand Due From Banks**

Cash on hand andbalances due from correspondent banks represent the major portion of theCompany’s non-earning assets. At December 31, 2006 these areas comprised 3.7%of total assets, as compared to 3.8% of total assets at December 31, 2005. TheCompany strives to maintain vault cash at a level consistent with thewithdrawal needs of the customers. The vault cash amount for December 31, 2006was $4.2 million.

The Company’soperating branches 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 Companyis taking advantage of quicker clearing times to offset timezone and geography challenges and improve availability. With traditional papercheck clearing, all non-local and country items in the 12th District receive availability that is at leastone day deferred. Under the 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 deposit deadlinesstarting as early as 5:00 p.m. Pacific through 9:00 a.m. Pacific time, imagecash letters enable institutions on the West Coast to reduce the clearing timeof many high value East Coast items by at least one business day, therebyincreasing funds available for investment and reducing risk.

###### **Premisesand Equipment**

Premises andequipment are stated at cost less accumulated depreciation and amortization.Depreciation is charged to income over the estimated useful lives of the assetsand leasehold improvements are amortized over the terms of the related lease,or the estimated useful lives of the improvements, whichever is shorter.Depreciation expense was $1,662,000 for the year ended December 31, 2006 ascompared to $1,574,000 during 2005 and $1,313,000 during 2004. The followingpremises and equipment table reflects the balances by major category of fixedassets:

44

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**Premises & Equipment**

(dollars in thousands)
| ** **                | ** ** | **As of December 31,** | ** ** |
|---------------------------|------------|---------------------------------------|------------|
| ** **                | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                | ** ** | **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 |   | $ | 1,519 |   | $ | — |   | $ | 1,519 |   |
| Buildings                 |       | $                                     | 8,713      |   | $ | 1,714 |   | $ | 6,999 |   | $ | 6,908 |   | $ | 1,425 |   | $ | 5,483 |   | $ | 5,761 |   | $ | 1,172 |   | $ | 4,589 |   |
| Leasehold Improvements    |       | $                                     | 2,258      |   | $ | 555 |   | $ | 1,703 |   | $ | 994 |   | $ | 386 |   | $ | 608 |   | $ | 841 |   | $ | 248 |   | $ | 593 |   |
| Construction in  progress |       | $                                     | 2,368      |   | $ | — |   | $ | 2,368 |   | $ | 622 |   | $ | — |   | $ | 622 |   | $ | 75 |   | $ | — |   | $ | 75 |   |
| Furniture and  Equipment  |       | $                                     | 8,282      |   | $ | 6,169 |   | $ | 2,113 |   | $ | 7,384 |   | $ | 5,052 |   | $ | 2,332 |   | $ | 6,242 |   | $ | 3,991 |   | $ | 2,251 |   |
| **Total**                 |       | $                                     | 23,797     |   | $ | 8,438 |   | $ | 15,359 |   | $ | 18,084 |   | $ | 6,863 |   | $ | 11,221 |   | $ | 14,438 |   | $ | 5,411 |   | $ | 9,027 |   |

 

The net book valueof the Company’s premises and equipment increased by $4,068,000 in 2006,primarily due to the opening of the new branches in Red Bluff, Redding,Marysville and Corning .  In 2005 theCompany purchased a 14,000 square foot building in Chico that will serve as thecorporate administrative headquarters and also house other service departments.This building was remodeled and an additional 5,000 square feet was added.   As of the end of January 2007 the buildingis fully occupied.  As a percentage oftotal assets, the Company’s premises and equipment was 2.8%, at the end of2006, 2.3% at the end of 2005 and 2.0% at the end of 2004.

###### **Deposits**

The compositionand cost of the Company’s deposit base are important components in analyzingthe Company’s net interest margin and balance sheet liquidity characteristics,both of which are discussed in greater detail in other sections herein. Netinterest margin is improved to the extent that growth in deposits can beconcentrated in historically lower-cost core deposits, namelynon-interest-bearing demand, NOW accounts, savings accounts and money marketdeposit accounts. Liquidity is impacted by the volatility of deposits or otherfunding instruments, or in other words their propensity to leave theinstitution for rate-related or other reasons. Potentially, the most volatiledeposits in a financial institution are large certificates of deposit, whichgenerally mean time deposits with balances exceeding $100,000. Because thesedeposits (particularly when considered together with a customer’s otherspecific deposits) may exceed FDIC insurance limits, depositors may select shortermaturities to offset perceived risk elements associated with deposits over$100,000.  Certificates of depositsexceeding $100,000 represented 15.9% of average total deposits in 2006, 11.3%in 2005 and 9.9% in 2004.  While thetrend of these deposits has been steadily increasing over the past three years,the Company’s community-oriented deposit gathering activities in Butte, Colusa,Shasta, Sutter, Tehama, and Yuba counties have engendered a less volatile thanusual base of depositor certificates over $100,000.

The Company’stotal deposit volume increased to $485 million at the end of 2006, as comparedto $434 million at the end of 2005. Deposit growth of $51 million was achievedduring 2006, primarily as a result of the full year of operations for thebranches opened in 2005 and the new branches opened in 2006. The mix of thedeposits changed from 2005 to 2006 as the growth was realized in certificatesof deposit rather than the lower cost core deposit accounts (demand deposits,NOW, money market, and savings). We expect deposit rates to be relativelyunchanged in 2007, and our focus will be to attract lower cost deposits to fundour loan growth and maintain a reasonable net interest margin in 2007.

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

45

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**Deposit Maturity Distribution**

(dollars in thousands)
|                                              | ** ** | **As of December 31, 2006** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                   | ** ** | **Three**                                       | ** ** | **Three** | ** ** | **One** | ** ** | **Over** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **months**                                      | ** ** | **to twelve** | ** ** | **to three** | ** ** | **three** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **or less**                                | ** ** | **months** | ** ** | **years** | ** ** | **Years** | ** ** | **Total** | ** ** |
| Time  Certificates of Deposits < $100,000 |       | $                                               | 19,092     |   | $ | 61,029 |   | $ | 11,314 |   | $ | 253 |   | $ | 91,688 |   |
| Other Time  Deposits > $100,000           |       | $                                               | 16,999     |   | $ | 50,372 |   | $ | 10,788 |   | $ | 413 |   | $ | 78,572 |   |
|                                         |       |                                            |       |   |   |   |   |   |   |   |   |
| TOTAL                                        |       | $                                               | 36,091     |   | $ | 111,401 |   | $ | 22,102 |   | $ | 666 |   | $ | 170,260 |   |

 

**NotesPayable and Other Borrowings**

The Company has$15 million 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, 2006 and 2005.

The followingsummarizes the note payable to the Company’s subsidiary grantor trust atDecember 31, 2006:
|                                                                                                                                                                                                                                                                      | ** ** | **(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%  (8.66% at December 31, 2006), redeemable beginning December 31, 2007, due  December 31, 2032. |       | $                                | 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, 2006, 2005and 2004 related to the junior subordinated debentures was $733,000, $592,000and $438,000, respectively. These junior subordinated debentures currentlyqualify as Tier 1 capital when determining regulatory risk-based capitalratios.

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, 2006, the interest rate was8.25%. Advances on the line of credit totaled $1,217,000, $981,000 at December31, 2006 and 2005, respectively. A summary of the activity in this line ofcredit follows.
| ESOP Note Payable                  | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|----------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| **(dollars in thousands)**         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance at  December 31                      |       | $          | 1,217      |       | $          | 981        |       | $ | 835 |   |
|                                         |       |       |       |       |       |       |       |
| Average amount  outstanding                  |       | $          | 1,068      |       | $          | 865        |       | $ | 778 |   |
|                                         |       |       |       |       |       |       |       |
| Maximum amount  outstanding at any month end |       | $          | 1,142      |       | $          | 1,080      |       | $ | 848 |   |
|                                         |       |       |       |       |       |       |       |
| Average interest rate  for the year          |       | 7.94       | %          | 6.13       | %          | 4.31       | %          |

 

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

46

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###### **CapitalResources**

At December 31,2006, the Company had total shareholders equity of $45.7 million, comprised of$8.2 million in common stock, and $37.5 million in retained earnings. Totalshareholders equity at the end of 2005 was $41.6 million. Net income hasprovided $20 million in capital over the last three years, of which $4.1million or approximately 20% 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, the proceeds ofwhich are considered Tier 1 capital for regulatory purposes but long-term debtin accordance with GAAP.

The Company paidquarterly cash dividends totaling $1,933,000 or $.26 per share in 2006 and$1,092,000 or $.16 per share in 2005, representing 27% and 15.8%, respectivelyof the prior year’s earnings.  Since thesecond quarter of 2001, the Company has adhered to a policy of paying quarterlycash dividends totaling about 18% of the prior year’s net earnings to theextent consistent with general considerations of safety and soundness, providedthat such payments do not adversely affect the Bank’s or the Company’sfinancial condition and are not overly restrictive to its growth capacity. TheCompany anticipates paying dividends in the future consistent with the generaldividend policy as described above. However, no assurance can be given that theBank’s and the Company’s future earnings and/or growth expectations in anygiven year will justify the payment of such a dividend.

The Company uses 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 FDICguidelines: Tier 1 and Tier 2 Capital. Tier 1 Capital includes commonshareholders’ equity and the proceeds from the issuance of trust-preferredsecurities (subject to the limitations previously discussed), less goodwill andcertain other deductions, notably the unrealized net gains or losses (after taxadjustments) on securities available for sale, which are carried at fair marketvalue. Tier 2 Capital includes preferred stock and certain types of debtequity, which the Company does not hold, as well as the allowance for loanlosses, subject to certain limitations. (For a more detailed definition, see “Item1, Business-Supervision and Regulation — Capital Adequacy Requirements”herein.)

At December 31,2006, the Company had a Tier 1 risk based capital ratio of 10.9%, a totalcapital to risk-weighted assets ratio of 11.9%, and a leverage ratio of 10.1%.The Company had a Tier 1 risk-based capital ratio of 11.4%, a total risk-basedcapital ratio of 12.5%, and a leverage ratio of 9.8% at December 31, 2005. Note11 of the Notes to Consolidated Financial Statements provides more detailedinformation concerning the Company’s capital amounts and ratios as of December31, 2006 and 2005.

At the currenttime, the Bank is considered “well capitalized” under the Prompt CorrectiveAction standards. It is anticipated that the current level of capital willallow the Company to grow and remain well capitalized, although no assurancecan be given that this will be the case.

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

The Company has certain ongoing commitments underoperating leases. See Note 10 to the consolidated financial statements at Item8 of this report for the terms. These commitments do not significantly impactoperating results. As of December 31, 2006 commitments to extend credit andstand-by-letters of credit were the Company’s only financial instruments withoff-balance sheet risk. Loan commitments decreased to $186 million at December31, 2006 from $201 million at December 31, 2005. Stand-by-letters of creditincreased slightly to $5.1 million from $4.9 million over the same period.  The commitments and stand-by letters ofcredit represent 42% of the total loans outstanding at year-end 2006 versus 49%at December 31, 2005.

47

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The following chart summarizes certain contractual obligations of the Company as of December 31, 2006:
| ** **                         | ** ** | **Less than** | ** ** | ** **         | ** ** | ** **         | ** ** | **More than** | ** ** | ** ** | ** ** |
|------------------------------------|------------|--------------------|------------|--------------------|------------|--------------------|------------|--------------------|------------|------------|------------|
| ** **                         | ** ** | **1 year**    | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **5 years**   | ** ** | **Total**  | ** ** |
|                               |       |               |       |               |       |               |       |               |       |       |       |
| Subordinated  debentures           |       | —             |       | —             |       | —             |       | 8,248              |       | 8,248      |       |
| Operating lease  obligations       |       | 918                |       | 1,720              |       | 2,352              |       | 5,844              |       | 10,834     |       |
| Deferred  compensation (1)         |       | —             |       | —             |       | —             |       | 4,149              |       | 4,149      |       |
| Supplemental  retirement plans (1) |       | 116                |       | 242                |       | 390                |       | 1,412              |       | 2,160      |       |
| Notes payable                      |       |               |       |               |       |               |       | 1,215              |       | 1215       |       |
| Total contractual  obligations     |       | $                  | 1,034      |               | $          | 1,962              |       | $                  | 2,742      |       | $          | 20,868 |   | $ | 26,606 |   |
|                                    |            |                    |            |                    |            |                    |            |                    |            |            |            |  |  |  |  |  |

 

----

(1)          These amounts represent the accruedliabilities as of December 31, 2006 under the Company’s deferred compensationand supplemental retirement plans. See Note 15 to the consolidated financialstatements at Item 8 of this report for additional information related to theCompany’s deferred compensation and supplemental retirement plan liabilities.

###### **Liquidityand Market Risk Management**

The Company mustaddress on a daily basis the various and sundry factors which impact itscontinuing operations. Three of these factors, the economic climate whichencompasses our business environment, the regulatory framework which governsour practices and procedures, and credit risk have been previously discussed.There are other risks specific to the operation of a financial institutionwhich also need to be managed, and this section will address liquidity risk andmarket risk.

Liquidity refersto the Company’s ability to maintain a cash flow adequate to fund operations,and to meet obligations and other commitments in a timely and cost-effectivefashion. 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.

An integral partof the Company’s ability to manage its liquidity position appropriately isprovided by the Company’s large base of core deposits, which were generated byoffering traditional banking services in the communities in its service areaand which have, historically, been a very stable source of funds.

Additionally, theCompany maintains $15 million in unsecured borrowing arrangements with two ofits correspondent banks. The Company also has the ability to raise depositsthrough various deposit brokers, sell investment securities, or sell loans ifrequired for liquidity purposes.

Market risk arisesfrom changes in interest rates, exchange rates, commodity prices and equityprices. The Company’s market risk exposure is primarily that of interest raterisk, and it has risk management policies to monitor and limit earnings andbalance sheet exposure to changes in interest rates. The Company does notengage in the trading of financial instruments.

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

48

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identify moredynamic interest rate risk exposures than those apparent in the standardre-pricing gap analysis.

Modeling softwareis used by the Company for asset/liability management in order to simulate theeffects of potential interest rate changes on the Company’s net interestmargin. These simulations can also provide both static and dynamic informationon the projected fair market values of the Company’s financial instrumentsunder differing interest rate assumptions. The simulation program utilizesspecific individual loan and deposit maturities, embedded options, rates andre-pricing characteristics to determine the effects of a given interest ratechange on the Company’s interest income and interest expense. Rate scenariosconsisting of key rate and yield curve projections are run against the Company’sinvestment, loan, deposit and borrowed funds portfolios. These rate projectionscan be shocked (an immediate and sustained change in rates, up or down), ramped(an incremental increase or decrease in rates over a specified time period),economic (based on current trends and econometric models) or stable (unchangedfrom current actual levels). The Company typically uses seven standard interestrate scenarios in conducting the simulation, namely stable, an upward shock of100, 200, and 300 basis points, and a downward shock of 100, 200, and 300 basispoints.  The Company’s policy is to limitthe change in the Company’s net interest margin and economic value to plus orminus 5%, 15%, and 25% 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, 2006, the Company had the following estimatednet interest margin sensitivity profile:
| ** **                  | ** ** | **Immediate Change in Rate** | ** ** | **Immediate Change in Rate** | ** ** | **Immediate Change in Rate** | ** ** |
|-----------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| ** **                  | ** ** | **+100 bp**                            | ** ** | **-100 bp**                            | ** ** | **+200 bp**                            | ** ** | **-200 bp** | ** ** | **+300 bp** | ** ** | **-300 bp** | ** ** |
| Net Interest  Income Change |       | $                                           | 1,883,000  |                                        | $          | (1,974,000                                  | )          | $ | 3,752,000 |   | $ | (4,211,000 | ) | $ | 5,548,000 |   | $ | (6,850,000 | ) |
|                             |            |                                             |            |                                             |            |                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

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 $3,752,000, or approximately 12.3%. Likewise, if there were animmediate downward adjustment of 200 basis points in interest rates, theCompany’s net interest income would likely decrease by approximately$4,211,000, or 13.8%, over the next year.

The results forthe Company’s December 31, 2006, 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 ofchange is based on the profiles of each loan and deposit class, which includethe rate, the likelihood of prepayment or repayment, whether its rate is fixedor floating, 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 certain assumptionsabout interest rates and likely changes in the yield curve.

