**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20006**

 

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**FORM 10-K**

** **

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

 

**For the fiscal year ended December 31, 2002**

 

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| **COMMUNITY  VALLEY BANCORP**                           |
|---------------------------------------------------------|
| (Exact name of registrant as specified in its charter)  |
|                                                    |   |   |
| **California**                                          |   | **68-0479553** |
| State of incorporation                                  |   | I.R.S. Employer Identification Number |
|                                                    |   |   |
| **2041 Forest Avenue  Chico, California**               |   | **95928** |
| Address of principal executive offices                  |   | Zip Code |
|                                                    |   |   |
| **(530)  899-2344**                                     |
| Registrant’s telephone number, including area code |

 

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

 

Securities registered pursuant to Section 12(g) of the Act:  **CommonStock, No Par Value**

 

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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   ý      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.  ý

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Act). Yes  o  No  ý

 

As of February 19,2003, the aggregate market value of the voting stock held by non-affiliates ofthe Registrant was approximately $18.5 million, based on the sales pricereported to the Registrant on that date of $20.25 per share.

 

Shares of CommonStock held by each officer and director and each person owning more than fivepercent of the outstanding Common Stock have been excluded in that such personsmay be deemed to be affiliates.  Thisdetermination of the affiliate status is not necessarily a conclusivedetermination for other purposes.

 

The number ofshares of Common Stock of the registrant outstanding as of February 19, 2003was 2,692,028.

 

DocumentsIncorporated by Reference:  Portions of the definitive proxy statement for the 2003 Annual Meeting ofShareholders to be filed with the Federal Deposit Insurance Corporationpursuant to SEC Regulation 14A are incorporated by reference in Part III, Items10-14.

 

 

 

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**TABLE OF CONTENTS**

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

 

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**PARTI**

 

**Item1. ****           Business**

 

**General**

 

**TheCompany**

Community Valley Bancorp (the “Company”) is a California corporationregistered as a bank holding company under the Bank Holding Company Act of1956, as amended (the “BHC Act”), and is headquartered in Chico,California.  The Company wasincorporated in July, 2001 and acquired all of the outstanding shares of ButteCommunity Bank (the “Bank”) in May, 2002. The Company’s principal subsidiary is the Bank.  The Company’s only other subsidiary isCommunity Valley Bancorp Trust I, which was formed in December, 2002 solely tofacilitate the issuance of capital trust pass-through securities.  The Company exists primarily for the purposeof holding the stock of the Bank and of such other subsidiaries as it mayacquire or establish.

 

The Company’s principal source of income is currently dividends fromthe Bank, but the Company intends to explore supplemental sources of income inthe future.  The expenditures of theCompany, including (but not limited to) the payment of dividends toshareholders, if and when declared by the Board of Directors, and the cost ofservicing debt will generally be paid from such payments made to the Company bythe Bank.

 

At December 31, 2002, the Company had consolidated assets of $337.2million, deposits of $298.0 million and shareholders’ equity of $25.4million.  The Company’s liabilitiesinclude $8.0 million in capital trust pass-through securities issued byCommunity Valley Trust I (see “Recent Developments” for further details).

 

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

 

**The Bank**

Butte Community Bank was incorporated under the laws of the State ofCalifornia on May 11, 1990 and commenced operations as a Californiastate-chartered commercial bank on December 14, 1990.  The Bank’s Administrative Office is located at 2041 ForestAvenue, Chico, California.  The Bank isan insured bank under the Federal Deposit Insurance Act up to the maximumlimits thereof.  The Bank is not amember of the Federal Reserve System. At December 31, 2002, the Bank had approximately $335.8 million inassets, $229.7 million in loans and $305.8 million in deposits.

 

We operate six full-service branch offices in four Butte Countycommunities, one full-service branch office in Sutter County, and one Loan Productionoffice in Placer County.  We offer afull range of banking services to individuals and various-sized businesses inthe communities we serve.  The locationsof those offices are: 

 
| Chico:    |   | Main Office   2041 Forest Avenue                            |   | Paradise:  |   | Paradise Branch   672 Pearson Road      |
|-----------|--------|-------------------------------------------------------------|--------|-----------------|--------|-----------------------------------------|
|      |   |                                                        |   |            |   |                                    |
|      |   | Administrative Headquarters  2041 Forest Avenue             |   | Oroville:  |   | Oroville Branch  2227 Myers Street      |
|      |   |                                                        |   |            |   |                                    |
|      |   | North Chico Branch  208 West East Avenue                    |   | Magalia:        |   | Magalia Branch   14115 Lakeridge Circle |
|      |   |                                                        |   |            |   |                                    |
|      |   | Central Chico Branch  900 Mangrove Avenue                   |   | Yuba City       |   | Yuba City Branch  1600 Butte House Road |
|      |   |                                                        |   |            |   |                                    |
| Roseville |   | Roseville Loan Office   114 N Sunrise Avenue  Suite C3 |   |            |   |                                    |

 

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In addition, our Real Estate Loan Center, Data Processing, Call Center,Central Note Department and Bank Card Center are located at 1390 RidgewoodDrive, Chico.  We also have specializedcredit centers for agricultural lending and construction and real estatelending within a number of these branch offices.  These facilities are located in the cities of Chico, Paradise,and Oroville in Butte County, the city of Yuba City in Sutter County, and thecity of Roseville in Placer County.

 

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

 

With a predominant focus on personal service, Butte Community Bank haspositioned itself as a multi-community independent bank serving the financialneeds of individuals and businesses, including agricultural and real estatecustomers in Butte and other surrounding counties.    Our principal retail lending services include home equity andconsumer loans. In addition, we have two other significant dimensions whichsurround this core of retail community banking:  Agricultural lending, and real estate financing (bothconstruction and long term).

 

The Agricultural Credit Centers located in Yuba City, and Chico providea complete line of credit services in support of the agricultural activitieswhich are key to the continued economic development of the communities weserve.  “Ag lending” clients include afull range of individual farming customers and small business farmingorganizations.

 

The Bank Card Center, headquartered in Chico, provides a range ofcredit, debit and ATM card services, which are made available to each of thecustomers served by the branch banking offices.  In addition, we staff our Chico, Paradise, Oroville, and YubaCity offices with real estate lending specialists.  These officers are responsible for a complete line of landacquisition and development loans, construction loans for residential andcommercial development, and the origination of multifamily creditfacilities.  Secondary market servicesare provided though the Bank’s affiliations with Fannie Mae and variousnon-governmental programs.  The Bankservices these real estate loans sold on the secondary market, and as of yearend the portfolio was in excess of $95 million.  We also have an orientation toward Small Business Administrationlending and have been designated as a Preferred Lender since 1998.  The Bank’s SBA program generatedapproximately $4 million in loans during the past year.  It is anticipated that loans under thisprogram will be an increasing segment of our loan portfolio over the next fewyears.  The Bank was also recognized asthe number one USDA Business and Industry Lender in California and seventh inthe nation during 2002.  The Bankoriginated $18 million in loans through this program during 2002.

 

As of December 31, 2002, the principal areas in which we directedour lending activities, and the percentage of our total loan portfolio for whicheach of these areas was responsible, were as follows: (i) agricultural loans(8%); (ii) commercial and industrial (including SBA) loans (21%); (iii) realestate loans (mortgage and construction) (63%); (iv) consumer loans (8%).

 

In addition to the lending activities noted above, we offer a widerange of deposit products for the retail banking market including checking,interest bearing transaction, savings, time certificates of deposit andretirement accounts, as well as telephone banking and internet banking withbill pay options.  As ofDecember 31, 2002, we had 22,623 deposit accounts with balances totalingapproximately $298 million, compared to 20,438 deposit accounts with balancestotaling approximately $246 million at December 31, 2001.  Butte Community Bank attracts depositsthrough its customer-oriented product mix, competitive pricing, convenientlocations, extended hours and drive-up banking, all provided with the highestlevel of customer service.

 

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We also offer other products and services to our customers, whichcomplement the lending and deposit services previously reviewed.  These include cashier’s checks, traveler’schecks, bank-by-mail, ATM, night depository, safe deposit boxes, direct deposit,automated payroll services and other customary banking services.   Shared ATM and Point of Sale (POS) networksallow customers access to the national and international funds transfernetworks.  During the past three yearswe have substantially enhanced our ATM locations to include off-site areas notpreviously served by cash or deposit facilities.  We now have a total of eight such remote ATM’s at eight differentlocations, including a hospital, two grocery stores, an entertainment center,and three gas stations.  These locationsfacilitate cash advances which would not otherwise be available to consumers atnon-branch locations, thereby increasing consumer convenience.    In addition to such specifically orientedcustomer applications, we provide safe deposit, wire transfer capabilities anda convenient customer service group in our Call Center to answer questions andassure a high level of customer satisfaction with the level of services andproducts we provide.

 

Most of the Bank’s deposits are attracted from individuals,business-related sources and smaller municipal entities.  This results in a relatively modest averagedeposit balance of approximately $11,000 at December 31, 2002, but makesthe Bank less subject to adverse effects from the loss of a substantialdepositor who may be seeking higher yields in other markets or who may haveneed of money otherwise on deposit with the Bank, especially during periods ofinflation or conservative monetary policies.

 

For non-deposit services, we have a strategic alliance with FinancialNetwork Investment Corporation.  Throughthis arrangement, our registered and licensed representatives provide Bankcustomers with convenient access to annuities, insurance products, mutualfunds, and a full range of investment products.  They conduct business from offices located in our Chico,Paradise, Oroville, and Yuba City branches.

 

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

 

The officers and em­ployees of the Bank are continual­ly engaged inmarketing activities, including the evaluation and develop­ment of new productsand services, which enable the Bank to retain and improve its competitiveposition in its service area.  Duringthe year 2002, the Bank further ex­panded its off-site ATM locations byinstalling an ATM at the East Avenue Safeway shopping center in Chico.  This center has several restaurants andbusinesses and is also close to Pleasant Valley High School.

 

All of these developments are meant to increase public convenience inthe Bank’s service area and enhance public access to the electronic paymentssystem.  The cost to the Bank for thesedevel­opment, implementation, and marketing activities cannot expressly becalculated with any degree of certainty.

 

The Bank holds no patentsor licenses (other than licenses required by appropriate bank regulatoryagencies), franchises, or concessions.   The Bank is not dependent on a single customer or group of relatedcustomers for a material portion of its deposits, nor is a material portion ofthe Bank’s loans concentrated within a single industry or group of relatedindustries.  There has been no materialeffect upon the Bank’s capital expendi­tures, earnings, or competitive positionas a result of Federal, state, or local environmental regulation.

 

**Recent Developments**

 

On July 16, 2001, Community Valley Bancorp was incorporated as a bankholding company, for the purpose of acquiring Butte Community Bank (the “Bank”)in a one bank holding company reorganization. Shortly after the incorporation,Community Valley Bancorp filed a registration statement on Form S-4 with theSecurities and Exchange Commission in order to register its common stock whichwas issued pursuant to the terms of a Plan of 

 

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Reorganization and Agreement of Merger dated April 22, 2002.  The Plan of Reorganization and Agreement ofMerger provided for the exchange of shares of the Bank for shares of CommunityValley Bancorp on a share-for-share basis (the “Reorganization”).  The registration statement was declaredeffective on April 16, 2002.  TheReorganization was approved by the Company’s shareholders on May 23, 2002, andall required regulatory approvals or non-disapprovals with respect to theReorganization were obtained.  TheReorganization was consummated on June 17, 2002, subsequent to which the Bankcontinued its operations as previously conducted but as a wholly-ownedsubsidiary of Community Valley Bancorp. The new corporate structure is intended to give Community Valley Bancorpand the Bank greater flexibility in terms of operation, expansion anddiversification.

 

On December 19, 2002, Community Valley Bancorp Trust I, a newly formedDelaware statutory business trust and a wholly-owned subsidiary of the Company(the “Trust”), issued an aggregate of $8,000,000 of principal amount ofFloating Rate Trust Preferred Securities (Capital Trust Pass-through Securities of the Trust) (the “TrustPreferred Securities”).  Bear Stearns,Inc. acted as placement agent in connection with the offering of the trustsecurities. The securities issued by the Trust are fully guaranteed by theCompany with respect to distributions and amounts payable upon liquidation,redemption or repayment.  The entireproceeds to the Trust from the sale of the Trust Preferred Securities were usedby the Trust in order to purchase $8,000,000 in principal amount of Fixed RateJunior Subordinated Deferrable Interest Debentures due 2032 issued by theCompany (the “Subordinated Debt Securities”). The Trust Preferred Securities are included as Tier 1 capital forpurposes of calculating the Company’s regulatory capital ratios.    A portion of the proceeds was used toretire debt incurred during 2002 to pay for the formation of the holding company,and the remainder has been placed in a demand deposit account at the Bank.

 

**Competition**

 

The banking business in California generally, and specifically in ourmarket areas, is highly competitive with respect to virtually all products andservices and has become increasingly more so in recent years.  The industry continues to consolidate andstrong, unregulated competitors have entered banking markets with focusedproducts targeted at highly profitable customer segments.  Many largely unregulated competitors areable to compete across geographic boundaries and provide customers increasingaccess to meaningful alternatives to banking services in nearly all significantproducts.  These competitive trends arelikely to continue.

 

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

 

In addition to other banks, competitors include savings institutions,credit unions, and numerous non-banking institutions such as finance companies,leasing companies, insurance companies, brokerage firms, and investment bankingfirms.  In recent years, increasedcompetition has also developed from specialized finance and non-financecompanies that offer wholesale finance, credit card, and other consumer financeservices, including on-line banking services and personalfinance software.  Strong competitionfor deposit and loan products affects the rates of those products as well asthe terms on which they are offered to customers.  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.  The Financial Modernization Act, which,effective March 11, 2000, has made it possible for full affiliations to occurbetween banks and securities firms, insurance companies, and other financialcompanies, is also expected to 

 

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intensify competitive conditions.

 

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

 

For many years, we have countered this increasing competition byproviding our own style of community-oriented, personalized service.  We rely upon local promotional activity,personal contacts by our officers, directors, employees, and shareholders,automated 24-hour banking, and the individualized service which we can providethrough our flexible policies.    Inaddition, to meet the needs of customers with electronic access requirements,the Company has embraced the electronic age and installed telephone banking andpersonal computer and internet banking with bill payment capabilities.  This high tech and high touch approachallows the individual to customize the Bank’s contact methodologies to their particularpreference.  Moreover, for customerswhose loan demands exceed our legal lending limit, we attempt to arrange forsuch loans on a participation basis with correspondent banks.  We also assist our customers in obtainingfrom our correspondent banks other services that the Bank may not offer.

 

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

 

**Employees**

 

As of December 31, 2002 the Company had 94 full-time and 83 part-timeemployees.  On a full time equivalentbasis, the Company’s staff level was 152 at December 31, 2002, as compared to132 at December 31, 2001.  None of ouremployees is concurrently represented by a union or covered by a collectivebargaining agreement.  Management of theCompany believes its employee relations are satisfactory.

 

**Regulation and Supervision**

 

The Company and the Bank are subject to significant regulation byfederal and state regulatory agencies. 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 be given that such statutesor regulations will not change in the future.

 

**TheCompany**

 

The Company is a bank holding company within the meaning of the BankHolding Company Act of 1956 and is registered as such with the Board ofGovernors of the Federal Reserve System (the “Federal Reserve Board”).  A bank holding company is required to filewith the Federal Reserve Board annual reports and other information regardingits business operations and those of its subsidiaries.  It is also subject to examination by theFederal Reserve Board and is required to obtain Federal Reserve Board approvalbefore acquiring, directly or indirectly, ownership or control of any votingshares of any bank if, after such acquisition, it would directly or indirectlyown or control more than 5% of the voting stock of that bank, unless it alreadyowns a majority of the voting 

 

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stock of that bank.

 

The Federal Reserve Board has by regulation determined certainactivities in which a bank holding company may or may not conductbusiness.  A bank holding company mustengage, with certain exceptions, in the business of banking or managing orcontrolling banks or furnishing services to or performing services for itssubsidiary banks.  The permissibleactivities and affiliations of certain bank holding companies have recentlybeen expanded.  (See “FinancialModernization Act” below.)