49

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**Selected Quarterly Financial Data**

(Dollars inthousands, except per share data)
| 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 |   |

 
| 2005 Quarter                                    | ** ** | **1st** | ** ** | **2nd** | ** ** | **3rd** | ** ** | **4th** | ** ** |
|------------------------------------------------------|------------|---------|------------|---------|------------|---------|------------|---------|------------|
|                                                 |       |    |       |    |       |    |       |    |       |
| Interest income                                      |       | $       | 7,054      |    | $          | 7,675   |       | $       | 8,583      |   | $ | 9,126 |   |
| Net Interest  income                                 |       | $       | 5,907      |    | $          | 6,506   |       | $       | 7,177      |   | $ | 7,514 |   |
| Net interest  income after provision for loan losses |       | $       | 5,682      |    | $          | 6,281   |       | $       | 6,952      |   | $ | 7,367 |   |
|                                                 |       |    |       |    |       |    |       |    |       |
| Net Income                                           |       | $       | 1,454      |    | $          | 1,730   |       | $       | 2,159      |   | $ | 1,855 |   |
|                                                 |       |    |       |    |       |    |       |    |       |
| Net income per  share, basic                         |       | $       | 0.20       |    | $          | 0.24    |       | $       | 0.30       |   | $ | 0.26 |   |
|                                                 |       |    |       |    |       |    |       |    |       |
| Net income per  share, diluted                       |       | $       | 0.19       |    | $          | 0.23    |       | $       | 0.29       |   | $ | 0.24 |   |
|                                                 |       |    |       |    |       |    |       |    |       |
| Dividends Declared                                   |       | $       | 0.04       |    | $          | 0.04    |       | $       | 0.04       |   | $ | 0.04 |   |

 

**Item 7a. Quantitative and Qualitative DisclosuresAbout Market Risk**

The informationrequire by 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 Statementsand Supplementary Data**

The financialstatements begin on page 57 of this report.

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

There were nochanges or disagreements with Accountants for the year 2006.

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

As of the end ofthe period 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 defined inRules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of1934).  Based on this evaluation, our Chief Executive Officer and ChiefFinancial Officer concluded that our disclosure controls and procedures areeffective to ensure that information required to be disclosed by us in reportsthat we file or submit under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in Securities andExchange Commission rules and forms.  There was no change in our internalcontrol over financial reporting during our most recently completed fiscalquarter that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

**Item 9b. Other Information**

50

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**PART III**

**Item 10. Directors and Executive Officers and CorporateGovernance**

The informationrequired by Item 10 of Form 10-K is incorporated by reference to theinformation contained in the Company’s Proxy Statement for the 2007 AnnualMeeting of Shareholders which will be filed pursuant to Regulation 14A.

**Item 11. Executive Compensation**

The informationrequired by Item 11 of Form 10-K is incorporated by reference to theinformation contained in the Company’s Proxy Statement for the 2007 AnnualMeeting of Shareholders which will be filed pursuant to Regulation 14A.

**Item 12. Security Ownership of Certain Beneficial Owners andManagement**

The informationrequired by Item 12 of Form 10-K is incorporated by reference to the informationcontained in the Company’s Proxy Statement for the 2007 Annual Meeting ofShareholders which will be filed pursuant to Regulation 14A.

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

The informationrequired by Item 13 of Form 10-K is incorporated by reference to theinformation contained in the Company’s Proxy Statement for the 2007 AnnualMeeting of Shareholders which will be filed pursuant to Regulation 14A.

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

The informationrequired by Item 14 of Form 10-K is incorporated by reference to theinformation contained in the Company’s Proxy Statement for the 2007 AnnualMeeting of Shareholders which will be filed pursuant to Regulation 14A.

51

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**PART IV**

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

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

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

Thefollowing financial statements and independent auditor’s reports are includedin this Annual Report on Form 10-K immediately following.
|        |   | I.   |   | Report of Independent Registered Public Accounting  Firm                                                            |   |   |
|--------|--------|------|--------|---------------------------------------------------------------------------------------------------------------------|--------|--------|
|   |   | II.  |   | Consolidated Balance Sheet - December 31, 2006 and  2005                                                            |   |   |
|   |   | III. |   | Consolidated Statement of Income - Years Ended  December 31, 2006, 2005 and 2004                               |   |   |
|   |   | IV.  |   | Consolidated Statement of Changes in Shareholders’  Equity - Years Ended December 31, 2006, 2005 and 2004 |   |   |
|   |   | V.   |   | Consolidated Statement of Cash Flows - Years Ended  December 31, 2006, 2005 and 2004                                |   |   |
|   |   | VI.  |   | Notes to the Consolidated Financial Statements                                                                      |   |   |

 

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

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

**(3)**        **Exhibits**
| Exhibit    | ** ** | ** **                                                                                                                       | ** ** | ** ** |
|------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| **Number** | ** ** | **Document Description**                                                                                                         |
|       |       |                                                                                                                             |
| (3.1)      |       | Articles of Incorporation incorporated by reference  from the Company’s Registration Statement Form S-4EF, file #333-85950. |
| (3.2)      |       | Bylaws incorporated by reference from the Company’s  Registration Statement Form S-4EF, file  #333-85950.                   |

 

52

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| (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 attached hereto.                                                                                                                                                                                                                                  |
| (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, attached hereto.                                                                                                                                                                                                                          |
| (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)   |   | 000 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 2                                                                                               |
| (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                                                                                                 |

 

53

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| (10.11) |   | 2000 Stock Option Agreement for M Robert Ching dated  May 1, 2000. Incorporated by reference to the Company’s Quarterly Report on  Form 10-Q for the period ended June 30, 2002, filed with the Commission on  August 14, 2002.    |
|---------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (10.12) |   | 1997 Stock Option Agreement for Eugene B. Even dated  May 1, 1997 Incorporated by reference to the Company’s Quarterly Report on  Form 10-Q for the period ended June 30, 2002, filed with the Commission on  August 14, 2002      |
| (10.13) |   | 2000 Stock Option Agreement for Eugene B Even dated  May 1, 2000. Incorporated by reference to the Company’s Quarterly Report on  Form 10-Q for the period ended June 30, 2002, filed with the Commission on  August 14, 2002.     |
| (10.14) |   | 1997 Stock Option Agreement for John D Lanam dated  May 1, 1997. Incorporated by reference to the Company’s Quarterly Report on  Form 10-Q for the period ended June 30, 2002, filed with the Commission on  August 14, 2002.      |
| (10.15) |   | 2000 Stock Option Agreement for John D Lanam dated  May 1, 2000. Incorporated by reference to the Company’s Quarterly Report on  Form 10-Q for the period ended June 30, 2002, filed with the Commission on  August 14, 2002.      |
| (10.16) |   | 1997 Stock Option Agreement for Donald W Leforce  dated May 1, 1997. Incorporated by reference to the Company’s Quarterly  Report on Form 10-Q for the period ended June 30, 2002, filed with the Commission  on August 14, 2002.  |
| (10.17) |   | 2000 Stock Option Agreement for Donald W. Leforce  dated May 1, 2000 Incorporated by reference to the Company’s Quarterly Report  on Form 10-Q for the period ended June 30, 2002, filed with the Commission on  August 14, 2002   |
| (10.18) |   | 1997 Stock Option Agreement for Ellis L. Matthews  dated May 1, 1997 Incorporated by reference to the Company’s Quarterly Report  on Form 10-Q for the period ended June 30, 2002, filed with the Commission on  August 14, 2002   |
| (10.19) |   | 2000 Stock Option Agreement for Ellis L. Matthews  dated May 1, 2000 Incorporated by reference to the Company’s Quarterly Report  on Form 10-Q for the period ended June 30, 2002, filed with the Commission on  August 14, 2002   |
| (10.20) |   | 1997 Stock Option Agreement for Robert L Morgan  dated May 1, 1997 Incorporated by reference to the Company’s Quarterly Report  on Form 10-Q for the period ended June 30, 2002, filed with the Commission on  August 14, 2002.    |
| (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 |

 

54

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

 

55

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| (21)   |   | List of Subsidiaries: Butte Community Bank, BCB  Insurance Agency, Community Valley Trust I (unconsolidated)                                                                                                  |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (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                                                                                                                                                        |
| (99.1) |   | 1991 Stock Option Plan is incorporated by reference  from the Company’s Registration Statement Form S-8, filed August 14, 2002 .                                                                         |
| (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. |

 

(b)  Reports on Form 8-K

On January 20, 2006 theCompany issued a press release announcing earnings for the fourth quarter andyear ending December 31, 2005.

On March 15, 2006 thecompany issued a press release announcing the payment of a five cent dividendto shareholders of record as of March 31, 2006. The payment date for the dividendwas April 28, 2006.

On April 13, 2006 theCompany issued a press release announcing earnings for the first quarter of2006.

On April 14, 2006 theCompany issued a press release announcing the acceptance of CommunityValley Bancorp toThe Nasdaq Capital Markets.

On June 27, 2006 the Companyissued a press release announcing the payment of a six cent dividend toshareholders of record as of June 30, 2006. The payment date for the dividendwas July 28, 2006.

On July 14, 2006 the Companyissued a press release announcing second quarter 2006 earnings.

On September 15, 2005 theCompany issued a press release announcing the payment of a seven cent dividendto shareholders of record as of September 29, 2005. The payment date for thedividend was October 27, 2006.

On October 18, 2006 theCompany issued a press release announcing third quarter 2006 earnings.

On December 23, 2005 theCompany issued a press release announcing the payment of a eight cent dividendto shareholders of record as of December 29, 2005. The payment date for thedividend was January 26, 2007.

On January 26, 2007 theCompany issued a press release announcing earnings for the fourth quarter andyear ending December 31, 2006.

56

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities and Exchange Actof 1934, the Registrant has duly caused this report to be signed on its behalfby the undersigned thereunto duly authorized.
| Dated: March 9, 2007 | ** ** | **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 |
|                      |            |                              |  |  |  |  |  |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.
| Signature               | ** ** | **Title** | ** **                        | **Date** |
|-------------------------|------------|-----------|-----------------------------------|----------|
|                    |       |      |                              |     |
| */s/ M. Robert Ching*   | * *   |      | Director                          |     | March 9, 2007 |
| M. Robert Ching         |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ John F. Coger*     | * *   | * *  | Executive Vice President, CFO/COO |     | March 9, 2007 |
| John F. Coger           |       |      | and Director                      |     |   |
|                    |       |      |                              |     |   |
| */s/Eugene B. Even*     | * *   |      | Director                          |     | March 9, 2007 |
| Eugene B. Even          |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ John D. Lanam*     | * *   |      | Director                          |     | March 9, 2007 |
| John D. Lanam           |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ Donald W. Leforce* | * *   |      | Chairman of the Board             |     | March 9, 2007 |
| Donald W. Leforce       |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ Charles Mathews*   | * *   |      | Director                          |     | March 9, 2007 |
| Charles Mathews         |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ Ellis L. Matthews* | * *   |      | Director                          |     | March 9, 2007 |
| Ellis L. Matthews       |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ Luther McLaughlin* | * *   |      | Director                          |     | March 9, 2007 |
| Luther McLaughlin       |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ Robert L. Morgan*  | * *   |      | Director                          |     | March 9, 2007 |
| Robert L. Morgan        |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ Keith C. Robbins*  | * *   | * *  | President, Chief Executive        |     | March 9, 2007 |
| Keith C. Robbins        |       |      | Officer and Director              |     |   |
|                    |       |      |                              |     |   |
| */s/ James S. Rickards* | * *   |      | Director and                      |     | March 9, 2007 |
| James S. Rickards       |       |      | Corporate Secretary               |     |   |
|                    |       |      |                              |     |   |
| */s/ Gary B. Strauss*   | * *   |      | Director                          |     | March 9, 2007 |
| Gary B. Strauss         |       |      | Vice Chairman                     |     |   |
|                    |       |      |                              |     |   |
|                    |       |      |                              |     |   |
| */s/ Hubert Townshend*  | * *   | * *  | Director                          |     | March 9, 2007 |
| Hubert Townshend        |       |      |                              |     |   |

 

 

 

57

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**COMMUNITYVALLEY BANCORP AND SUBSIDIARIES**

**CONSOLIDATEDFINANCIAL STATEMENTS**

**AS OFDECEMBER 31, 2006 AND 2005**

**AND FORTHE YEARS ENDED**

**DECEMBER 31,2006, 2005 AND 2004**

**AND**

**REPORT OFINDEPENDENT REGISTERED**

**PUBLICACCOUNTING FIRM**

58

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

The management ofCommunity Valley Bancorp is responsible for establishing and maintainingadequate internal control over financial reporting, as defined in Rules13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934.

Management,including the undersigned Chief Executive Officer and Chief Financial Officer,assessed the effectiveness of our internal control over financial reportingpresented in conformity with accounting principles generally accepted in the UnitedStates of America as of December 31, 2006. In conducting its assessment,management used the criteria issued by the Committee of SponsoringOrganizations of the Treadway Commission in *InternalControl—Integrated Framework*. Based on this assessment, managementconcluded that, as of December 31, 2006, our internal control overfinancial reporting was effective based on those criteria.

Management’sassessment of the effectiveness of our internal control over financialreporting as of December 31, 2006, has been audited by Perry-Smith LLP,the independent registered public accounting firm that audited the consolidatedfinancial statements included in this annual report, as stated in their reportappearing on page A-4, which expresses unqualified opinions on management’sassessment and on the effectiveness of our internal control over financialreporting as of December 31, 2006.
| /s/ Keith C Robbins                 |   |
|-------------------------------------|--------|
| Keith C. Robbins                    |
| President, Chief  Executive Officer |
|                                |
| /s/ John F Coger                    |   |
| John F Coger                        |
| Executive Vice  President, CFO/COO  |

 

March 2, 2007

59

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL CONTROL OVERFINANCIAL REPORTING**

The Board ofDirectors

Community Valley Bancorp

We have auditedmanagement’s assessment, included in the accompanying Report of Management onInternal Control Over Financial Reporting, that Community Valley Bancorp andsubsidiaries (the “Company”) maintained effective internal control overfinancial reporting as of December 31, 2006, based on criteria establishedin *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. Our responsibilityis to express an opinion on management’s assessment and an opinion on theeffectiveness of the Company’s internal control over financial reporting basedon our audit.

We conducted ouraudit in accordance with the standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whether effectiveinternal control over financial reporting was maintained in all materialrespects. Our audit included obtaining an understanding of internal controlover financial reporting, evaluating management’s assessment, testing andevaluating the design and operating effectiveness of internal control, andperforming such other procedures as we considered necessary in thecircumstances. We believe that our audit provides a reasonable basis for ouropinion.

A company’sinternal control over financial reporting is a process designed to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance withaccounting principles generally accepted in the United States of America. Acompany’s internal 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 itsinherent limitations, internal control over financial reporting may not preventor detect misstatements. Also, projections of any evaluation of effectivenessto future periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

In our opinion,management’s assessment that Community Valley Bancorp and subsidiariesmaintained effective internal control over financial reporting as ofDecember 31, 2006, is fairly stated, in all material respects, based onthe COSO criteria. Also in our opinion, Community Valley Bancorp andsubsidiaries maintained, in all material respects, effective internal controlover financial reporting as of December 31, 2006, based on the COSOcriteria.

We have alsoaudited, in accordance with the standards of the Public Company AccountingOversight Board (United States), the consolidated balance sheet of CommunityValley Bancorp and subsidiaries as of December 31, 2006 and 2005, and therelated consolidated statements of income, changes in shareholders’ equity andcomprehensive income, and cash flows for each of the years in the three-yearperiod ended December 31, 2006 and our report dated March 9, 2007expressed an unqualified opinion.
|  |   | /s/ Perry-Smith LLP |   |   |
|--|--------|---------------------|--------|--------|

 

Sacramento, California

March 9, 2007

60

----

***REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM***

The Board of Directorsand Shareholders

Community ValleyBancorp

Wehave audited the accompanying consolidated balance sheet of Community ValleyBancorp and subsidiaries as of December 31, 2006 and 2005, and the relatedconsolidated statements of income, changes in shareholders’ equity and cashflows for each of the years in the three-year period ended December 31,2006. 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.

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audits to obtain reasonable assurance about whetherthe consolidated financial statements are free of material misstatement. Anaudit includes 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 ouropinion, the consolidated financial statements referred to above presentfairly, in all material respects, the consolidated financial position ofCommunity Valley Bancorp and subsidiaries as of December 31, 2006 and 2005and the consolidated results of their operations and their cash flows for eachof the years in the three-year period ended December 31, 2006, inconformity with accounting principles generally accepted in the United Statesof America.

We have also audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), theeffectiveness of Community Valley Bancorp and subsidiaries’ internal controlover financial reporting as of December 31, 2006, based on criteriaestablished in *Internal Control-IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission and our report dated March 9, 2007 expressed anunqualified opinion on management’s assessment of the effectiveness ofCommunity Valley Bancorp’s internal control over financial reporting and anunqualified opinion on the effectiveness of Community Valley Bancorp’s internalcontrol over financial reporting.
|  |   | /s/ Perry-Smith LLP |   |   |
|--|--------|---------------------|--------|--------|

 

Sacramento, California

March 9, 2007

61

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**COMMUNITY VALLEY BANCORP AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEET**

**December 31, 2006 and 2005**
| ** **                                                                                                                                  | ** ** | **2006**    | ** **  | **2005**    | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|-------------|-------------|------------|
| **ASSETS**                                                                                                                                  | ** ** | ** **  | ** **  | ** **  | ** ** |
|                                                                                                                                        |       |        |        |        |       |
| Cash and due  from banks                                                                                                                    |       | $           | 20,558,000  |        | $          | 18,988,000 |   |
| Federal funds  sold                                                                                                                         |       | 42,070,000  |        | 29,015,000  |       |
|                                                                                                                                        |       |        |        |        |       |
| Total cash and cash equivalents                                                                                                             |       | 62,628,000  |        | 48,003,000  |       |
|                                                                                                                                        |       |        |        |        |       |
| Interest-bearing  deposits in banks                                                                                                         |       | 2,278,000   |        | 6,636,000   |       |
| Loans held for  sale, at lower of cost or market                                                                                            |       | 790,000     |        | 2,197,000   |       |
| Investment  securities (Note 2):                                                                                                            |       |        |        |        |       |
| Available-for-sale, at fair value                                                                                                           |       | 3,350,000   |        | 4,344,000   |       |
| Held-to-maturity, at cost                                                                                                                   |       | 1,777,000   |        | 2,332,000   |       |
| Loans, less  allowance for loan losses of $5,274,000 in 2006 and $4,716,000 in 2005 (Notes  3, 10 and 14)                                   |       | 442,251,000 |        | 401,221,000 |       |
| Premises and  equipment, net (Note 5)                                                                                                       |       | 15,359,000  |        | 11,221,000  |       |
| Bank owned life  insurance (Note 15)                                                                                                        |       | 9,798,000   |        | 8,447,000   |       |
| Accrued interest  receivable and other assets (Notes 4 and 13)                                                                              |       | 11,806,000  |        | 10,376,000  |       |
|                                                                                                                                        |       |        |        |        |       |
| Total assets                                                                                                                                |       | $           | 550,037,000 |        | $          | 494,777,000 |   |
|                                                                                                                                        |       |        |        |        |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                               | ** ** | ** **  | ** **  | ** **  | ** ** |
|                                                                                                                                        |       |        |        |        |       |
| Deposits:                                                                                                                                   |       |        |        |        |       |
| Non-interest bearing                                                                                                                        |       | $           | 76,988,000  |        | $          | 83,336,000 |   |
| Interest bearing (Note 6)                                                                                                                   |       | 407,868,000 |        | 350,682,000 |       |
|                                                                                                                                        |       |        |        |        |       |
| Total deposits                                                                                                                              |       | 484,856,000 |        | 434,018,000 |       |
|                                                                                                                                        |       |        |        |        |       |
| Notes Payable  (Notes 8 and 15)                                                                                                             |       | 1,217,000   |        | 1,782,000   |       |
| Junior  subordinated debentures (Note 9)                                                                                                    |       | 8,248,000   |        | 8,248,000   |       |
| Accrued interest  payable and other liabilities (Note 15)                                                                                   |       | 9,989,000   |        | 9,174,000   |       |
|                                                                                                                                        |       |        |        |        |       |
| Total liabilities                                                                                                                           |       | 504,310,000 |        | 453,222,000 |       |
|                                                                                                                                        |       |        |        |        |       |
| Commitments and  contingencies (Note 10)                                                                                                    |       |        |        |        |       |
|                                                                                                                                        |       |        |        |        |       |
| Shareholders’  equity (Note 11):                                                                                                       |       |        |        |        |       |
| Common stock - no par value; authorized – 20,000,000  shares, outstanding – 7,394,664 shares in 2006 and 7,408,047 shares in 2005 |       | 9,727,000   |        | 9,051,000   |       |
| Unallocated ESOP shares (155,258 shares in 2006 and  185,051 shares in 2005, at cost) (Note 15)                                             |       | (1,514,000  | )           | (1,391,000  | )          |
| Retained earnings                                                                                                                           |       | 37,505,000  |        | 33,908,000  |       |
| Accumulated other comprehensive income (loss), net  of taxes (Note 2)                                                                       |       | 9,000       |        | (13,000     | )          |
|                                                                                                                                        |       |        |        |        |       |
| Total shareholders’ equity                                                                                                             |       | 45,727,000  |        | 41,555,000  |       |
|                                                                                                                                        |       |        |        |        |       |
| Total  liabilities and shareholders’ equity                                                                                            |       | $           | 550,037,000 |        | $          | 494,777,000 |   |

 

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

62

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**COMMUNITYVALLEY BANCORP AND SUBSIDIARIES**

**CONSOLIDATED STATEMENT OF INCOME**

**For theYears Ended December 31, 2006, 2005 and 2004**
| ** **                                                   | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|--------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
|                                                         |       |       |       |       |       |       |       |
| Interest income:                                             |       |       |       |       |       |       |       |
| Interest and fees on loans                                   |       | $          | 39,544,000 |       | $          | 30,946,000 |       | $ | 24,043,000 |   |
| Interest on Federal funds sold                               |       | 846,000    |       | 943,000    |       | 488,000    |       |
| Interest on deposits in banks                                |       | 178,000    |       | 239,000    |       | 244,000    |       |
| Interest on investment securities:                           |       |       |       |       |       |       |       |
| Taxable                                                      |       | 181,000    |       | 199,000    |       | 151,000    |       |
| Exempt from Federal income taxes                             |       | 65,000     |       | 111,000    |       | 54,000     |       |
|                                                         |       |       |       |       |       |       |       |
| Total interest income                                        |       | 40,814,000 |       | 32,438,000 |       | 24,980,000 |       |
|                                                         |       |       |       |       |       |       |       |
| Interest  expense:                                           |       |       |       |       |       |       |       |
| Interest expense on deposits (Note 6)                        |       | 8,708,000  |       | 4,668,000  |       | 3,585,000  |       |
| Interest expense on junior subordinated debentures  (Note 9) |       | 733,000    |       | 592,000    |       | 438,000    |       |
| Interest expense on notes payable (Notes 8 and 15)           |       | 91,000     |       | 71,000     |       | 33,000     |       |
|                                                         |       |       |       |       |       |       |       |
| Total interest expense                                       |       | 9,532,000  |       | 5,331,000  |       | 4,056,000  |       |
|                                                         |       |       |       |       |       |       |       |
| Net interest income before provision for loan losses         |       | 31,282,000 |       | 27,107,000 |       | 20,924,000 |       |
|                                                         |       |       |       |       |       |       |       |
| Provision for  loan losses (Note 3)                          |       | 638,000    |       | 724,000    |       | 734,000    |       |
|                                                         |       |       |       |       |       |       |       |
| Net interest income after provision for loan losses          |       | 30,644,000 |       | 26,383,000 |       | 20,190,000 |       |
|                                                         |       |       |       |       |       |       |       |
| Non-interest  income:                                        |       |       |       |       |       |       |       |
| Service charges and fees                                     |       | 2,686,000  |       | 2,351,000  |       | 2,086,000  |       |
| Gain on sale of loans                                        |       | 1,578,000  |       | 1,806,000  |       | 1,637,000  |       |
| Loan servicing income                                        |       | 457,000    |       | 481,000    |       | 571,000    |       |
| Other (Note 12)                                              |       | 2,048,000  |       | 2,073,000  |       | 1,724,000  |       |
|                                                         |       |       |       |       |       |       |       |
| Total non-interest income                                    |       | 6,769,000  |       | 6,711,000  |       | 6,018,000  |       |
|                                                         |       |       |       |       |       |       |       |
| Non-interest  expenses:                                      |       |       |       |       |       |       |       |
| Salaries and employee benefits (Notes 3 and 15)              |       | 15,425,000 |       | 12,270,000 |       | 9,980,000  |       |
| Occupancy and equipment (Notes 5 and10)                      |       | 3,480,000  |       | 2,969,000  |       | 2,525,000  |       |
| Other (Note 12)                                              |       | 6,255,000  |       | 5,686,000  |       | 4,290,000  |       |
|                                                         |       |       |       |       |       |       |       |
| Total non-interest expenses                                  |       | 25,160,000 |       | 20,925,000 |       | 16,795,000 |       |
|                                                         |       |       |       |       |       |       |       |
| Income before provision for income taxes                     |       | 12,253,000 |       | 12,169,000 |       | 9,413,000  |       |
|                                                         |       |       |       |       |       |       |       |
| Provision for  income taxes (Note 13)                        |       | 5,102,000  |       | 4,971,000  |       | 3,803,000  |       |
|                                                         |       |       |       |       |       |       |       |
| Net income                                                   |       | $          | 7,151,000  |       | $          | 7,198,000  |       | $ | 5,610,000 |   |
|                                                         |       |       |       |       |       |       |       |
| Basic earnings  per share (Note 11)                          |       | $          | .98        |       | $          | 1.00       |       | $ | .79 |   |
|                                                         |       |       |       |       |       |       |       |
| Diluted earnings per  share (Note 11)                        |       | $          | .93        |       | $          | .95        |       | $ | .74 |   |

 

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

63

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**COMMUNITYVALLEY BANCORP AND SUBSIDIARIES**

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

**For the Years Ended December 31, 2006, 2005and 2004**
| ** **                                                                  | ** ** | ** **            | ** ** | ** ** | ** ** | ** **      | ** ** | ** **   | ** ** | **Accumulated**            | ** ** | ** **        | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------|------------|------------|------------|-----------------|------------|--------------|------------|----------------------------|------------|-------------------|------------|------------|------------|
| ** **                                                                  | ** ** | ** **            | ** ** | ** ** | ** ** | ** **      | ** ** | ** **   | ** ** | **Other**                  | ** ** | ** **        | ** ** | ** ** | ** ** |
| ** **                                                                  | ** ** | ** **            | ** ** | ** ** | ** ** | **Unallocated** | ** ** | ** **   | ** ** | **Comprehensive**          | ** ** | **Total**         | ** ** | **Total**  | ** ** |
| ** **                                                                  | ** ** | **Common Stock** | ** ** | **ESOP**   | ** ** | **Retained**    | ** ** | **Income**   | ** ** | **Shareholders’**     | ** ** | **Comprehensive** | ** ** |
| ** **                                                                  | ** ** | **Shares**            | ** ** | ** ** | ** ** | **Shares**      | ** ** | **Earnings** | ** ** | **Net of Taxes** | ** ** | **Equity**        | ** ** | **Income** | ** ** |
|                                                                        |       |                  |       |       |       |            |       |         |       |                       |       |              |       |       |       |
| Balance,  January 1, 2004                                              |       | 7,243,648             |       | $          | 7,272,000  |            | $          | (1,070,000   | )          | $                          | 23,745,000 |              | $          | 2,000      |       | $ | 29,949,000 |   |   |   |
| Comprehensive  income:                                                      |       |                  |       |       |       |            |       |         |       |                       |       |              |       |       |       |
| Net income                                                                  |       |                  |       |       |       |            |       | 5,610,000    |       |                       |       | 5,610,000         |       | $          | 5,610,000  |   |
| Other  comprehensive loss:                                                  |       |                  |       |       |       |            |       |         |       |                       |       |              |       |       |       |
| Net change in  unrealized gains on available-for-sale investment securities |       |                  |       |       |       |            |       |         |       | 9,000                      |       | 9,000             |       | 9,000      |       |
| Total  comprehensive income                                                 |       |                  |       |       |       |            |       |         |       |                       |       |              |       | $          | 5,619,000  |   |
|                                                                        |       |                  |       |       |       |            |       |         |       |                       |       |              |       |       |       |
| Exercise of stock  options and related tax benefit (Note 11)                |       | 68,404                |       | 532,000    |       |            |       |         |       |                       |       | 532,000           |       |       |       |
| Amortization of  stock compensation - ESOP shares (Note 15)                 |       |                  |       | 104,000    |       | 76,000          |       |         |       |                       |       | 180,000           |       |       |       |
| Shares acquired  or redeemed by ESOP (Note 15)                              |       |                  |       |       |       | (150,000        | )          |         |       |                       |       | (150,000          | )          |       |       |
| Cash dividends -  $0.15 per share                                           |       |                  |       |       |       |            |       | (1,091,000   | )          |                       |       | (1,091,000        | )          |       |       |
| Cash in lieu of  fractional shares in four-for-three stock split (Note 11)  |       |                  |       | (6,000     | )          |            |       |         |       |                       |       | (6,000            | )          |       |       |
| Repurchase and  retirement of common stock                                  |       | (38,470               | )          | (40,000    | )          |            |       | (462,000     | )          |                       |       | (502,000          | )          |       |       |
|                                                                        |       |                  |       |       |       |            |       |         |       |                       |       |              |       |       |       |
| Balance,  December 31, 2004                                            |       | 7,273,582             |       | 7,862,000  |       | (1,144,000      | )          | 27,802,000   |       | 11,000                     |       | 34,531,000        |       |       |       |
|                                                                        |       |                  |       |       |       |            |       |         |       |                       |       |              |       |       |       |
| Comprehensive  income:                                                      |       |                  |       |       |       |            |       |         |       |                       |       |              |       |       |       |
| Net income                                                                  |       |                  |       |       |       |            |       | 7,198,000    |       |                       |       | 7,198,000         |       | $          | 7,198,000  |   |
| Other  comprehensive loss:                                                  |       |                  |       |       |       |            |       |         |       |                       |       |              |       |       |       |
| Net change in  unrealized gains on available-for-sale investment securities |       |                  |       |       |       |            |       |         |       | (24,000                    | )          | (24,000           | )          | (24,000    | )          |
|                                                                        |       |                  |       |       |       |            |       |         |       |                       |       |              |       |       |       |
| Total  comprehensive income                                                 |       |                  |       |       |       |            |       |         |       |                       |       |              |       | $          | 7,174,000  |   |
|                                                                        |       |                  |       |       |       |            |       |         |       |                       |       |              |       |       |       |
| Exercise of stock  options and related tax benefit (Note 11)                |       | 134,465               |       | 1,039,000  |       |            |       |         |       |                       |       | 1,039,000         |       |       |       |
| Amortization of  stock compensation - ESOP shares (Note 15)                 |       |                  |       | 150,000    |       | 101,000         |       |         |       |                       |       | 251,000           |       |       |       |
| Shares acquired  or redeemed by ESOP (Note 15)                              |       |                  |       |       |       | (348,000        | )          |         |       |                       |       | (348,000          | )          |       |       |
| Cash dividends -  $0.16 per share                                           |       |                  |       |       |       |            |       | (1,092,000   | )          |                       |       | (1,092,000        | )          |       |       |
|                                                                        |       |                  |       |       |       |            |       |         |       |                       |       |              |       |       |       |
| Balance,  December 31, 2005                                            |       | 7,408,047             |       | 9,051,000  |       | (1,391,000      | )          | 33,908,000   |       | (13,000                    | )          | 41,555,000        |       |       |       |
|                                                                        |       |                  |       |       |       |            |       |         |       |                       |       |              |       |       |       |
| Comprehensive  income:                                                      |       |                  |       |       |       |            |       |         |       |                       |       |              |       |       |       |
| Net income                                                                  |       |                  |       |       |       |            |       | 7,151,000    |       |                       |       | 7,151,000         |       | $          | 7,151,000  |   |
| Other  comprehensive income:                                                |       |                  |       |       |       |            |       |         |       |                       |       |              |       |       |       |
| Net change in  unrealized gains 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 (Note 11)                |       | 130,567               |       | 1,000,000  |       |            |       |         |       |                       |       | 1,000,000         |       |       |       |
| Amortization of  stock compensation - ESOP shares (Note 15)                 |       |                  |       | 378,000    |       | 231,000         |       |         |       |                       |       | 609,000           |       |       |       |
| Shares acquired  or redeemed by ESOP (Note 15)                              |       |                  |       |       |       | (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        |       |       |       |
|                                                                             |            |                       |            |            |            |                 |            |              |            |                            |            |                   |            |            |            |  |  |  |  |  |  |