 

**The Bank**

 

As a California state-chartered bank whose accounts are insured by theFDIC up to a maximum of $100,000 per depositor, the Bank is subject toregulation, supervision and regular examination by the Department of FinancialInstitutions (the “DFI”) and the FDIC. In addition, while the Bank is not a member of the Federal ReserveSystem, it is subject to certain regulations of the Federal Reserve Board.  The regulations of these agencies governmost aspects of the Bank’s business, including the making of periodic reportsby the Bank, and the Bank’s activities relating to dividends, investments,loans, borrowings, capital requirements, certain check-clearing activities,branching, mergers and acquisitions, reserves against deposits and numerousother areas.  Supervision, legal actionand examination of the Bank by the FDIC are generally intended to protectdepositors and are not intended for the protection of shareholders.

 

The earnings and growth of the Bank are largely dependent on itsability to maintain a favorable differential or “spread” between the yield onits interest-earning assets and the rate paid on its deposits and otherinterest-bearing liabilities.  As a result,the Bank’s performance is influenced by general economic condi­tions, bothdomestic and foreign, the monetary and fiscal policies of the federalgovernment, and the policies of the regulatory agencies, particularly theFederal Reserve Board.  The FederalReserve Board implements national monetary policies (such as seeking to curbinflation and combat recession) by its open-market operations in United StatesGovernment securities, by adjusting the required level of reserves forfinancial institutions subject to its reserve requirements and by varying thediscount rate applicable to borrowings by banks which are members of theFederal Reserve System.  The actions ofthe Federal Reserve Board in these areas influence the growth of bank loans,investments and deposits and also affect interest rates charged on loans anddeposits.  The nature and impact of anyfuture changes in monetary policies cannot be predicted.

 

**CapitalAdequacy Requirements**

 

The Company and the Bank are subject to the regulations of the FederalReserve Board and the FDIC, respectively, governing capital adequacy.  Those regulations incorporate both risk-basedand leverage capital requirements.  Eachof the federal regulators has established risk-based andleverage capital guidelines for the banks or bank holding companies it regulates,which set total capital requirements and define capital in terms of “corecapital elements,” or Tier 1 capital; and “supplemental capital elements,” orTier 2 capital.  Tier 1 capital isgenerally 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 ascore capital elements: (i) common shareholders’ equity; (ii) qualifyingnon-cumulative perpetual preferred stock and related surplus (not to exceed 25%of pro-forma tier 1 capital); and (iii) minority interests in the equityaccounts 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 relatedsurplus.  The maximum amount ofsupplemental capital elements which qualifies as Tier 2 capital is limited to100% of Tier 1 capital, net of goodwill.

 

The minimum required ratio of qualifying total capital to total risk-weightedassets is 8.0% (“Total Risk-Based Capital Ratio”), at least one-half of whichmust be in the form of Tier 1 capital, and the minimum required ratio 

 

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of Tier 1 capital to total risk-weightedassets is 4.0% (“Tier 1 Risk-Based Capital Ratio”).  Risk-based capital ratios are calculated to provide a measureof capital that reflects the degree of risk associated with a bankingorganization’s operations for both transactions reported on the balance sheetas assets, and transactions, such as letters of credit and recoursearrangements, which are recorded as off-balance sheet items.  Under the risk-based capitalguidelines, the nominal dollar amounts of assets and credit-equivalentamounts of off-balance sheet items are multiplied by one of severalrisk adjustment percentages, which range from 0% for assets with low creditrisk, such as certain U. S. Treasury securities, to 100% for assets withrelatively high credit risk, such as business loans.  As of December 31, 2002 and 2001, the Bank’s TotalRisk-Based Capital Ratios were 10.9% and 11.6%, respectively and itsTier 1 Risk-Based Capital Ratios were 9.7% and 10.4%, respectively.  As of December 31, 2002, the Company’s TotalRisk-Based Capital was 14.0% and its Tier 1 Risk-Based CapitalRatio was 12.8%.

 

The risk-based capital requirements also takeinto account concentrations of credit (i.e., relatively large proportions ofloans involving one borrower, industry, location, collateral or loan type) andthe risks of “non-traditional” activities (those that have not customarilybeen part of the banking business). The regulations require institutions withhigh or inordinate levels of risk to operate with higher minimum capitalstandards, and authorize the regulators to review an institution’s managementof such risks in assessing an institution’s capital adequacy.

 

The risk-based capital regulations alsoinclude exposure to interest rate risk as a factor that the regulators willconsider in evaluating a bank’s capital adequacy.  Interest rate risk is the exposure of a bank’s current and futureearnings and equity capital arising from adverse movements in interestrates.  While interest risk is inherentin a bank’s role as financial intermediary, it introduces volatility to bankearnings and to the economic value of the bank.

 

The FDIC and the Federal Reserve Board also require the maintenance ofa leverage capital ratio designed to supplement the risk-based capitalguidelines.  Banks and bank holdingcompanies that have received the highest rating of the five categories used byregulators 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 requiredto maintain a leverage ratio of at least 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 circumstanceswarrant.  As of December 31, 2002and 2001, the Bank’s Leverage Capital Ratios were 7.9% and 7.7%,respectively.  As of December 31, 2002,the Company’s leverage capital ratio was 10.4%, exceeding regulatoryminimums.  See Part II, Item 7,Management’s Discussion and Analysis of Financial Condition and Results ofOperation — Liquidity and Market Risk Management.

 

**PromptCorrective Action Provisions**

 

Federal law requires each federal banking agency to take promptcorrective action to resolve the problems of insured financial institutions,including but not limited to those that fall below one or more prescribedminimum capital ratios.  The federalbanking agencies have by regulation defined the following five capitalcategories: “well capitalized” (Total Risk-Based Capital Ratio of 10%; Tier 1Risk-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“critically undercapitalized” (tangible equity to total assets less than2%).  A bank may be treated as though itwere in the next lower capital category if after notice and the opportunity fora hearing, the appropriate federal agency finds 

 

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an unsafe or unsound condition or practice so warrants, but no bank maybe treated as “critically undercapitalized” unless its actual capital ratiowarrants such treatment.

 

At each successively lower capital category, an insured bank is subjectto increased restrictions on its operations. For example, a bank is generally prohibited from paying management feesto any controlling persons or from making capital distributions if to do sowould make the bank “undercapitalized.” Asset growth and branching restrictions apply to undercapitalized banks,which are required to submit written capital restoration plans meetingspecified requirements (including a guarantee by the parent holding company, ifany).  “Significantly undercapitalized”banks are subject to broad regulatory authority, including among other things,capital directives, forced mergers, restrictions on the rates of interest theymay pay on deposits, restrictions on asset growth and activities, andprohibitions on paying certain bonuses without FDIC approval.  Even more severe restrictions apply tocritically undercapitalized banks.  Mostimportantly, except under limited circumstances, not later than 90 days afteran insured bank becomes critically undercapitalized, the appropriate federalbanking agency is required to appoint a conservator or receiver for the bank.

 

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

 

**Safetyand Soundness Standards**

 

The federal banking agencies have also adopted guidelines establishingsafety and soundness standards for all insured depository institutions.  Those guidelines relate to internalcontrols, information systems, internal audit systems, loan underwriting anddocumentation, compensation and interest rate exposure.  In general, the standards are designed toassist the federal banking agencies in identifying and addressing problems atinsured depository institutions before capital becomes impaired.  If an institution fails to meet thesestandards, the appropriate federal banking agency may require the institutionto submit a compliance plan and institute enforcement proceedings if anacceptable compliance plan is not submitted.