 

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

64

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**COMMUNITYVALLEY BANCORP AND SUBSIDIARIES**

**CONSOLIDATED STATEMENT OF CASH FLOWS**

**For the Years Ended December 31, 2006, 2005and 2004**
| ** **                                                                         | ** ** | **2006**    | ** ** | **2005**    | ** ** | **2004**    | ** ** |
|------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|
| Cash flows from  operating activities:                                             |       |        |       |        |       |        |       |
| Net income                                                                         |       | $           | 7,151,000  |        | $          | 7,198,000   |       | $ | 5,610,000 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |        |       |        |       |        |       |
| Provision for  loan losses                                                         |       | 638,000     |       | 724,000     |       | 734,000     |       |
| (Increase)  decrease in loan origination fees, net                                 |       | (307,000    | )          | 86,000      |       | (11,000     | )          |
| Depreciation,  amortization and accretion, net                                     |       | 1,671,000   |       | 1,556,000   |       | 1,350,000   |       |
| Increase in cash  surrender value of bank owned life insurance, net                |       | (331,000    | )          | (294,000    | )          | (284,000    | )          |
| Non-cash  compensation cost associated with the ESOP                               |       | 609,000     |       | 251,000     |       | 180,000     |       |
| Stock based  compensation                                                          |       | 175,000     |       |        |       |        |       |
| Excess tax  benefit from exercise of stock-based compensation awards               |       | (489,000    | )          |        |       |        |       |
| Gain on  disposition of equipment                                                  |       |        |       | (31,000     | )          |        |       |
| Decrease  (increase) in loans held for sale                                        |       | 1,407,000   |       | (707,000    | )          | 789,000     |       |
| Decrease in  accrued interest receivable and other assets                          |       | 94,000      |       | 871,000     |       | 1,218,000   |       |
| Increase in  accrued interest payable and other liabilities                        |       | 519,000     |       | 1,767,000   |       | 1,876,000   |       |
| Provision for  deferred income taxes                                               |       | (1,050,000  | )          | (1,331,000  | )          | (64,000     | )          |
|                                                                               |       |        |       |        |       |        |       |
| Net cash  provided by operating activities                                         |       | 10,087,000  |       | 10,090,000  |       | 11,398,000  |       |
|                                                                               |       |        |       |        |       |        |       |
| Cash flows from  investing activities:                                             |       |        |       |        |       |        |       |
| Purchases of  held-to-maturity investment securities                               |       |        |       | (1,234,000  | )          | (1,013,000  | )          |
| Purchases of  available-for-sale investment securities                             |       |        |       | (2,008,000  | )          | (4,145,000  | )          |
| Proceeds from  matured or called available-for-sale investment securities          |       | 1,000,000   |       | 2,027,000   |       | 300,000     |       |
| Proceeds from  matured or called held-to- maturity investment securities           |       | 246,000     |       | 1,119,000   |       | 1,870,000   |       |
| Proceeds from  principal repayments of available-for-sale investment securities    |       | 31,000      |       |        |       |        |       |
| Proceeds from  principal repayments of held-to-maturity investment securities      |       | 300,000     |       | 358,000     |       | 332,000     |       |
| Net increase  (decrease) in interest-bearing deposits in banks                     |       | 4,358,000   |       | 2,079,000   |       | (790,000    | )          |
| Net increase in  loans                                                             |       | (41,361,000 | )          | (62,477,000 | )          | (69,722,000 | )          |
| Premiums paid  for life insurance policies                                         |       | (1,020,000  | )          | (1,450,000  | )          | (122,000    | )          |
| Purchases of  premises and equipment                                               |       | (5,820,000  | )          | (3,802,000  | )          | (1,786,000  | )          |
| Proceeds from  sale of equipment                                                   |       | 20,000      |       | 65,000      |       |        |       |
| Net cash used in  investing activities                                             |       | (42,246,000 | )          | (65,323,000 | )          | (75,076,000 | )          |
| Cash flows from  financing activities:                                             |       |        |       |        |       |        |       |
| Net increase in  demand, interest-bearing and savings deposits                     |       | $           | 2,597,000  |        | $          | 17,561,000  |       | $ | 37,110,000 |   |
| Net increase in  time deposits                                                     |       | 48,241,000  |       | 17,398,000  |       | 19,438,000  |       |
| (Repayment)  proceeds from note payable                                            |       | (800,000    | )          | 800,000     |       |        |       |
| Proceeds from  ESOP note payable                                                   |       | 354,000     |       | 348,000     |       | 879,000     |       |
| Repayments of  ESOP note payable                                                   |       | (119,000    | )          | (199,000    | )          | (878,000    | )          |
| Purchase of  unallocated ESOP shares                                               |       | (354,000    | )          | (348,000    | )          | (150,000    | )          |
| Proceeds from  exercise of stock options, including tax benefit                    |       | 1,000,000   |       | 527,000     |       | 284,000     |       |
| Cash paid for  fractional shares                                                   |       |        |       |        |       | (6,000      | )          |
| Payment of cash  dividends                                                         |       | (1,637,000  | )          | (1,069,000  | )          | (1,089,000  | )          |
| Repurchase of  common stock                                                        |       | (2,498,000  | )          |        |       | (502,000    | )          |
|                                                                               |       |        |       |        |       |        |       |
| Net cash  provided by financing activities                                         |       | 46,784,000  |       | 35,018,000  |       | 55,086,000  |       |
|                                                                               |       |        |       |        |       |        |       |
| Increase  (decrease) in cash and cash equivalents                                  |       | 14,625,000  |       | (20,215,000 | )          | (8,592,000  | )          |
|                                                                               |       |        |       |        |       |        |       |
| Cash and cash  equivalents at beginning of year                                    |       | 48,003,000  |       | 68,218,000  |       | 76,810,000  |       |
|                                                                               |       |        |       |        |       |        |       |
| Cash and cash  equivalents at end of year                                          |       | $           | 62,628,000 |        | $          | 48,003,000  |       | $ | 68,218,000 |   |
|                                                                               |       |        |       |        |       |        |       |
| Supplemental  disclosure of cash flow information:                                 |       |        |       |        |       |        |       |
|                                                                               |       |        |       |        |       |        |       |
| Cash paid during  the year for:                                                    |       |        |       |        |       |        |       |
| Interest                                                                           |       | $           | 9,147,000  |        | $          | 5,158,000   |       | $ | 4,084,000 |   |
| Income taxes                                                                       |       | $           | 6,064,000  |        | $          | 5,780,000   |       | $ | 2,830,000 |   |
|                                                                               |       |        |       |        |       |        |       |
| Non-cash  investing activities:                                                    |       |        |       |        |       |        |       |
| Net change in  unrealized gains on available-for-sale investment securities        |       | $           | 22,000     |        | $          | (24,000     | )          | $ | 9,000 |   |
|                                                                               |       |        |       |        |       |        |       |
| Non-cash  financing activities:                                                    |       |        |       |        |       |        |       |
| Release of  unallocated ESOP shares                                                |       | $           | 231,000    |        | $          | 101,000     |       | $ | 76,000 |   |
| Accrual of cash  dividend declared                                                 |       | $           | 592,000    |        | $          | 296,000     |       | $ | 273,000 |   |

 

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

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

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**1.             SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

General

In May 2002,Community Valley Bancorp (“Community Valley”) was incorporated as a bankholding company for the purpose of acquiring Butte Community Bank (the “Bank”)in a one bank holding company reorganization. In 2004, Community Valley 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 Bankis a state-chartered financial institution with thirteen branches in ten citiesincluding Chico, Magalia, Oroville, Paradise, Redding, Red Bluff, Colusa,Corning, Marysville, and Yuba City and loan production offices in CitrusHeights and Gridley. The Bank provides traditional deposit and lending servicesincluding commercial and construction loans, government guaranteed loans suchas those available from the USDA and SBA, merchant services and investmentservices.

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

On December 1, 2004,Community Valley formed a wholly-owned subsidiary, BCB Insurance Agency LLC forthe purpose of providing insurance related services.

The accounting and reportingpolicies of Community Valley Bancorp and its subsidiaries (collectively, the “Company”)conform with accounting principles generally accepted in the United Statesof America and prevailing practice within the banking industry. The moresignificant of these policies applied in the preparation of the accompanyingconsolidated financial statements are discussed below.

Segment Information

Management has determinedthat since all of the banking products and services offered by the Company areavailable in each branch of the Bank, all branches are located within the sameeconomic environment and management does not allocate resources based on theperformance of different lending or transaction activities, it is appropriateto aggregate the Bank branches and report them as a single operating segment.No customer accounts for more than 10 percent of revenues for the Company orthe Bank.

Principles of Consolidation

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

For financial reportingpurposes, the Company’s investment in the Trust of $248,000 (see Note 9) isaccounted for under the equity method and is included in accrued interestreceivable and other assets on the consolidated balance sheet. The juniorsubordinated debentures issued and guaranteed by the Company and held by theTrust are reflected as debt in the Company’s consolidated balance sheet.

Stock Splits

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

Reclassifications

Certain reclassificationshave been made to prior years’ balances to conform to classifications usedin 2006.

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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 of theconsolidated statement of cash flows, cash and cash equivalents include cashand due from banks and Federal funds sold. Federal funds are generally sold forone-day periods.

Investment Securities

Investment securities areclassified into the following categories:

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

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

Management determines theappropriate classification of its investments at the time of purchase andmay only change the classification in certain limited circumstances. Alltransfers between categories are accounted for at fair value. As ofDecember 31, 2006 and 2005 the Company did not have any investmentsecurities classified as trading and there were no transfers of securitiesbetween categories.

Gains or losses on thesale of investment securities are computed using the specific identificationmethod. Interest earned on investment securities is reported in interestincome, 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, 2006 and 2005, therewere no such loans being accounted for under this policy.

Loans Held for Sale, LoanSales and Servicing Rights

The Company accounts forthe transfer and servicing of financial assets based on the financial andservicing assets it controls and liabilities it has incurred, derecognizesfinancial assets when control has been surrendered, and derecognizesliabilities when extinguished.

Servicing rights acquiredthrough 1) a purchase or 2) the origination of loans which are sold withservicing rights retained are recognized as separate assets or liabilities.Servicing assets or liabilities are recorded at the difference between thecontractual servicing fees and adequate compensation for performing theservicing, and are subsequently amortized in proportion to and over the periodof 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 servicing assets inexcess of the contractually specified servicing fees have been reclassified atfair value as an interest-only (IO) strip receivable and treated like anavailable-for-sale security. The servicing asset, net of any required valuationallowance, and IO strip receivable are included in accrued interest and otherassets. At December 31, 2006 and 2005, IO strips were not significant.

*Government Guaranteed Loans*

Included in the loanportfolio are loans which are 85% to 90% guaranteed by the Small Business Administration(SBA), U.S. Department of Agriculture, Rural Business – Cooperative Service(RBS) and Farm Services Agency (FSA). The guaranteed portion of these loansmay be sold to a third party, with the Company retaining the unguaranteedportion. The Company generally receives a premium in excess of the adjustedcarrying value of the loan at the time of sale. The Company may berequired to refund a portion of the sales premium if the borrower defaults orthe loan prepays within ninety days of the settlement date.

The Company’s investmentin the loan is allocated between the retained portion of the loan, theservicing asset, the IO strip, and the sold portion of the loan based on theirrelative fair values on the date the loan is sold. The gain on the sold portionof the loan is recognized as income at the time of sale. The carrying value ofthe retained portion of the loan is discounted based on the estimated value ofa 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 Company serviced SBA,RBS and FSA government guaranteed loans for others totaling $79,675,000 and$70,894,000 as of December 31, 2006 and 2005, respectively.

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MortgageLoans

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

The Company servicedloans for the Federal National Mortgage Association (FNMA) totaling$152,618,000 and $157,210,000 as of December 31, 2006 and 2005,respectively.

*Participation Loans*

The Company also servicedloans which it has participated with other financial institutions totaling$10,118,000 and $1,540,000 as of December 31, 2006 and 2005, respectively.

## Allowance for Loan Losses

The allowance for loanlosses is maintained to provide for losses related to impaired loans and otherlosses that can be reasonably expected to occur in the normal course ofbusiness. The determination of the allowance for loan losses is based onestimates made by management, to include consideration of the character of theloan portfolio, specifically identified problem loans, potential lossesinherent in the portfolio taken as a whole and economic conditions in theCompany’s service area.

Classified loans andloans determined to be impaired are evaluated by management for specific riskof 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) where the Company has not experienced losses, the loss experience ofpeer banks. These estimates are particularly susceptible to changes in theeconomic environment and market conditions.

The Company’s Board ofDirectors 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 for loanlosses is established through a provision for loan losses which is charged toexpense. 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, 2006 and 2005 reflectsmanagement’s estimate of possible losses in the portfolio.

##### Allowance for Losses Related to UndisbursedLoan Commitments

The Company maintains aseparate allowance for losses related to undisbursed loan commitments.Management estimates the amount of probable losses by applying the loss factorsused in the allowance for loan loss methodology to an estimate of the expectedusage and applies the factor to the unused portion of undisbursed lines ofcredit. The allowance totaled $619,000 and $481,000 at December 31, 2006and 2005, respectively, and is included in accrued interest payable and otherliabilities on the balance sheet.

Premises and Equipment

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

The Company evaluatespremises and equipment for financial impairment as events or changes incircumstances indicate that the carrying amount of such assets may not befully recoverable.

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Income Taxes

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

The Company accounts forincome taxes using the liability or balance sheet method. Under this method,deferred tax assets and liabilities are recognized for the tax consequences oftemporary differences between the reported amounts of assets and liabilitiesand their tax bases. Deferred tax assets and liabilities are adjusted for theeffects of changes in tax laws and rates on the date of enactment. On theconsolidated balance sheet, net deferred tax assets are included in accruedinterest receivable and other assets.

Earnings Per Share

Basic earnings per share(EPS), which excludes dilution, is computed by dividing income available tocommon shareholders by the weighted-average number of common shares outstandingfor the period, excluding the effect of unallocated shares of the EmployeeStock Ownership Plan.  Diluted EPSreflects 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

Comprehensive income is amore inclusive financial reporting methodology that includes disclosure ofother comprehensive income (loss) that historically has not been recognized inthe calculation of net income. Unrealized gains or losses on the Company’savailable-for-sale investment securities and IO strip are the principle sourceof other comprehensive income or loss. Total comprehensive income and thecomponents of accumulated other comprehensive income (loss) are presented inthe consolidated statement of changes in shareholders’ 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, 210,516 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 these plans. Under the Company’s2000 stock option plan, 508,767 shares of common stock remain reserved forissuance to employees and directors, of which 66,877 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 measurethe cost of employees services received in exchange for an award of equityinstruments based 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 applies tothe unvested portion of previously issued awards, new awards and to awardsmodified, repurchased or canceled after the adoption date.  Accordingly, commencing January 1, 2006, theCompany recognized stock-based compensation for all current award grants andfor the unvested portion of previous award grants that are expected to vestbased on the grant date fair value.  TheCompany applied the alternative transition method in calculating its pool ofexcess tax benefits available to absorb future tax deficiencies as provided byFSP FAS 123(R)-3, *Transition Election Related to Accountingfor the Tax Effects of share-Based Payment Awards.*  Prior to 2006, the Company accounted forstock-based compensation awards under Accounting Principles Board Opinion No.25 intrinsic value method, under which no compensation expense was recognizedbecause all historical options granted were at an exercise price equal to themarket value of the Company’s stock on the grant date.  Prior period financial statements have notbeen adjusted to reflect fair value stock-based compensation expense under SFASNo. 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, 2006 are $175,000 and $163,000,respectively, lower than if it had continued to account for share-basedcompensation under APB 25.  Basic anddiluted earnings per share for the year ended December 31, 2006 would have been$.02 higher without the adoption of SFAS 123(R).

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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 determine theexpected term of the Company’s options for 2006 and 2005.  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 following tableillustrates the effect on net income and earnings per share for the years endedDecember 31, 2005 and 2004 as if the Company had applied the fair valuerecognition provisions of SFAS No. 123 to options granted under the Company’sstock option plan:

The fair value of eachoption is estimated on the date of grant using the following assumptions:
|                                                                 | ** ** | **2006**  | ** ** | **2005**  | ** ** | **2004** | ** ** |
|-----------------------------------------------------------------|------------|-----------|------------|-----------|------------|----------|------------|
|                                                            |       |      |       |      |       |     |       |
| Expected  volatility                                            |       | 11.54     | %          | 12.38     | %          | 15.21    | %          |
| Risk-free  interest rate                                        |       | 4.6       | %          | 4.0       | %          | 4.02     | %          |
| Expected option  life                                           |       | 7.5 years |       | 7.5 years |       | 10 years |       |
| Expected  dividend yield                                        |       | 1.47      | %          | 1.11      | %          | 1.36     | %          |
| Weighted average fair  value of options granted during the year |       | $         | 3.75       |      | $          | 3.25     |       | $ | 3.35 |   |
|                                                                 |            |           |            |           |            |          |            |  |  |  |

 

|                                                                                                                                         | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                                                                                    |       |     |       |     |       |
| Net income, as  reported                                                                                                                |       | $        | 7,198,000  |     | $          | 5,610,000 |   |
| Deduct: Total  stock-based compensationexpense determined under the fair value based method  for all awards, net of related tax effects |       | 353,000  |       | 311,000  |       |
|                                                                                                                                    |       |     |       |     |       |
| Pro forma net  income                                                                                                                   |       | $        | 6,845,000  |     | $          | 5,299,000 |   |
|                                                                                                                                    |       |     |       |     |       |
| Basic earnings  per share -as reported                                                                                                  |       | $        | 1.00       |     | $          | 0.79 |   |
| Basic earnings  per share - pro forma                                                                                                   |       | $        | 0.95       |     | $          | 0.74 |   |
|                                                                                                                                    |       |     |       |     |       |
| Diluted earnings  per share - as reported                                                                                               |       | $        | 0.95       |     | $          | 0.74 |   |
| Diluted earnings per  share - pro forma                                                                                                 |       | $        | 0.90       |     | $          | 0.70 |   |

 

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Impact of New FinancialAccounting Standards  

*Accountingfor Servicing of Financial Assets*

In March 2006, theFinancial Accounting Standards Board (FASB) issued Statement No. 156 (SFAS156), *Accounting for Servicing of FinancialAssets – An Amendment of FASB Statement No. 140*.  SFAS 156 requires that all separatelyrecognized servicing assets and servicing liabilities be initially measured atfair value, if practicable, and permits, but does not require, the subsequentmeasurement of servicing assets and servicing liabilities at fair value.  Under SFAS 156, an entity can electsubsequent fair value measurement of its servicing assets and servicingliabilities by class.  An entity shouldapply the requirements for recognition and initial measurement of servicingassets and servicing liabilities prospectively to all transactions after theeffective date. SFAS 156 permits an entity to reclassify certainavailable-for-sale securities to trading securities provided that they areidentified in some manner as offsetting the entity’s exposure to changes infair value of servicing assets or servicing liabilities subsequently measuredat fair value.  The provisions of SFAS156 are effective for an entity as of the beginning of its first fiscal yearthat begins after September 15, 2006 and the Bank adopted these provisionson January 1, 2007.  Management does notexpect the adoption of SFAS 156 to have a material impact on the Bank’sfinancial position or results of operations

*Accounting for Uncertainty inIncome Taxes*

In July 2006,, the FASBissued Interpretation No. 48, *Accounting forUncertainty in Income Taxes – an interpretation of FASB Statement 109*(FIN 48).   FIN 48 clarifies the accounting foruncertainty in income taxes recognized in a company’s financial statements inaccordance with FASB Statement No. 109, *Accountingfor Income Taxes*.  The Companypresently recognizes income tax positions based on management’s estimate ofwhether it is reasonably possible that a liability has been incurred forunrecognized income tax benefits by applying FASB Statement No. 5, *Accounting for Contingencies*.  FIN 48 prescribes a comprehensive model forrecognizing, measuring, presenting and disclosing in the financial statementstax positions taken or expected to be taken in a tax return.

The provisions of FIN 48will be effective for the Company on January 1, 2007 and are to be applied toall tax positions upon initial application of this standard. Only tax positionsthat meet the more-likely-than-not recognition threshold at the effective datemay be recognized or continue to be recognized upon adoption.

The cumulative effect ofapplying the provisions of FIN 48, if any, will be reported as an adjustment tothe opening balance of retained earnings for he fiscal year of adoption.  Management does not expect the adoption tohave a material impact on the Company’s financial position or results ofoperations.

*Considering the Effects of Prior Year Misstatements*

In September 2006, the Securities and ExchangeCommission published Staff Accounting Bulleting No. 108 *Considering the Effects of Prior Year Misstatementswhen Quantifying Misstatements in Current Year Financial Statements*. The interpretations in this Staff Accounting Bulleting are being issued toaddress diversity in practice in quantifying financial statement misstatementsand the potential under current practice to build up improper amounts on thebalance sheet.  This guidance will apply to the first fiscal year endingafter November 15, 2006, or December 31, 2006 for the Company.  Theadoption of SAB 108 did not  have amaterial impact on the Company’s financial position, results of operations or cash flows and nocumulative adjustment was required..

*Fair Value Measurements*

In September 2006, the FASB issued StatementNo. 157 (SFAS 157), *Fair ValueMeasurements*. SFAS 157 defines fair value, establishes a frameworkfor measuring fair value and expands disclosures about fair value measurements.  SFAS 157 applies whenever other standardsrequire (or permit) assets or liabilities to be measured at fair value but doesnot expand the use of fair value in any new circumstances.  In this standard, the FASB clarifies theprinciple that fair value should be based on the assumptions marketparticipants would use when pricing the asset or liability.  In support of this principle, SFAS 157establishes a fair value hierarchy that prioritizes the information used to developthose assumptions.  The provisions ofSFAS 157 are effective for financial statements issued for fiscal yearsbeginning after November 15, 2007 and interim periods within those fiscalyears.  The provisions should be appliedprospectively, except for certain specifically identified financialinstruments.  Management does not expectthe adoption of SFAS 157 to have a material impact to the Bank’s financialposition or result of operations.

72

 

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*Accounting for Purchases of LifeInsurance*

InSeptember 2006, the FASB ratified the consensuses reached by theEmerging Issues Task Force (the Task Force) on Issue No. 06-5 (EITF 06-5) *Accounting for the Purchases of Life Insurance –Determining the Amount that Could be Realized in Accordance with FASB TechnicalBulletin No. 85-4* (FTB 85-4). FTB 85-4 indicates that the amount of the asset included in the balancesheet for life insurance contracts within its scope should be “the amount thatcould be realized under the insurance contract as of the date of the statementof financial position.”  Questions arosein applying the guidance in FTB 85-4 to whether “the amount that could berealized” should consider 1) any additional amounts included in thecontractual terms of the insurance policy other than the cash surrender valueand 2) the contractual ability to surrender all of the individual-life policies(or certificates in a group policy) at the same time.  EITF 06-5 determined that “the amount thatcould be realized” should 1) consider any additional amounts included in thecontractual terms of the policy and 2) assume the surrender of anindividual-life by individual-life policy (or certificate by certificate in agroup policy).  Any amount that isultimately realized by the policy holder upon the assumed surrender of thefinal policy (or final certificate in a group policy) shall be included in the “amountthat could be realized.”  An entityshould apply the provisions of EITF 06-5 through either a change in accountingprinciple through a cumulative-effect adjustment to retained earnings as of thebeginning of the year of adoption or a change in accounting principle throughretrospective application to all prior periods. The provisions of EITF 06-5 are effective for fiscal years beginningafter December 15, 2006.  Managementhas not yet completed its evaluation of the impact that EITF 06-5 will have.

*Accounting for Deferred Compensationand Postretirement Benefit Aspects of Endorsement Split-Dollar Life InsuranceArrangements*

In September 2006, theFASB ratified the consensuses reached by the Task Force on Issue No. 06-4(EITF 06-4) *Accounting for DeferredCompensation and Postretirement Benefit Aspects of Endorsement Split-DollarLife Insurance Arrangements*. A question arose when an employer enters into an endorsementsplit-dollar life insurance arrangement related to whether the employer shouldrecognize a liability for the future benefits or premiums to be provided to theemployee.  EITF 06-4 indicates that anemployer should recognize a liability for future benefits and that a liabilityfor the benefit obligation has not been settled through the purchase of anendorsement type policy. An entity should apply the provisions of EITF 06-4either through a change in accounting principle through a cumulative-effectadjustment to retained earnings as of the beginning of the year of adoption ora change in accounting principle through retrospective application to all priorperiods.  The provisions of EITF 06-4 areeffective for fiscal years beginning after December 15, 2007.  Management has not yet completed its evaluationof the impact that EITF 06-4 will have.

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**2.             INVESTMENTSECURITIES**

The amortized cost andestimated fair value of investment securities at December 31, 2006 and2005 consisted of the following:
|                                                  | ** ** | **2006**      | ** ** |
|--------------------------------------------------|------------|---------------|------------|
| ** **                                       | ** ** | ** **    | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                                       | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **Available for Sale**                 | ** ** | **Cost**      | ** ** | **Gains** | ** ** | **Losses** | ** ** | **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 |   |

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

 

Net unrealized gains and(losses)on available-for-sale investment securities totaling $16,000 and  $(21,000) were recorded, net of $(7,000) and$8,000 in tax (expenses)benefits, respectively, as accumulated othercomprehensive  income (loss)withinshareholders’ equity at December 31, 2006 and 2005, respectively. Therewere no sales or transfers of available-for-sale investment securities for theyears ended December 31, 2006, 2005 and 2004.
|                                | ** ** | **2006**      | ** ** |
|--------------------------------|------------|---------------|------------|
| ** **                     | ** ** | ** **    | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                     | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **Held to Maturity** | ** ** | **Cost**      | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
|                           |       |          |       |   |   |   |   |   |   |
| Debt securities:               |       |          |       |   |   |   |   |   |   |
| U.S. Government agencies       |       | $             | 1,777,000  |   | $ | 3,000 |   | $ | (21,000 | ) | 1,759,000 |   |
|                           |       |          |       |   |   |   |   |   |   |
|                           |       | $             | 1,777,000  |   | $ | 3,000 |   | $ | (21,000 | ) | $ | 1,759,000 |   |
|                                |            |               |            |  |  |  |  |  |  |  |  |  |  |

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

 

There were no sales ortransfers of held-to-maturity investment securities for the years endedDecember 31, 2006, 2005 and 2004.

74

 

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Investmentsecurities with unrealized losses at December 31, 2006 and 2005 aresummarized and classified according to the duration of the loss period asfollows:
|                           | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total** | ** ** |
|---------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|-----------|------------|
| ** **                | ** ** | **Fair**                               | ** ** | **Unrealized**                       | ** ** | **Fair**  | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                | ** ** | **Value**                              | ** ** | **Losses**                           | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
| Debt securities:          |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| U.S. Government  agencies |       | $                                      | 1,981,000  |                                 | $          | (19,000   | )          | $ | 1,484,000 |   | $ | (18,000 | ) | $ | 3,465,000 |   | $ | (37,000 | ) |
|                           |            |                                        |            |                                      |            |           |            |  |  |  |  |  |  |  |  |  |  |  |  |

 
|                                                  | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total** | ** ** |
|--------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|-----------|------------|
| ** **                                       | ** ** | **Fair**                               | ** ** | **Unrealized**                       | ** ** | **Fair**  | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                                       | ** ** | **Value**                              | ** ** | **Losses**                           | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
| Debt securities:                                 |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| U.S. Government agencies                         |       | $                                      | 987,000    |                                 | $          | (22,000   | )          | $ | 2,953,000 |   | $ | (47,000 | ) | $ | 3,940,000 |   | $ | (69,000 | ) |
| Obligations of states and political subdivisions |       |                                   |       |                                 |       | 736,000   |       | (16,000 | ) | 736,000 |   | (16,000 | ) |
| U.S. Treasuries                                  |       | 240,000                                |       | (2,000                               | )          |      |       |   |   | 240,000 |   | (2,000 | ) |
|                                             |       | $                                      | 1,277,000  |                                 | $          | (24,000   | )          | $ | 3,689,000 |   | $ | (63,000 | ) | $ | 4,916,000 |   | $ | (87,000 | ) |

 

U.S. GovernmentAgencies

At December 31,2006, the Company held 9 U.S. Government agency securities of which 2 were in aloss position for less than twelve months and 2 were in a loss position and hadbeen in a loss position for twelve months or more. The unrealized losses on theCompany’s investments in direct obligations of U.S. government agencies werecaused by interest rate increases. The contractual terms of those investmentsdo not permit the issuer to settle the securities at a price less than theamortized costs 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 those investments until arecovery of fair value, which may be maturity, the Company does not considerthose investments to be other-than-temporarily impaired at December 31, 2006.

The amortized costand estimated fair value of investment securities at December 31, 2006, bycontractual maturity, are shown below. Expected maturities will differ fromcontractual maturities because the issuers of securities may have theright to call or prepay obligations with or without prepayment penalties.
|                                                           | ** ** | **Available for Sale** | ** ** | **Held to Maturity** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                | ** ** | ** **                       | ** ** | **Estimated**                  | ** ** | ** ** | ** ** | **Estimated** | ** ** |
| ** **                                                | ** ** | **Amortized**                    | ** ** | **Fair**                       | ** ** | **Amortized** | ** ** | **Fair** | ** ** |
| ** **                                                | ** ** | **Cost**                         | ** ** | **Value**                      | ** ** | **Cost** | ** ** | **Value** | ** ** |
|                                                      |       |                             |       |                           |       |   |   |   |   |
| Within one year                                           |       | $                                | 1,000,000  |                           | $          | 998,000 |   |   |   |   |   |
| After one year  through five years                        |       |                             |       |                           |       | $ | 1,000,000 |   | $ | 982,000 |   |
| After five years  through ten years                       |       |                             |       |                           |       |   |   |   |   |
| After ten years                                           |       | 1,357,000                        |       | 1,389,000                      |       |   |   |   |   |
|                                                      |       |                             |       |                           |       |   |   |   |   |
|                                                      |       | 2,357,000                        |       | 2,387,000                      |       | 1,000,000 |   | 982,000 |   |
|                                                      |       |                             |       |                           |       |   |   |   |   |
| Investment  securities not due at a single maturity date: |       |                             |       |                           |       |   |   |   |   |
| SBA pools                                                 |       | 977,000                          |       | 963,000                        |       | 777,000 |   | 777,000 |   |
|                                                      |       |                             |       |                           |       |   |   |   |   |
|                                                      |       | $                                | 3,334,000  |                           | $          | 3,350,000 |   | $ | 1,777,000 |   | $ | 1,759,000 |   |

 

Investmentsecurities with amortized costs totaling $3,357,000 and $3,357,000 and fairvalues totaling $3,370,000 and $3,349,000 were pledged to secure publicdeposits and treasury, tax and loan accounts at December 31, 2006 and 2005,respectively.