 

**Premiumsfor Deposit Insurance**

 

The FDIC regulations also implement a risk-based premiumsystem, whereby insured depository institutions are required to pay insurancepremiums depending on their risk classification.  Under this system, institutions such as the Bank which areinsured by the Bank Insurance Fund (“BIF”), are categorized into one of threecapital categories (well capitalized, adequately capitalized, andundercapitalized) and one of three supervisory categories based on federalregulatory evaluations.  The threesupervisory categories are: financially sound with only a few minor weaknesses(Group A), demonstrates weaknesses that could result in significantdeterioration (Group B), and poses a substantial probability of loss (GroupC).  The capital ratios used by the FDICto define well capitalized, adequately capitalized and undercapitalized are thesame in the FDIC’s prompt corrective action regulations.  The current BIF base assessment rates(expressed as cents per $100 of deposits) are summarized as follows:

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

 

10

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In addition, BIF member banks (such as the Bank) must pay an amountwhich fluctuates but is currently 1.84 basis points, or cents per $100 ofinsured deposits, toward the retirement of the Financing Corporation bondsissued in the 1980’s to assist in the recovery of the savings and loanindustry.

 

**CommunityReinvestment Act**

 

The Bank is subject to certain requirements and reporting obligationsinvolving Community Reinvestment 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.  In measuring a bank’s compliance with itsCRA obligations, the regulators utilize a performance-based evaluation systemwhich bases CRA ratings on the bank’s actual lending service and investmentperformance, rather than on the extent to which the institution conducts needsassessments, documents community outreach activities or complies with otherprocedural requirements.  In connectionwith its assessment of CRA performance, the FDIC assigns a rating of“outstanding,” “satisfactory,” “needs to improve” or “substantialnoncompliance.”  The Bank was lastexamined for CRA compliance in June, 1999 and received an “outstanding” CRAAssessment Rating.

 

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

 

The bank regulatory agencies are increasingly focusing attention oncompliance with consumer protection laws and regulations.  Examination and enforcement has become intense,and banks have been advised to carefully monitor compliance with variousconsumer protection laws and their implementing regulations. The federalInteragency Task Force on Fair Lending issued a policy statement ondiscrimination in home mortgage lending describing three methods that federalagencies will use to prove discrimination: overt evidence of discrimination,evidence of disparate treatment, and evidence of disparate impact.  In addition to CRA and fair lendingrequirements, the Bank is subject to numerous other federal consumer protectionstatutes and regulations.  Due toheightened regulatory concern related to compliance with consumer protectionlaws and regulations generally, the Bank may incur additional compliance costsor be required to expend additional funds for investments in the localcommunities it serves.

 

**InterstateBanking and Branching**

 

The Riegle-Neal Interstate Banking and BranchingEfficiency Act of 1994 (the “Interstate Banking Act”) regulates the interstateactivities of banks and bank holding companies and establishes a framework fornationwide interstate banking and branching. Since June 1, 1997, a bank in one state has generally been permitted tomerge with a bank in another state without the need for explicit state law authorization.  However, states were given the ability toprohibit interstate mergers with banks in their own state by “opting-out”(enacting state legislation applying equality to all out-of-state banksprohibiting such mergers ) prior to June 1, 1997.

 

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

 

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

 

In 1995 California enacted legislation to implement importantprovisions of the Interstate Banking Act discussed 

 

11

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above and to repeal California’s previous interstate banking laws,which were largely preempted by the Interstate Banking Act.

 

The changes effected by Interstate Banking Act and California laws haveincreased competition in the environment in which the Bank operates to theextent that out-of-statefinancial institutions directly or indirectly enter the Bank’s marketareas.  It appears that the InterstateBanking Act has contributed to the accelerated consolidation of the bankingindustry. While many large out-of-state banks have already entered theCalifornia market as a result of this legislation, it is not possible topredict the precise impact of this legislation on the Bank and the Company andthe competitive environment in which they operate.

 

**FinancialModernization Act**

 

Effective March 11, 2000 the Gramm-Leach-Bliley Act eliminated mostbarriers to affiliations among banks and securities firms, insurance companies,and other financial service providers, and enabled full affiliations to occurbetween such entities.  This legislationpermits bank holding companies to become “financial holding companies” andthereby acquire securities firms and insurance companies and engage in otheractivities that are financial in nature. A bank holding company may become a financial holding company if each ofits subsidiary banks is well capitalized under the FDICIA prompt correctiveaction provisions, is well managed, and has at least a satisfactory ratingunder the CRA by filing a declaration that the bank holding company wishes tobecome a financial holding company.   Noregulatory approval will be required for a financial holding company to acquirea company, other than a bank or savings association, engaged in activities thatare financial in nature or incidental to activities that are financial innature, as determined by the Federal Reserve Board.  The Company has no current intention of becoming a financialholding company, but may do at some point in the future if deemed appropriatein view of opportunities or circumstances at the time.

 

The Gramm-Leach-Bliley Act defines “financial in nature” to includesecurities underwriting, dealing and market making; sponsoring mutual funds andinvestment companies; insurance underwriting and agency; merchant bankingactivities; and activities that the Board has determined to be closely relatedto banking.  A national bank (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 financialholding company or national banks with financial subsidiaries must continue tobe well capitalized and well managed in order to continue to engage inactivities that are financial in nature without regulatory actions orrestrictions, which could include divestiture of the financial in naturesubsidiary or subsidiaries.  Inaddition, a financial holding company or a bank may not acquire a company thatis engaged in activities that are financial in nature unless each of the subsidiarybanks of the financial holding company or the bank has a CRA rating ofsatisfactory or better.

 

The Gramm-Leach-Bliley Act also imposes significant new requirements onfinancial institutions with respect to the privacy of customer information, andmodifies other existing laws, including those related to communityreinvestment.

 

12

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**OtherPending and Proposed Legislation**

 

Other legislative and regulatory initiatives which could affect theCompany, the Bank and the banking industry in general are pending, andadditional initiatives may be proposed or introduced before the United StatesCongress, the California legislature and other governmental bodies in thefuture.  Such proposals, if enacted, mayfurther alter the structure, regulation and competitive relationship amongfinancial institutions, and may subject the Bank to increased regulation,disclosure and reporting requirements. In addition, the various banking regulatory agencies often adopt newrules and regulations to implement and enforce existing legislation.  It cannot be predicted whether, or in whatform, any such legislation or regulations may be enacted or the extent to whichthe business of the Company or the Bank would be affected thereby.

 

**RISK FACTORS**

 

This discussion andanalysis provides insight into Management’s assessment of the operating trendsover the last several years and its expectations for 2003.  Such expressions of expectations are nothistorical in nature and are “forward-looking statements” within the meaning ofthe Private Securities Litigation Reform Act of 1995.  Forward-looking statements are subject to risks and uncertaintiesthat may cause actual future results to differ materially from those expressedin any forward-looking statement.  Suchrisks and uncertainties with respect to the Company 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;

•                        substantialincreases in energy costs in California; and

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

 

**Competition**

 

The Company facescompetition from other financial institutions and from businesses in otherindustries that have developed financial products.  Banks once had an almost exclusive franchise for deposit productsand provided the majority of business financing.  With deregulation in the 1980’s, other kinds of financialinstitutions began to offer competing products.  Also, increased competition in consumer financial products hascome from companies not typically associated with the banking and financialservices industry, such as AT &T, General Motors and various softwaredevelopers.  Similar competition isfaced for commercial financial products from insurance companies and investmentbankers.  Community banks, including theCompany, attempt to offset this trend by developing new products thatcapitalize on the service quality that a local institution can offer.  Among these are new loan, deposit, andinvestment products.  The Company’sprimary competitors are different for each specific product and marketarea.  While this offers specialchallenges for the marketing of our products, it offers protection from onecompetitor dominating the Company in its market areas.  Many of these competitors are much larger intotal assets and capitalization, have greater access to capital markets andoffer a broader array of financial services than we do, which creates certaincompetitive disadvantages for the Company.

 

13

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**Economic Conditions**

 

From a nationalperspective, the most significant economic factors impacting the Company in thelast three years have been the steady slowing of growth in the economy and theactions of the Federal Reserve Board (“the Fed”) to manage the decline.  Early in 2001, the Fed began to lower ratesand continued throughout the year until it had lowered its target short-termrate by 4.75% to its lowest rate in 40 years.  These changes, especially given the extreme rate of decline in2001, impact the Company as market rates for loans, investments and depositsrespond to the Fed’s actions.  We arealso affected by certain industry-specificeconomic factors. For example, a significant portion of our total loanportfolio is related to real estate obligations, particularly residential realestate loans.  A downturn in theresidential real estate industry in California could have an adverse effect onour operations.  Similarly, a sizableportion of our total loan portfolio is to borrowers either directly orindirectly involved in the agricultural industry.

 

**Risk Management**

 

The Company sees theprocess of addressing the potential impacts of the external factors listedabove as part of its management of risk. In addition to common business risks such as disasters, theft, and lossof market share, the Company is subject to special types of risk due to thenature of its business.  New andsophisticated financial products are continually appearing with different typesof risk which need to be defined and managed if the Company chooses to offerthem to its customers.  Also, the risksassociated with existing products must be reassessed periodically.  The Company cannot operate risk-free andmake a profit.  Instead, the process ofrisk definition and assessment allows the Company to select the appropriatelevel of risk for the anticipated level of reward and then decide on the stepsnecessary to manage this risk.  TheCompany’s Risk Officer and the other members of its Senior Management Teamunder the direction and oversight of the Board of Directors lead the riskmanagement process.

 

Some of the risks facedby the Company are those faced by most enterprises — reputational risk,operational risk, and legal risk.  Thespecial risks related to financial products are **credit risk** and **interestrate risk.**  Credit riskrelates to the possibility that a debtor will not repay according to the termsof the debt contract.  Credit risk isdiscussed in the sections related to loans. Interest rate risk relates to the adverse impacts of changes in interestrates.  The effective management ofthese and other risks mentioned above is the backbone of the Company’s businessstrategy.

 

**As a Result of Our Growth**

 

Our Company’s(1) totalassets increased from $272 million at December 31, 2001 to $337 million atDecember 31, 2002, with most of the growth occurring in the second half of theyear.  Management’s intention is to leveragethe Company’s current infrastructure to sustain the momentum achieved in thelatter part of 2002, although no assurance can be provided that this strategywill result in significant growth.  Ourability 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.

 

----

(1) Inasmuch as theCompany did not acquire the outstanding shares of the Bank until May, 2002, thefinancial information contained throughout this Annual Report for 2001 andearlier is for the Bank only. Information for 2002 is for the Company on a consolidated basis unlessotherwise stated.

 

14

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

 

The Company earns incomefrom two sources.  The primary source isfrom the management of its financial assets and liabilities and the second isfrom charging fees for services provided. The first source involves functioning as a **financial intermediary**, thatis, the Company accepts funds from depositors or obtains funds from othercreditors and then either lends the funds to borrowers or invests those fundsin securities or other financial instruments. Income is earned as a spread between the interest earned from the loansor investments and the interest paid on the deposits and other borrowings.  The second source, fee income, is discussedin other sections of this analysis, specifically in “Noninterest Revenue.”

 

**Changes in Net Interest Income and Net Interest Margin**

 

**Net interest income** is the difference orspread between the interest and fees earned on loans and investments (theCompany’s **earningassets**) and the interest expense paid on deposits and otherliabilities.  The amount by whichinterest income will exceed interest expense depends on two factors: (1) thevolume or balance of earning assets compared to the volume or balance of interest-bearingdeposits and liabilities, and (2) the interest rate earned on those interestearning assets compared with the interest rate paid on those interest-bearingdeposits and liabilities.

 

15

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**Net interest margin**is net interest incomeexpressed as a percentage of average earning assets.  It is used to measure the difference between the average rate ofinterest earned on assets and the average rate of interest that must be paid onliabilities used to fund those assets.  To maintain its net interest margin, the Company must manage therelationship between interest earned and paid. A shift in the relative size of the major balance sheet categories hasan impact on net interest income and net interest margin.  To the extent that funds invested insecurities can be repositioned into loans, earnings increase because of thehigher rates paid on loans.  However,additional credit risk is incurred with loans compared to the very low risk ofloss on securities, and the Company must carefully monitor the underwritingprocess to ensure that the benefit of the additional interest earned is notoffset by additional credit losses.   Ingeneral, depositors are willing to accept a lower rate on their funds than are otherproviders of funds because of the Federal Deposit Insurance Corporation(“FDIC”) insurance coverage.  To theextent that the Company can fund asset growth by deposits, especially the lowercost transaction accounts, rather than borrowing funds from other financialinstitutions, the average rates paid on funds will be less, and net interestincome more.

 

**The Allowance for Loan Losses May Not Cover Actual LoanLosses.**  Weattempt to limit the risk that borrowers will fail to repay loans by carefullyunderwriting the loans, nevertheless losses can and do occur.  We create an allowance for estimated loanlosses in our accounting records, based on estimates of the following:

 

•                     industrystandards;

•                     historicalexperience with our loans;

•                     evaluationof economic conditions;

•                     regularreviews of the quality mix and size of the overall loan portfolio;

•                     regularreviews of delinquencies; and

•                     thequality of the collateral underlying our loans.

 

We maintain an allowancefor loan losses at a level which we believe is adequate to absorb anyspecifically identified losses as well as any other losses inherent in our loanportfolio.  However, changes ineconomic, operating and other conditions, including changes in interest rates,which are beyond our control, may cause our actual loan losses to exceed our currentallowance estimates.  If the actual loanlosses exceed the amount reserved, it will hurt our business.  In addition, the FDIC and the Department ofFinancial Institutions, as part of their supervisory functions, periodicallyreview our allowance for loan losses. Such agencies may require us to increase our provision for loan lossesor to recognize further loan losses, based on their judgments, which may bedifferent from those of our management. Any increase in the allowance required by the FDIC or the Department ofFinancial Institutions could also impact our business.

 

**Item2. ****           Properties**

 

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

 

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

 

16

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| **Location**                                   |   | **Use of  Facilities** |   | **Square  Feet of  Office Space** |   | **Land and  Building Cost** |      |
|------------------------------------------------|--------|------------------------|--------|-----------------------------------|--------|-----------------------------|-----------|
|                                           |   |                   |   |                              |   |                        |      |
| 672 Pearson Road                               |   | Branch Office          |   | 4,200                             |   | $                           | 612,261   |   |
| Paradise, California                           |   |                   |   |                              |   |                        |      |
| (Opened December 1990)                         |   |                   |   |                              |   |                        |      |
|                                           |   |                   |   |                              |   |                        |      |
| 2227 Myers Street                              |   | Branch Office          |   | 9,800                             |   | $                           | 1,029,737 |   |
| Oroville, California                           |   |                   |   |                              |   |                        |      |
| (Opened December 1990)                         |   |                   |   |                              |   |                        |      |
|                                           |   |                   |   |                              |   |                        |      |
| 2041 Forest Avenue                             |   | Branch Office          |   | 8,000                             |   | $                           | 1,543,845 |   |
| Chico, California                              |   |                   |   |                              |   |                        |      |
| (Opened September, 1996)                       |   |                   |   |                              |   |                        |      |
|                                           |   |                   |   |                              |   |                        |      |
| 1390 Ridgewood Drive                           |   | Central Services       |   | 8,432                             |   | $                           | 1,098,293 |   |
| Chico, California                              |   |                   |   |                              |   |                        |      |
| (Opened May, 1998)                             |   |                   |   |                              |   |                        |      |
|                                           |   |                   |   |                              |   |                        |      |
| 1600 Butte House Road                          |   | Branch Office          |   | 6,580                             |   | $                           | 1,448,340 |   |
| Yuba City, California (Opened September, 1997) |   |                   |   |                              |   |                        |      |

 

The following facilitiesare leased by the Bank:

 
| **Location**                            |   | **Use of  Facilities** |   | **Square  Feet of  Office Space** |   | **Monthly  Rent  as of 12/31/02** |   | **Term of  Lease** |    |
|-----------------------------------------|--------|------------------------|--------|-----------------------------------|--------|-----------------------------------|--------|--------------------|---------|
|                                    |   |                   |   |                              |   |                              |   |               |    |
| 14115 Lakeridge Circle                  |   | Branch Office          |   | 5,109                             |   | $                                 | 2,555  |               | 5/1/03  | (1) |
| Magalia, California  (Opened June 1993) |   |                   |   |                              |   |                              |   |               |    |
|                                    |   |                   |   |                              |   |                              |   |               |    |
| 208 West East Avenue                    |   | Branch Office          |   | 3,407                             |   | $                                 | 3,850  |               | 3/31/03 | (2) |
| Chico, California                       |   |                   |   |                              |   |                              |   |               |    |
| (Opened June, 1999)                     |   |                   |   |                              |   |                              |   |               |    |
|                                    |   |                   |   |                              |   |                              |   |               |    |
| 114 N. Sunrise Avenue                   |   | Loan Office            |   | 1,360                             |   | $                                 | 1,700  |               | 1/31/03 | (3) |
| Roseville, California                   |   |                   |   |                              |   |                              |   |               |    |
| (Opened February, 2000)                 |   |                   |   |                              |   |                              |   |               |    |
|                                    |   |                   |   |                              |   |                              |   |               |    |
| 900 Mangrove Avenue                     |   | Branch Office          |   | 6,000                             |   | $                                 | 6,300  |               | 9/30/11 | (4) |
| Chico, California                       |   |                   |   |                              |   |                              |   |               |    |

 

Additionally, the Bank has eight remote ATM locations.  The amount of monthly rent at theselocations is minimal.