75

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

Outstanding loansare summarized as follows:
|                                      | ** ** | **December 31,** | ** **  |
|--------------------------------------|------------|-----------------------|-------------|
| ** **                           | ** ** | **2006**              | ** **  | **2005** | ** ** |
|                                 |       |                  |        |   |   |
| Real estate -  mortgage              |       | $                     | 208,102,000 |   | $ | 173,450,000 |   |
| Real estate -  construction          |       | 105,449,000           |        | 111,130,000 |   |
| Commercial                           |       | 65,241,000            |        | 61,162,000 |   |
| Agricultural                         |       | 25,745,000            |        | 24,803,000 |   |
| Installment                          |       | 43,789,000            |        | 36,500,000 |   |
|                                 |       |                  |        |   |   |
|                                 |       | 448,326,000           |        | 407,045,000 |   |
|                                 |       |                  |        |   |   |
| Deferred loan  origination fees, net |       | (801,000              | )           | (1,108,000 | ) |
| Allowance for  loan losses           |       | (5,274,000            | )           | (4,716,000 | ) |
|                                 |       |                  |        |   |   |
|                                 |       | $                     | 442,251,000 |   | $ | 401,221,000 |   |

 

Changes in theallowance for loan losses were as follows:
|                                  | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------|------------|--------------------------------------------|------------|
| ** **                       | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
|                             |       |                                       |       |   |   |   |   |
| Balance,  beginning of year      |       | $                                          | 4,716,000  |   | $ | 4,000,000 |   | $ | 3,262,000 |   |
| Provision  charged to operations |       | 638,000                                    |       | 724,000 |   | 734,000 |   |
| Losses charged  to allowance     |       | (82,000                                    | )          | (9,000 | ) | (24,000 | ) |
| Recoveries                       |       | 2,000                                      |       | 1,000 |   | 28,000 |   |
|                             |       |                                       |       |   |   |   |   |
| Balance, end of  year            |       | $                                          | 5,274,000  |   | $ | 4,716,000 |   | $ | 4,000,000 |   |

 

AtDecember 31, 2006 and 2005, nonaccrual loans totaled $2,282,000 and$9,000, which were considered impaired loans. A valuation allowance of $12,000was allocated to these loans in 2006 and no allowance was allocated in 2005.The average recorded investment in impaired loans for the years ended December31, 2006 and 2005 was $1,616,000 and $ 31,000, respectively. Interest foregoneon nonaccrual loans totaled $106,000 for the year ended December 31, 2006,and $1,000 for each of the years ended 2005 and 2004. Interest recognized forcash payment received on nonaccrual loans was not significant for the yearsended December 31, 2006, 2005 and 2004, respectively.

The Company didnot hold any real estate acquired by foreclosure at December 31, 2006 or2005.

Salaries andemployee benefits totaling $1,246,000, $1,766,000 and $1,190,000 have beendeferred as loan origination costs for the years ended December 31, 2006,2005 and 2004, respectively.

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

Accrued interestreceivable and other assets consisted of the following:
|                                     | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **2006**              | ** ** | **2005** | ** ** |
|                                |       |                  |       |   |   |
| Accrued interest  receivable        |       | $                     | 4,197,000  |   | $ | 3,424,000 |   |
| Deferred tax  assets, net (Note 13) |       | 5,225,000             |       | 4,190,000 |   |
| Mortgage  servicing assets          |       | 872,000               |       | 1,073,000 |   |
| Prepaid expenses                    |       | 1,270,000             |       | 1,008,000 |   |
| Other                               |       | 242,000               |       | 681,000 |   |
|                                |       |                  |       |   |   |
|                                |       | $                     | 11,806,000 |   | $ | 10,376,000 |   |

 

Originatedmortgage servicing assets totaling $208,000, $142,000 and $515,000 wererecognized during the years ended December 31, 2006, 2005 and 2004,respectively. Amortization of mortgage servicing assets totaled $409,000,$417,000 and $381,000 for the years ended December 31, 2006, 2005and 2004,respectively.

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

Premises andequipment consisted of the following:
|                                                 | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **2006**              | ** ** | **2005** | ** ** |
|                                            |       |                  |       |   |   |
| Land                                            |       | $                     | 2,176,000  |   | $ | 2,176,000 |   |
| Buildings and  improvements                     |       | 8,713,000             |       | 6,908,000 |   |
| Furniture,  fixtures and equipment              |       | 8,282,000             |       | 7,384,000 |   |
| Leasehold  improvements                         |       | 2,258,000             |       | 994,000 |   |
| Construction in  progress                       |       | 2,368,000             |       | 622,000 |   |
|                                            |       |                  |       |   |   |
|                                            |       | 23,797,000            |       | 18,084,000 |   |
| Less accumulated  depreciation and amortization |       | 8,438,000             |       | 6,863,000 |   |
|                                            |       |                  |       |   |   |
|                                            |       | $                     | 15,359,000 |   | $ | 11,221,000 |   |

 

Depreciation andamortization included in occupancy and equipment expense totaled $1,662,000,$1,574,000 and $1,313,000 for the years ended December 31, 2006, 2005 and2004 respectively.

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

Interest-bearingdeposits consisted of the following:
|                                 | ** ** | **December 31,** | ** **  |
|---------------------------------|------------|-----------------------|-------------|
| ** **                      | ** ** | **2006**              | ** **  | **2005** | ** ** |
|                            |       |                  |        |   |   |
| Savings                         |       | $                     | 73,913,000  |   | $ | 36,061,000 |   |
| Money market                    |       | 37,783,000            |        | 42,029,000 |   |
| NOW accounts                    |       | 125,912,000           |        | 151,930,000 |   |
| Individual  retirement accounts |       | 7,387,000             |        | 6,030,000 |   |
| Time, $100,000  or more         |       | 76,577,000            |        | 58,573,000 |   |
| Other time                      |       | 86,296,000            |        | 56,059,000 |   |
|                            |       |                  |        |   |   |
|                            |       | $                     | 407,868,000 |   | $ | 350,682,000 |   |

 

Aggregate annualmaturities of time deposits at December 31, 2006 are as follows:
| Year Ending      | ** ** | ** ** | ** **  |
|-----------------------|------------|------------|-------------|
| **December 31,** | ** ** | ** ** | ** **  |
|                  |       |       |        |
| 2007                  |       | $          | 142,501,000 |   |
| 2008                  |       | 19,161,000 |        |
| 2009                  |       | 646,000    |        |
| 2010                  |       | 417,000    |        |
| 2011                  |       | 148,000    |        |
|                  |       |       |        |
|                  |       | $          | 162,873,000 |   |

 

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Interest expenserecognized on interest-bearing deposits consisted of the following:
|                                 | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------|------------|--------------------------------------------|------------|
| ** **                      | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
|                            |       |                                       |       |   |   |   |   |
| Savings                         |       | $                                          | 337,000    |   | $ | 181,000 |   | $ | 145,000 |   |
| Money market                    |       | 616,000                                    |       | 368,000 |   | 285,000 |   |
| NOW accounts                    |       | 1,210,000                                  |       | 934,000 |   | 811,000 |   |
| Individual  retirement accounts |       | 242,000                                    |       | 183,000 |   | 161,000 |   |
| Time, $100,000  or more         |       | 3,061,000                                  |       | 1,492,000 |   | 1,136,000 |   |
| Other time                      |       | 3,242,000                                  |       | 1,510,000 |   | 1,047,000 |   |
|                            |       |                                       |       |   |   |   |   |
|                            |       | $                                          | 8,708,000  |   | $ | 4,668,000 |   | $ | 3,585,000 |   |

 

**7.****                                      SHORT-TERMBORROWING 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, 2006 and 2005.

**8.****                                      NOTESPAYABLE**

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, 2006, the interest ratewas 8.25%. Advances on the line of credit totaled $1,217,000 and $982,000 atDecember 31, 2006 and 2005, respectively.

Note Payable

On June 1, 2005, Community Valley Bancorp enteredinto a short term, unsecured note payable in a principal amount of $800,000 inconjunction with the purchase of real property. The interest rate on the noteat December 31, 2005 was 4.5%. The note was paid in full onJanuary 4, 2006.

**9.**                                      JUNIOR SUBORDINATED DEBENTURES

Community Valley Bancorp Trust I (CVB Trust I) is aDelaware statutory business trust formed by the Company for the sole purpose ofissuing trust preferred securities fully and unconditionally guaranteed by theCompany. Under applicable regulatory guidance, the amount of trust preferredsecurities that is eligible as Tier 1 capital is limited to twenty-five percentof the Company’s Tier 1 capital on a pro forma basis. At December 31,2006, all of the trust preferred securities that have been issued qualify asTier 1 capital.

InDecember 2002, the Company issued to CVB Trust I Subordinated Debenturesdue December 31, 2032. Simultaneously, CVB Trust I issued 8,000 floatingrate trust preferred securities, with liquidation values of $1,000 persecurity, for gross proceeds of $8,000,000. The Subordinated Debenturesrepresent the sole assets of the Trust. The Subordinated Debentures are redeemableby the Company, subject to receipt by the Company of prior approval from theFederal Reserve Bank (FRB), if then required under applicable capitalguidelines or policies of the FRB. The Company may redeem the SubordinatedDebentures held by CVB Trust I on any December 31st on or afterDecember 31, 2007. The redemption price shall be par plus accrued andunpaid interest, except in the case of redemption under a special event, whichis defined in the debenture. The floating rate trust preferred securities aresubject to mandatory redemption to the extent of any early redemption of theSubordinated Debentures and upon maturity of the Subordinated Debentures onDecember 31, 2032.

Holders of the trust preferred securities are entitled to cumulativecash distributions on the liquidation amount of $1,000 per security. Interestrates on the trust preferred securities and Subordinated Debentures are thesame and are computed on a 360-day basis. The stated interest rate is thethree-month London Interbank Offered Rate (LIBOR) plus 3.30% (8.66% atDecember 31, 2006) with a maximum rate of 12.5% annually, adjustablequarterly.

Interest expense recognized by the Company for the years endedDecember 31, 2006, 2005 and 2004 related to the subordinated debentureswas $733,000, $592,000 and $438,000 respectively. The amount of deferred costsat December 31, 2006 and 2005 was $48,000 and $96,000, respectively. Theamortization of the deferred costs was $48,000 for each of the years endedDecember 31, 2006, 2005 and 2004.

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

Leases

The Company leasescertain of its branch offices and certain equipment under noncancellableoperating leases. These leases expire on various dates through 2014 and havevarious renewal options ranging from five to fifteen years. Rental paymentsinclude minimum rentals, plus adjustments for changing price indexes. Futureminimum lease payments and sublease rental income are as follows:
|                       | ** ** | ** **   | ** ** | **Minimum**  | ** ** |
|-----------------------|------------|--------------|------------|--------------|------------|
| ** **            | ** ** | **Minimum**  | ** ** | **Sublease** | ** ** |
| **Year Ending**  | ** ** | **Lease**    | ** ** | **Rental**   | ** ** |
| **December 31,** | ** ** | **Payments** | ** ** | **Income**   | ** ** |
|                  |       |         |       |         |       |
| 2007                  |       | $            | 918,000    |         | $          | 274,000 |   |
| 2008                  |       | 857,000      |       | 272,000      |       |
| 2009                  |       | 863,000      |       | 275,000      |       |
| 2010                  |       | 866,000      |       | 281,000      |       |
| 2011                  |       | 798,000      |       | 203,000      |       |
| Thereafter            |       | 6,532,000    |       | 257,000      |       |
|                  |       |         |       |         |       |
|                  |       | $            | 10,834,000 |         | $          | 1,562,000 |   |

 

Rental expenseincluded in occupancy and equipment expense totaled $753,000, $524,000 and$458,000 for the years ended December 31, 2006, 2005 and 2004,respectively. Sublease income included in occupancy expense totaled $144,000,$134,000 and $132,000 for the years ended December 31, 2006, 2005 and2004, 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 consolidated balancesheet.

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

The followingfinancial instruments represent off-balance-sheet credit risk:
|                               | ** ** | **December 31,** | ** **  |
|-------------------------------|------------|-----------------------|-------------|
| ** **                    | ** ** | **2006**              | ** **  | **2005** | ** ** |
|                          |       |                  |        |   |   |
| Commitments to  extend credit |       | $                     | 186,299,000 |   | $ | 200,693,000 |   |
| Standby letters of  credit    |       | $                     | 5,139,000   |   | $ | 4,895,000 |   |

 

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 of credit,which represents the fees received for issuing the guarantees, was notsignificant at December 31, 2006 and 2005. The Company recognizes thesefees as revenues over the term of the commitment or when the commitment isused.

80

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Commercial loancommitments and standby letters of credit represent approximately 15% of totalcommitments and are generally unsecured or secured by collateral other thanreal estate and have variable interest rates. Agricultural loan commitmentsrepresent approximately 6% of total commitments and are generally secured bycrop assignments, accounts receivable and farm equipment and have variableinterest rates. Real estate loan commitments represent approximately 64% 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 15% 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 itsportfolio is secured by commercial and residential real estate. However,personal and business income represents the primary source of repayment for amajority of these loans.

In addition, theCompany’s real estate and construction loans represent approximately 70% ofoutstanding loans at both December 31, 2006, and 2005. Collateral valuesassociated with this lending concentration can vary significantly based on thegeneral level of interest rates and both local and regional economicconditions. In management’s opinion, although this concentration has no morethan the normal risk of collection, a substantial decline in the performance ofthe economy in general or a decline in real estate values in the Company’sprimary market areas, in particular, could have an adverse impact on thecollectibility of these loans.

Correspondent Banking Agreements

The Companymaintains funds on deposit with other federally insured financial institutionsunder correspondent banking agreements. Uninsured deposits totaled $1,345,000at December 31, 2006.

Federal ReserveRequirements

Banks are requiredto maintain reserves with the Federal Reserve Bank equal to a percentage oftheir reservable deposits less vault cash. The Bank’s vault cash fulfilled itsreserve requirement at December 31, 2006.

Contingencies

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

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

Dividends

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

The CaliforniaFinancial Code restricts the total dividend payment of any bank in any calendaryear to the lesser of (1) the bank’s retained earnings or (2) thebank’s net income for its last three fiscal years, less distributions made toshareholders during the same three-year period. At December 31, 2006,retained earnings of $15,642,000 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).

81

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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, no shares of the Company’s common stock wererepurchased. During 2004, 38,470 shares of the Company’s common stock wererepurchased for $502,000 at an average price of $13.05 per share.