 

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(1)****Thisis the termination date of the current 5-year lease; the Company has the righthowever, to terminate the laese with 180 days advance notice.

(2) This is the terminationdate of the current 1-year lease.

(3)This is the termination date of the current 3-year lease.

(4)This is the termination date of the origional lease.  The Company also has four renewal options for five years eachunder this lease agreement.

 

17

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Management believes that the Company’s existing facilities are adequateto accommodate the Company’s operations for the immediately foreseeable future.

 

**Item3. ****           LegalProceedings**

 

From time to time, the Company is a party to claims and legalproceedings arising in the ordinary course of business. After taking intoconsideration information furnished by counsel to the Company as to the currentstatus of these claims or proceedings to which the Company is a party,management is of the opinion that the ultimate aggregate liability representedthereby, if any, will not have a material adverse affect on the financialcondition of the Company.

 

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

 

Not applicable.

 

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**PARTII**

 

**Item 5****. ****           Marketfor Common Equity and Related Shareholder Matters**

 

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

 

Community Valley Bancorp has been listed on the Nasdaq OTC BulletinBoard since June 17, 2002 (the effective date of the holding companyreorganization), and Butte Community Bank was previously also listed on theNasdaq OTC Bulletin Board.  Our CommonStock trades under the symbol CVLL and the CUSIP number for such common stockis #20415P101.   Previously the ButteCommunity Bank CUSIP number for the common stock was #12406Q107.  Trading in the Company has not beenextensive and such trades cannot be characterized as amounting to an activetrading market.  Management is aware ofthe following securities dealers who make a market in the Company’s stock:Hoefer & Arnett, San Francisco, California, Wachovia First UnionSecurities, Grass Valley, California, and Wedbush Morgan Securities, Portland,Oregon (the “Securities Dealers”).

 

The following table summarizes trades of the Company setting forth theapproximate high and low sales prices and volume of trading for the periodsindicated, based upon information provided by public sources.  The information in the following table doesnot include trading activity between dealers.

 
| **Calendar  Quarter Ended** |   | **Sale Price of the Company’s  Common Stock** |   | **Approximate  Trading Volume  Shares** |   |
|-----------------------------|--------|----------------------------------------------------|--------|-----------------------------------------|--------|
| **High**                    |   | **Low**                                            |   |
| March 31, 2001              |   | 12.00                                              |   | 12.00                                   |   | 14,200 |   |
| June 30, 2001               |   | 11.66                                              |   | 11.63                                   |   | 22,400 |   |
| September 30, 2001          |   | 13.13                                              |   | 12.19                                   |   | 103,100 |   |
| December 31, 2001           |   | 15.38                                              |   | 15.38                                   |   | 81,600 |   |
| March 31, 2002              |   | 18.00                                              |   | 18.00                                   |   | 40,100 |   |
| June 30, 2002               |   | 21.86                                              |   | 18.19                                   |   | 50,300 |   |
| September 30, 2002          |   | 20.44                                              |   | 18.79                                   |   | 20,700 |   |
| December 31, 2002           |   | 20.40                                              |   | 18.75                                   |   | 48,400 |   |

 

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

 

On February 19, 2003 there were approximately 449 shareholders ofrecord of the Company.

 

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

 

As a bank holding company which currently has no significant assetsother than its equity interest in the Bank and the proceeds from the issuanceof the Trust Preferred Securities previously mentioned, the Company’s abilityto declare dividends depends primarily upon dividends it receives from theBank.  The Bank’s dividend practices inturn depend upon the Bank’s earnings, financial position, current andanticipated cash requirements and other factors deemed relevant by the Bank’sBoard of Directors at that time.

 

The Company paid quarterly cash dividends totaling $1.08 million or$0.33 per share in 2002 and $591 thousand or $0.22 per share in 2001,representing 22% and 16%, respectively of the prior year’s earnings.  (As the holding company reorganizationbecame effective on June 17, 2002, all of the dividends paid prior to that datewere paid by the Bank, rather than the Company.)  The Company anticipates paying dividends in the future 

 

19

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consistent with the general dividend policy.  The policy is to declare and pay dividends of no more than 40% ofits previous years net income to shareholders. However, no assurance can be given that the Bank’s and the Company’sfuture earnings and/or growth expectations in any given year will justify thepayment of such a dividend.

 

The power of the Bank’s Board of Directors to declare cash dividends isalso limited by statutory and regulatory restrictions which restrict the amountavailable for cash dividends depending upon the earnings, financial conditionand cash needs of the Bank, as well as general business conditions.  Under California banking law, the Bank maydeclare dividends in an amount not exceeding the lesser of its retainedearnings or its net income for the last three years (reduced by dividends paidduring such period) or, with the prior approval of the California Commissionerof Financial Institutions, in an amount not exceeding the greatest of (i) theretained earnings of the Bank, (ii) the net income of the Bank for its lastfiscal year, or (iii) the net income of the Bank for its current fiscal year.  The payment of any cash dividends by theBank will depend not only upon the Bank’s earnings during a specified period,but also on the Bank meeting certain regulatory capital requirements.

 

The Company’s ability to pay dividends is also limited by statecorporation law. The California General Corporation Law prohibits the Companyfrom paying dividends on the Common Stock unless: (i) its retained earnings,immediately prior to the dividend payment, equals or exceeds the amount of thedividend or (ii) immediately after giving effect to the dividend the sum of theCompany’s assets (exclusive of goodwill and deferred charges) would be at leastequal to 125% of its liabilities (not including deferred taxes, deferred incomeand other deferred liabilities) and the current assets of the Company would beat least equal to its current liabilities, or, if the average of its earningsbefore taxes on income and before interest expense for the two preceding fiscalyears was less than the average of its interest expense for the two precedingfiscal years, at least equal to 125% of its current liabilities.

 

**(d) Recent Sales of Unregistered Securities**

 

 On December 19, 2002, the Company issued anaggregate of $8,000,000 in principal amount of its Floating Rate JuniorSubordinated Deferrable Interest Debentures due 2032 (the “Subordinated DebtSecurities”).  All of the SubordinatedDebt Securities were issued to Community Valley Trust I, a Delaware statutorybusiness trust and a wholly-owned subsidiary of the Company (the “Trust”).   The Subordinated Debt Securities were notregistered under the Securities Act in reliance on the exemption set forth inSection 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 theplacement agent in connection with the offering of the Trust PreferredSecurities for aggregate commissions of $240,000 payable by the Trust.  The sale of the Trust Preferred Securitieswas part of a larger transaction arranged by Bear Stearns & Co. pursuant towhich the Trust Preferred Securities were deposited into a special purposevehicle along with similar securities issued by a number of other banks and thespecial purpose vehicle then issued its securities to the public (the “PooledTrust Preferred Securities”).  ThePooled Trust Preferred Securities were sold by Bear Stearns & Co. Inc. only(i) to those entities Bear Stearns & Co. Inc. reasonably believed werequalified institutional  buyers (asdefined in Rule 144A under the Securities Act), (ii) to “accredited investors”(as defined in Rule 501(a)(1), (2), (3) or (7) or Regulation D promulgatedunder the Securities Act) or (iii) in offshore transactions in compliance withRule 903 of Regulation S under the Securities Act.  The Trust Preferred Securities were not registered under the SecuritiesAct in reliance on exemptions set forth in Rule 144A, Regulation D andRegulation S, as applicable.

 

**Item 6****. ****           SelectedFinancial Data**

 

The “selected financial data” for 2002 which follows is derived fromthe audited Consolidated Financial Statements of the Company and other datafrom our internal accounting system. The selected financial data should be read in conjunction with theaudited Consolidated Financial Statements and Notes thereto, and 

 

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Management’s Discussion and Analysis of Financial Condition and Resultsof Operations in Item 7 below. Statistical information below is generally based on average dailyamounts.

 

**Selected Financial Data**

 
|                                                       |   | **As  of December 31,  (Dollars in thousands, except per share data)** |    |
|------------------------------------------------------------|--------|------------------------------------------------------------------------|---------|
|                                                       |   | **2002**                                                               |    | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
| **Income  Statement Summary**                              |   |                                                                   |    |   |   |   |   |   |   |   |   |
| Interest income                                            |   | $                                                                      | 18,572  |   | $ | 19,389 |   | $ | 16,532 |   | $ | 12,188 |   | $ | 11,003 |   |
| Interest expense                                           |   | $                                                                      | 4,774   |   | $ | 7,344 |   | $ | 5,518 |   | $ | 3,705 |   | $ | 3,674 |   |
| Net interest income before  provision for loan losses      |   | $                                                                      | 13,798  |   | $ | 12,044 |   | $ | 11,014 |   | $ | 8,483 |   | $ | 7,329 |   |
| Provision for loan losses                                  |   | $                                                                      | 603     |   | $ | 500 |   | $ | 805 |   | $ | 305 |   | $ | 565 |   |
| Non-interest income                                        |   | $                                                                      | 6,561   |   | $ | 4,026 |   | $ | 3,168 |   | $ | 2,796 |   | $ | 2,931 |   |
| Non-interest expense                                       |   | $                                                                      | 12,531  |   | $ | 9,335 |   | $ | 8,398 |   | $ | 7,336 |   | $ | 6,199 |   |
| Income before provision for  income taxes                  |   | $                                                                      | 7,225   |   | $ | 6,235 |   | $ | 4,979 |   | $ | 3,638 |   | $ | 3,496 |   |
| Provision for income taxes                                 |   | $                                                                      | 2,375   |   | $ | 2,424 |   | $ | 1,932 |   | $ | 1,415 |   | $ | 1,365 |   |
| Net Income                                                 |   | $                                                                      | 4,850   |   | $ | 3,811 |   | $ | 3,047 |   | $ | 2,223 |   | $ | 2,131 |   |
|                                                       |   |                                                                   |    |   |   |   |   |   |   |   |   |
| **Balance  Sheet Summary**                                 |   |                                                                   |    |   |   |   |   |   |   |   |   |
| Total loans, net                                           |   | $                                                                      | 229,699 |   | $ | 197,875 |   | $ | 167,092 |   | $ | 116,864 |   | $ | 103,249 |   |
| Allowance for loan losses                                  |   | $                                                                      | (3,007  | ) | $ | (2,397 | ) | $ | (2,000 | ) | $ | (1,390 | ) | $ | (1,328 | ) |
| Securities held to maturity                                |   | $                                                                      | 2,873   |   | $ | 2,507 |   | $ | 4,105 |   | $ | 5,062 |   | $ | 5,075 |   |
| Securities available for  sale                             |   | $                                                                      | 514     |   | $ | 500 |   | $ | 463 |   | $ | 263 |   | $ | 832 |   |
| Due from banks time                                        |   | $                                                                      | 4,061   |   | $ | 694 |   | $ | 1,584 |   | $ | 3,664 |   | $ | 3,962 |   |
| Cash and due from banks                                    |   | $                                                                      | 15,621  |   | $ | 12,402 |   | $ | 12,100 |   | $ | 11,997 |   | $ | 8,669 |   |
| Federal funds sold                                         |   | $                                                                      | 57,410  |   | $ | 37,270 |   | $ | 11,630 |   | $ | 8,500 |   | $ | 10,550 |   |
| Other real estate                                          |   | $                                                                      | —  |   | $ | 12 |   | $ | 52 |   | $ | 431 |   | $ | 341 |   |
| Premises and equipment, net                                |   | $                                                                      | 6,653   |   | $ | 5,642 |   | $ | 5,217 |   | $ | 5,595 |   | $ | 4,514 |   |
| Total Interest-Earning  Assets                             |   | $                                                                      | 294,557 |   | $ | 238,846 |   | $ | 184,874 |   | $ | 134,353 |   | $ | 123,668 |   |
| Total Assets                                               |   | $                                                                      | 337,235 |   | $ | 272,464 |   | $ | 214,906 |   | $ | 159,332 |   | $ | 145,481 |   |
| Total Interest-Bearing  Liabilities                        |   | $                                                                      | 243,092 |   | $ | 201,434 |   | $ | 162,210 |   | $ | 123,291 |   | $ | 107,072 |   |
| Total Deposits                                             |   | $                                                                      | 297,981 |   | $ | 246,420 |   | $ | 194,125 |   | $ | 142,873 |   | $ | 131,755 |   |
| Total Liabilities                                          |   | $                                                                      | 311,855 |   | $ | 251,644 |   | $ | 198,062 |   | $ | 145,494 |   | $ | 134,081 |   |
| Total Shareholders’ Equity                            |   | $                                                                      | 25,380  |   | $ | 20,820 |   | $ | 16,844 |   | $ | 13,838 |   | $ | 11,400 |   |
|                                                       |   |                                                                   |    |   |   |   |   |   |   |   |   |
| **Per Share  Data****(1)**                                 |   |                                                                   |    |   |   |   |   |   |   |   |   |
| Net Income                                                 |   | $                                                                      | 1.87    |   | $ | 1.53 |   | $ | 1.29 |   | $ | 0.96 |   | $ | 0.94 |   |
| Book Value                                                 |   | $                                                                      | 9.78    |   | $ | 8.35 |   | $ | 7.12 |   | $ | 5.97 |   | $ | 5.02 |   |
| Cash Dividends                                             |   | $                                                                      | 0.33    |   | $ | 0.22 |   | $ | — |   | $ | — |   | $ | — |   |
| Weighted Average Common  Shares Outstanding, Basic         |   | 2,595,836                                                              |    | 2,492,572 |   | 2,365,935 |   | 2,318,524 |   | 2,271,996 |   |
| Weighted Average Common  Shares Outstanding, Diluted       |   | 2,729,947                                                              |    | 2,680,305 |   | 2,629,455 |   | 2,590,304 |   | 2,481,445 |   |
| **Key  Operating Ratios:**                                 |   |                                                                   |    |   |   |   |   |   |   |   |   |
| **Performance  Ratios:**                                   |   |                                                                   |    |   |   |   |   |   |   |   |   |
| Return on Average Equity(2)                                |   | 20.82                                                                  | %       | 19.73 | % | 20.08 | % | 17.61 | % | 21.14 | % |
| Return on Average Assets(3)                                |   | 1.69                                                                   | %       | 1.54 | % | 1.64 | % | 1.45 | % | 1.60 | % |
| Net Interest Margin(4)                                     |   | 5.36                                                                   | %       | 5.49 | % | 6.73 | % | 6.34 | % | 6.25 | % |
| Dividend Payout Ratio(5)                                   |   | 17.66                                                                  | %       | 14.39 | % |   |   |   |   |   |   |
| Equity to Assets Ratio(6)                                  |   | 8.12                                                                   | %       | 7.85 | % | 8.09 | % | 8.23 | % | 7.57 | % |
| Net Loans to Total Deposits  at Period End                 |   | 77.09                                                                  | %       | 80.30 | % | 86.07 | % | 81.80 | % | 78.36 | % |
| **Asset  Quality Ratios:**                                 |   |                                                                   |    |   |   |   |   |   |   |   |   |
| Non Performing Loans to  Total Loans                       |   | 0.25                                                                   | %       | 0.88 | % | 0.31 | % | 0.30 | % | 0.08 | % |
| Nonperforming Assets to  Total Loans and Other Real Estate |   | 0.25                                                                   | %       | 0.88 | % | 0.34 | % | 0.67 | % | 0.40 | % |
| Net Charge-offs  (Recoveries) to Average Loans             |   | 0.00                                                                   | %       | 0.05 | % | 0.13 | % | 0.21 | % | 0.13 | % |
| Allowance for Loan Losses  to Net Loans at Period End      |   | 1.31                                                                   | %       | 1.21 | % | 1.06 | % | 1.62 | % | 1.18 | % |
| Allowance for Loan Losses  to Non-Performing Loans         |   | 506.23                                                                 | %       | 134.81 | % | 340.72 | % | 175.95 | % | 314.69 | % |
| **Capital  Ratios:**                                       |   |                                                                   |    |   |   |   |   |   |   |   |   |
| Tier 1 Capital to Adjusted  Total Assets                   |   | 10.4                                                                   | %       | 7.7 | % | 7.8 | % | 8.7 | % | 7.8 | % |
| Tier 1 Capital to Total  Risk-Weighted Assets              |   | 12.8                                                                   | %       | 10.4 | % | 9.5 | % | 10.8 | % | 10.0 | % |
| Total Capital to Total  Risk-Weighted Assets               |   | 14.0                                                                   | %       | 11.6 | % | 10.6 | % | 11.8 | % | 11.1 | % |