Stock-Based Compensation

Stock option activity forthe years ended December 31, 2006, 2005 and 2004 is summarized as follows:
|                                         | ** ** | **2006**    | ** ** | **2005**     | ** ** | **2004**    | ** ** |
|-----------------------------------------|------------|-------------|------------|--------------|------------|-------------|------------|
| ** **                              | ** ** | ** **  | ** ** | **Weighted** | ** ** | ** **  | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                              | ** ** | ** **  | ** ** | **Average**  | ** ** | ** **  | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                              | ** ** | ** **  | ** ** | **Exercise** | ** ** | ** **  | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| ** **                              | ** ** | **Options** | ** ** | **Price**    | ** ** | **Options** | ** ** | **Price** | ** ** | **   Options   ** | ** ** | **Price** | ** ** |
|                                    |       |        |       |         |       |        |       |   |   |   |   |   |   |
| Incentive  Options                      |       |        |       |         |       |        |       |   |   |   |   |   |   |
|                                    |       |        |       |         |       |        |       |   |   |   |   |   |   |
| Options  outstanding, beginning of year |       | 487,962     |       | $            | 6.76       |        | 551,348    |   | $ | 6.28 |   | 481,070 |   | $ | 4.71 |   |
|                                    |       |        |       |         |       |        |       |   |   |   |   |   |   |
| Options granted                         |       | 23,000      |       | $            | 17.17      |        | 30,000     |   | $ | 14.48 |   | 107,618 |   | $ | 12.99 |   |
| Options exercised                       |       | (57,572     | )          | $            | 4.90       |        | (69,765    | ) | $ | 5.28 |   | (37,340 | ) | $ | 5.31 |   |
| Options cancelled                       |       | (15,194     | )          | $            | 12.49      |        | (23,621    | ) | $ | 9.79 |   |   |   |   |   |
|                                    |       |        |       |         |       |        |       |   |   |   |   |   |   |
| Options  outstanding, end of year       |       | 438,196     |       | $            | 7.35       |        | 487,962    |   | $ | 6.76 |   | 551,348 |   | $ | 6.28 |   |
|                                    |       |        |       |         |       |        |       |   |   |   |   |   |   |
| Options  exercisable, end of year       |       | 336,818     |       | $            | 5.65       |        | 352,016    |   | $ | 4.94 |   | 326,954 |   | $ | 5.15 |   |
|                                    |       |        |       |         |       |        |       |   |   |   |   |   |   |
| Non-Qualified  Options                  |       |        |       |         |       |        |       |   |   |   |   |   |   |
|                                    |       |        |       |         |       |        |       |   |   |   |   |   |   |
| Options  outstanding, beginning of year |       | 353,982     |       | $            | 4.17       |        | 414,682    |   | $ | 3.82 |   | 445,746 |   | $ | 3.75 |   |
|                                    |       |        |       |         |       |        |       |   |   |   |   |   |   |
| Options granted                         |       |        |       |         |       |        |       | 4,000 |   | $13.25 |   |   |   |
| Options exercised                       |       | (72,995     | )          | $            | 3.13       |        | (64,700    | ) | $ | 2.45 |   | (31,064 | ) | $ | 2.79 |   |
|                                    |       |        |       |         |       |        |       |   |   |   |   |   |   |
| Options  outstanding, end of year       |       | 280,987     |       | $            | 4.44       |        | 353,982    |   | $ | 4.17 |   | 414,682 |   | $ | 3.81 |   |
|                                    |       |        |       |         |       |        |       |   |   |   |   |   |   |
| Options exercisable,  end of year       |       | 277,021     |       | $            | 4.34       |        | 347,892    |   | $ | 4.04 |   | 361,554 |   | $ | 3.82 |   |

 

82

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A summary of options outstanding at December 31, 2006 follows:
|                                             | ** ** | **Number of**    | ** ** | **Weighted**    | ** ** | **Number of**    | ** ** | **Number of**             | ** ** |
|---------------------------------------------|------------|-----------------------|------------|-----------------|------------|-----------------------|------------|--------------------------------|------------|
| ** **                                  | ** ** | **Options**           | ** ** | **Average**     | ** ** | **Options**           | ** ** | **Options**                    | ** ** |
| ** **                                  | ** ** | **Outstanding**       | ** ** | **Remaining**   | ** ** | **Exercisable**       | ** ** | **Expected to vest** | ** ** |
| ** **                                  | ** ** | **December 31,** | ** ** | **Contractual** | ** ** | **December 31,** | ** ** | **December 31,**          | ** ** |
| **Range of Exercise Prices** | ** ** | **2006**              | ** ** | **Life**        | ** ** | **2006**              | ** ** | **2006**                       | ** ** |
| ** **                                  | ** ** | ** **            | ** ** | ** **      | ** ** | ** **            | ** ** | ** **                     | ** ** |
| Incentive  Options                          |       |                  |       |            |       |                  |       |                           |       |   |
|                                        |       |                  |       |            |       |                  |       |                           |       |
| $                                           | 2.29       | -                     | $          | 3.80            |       |                  | 146,738    |                           | .5 years   |   | 146,738 |   | n/a |   |
| $                                           | 4.54       | -                     | $          | 5.27            |       |                  | 61,650     |                           | 3.1 years  |   | 61,650 |   | n/a |   |
| $                                           | 7.13       | -                     | $          | 9.65            |       |                  | 95,143     |                           | 6.0 years  |   | 75,554 |   | 93,094 |   |
| $                                           | 12.37      | -                     | $          | 13.99           |       |                  | 87,665     |                           | 7.6 years  |   | 42,573 |   | 83,022 |   |
| $                                           | 14.00      | -                     | $          | 17.80           |       |                  | 47,000     |                           | 8.9 years  |   | 10,303 |   | 43,265 |   |
|                                        |       |                  |       |            |       |                  |       |                           |       |
|                                        |       | 438,196               |       |            |       | 336,818               |       | 219,381                        |       |
|                                        |       |                  |       |            |       |                  |       |                           |       |
| Non-qualified Options                       |       |                  |       |            |       |                  |       |                           |       |
|                                        |       |                  |       |            |       |                  |       |                           |       |
| $                                           | 2.29       |                  |       |            |       | 54,123                |       | .3 years                       |       | 54,123 |   | n/a |   |
| $                                           | 4.71       |                  |       |            |       | 218,328               |       | 3.3 years                      |       | 218,328 |   | n/a |   |
| $                                           | 9.65       |                  |       |            |       | 5,332                 |       | 6.8 years                      |       | 3,410 |   | 5,121 |   |
| $                                           | 13.25      |                  |       |            |       | 3,204                 |       | 8.2 years                      |       | 1,160 |   | 3,016 |   |
|                                        |       |                  |       |            |       |                  |       |                           |       |
|                                        |       | 280,987               |       |            |       | 277,021               |       | 8,137                          |       |

 

The weighted average grant date fair value of optionsgranted during the years ended December 31, 2006, 2005 and 2004 was $3.75, $3.25and $3.35.

The aggregate intrinsic value is calculated as thedifference between the exercise price of the underlying awards and the quotedprice of the Company’s common stock for options that were in-the-money atDecember 31, 2006. The aggregate intrinsic value of options outstanding for theyear ended December 31, 2006 was $6,438,000. The intrinsic value of optionsvested for the year ended December 31, 2006 was $6,167,000 and for optionsvested or expected to vest was $7,820,000. The intrinsic value of optionsexercised during the years ended December 31, 2006, 2005 and 2004 totaled$1,560,000, $1,383,000 and $618,000, respectively. The total fair value of theshares that vested during the years ended December 31, 2006, 2005 and 2004totaled $175,000, $390,000 and $347,000, respectively.

The compensation cost charged against income for stockoptions was $175,000 for the year ended December 31, 2006. Income tax benefitsrecognized for the year ended December 31, 2006 totaled $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, 2006, the total compensation costrelated to non-vested stock option awards granted to employees under theCompany’s stock option plans but not yet recognized was $391,000. Stock optioncompensation expense is recognized on a straight-line basis over the vestingperiod of the option. This cost is expected to be recognized over a weightedaverage remaining period of 2.33 years and will be adjusted for subsequentchanges in estimated forfeitures.

SFAS 123(R) requires the cash flows resulting from thetax benefits resulting from tax deductions in excess of the compensation cost recognizedfor those options (excess tax benefits) to be classified as a cash flow fromfinancing activities in the consolidated statement of cash flows. These excesstax benefits for the year ending December 31, 2006 totaled $489,000for the Company.

83

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Earnings Per Share

A reconciliationof the numerators and denominators of the basic and diluted earnings per sharecomputations is as follows:
|                                       | ** ** | ** ** | ** ** | **Weighted**       | ** ** | ** **         | ** ** |
|---------------------------------------|------------|------------|------------|--------------------|------------|--------------------|------------|
| ** **                            | ** ** | ** ** | ** ** | **Average**        | ** ** | ** **         | ** ** |
| ** **                            | ** ** | ** ** | ** ** | **Number of** | ** ** | ** **         | ** ** |
| ** **                            | ** ** | **Net**    | ** ** | **Shares**         | ** ** | **Per Share** | ** ** |
| **For the Year Ended** | ** ** | **Income** | ** ** | **Outstanding**    | ** ** | **Amount**         | ** ** |
|                                  |       |       |       |               |       |               |       |
| December 31,  2006               |       |       |       |               |       |               |       |
|                                  |       |       |       |               |       |               |       |
| Basic earnings  per share             |       | $          | 7,151,000  |               | 7,279,969  |               | $          | .98 |   |
|                                  |       |       |       |               |       |               |       |
| Effect of  dilutive stock options     |       |       |       | 381,076            |       |               |       |
|                                  |       |       |       |               |       |               |       |
| Diluted earnings  per share           |       | $          | 7,151,000  |               | 7,661,045  |               | $          | .93 |   |
|                                  |       |       |       |               |       |               |       |
| December 31,  2005               |       |       |       |               |       |               |       |
|                                  |       |       |       |               |       |               |       |
| Basic earnings  per share             |       | $          | 7,198,000  |               | 7,166,258  |               | $          | 1.00 |   |
|                                  |       |       |       |               |       |               |       |
| Effect of  dilutive stock options     |       |       |       | 445,446            |       |               |       |
|                                  |       |       |       |               |       |               |       |
| Diluted earnings  per share           |       | $          | 7,198,000  |               | 7,611,704  |               | $          | .95 |   |
|                                  |       |       |       |               |       |               |       |
| December 31,  2004               |       |       |       |               |       |               |       |
|                                  |       |       |       |               |       |               |       |
| Basic earnings  per share             |       | $          | 5,610,000  |               | 7,112,386  |               | $          | .79 |   |
|                                  |       |       |       |               |       |               |       |
| Effect of  dilutive stock options     |       |       |       | 488,706            |       |               |       |
|                                  |       |       |       |               |       |               |       |
| Diluted earnings per  share           |       | $          | 5,610,000  |               | 7,601,092  |               | $          | .74 |   |

 

All stock options outstanding were included in thecomputation of diluted earnings per share for the years ended December 31,2006, 2005 and 2004 as none of those stock options were consideredanti-dilutive.

Regulatory Capital

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

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, 2006 and 2005.

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

84

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|                                          | ** ** | ** ** | ** ** | ** **  | ** ** | ** **                 | ** ** | ** **                            | ** ** | **To Be Well Capitalized** | ** ** |
|------------------------------------------|------------|------------|------------|-------------|------------|----------------------------|------------|---------------------------------------|------------|-------------------------------------------|------------|
| ** **                               | ** ** | ** ** | ** ** | ** **  | ** ** | **For Capital**       | ** ** | **Under Prompt Corrective** | ** ** |
| ** **                               | ** ** | ** ** | ** ** | ** **  | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions**            | ** ** |
| ** **                               | ** ** | **Actual** | ** ** | **Minimum** | ** ** | **Minimum**                | ** ** | **Minimum**                           | ** ** | **Minimum**                               | ** ** |
| ** **                               | ** ** | **Amount** | ** ** | **Ratio**   | ** ** | **Amount**                 | ** ** | **Ratio**                             | ** ** | **Amount**                                | ** ** | **Ratio** | ** ** |
|                                     |       |       |       |        |       |                       |       |                                  |       |                                      |       |   |   |
| December 31,  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 | % |
|                                     |       |       |       |        |       |                       |       |                                  |       |                                      |       |   |   |
| December 31,  2005                  |       |       |       |        |       |                       |       |                                  |       |                                      |       |   |   |
|                                     |       |       |       |        |       |                       |       |                                  |       |                                      |       |   |   |
| Company:                                 |       |       |       |        |       |                       |       |                                  |       |                                      |       |   |   |
| Total capital (to risk-weighted assets)  |       | $          | 55,014,000 |        | 12.5       | %                          | $          | 34,916,000                            |       | 8.0                                       | %          | n/a |   | n/a |   |
| Tier 1 capital (to risk-weighted assets) |       | $          | 49,568,000 |        | 11.4       | %                          | $          | 17,458,000                            |       | 4.0                                       | %          | n/a |   | n/a |   |
| Tier 1 capital (to average assets)       |       | $          | 49,568,000 |        | 9.8        | %                          | $          | 20,216,000                            |       | 4.0                                       | %          | n/a |   | n/a |   |
|                                     |       |       |       |        |       |                       |       |                                  |       |                                      |       |   |   |
| Bank:                                    |       |       |       |        |       |                       |       |                                  |       |                                      |       |   |   |
| Total capital (to risk-weighted assets)  |       | $          | 49,142,000 |        | 11.3       | %                          | $          | 34,878,000                            |       | 8.0                                       | %          | $ | 43,597,000 |   | 10.0 | % |
| Tier 1 capital (to risk-weighted assets) |       | $          | 43,944,000 |        | 10.1       | %                          | $          | 17,439,000                            |       | 4.0                                       | %          | $ | 26,158,000 |   | 6.0 | % |
| Tier 1 capital  (to average assets)      |       | $          | 43,944,000 |        | 8.8        | %                          | $          | 20,000,000                            |       | 4.0                                       | %          | $ | 25,000,000 |   | 5.0 | % |

 

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

Other non-interestincome consisted of the following:
|                                                                  | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                       | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                             |       |                                       |       |   |   |   |   |
| Alternative  investment fees                                     |       | $                                          | 350,000    |   | $ | 520,000 |   | $ | 428,000 |   |
| Merchant card  processing fees                                   |       | 381,000                                    |       | 390,000 |   | 337,000 |   |
| Earnings from  cash surrender value of bank owned life insurance |       | 331,000                                    |       | 294,000 |   | 284,000 |   |
| Other                                                            |       | 986,000                                    |       | 869,000 |   | 675,000 |   |
|                                                             |       |                                       |       |   |   |   |   |
|                                                             |       | $                                          | 2,048,000  |   | $ | 2,073,000 |   | $ | 1,724,000 |   |

 

Other expenses consistedof the following:
|                                       | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------|------------|--------------------------------------------|------------|
| ** **                            | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                  |       |                                       |       |   |   |   |   |
| Professional  fees                    |       | $                                          | 1,269,000  |   | $ | 1,035,000 |   | $ | 633,000 |   |
| Telephone and  postage                |       | 630,000                                    |       | 580,000 |   | 511,000 |   |
| Stationery and  supplies              |       | 710,000                                    |       | 545,000 |   | 521,000 |   |
| Advertising and  promotion            |       | 660,000                                    |       | 412,000 |   | 302,000 |   |
| Director fees  and retirement accrual |       | 450,000                                    |       | 469,000 |   | 408,000 |   |
| Other                                 |       | 2,536,000                                  |       | 2,645,000 |   | 1,915,000 |   |
|                                  |       |                                       |       |   |   |   |   |
|                                  |       | $                                          | 6,255,000  |   | $ | 5,686,000 |   | $ | 4,290,000 |   |

 

**13.****                               INCOMETAXES**

The provision forincome taxes for the years ended December 31, 2006, 2005 and 2004consisted of the following:
|                             | ** ** | **Federal** | ** ** | **State** | ** ** | **Total**  | ** ** |
|-----------------------------|------------|-------------|------------|-----------|------------|------------|------------|
| 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 |   |
|                        |       |        |       |      |       |       |       |
| 2004                        |       |        |       |      |       |       |       |
|                        |       |        |       |      |       |       |       |
| Current                     |       | $           | 2,837,000  |      | $          | 1,030,000  |       | $ | 3,867,000 |   |
| Deferred                    |       | (21,000     | )          | (43,000   | )          | (64,000    | )          |
|                        |       |        |       |      |       |       |       |
| Provision for  income taxes |       | $           | 2,816,000  |      | $          | 987,000    |       | $ | 3,803,000 |   |

 

86

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Deferred tax assets (liabilities) are comprised of the following atDecember 31, 2006 and 2005:
|                                                                | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|----------------------------------------------------------------|------------|-----------|------------|-----------|------------|
|                                                           |       |      |       |      |       |
| Deferred tax  assets:                                          |       |      |       |      |       |
| Allowance for loan losses                                      |       | $         | 2,585,000  |      | $          | 2,267,000 |   |
| Deferred compensation                                          |       | 2,714,000 |       | 2,157,000 |       |
| Future benefit of state tax deduction                          |       | 507,000   |       | 487,000   |       |
| Premises and equipment                                         |       | 336,000   |       | 60,000    |       |
| Unrealized losses on available-for-sale investment  securities |       |      |       | 8,000     |       |
| Other                                                          |       | 27,000    |       | 9,000     |       |
|                                                           |       |      |       |      |       |
| Total deferred tax assets                                      |       | 6,169,000 |       | 4,988,000 |       |
|                                                           |       |      |       |      |       |
| Deferred tax  liabilities:                                     |       |      |       |      |       |
| Future liability of state deferred tax assets                  |       | (436,000  | )          | (354,000  | )          |
| Accrual to cash - deferred loan costs                          |       | (225,000  | )          | (225,000  | )          |
| Prepaid expenses                                               |       | (276,000  | )          | (219,000  | )          |
| Unrealized gains on available-for-sale investment  securities  |       | (7,000    | )          |      |       |
|                                                           |       |      |       |      |       |
| Total deferred tax liabilities                                 |       | (944,000  | )          | (798,000  | )          |
|                                                           |       |      |       |      |       |
| Net deferred tax  assets                                       |       | $         | 5,225,000  |      | $          | 4,190,000 |   |

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,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                      | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                      | ** ** | **Amount**                                 | ** ** | **Rate %** | ** ** | **Amount** | ** ** | **Rate %** | ** ** | **Amount** | ** ** | **Rate %** | ** ** |
|                                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Federal income  tax expense, at statutory rate  |       | $                                          | 4,289,000  |   | 35.0 |   | $ | 4,261,000 |   | 35.0 |   | $ | 3,200,000 |   | 34.0 |   |
| State franchise  tax, net of Federal tax effect |       | 877,000                                    |       | 7.2 |   | 871,000 |   | 7.2 |   | 673,000 |   | 7.1 |   |
| Tax-exempt  income from life insurance policies |       | (116,000                                   | )          | (1.0 | ) | (99,000 | ) | (.8 | ) | (117,000 | ) | (1.2 | ) |
| Other                                           |       | 52,000                                     |       | .4 |   | (62,000 | ) | (.6 | ) | 47,000 |   | .5 |   |
|                                            |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
|                                            |       | $                                          | 5,102,000  |   | 41.6 |   | $ | 4,971,000 |   | 40.8 |   | $ | 3,803,000 |   | 40.4 |   |

 

87

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**14.          RELATED PARTY TRANSACTIONS**

During the normalcourse of business, the Company enters into transactions with related parties,including Directors and executive officers. These transactions includeborrowings with substantially the same terms, including rates and collateral,as loans to unrelated parties. The following is a summary of the aggregateactivity involving related party borrowers during 2006:
| Balance, January 1, 2006                             |   | $           | 6,349,000 |   |
|---------------------------------------------------------------------|--------|-------------|-----------|--------|
|                                                                |   |        |      |
| Disbursements                                                       |   | 7,376,000   |      |
| Amounts repaid                                                      |   | (11,798,000 | )         |
|                                                                |   |        |      |
| Balance,  December 31, 2006                                    |   | $           | 1,927,000 |   |
|                                                                |   |        |      |
| Undisbursed commitments  to related parties, December 31, 2006 |   | $           | 2,478,000 |   |

 

The Company engages a related party for certainconstruction projects related to the Company’s buildings. Total fees paid tothis related party for construction activities for the year ended December 31,2006 and 2005 were $1,488,000 and $395,000.

**15.          EMPLOYEE BENEFIT PLANS**

SalaryContinuation and Retirement Plans

Salarycontinuation plans are in place for twelve key executives. In addition, aretirement plan is in place for members of the Board of Directors. Under theseplans, the directors and executives, or designated beneficiaries, will receivemonthly payments for five to twenty years after retirement or death. Thesebenefits are substantially equivalent to those available under insurancepolicies purchased by the Company on the lives of the directors and executives.In addition, the estimated present value of these future benefits is accruedover the period from the effective dates of the plans until their expectedretirement dates. The expense recognized under these plans for the years endedDecember 31, 2006, 2005 and 2004 totaled $1,111,000, $741,000 and$715,000, respectively.

In connection withthese plans, the Company purchased single premium life insurance policies withcash surrender values totaling $9,798,000 and $8,447,000 at December 31,2006 and 2005, respectively. Income earned on these policies, net of expenses,totaled $331,000, $294,000 and $284,000 for the years ended December 31,2006, 2005 and 2004, respectively.

Savings Plan

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

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

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

There were noemployer contributions for the years ended December 31, 2006, 2005 or2004.

Employee StockOwnership Plan

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

88

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

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

During 2006 and2005, the ESOP purchased 20,750 and 23,637 shares of the Company’s common stockat a cost of $354,000 and $348,000, respectively, using the proceeds from theline of credit to the ESOP. Interest expense of $88,000, $50,000 and $33,000was recognized in connection with the line of credit during the years endedDecember 31, 2006, 2005 and 2004, respectively.

Compensationexpense of $609,000, $251,000 and $180,000 was recognized for the years endedDecember 31, 2006, 2005 and 2004.

Allocated andunallocated ESOP shares at December 31, 2006, 2005 and 2004, adjusted forstock splits, were as follows:
|                                   | ** ** | **2006** | ** ** | **2005** | ** ** | **2004**  | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|-----------|------------|
|                              |       |     |       |     |       |      |       |
| Allocated shares                  |       | 289,355  |       | 238,812  |       | 223,020   |       |
| Unallocated  shares               |       | 155,258  |       | 185,051  |       | 179,256   |       |
|                              |       |     |       |     |       |      |       |
| Total ESOP shares                 |       | 444,613  |       | 423,863  |       | 402,276   |       |
|                              |       |     |       |     |       |      |       |
| Fair value of  unallocated shares |       | $        | 2,344,000  |     | $          | 2,637,000 |       | $ | 2,487,000 |   |
|                                   |            |          |            |          |            |           |            |  |  |  |

 

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

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

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

The followingmethods and assumptions were used by the Company to estimate the fair value ofits financial instruments at December 31, 2006 and 2005:

Cash and cashequivalents: Cash and cash equivalents include cash and duefrom banks and Federal funds sold and the carrying amount is estimated to befair value.

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

89

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

Loans:Fair values of loans held for sale are estimated using quoted market prices forsimilar loans or the amount that purchasers have committed to purchase theloans. For variable-rate loans that reprice frequently with no significantchange in credit risk, fair values are based on carrying values.  The fair values for other loans are estimatedusing discounted cash flow analyses, using interest rates offered at eachreporting date for loans with similar terms to borrowers of comparablecreditworthiness adjusted for the allowance for loan losses. The carryingamount of accrued interest receivable approximates its fair value.

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

Bank owned lifeinsurance policies: The fair values of life insurancepolicies are based on cash surrender values at each reporting date provided bythe insurers.

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

Deposits:The fair values for demand deposits are, by definition, equal to the amountpayable on demand at each reporting date represented by their carrying amount.Fair values for fixed-rate certificates of deposit are estimated using adiscounted cash flow analysis using interest rates offered at each reportingdate by the Bank for certificates with similar remaining maturities. Thecarrying amount of accrued interest payable approximates its fair value.

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

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

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

The estimated fairvalues of the Company’s financial instruments are as follows:
|                                                             | ** ** | **December 31, 2006** | ** **  | **December 31, 2005** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|
| ** **                                                  | ** ** | **Carrying**                    | ** **  | **Fair**                        | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| ** **                                                  | ** ** | **Amount**                      | ** **  | **Value**                       | ** ** | **Amount** | ** ** | **Value** | ** ** |
|                                                        |       |                            |        |                            |       |   |   |   |   |
| Financial  assets:                                          |       |                            |        |                            |       |   |   |   |   |
| Cash and due from banks                                     |       | $                               | 20,558,000  |                            | $          | 20,558,000 |   | $ | 18,988,000 |   | $ | 18,988,000 |   |
| Federal funds sold                                          |       | 42,070,000                      |        | 42,070,000                      |       | 29,015,000 |   | 29,015,000 |   |
| Interest-bearing deposits in banks                          |       | 2,278,000                       |        | 2,277,000                       |       | 6,636,000 |   | 6,597,000 |   |
| Loans held for sale                                         |       | 790,000                         |        | 800,000                         |       | 2,197,000 |   | 2,212,000 |   |
| Investment securities                                       |       | 5,127,000                       |        | 5,109,000                       |       | 6,676,000 |   | 6,640,000 |   |
| Loans                                                       |       | 442,251,000                     |        | 438,757,000                     |       | 401,221,000 |   | 399,544,000 |   |
| Other investments                                           |       | 118,000                         |        | 118,000                         |       | 118,000 |   | 118,000 |   |
| Accrued interest receivable                                 |       | 4,197,000                       |        | 4,197,000                       |       | 3,424,000 |   | 3,424,000 |   |
| Cash surrender value of Bank owned life insurance  policies |       | 9,798,000                       |        | 9,798,000                       |       | 8,447,000 |   | 8,447,000 |   |
| Mortgage servicing assets                                   |       | 872,000                         |        | 872,000                         |       | 1,073,000 |   | 1,073,000 |   |
|                                                        |       |                            |        |                            |       |   |   |   |   |
| Financial  liabilities:                                     |       |                            |        |                            |       |   |   |   |   |
| Deposits                                                    |       | $                               | 484,856,000 |                            | $          | 470,917,000 |   | $ | 434,018,000 |   | $ | 433,780,000 |   |
| Notes payable                                               |       | 1,217,000                       |        | 1,217,000                       |       | 1,782,000 |   | 1,782,000 |   |
| Junior subordinated debentures                              |       | 8,248,000                       |        | 8,248,000                       |       | 8,248,000 |   | 8,248,000 |   |
| Accrued interest  payable                                   |       | 1,037,000                       |        | 1,037,000                       |       | 652,000 |   | 652,000 |   |

 

90

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**17.          PARENT ONLY CONDENSED FINANCIALSTATEMENTS**

**CONDENSEDBALANCE SHEET**

**December 31,2006 and 2005**
| ** **                                           | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|------------------------------------------------------|------------|------------|------------|------------|------------|
| * *                                             | * *   | * *   | * *   | * *   | * *   |
| **ASSETS**                                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| * *                                             | * *   | * *   | * *   | * *   | * *   |
| Cash and cash equivalents                            |       | $          | 2,985,000  |       | $          | 4,358,000 |   |
| Investment in  bank subsidiary                       |       | 49,518,000 |       | 43,931,000 |       |
| Investment in  non-bank subsidiary                   |       | 716,000    |       | 865,000    |       |
| Other assets                                         |       | 2,747,000  |       | 2,084,000  |       |
|                                                 |       |       |       |       |       |
| Total assets                                         |       | $          | 55,966,000 |       | $          | 51,238,000 |   |
|                                                 |       |       |       |       |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**        | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                                 |       |       |       |       |       |
| Liabilities:                                         |       |       |       |       |       |
| ESOP note payable                                    |       | $          | 1,217,000  |       | $          | 982,000 |   |
| Junior subordinated debentures                       |       | 8,248,000  |       | 8,248,000  |       |
| Other liabilities                                    |       | 774,000    |       | 453,000    |       |
|                                                 |       |       |       |       |       |
| Total liabilities                                    |       | 10,239,000 |       | 9,683,000  |       |
|                                                 |       |       |       |       |       |
| Shareholders’  equity:                          |       |       |       |       |       |
| Common stock                                         |       | 9,727,000  |       | 9,051,000  |       |
| Unallocated ESOP shares                              |       | (1,514,000 | )          | (1,391,000 | )          |
| Retained earnings                                    |       | 37,505,000 |       | 33,908,000 |       |
| Accumulated other comprehensive income, net of taxes |       | 9,000      |       | (13,000    | )          |
|                                                 |       |       |       |       |       |
| Total shareholders’ equity                      |       | 45,727,000 |       | 41,555,000 |       |
|                                                 |       |       |       |       |       |
| Total  liabilities and shareholders’ equity     |       | $          | 55,966,000 |       | $          | 51,238,000 |   |

 

91

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**17.          PARENTONLY CONDENSED FINANCIAL STATEMENTS**

**CONDENSED STATEMENT OF INCOME**

**For the Years Ended December 31,2006, 2005 and 2004**
| ** **                                                    | ** ** | **2006**  | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|---------------------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| * *                                                      | * *   | * *  | * *   | * *  | * *   | * *  | * *   |
| Income:                                                       |       |      |       |      |       |      |       |
| Dividends declared by bank subsidiary                         |       | $         | 3,039,000  |      | $          | 2,258,000 |       | $ | 1,857,000 |   |
|                                                          |       |      |       |      |       |      |       |
| Expenses:                                                     |       |      |       |      |       |      |       |
| Professional fees                                             |       | 347,000   |       | 231,000   |       | 180,000   |       |
| Interest expense                                              |       | 821,000   |       | 642,000   |       | 439,000   |       |
| Other expenses                                                |       | 790,000   |       | 374,000   |       | 142,000   |       |
|                                                          |       |      |       |      |       |      |       |
| Total expenses                                                |       | 1,958,000 |       | 1,247,000 |       | 761,000   |       |
|                                                          |       |      |       |      |       |      |       |
| Income before equity in undistributed income of  subsidiaries |       | 1,081,000 |       | 1,011,000 |       | 1,096,000 |       |
|                                                          |       |      |       |      |       |      |       |
| Equity in  undistributed income of subsidiaries               |       | 5,416,000 |       | 5,707,000 |       | 4,235,000 |       |
|                                                          |       |      |       |      |       |      |       |
| Income before income tax benefit                              |       | 6,497,000 |       | 6,718,000 |       | 5,331,000 |       |
|                                                          |       |      |       |      |       |      |       |
| Income tax  benefit                                           |       | 654,000   |       | 480,000   |       | 279,000   |       |
|                                                          |       |      |       |      |       |      |       |
| Net income                                                    |       | $         | 7,151,000  |      | $          | 7,198,000 |       | $ | 5,610,000 |   |

 

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**17.          PARENT ONLY CONDENSED FINANCIAL STATEMENTS**

**CONDENSED STATEMENT OF CASH FLOWS**

**For the Years Ended December 31,2006, 2005 and 2004**
| ** **                                                                         | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| * *                                                                           | * *   | * *   | * *   | * *   | * *   | * *   | * *   |
| Cash flows from  operating activities:                                             |       |       |       |       |       |       |       |
| Net income                                                                         |       | $          | 7,151,000  |       | $          | 7,198,000  |       | $ | 5,610,000 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |       |       |       |       |       |       |
| Undistributed net income of subsidiary                                             |       | (5,416,000 | )          | (5,707,000 | )          | (4,235,000 | )          |
| Stock-based compensation                                                           |       | 175,000    |       |       |       |       |       |
| (Increase) decrease in other assets                                                |       | (54,000    | )          | 268,000    |       | (111,000   | )          |
| Increase in other liabilities                                                      |       | 25,000     |       | 44,000     |       | 67,000     |       |
|                                                                               |       |       |       |       |       |       |       |
| Net cash provided by operating activities                                          |       | 1,881,000  |       | 1,803,000  |       | 1,331,000  |       |
|                                                                               |       |       |       |       |       |       |       |
| Cash flows from  investing activities:                                             |       |       |       |       |       |       |       |
|                                                                               |       |       |       |       |       |       |       |
| Investment in BCB Insurance Agency LLC                                             |       |       |       |       |       | (1,000,000 | )          |
|                                                                               |       |       |       |       |       |       |       |
| Net cash used in investing activities                                              |       |       |       |       |       | (1,000,000 | )          |
|                                                                               |       |       |       |       |       |       |       |
| Cash flows from  financing activities:                                             |       |       |       |       |       |       |       |
| Proceed from ESOP note payable                                                     |       | 354,000    |       | 348,000    |       | 849,000    |       |
| Repayments of ESOP note payable                                                    |       | (119,000   | )          | (199,000   | )          | (16,000    | )          |
| Purchase of unallocated ESOP shares                                                |       | (354,000   | )          | (348,000   | )          | (150,000   | )          |
| Proceeds from exercise of stock options                                            |       | 1,000,000  |       | 527,000    |       | 284,000    |       |
| Cash paid for fractional shares                                                    |       |       |       |       |       | (6,000     | )          |
| Payment of cash dividends                                                          |       | (1,637,000 | )          | (1,069,000 | )          | (1,089,000 | )          |
| Repurchase of common stock                                                         |       | (2,498,000 | )          |       |       | (502,000   | )          |
|                                                                               |       |       |       |       |       |       |       |
| Net cash used in financing activities                                              |       | (3,254,000 | )          | (741,000   | )          | (630,000   | )          |
|                                                                               |       |       |       |       |       |       |       |
| Increase (decrease) in cash and cash equivalents                                   |       | 1,373,000  |       | 1,062,000  |       | (299,000   | )          |
|                                                                               |       |       |       |       |       |       |       |
| Cash and cash  equivalents at beginning of year                                    |       | 4,358,000  |       | 3,296,000  |       | 3,595,000  |       |
|                                                                               |       |       |       |       |       |       |       |
| Cash and cash  equivalents at end of year                                          |       | $          | 2,985,000  |       | $          | 4,358,000  |       | $ | 3,296,000 |   |

 

93

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