 

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(1) All per share data and the average numberof shares outstanding have been retroactively restated on a split-adjustedbasis

(2) Net income divided by averageshareholders’ equity.

(3) Net income divided by average totalassets.

(4) Net interest income divided by averageearning assets.

(5) Dividends declared per share divided bynet income per share.

(6) Average equity divided by average totalassets.

 

21

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

 

This discussion presents Management’s analysis of the financialcondition and results of operations of the Company as of and for each of theyears in the three-year period ended December 31, 2002.(1)  The discussion should be read in conjunctionwith the Consolidated Financial Statements of the Company and the Notes relatedthereto presented elsewhere in this Form 10-K Annual Report (see Item 8).

 

Statements contained in this report that are not purely historical areforward looking statements within the meaning of Section 21E of the SecuritiesExchange Act of 1934 as amended, including the Company’s expectations,intentions, beliefs, or strategies regarding the future.  All forward-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 isimportant to note that the Company’s actual results could materially differfrom those in such forward-looking statements. Factors that could cause actual results to differ materially from thosein such forward-looking statements are fluctuations in interest rates,inflation, government regulations, economic conditions, customerdisintermediation and competitive product and pricing pressures in thegeographic and business areas in which the Company conducts its operations.

 

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

 

For 2002, net income was $4.85 million, compared to the $3.81 millionearned in 2001 and net income of $3.05 million in 2000.  Net income per diluted share was $1.78 for2002, as compared to $1.43 during 2001 and $1.16 in 2000.  The Company’s Return on Average Assets(“ROA”) was 1.69% and Return on Average Equity (“ROE”) was 20.82% in 2002, ascompared to 1.54% and 19.73%, respectively, in 2001 and 1.64% and 20.08%,respectively, for 2000.

 

The Federal Reserve Board’s record reduction in the target overnightfed funds rate and discount rate during 2001 continued to impact the Companyduring the first part of 2002.  Theserate reductions injected liquidity into the banking system, which forced othermarket interest rates to decline in response. As is typical in many other community banks, the Company’s net interestmargin was negatively impacted as market rates fell in 2001 and 2002.  The rate-related decline in net interestincome, however, was more than offset by the increased income generated by ahigher level of average earning assets and favorable changes in the Company’sdeposit mix, and net interest income increased by $1.8 million from 2001 to 2002.  Moreover, the decline in market ratesboosted the Company’s volume of mortgage loans, which we were able to sell atsubstantial gains.  The Company was alsoable to sell several USDA Business and Industry guaranteed loans and SBA loansfor substantial gains.

 

On December 19, 2002, Community Valley Bancorp Trust I (the “Trust”), anewly formed Delaware statutory business trust and a wholly-owned subsidiary ofthe Company, issued an aggregate of $8,000,000 of principal amount of FloatingRate Trust Preferred Securities (Capital Trust Pass-through Securities of theTrust), which in turn were used to purchase the same amount of SubordinatedDebt Securities issued by the Company. These Trust Preferred Securities currently qualify as Tier 1 capitalwhen calculating regulatory risk-based capital ratios.  The issuance of the Trust PreferredSecurities in the fourth quarter of 2002 resulted in substantial improvement inthe Company’s capital ratios.  Inaddition, the Bank is considered to be “well capitalized”

 

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(1) As the holding company reorganization pursuant to which the Companybecame the sole shareholder of the Bank was effective in July 16, 2001, allfinancial information as of and for the years ended December 31, 2001 and anyearlier years or periods relates to the Bank rather than the Company.  Information as of and for the year endedDecember 31, 2002 is provided for the Bank and the Company on a consolidatedbasis.

 

22

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pursuant to the Federal Reserve’s prompt corrective actionguidelines.  We anticipate that thisincrease in capital will provide a springboard for future asset growth, whileallowing the Company to maintain its well capitalized position.  There can be no absolute assurance giventhat this in fact will occur, however, as numerous local market, generaleconomic and regulatory changes could impact capital ratios going forward.

 

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

 

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

 

The Company earns income from two primary sources.  The first is net interest income broughtabout by income from the successful deployment of earning assets less the costsof interest-bearing liabilities.  Thesecond is non-interest income, which generally comes from customer servicecharges and fees, but can also result from non-customer sources such as gainson loan sales.  The majority of theCompany’s expenses are operating costs which relate to providing a full rangeof banking services to our customers.

 

Net interest income, which is simply total interest income (includingfees) less total interest expense, was $13.8 million in 2002 compared to $12.04million and $11.01 million in 2001 and 2000, respectively.  This represents an increase of 14.6% in 2002over 2001 and an increase of 9.3% in 2001 over 2000.  The amount by which interest income exceeds interest expensedepends on several factors.  Among thosefactors are yields on earning assets, the cost of interest-bearing liabilities,the relative volume of total earning assets and total interest-bearingliabilities, and the mix of products which comprise the Company’s earningassets, deposits, and other interest-bearing liabilities.  Changes in the amount and mix ofinterest-earning assets and interest-bearing liabilities is referred to as“volume change.”  Change in interestrates earned on assets and rates paid on deposits and other borrowed funds isreferred to as “rate change.”

 

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

 

23

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|                                |   | **Years  Ended December 31,**                    |   |
|-------------------------------------|--------|--------------------------------------------------|--------|
| **Volume & Rate Variances**     |   | **2002 over 2001****Increase(decrease)  due to** |   | **2001 over 2000****Increase(decrease)  due to** |   |
| **(dollars  in thousands)**         |   | **Volume**                                       |   | **Rate** |   | **Net** |   | **Volume** |   | **Rate** |   | **Net** |   |
| **Earning  Assets:**                |   |                                             |   |   |   |   |   |   |   |   |   |   |   |
| Loans                               |   | $                                                | 2,156  |   | $ | (2,861 | ) | $ | (705 | ) | $ | 5,117 |   | $ | (2,158 | ) | $ | 2,959 |   |
| Federal funds sold                  |   | $                                                | 506    |   | $ | (592 | ) | $ | (86 | ) | $ | 652 |   | $ | (617 | ) | $ | 35 |   |
| Investment Securities:              |   |                                             |   |   |   |   |   |   |   |   |   |   |   |
| Taxable                             |   | $                                                | (8     | ) | $ | (8 | ) | $ | (16 | ) | $ | (25 | ) | $ | (1 | ) | $ | (26 | ) |
| Non-taxable(1)                      |   | $                                                | (32    | ) | $ | 2 |   | $ | (30 | ) | $ | (15 | ) | $ | — |   | $ | (15 | ) |
| Deposits in banks                   |   | $                                                | 50     |   | $ | (30 | ) | $ | 20 |   | $ | (100 | ) | $ | 4 |   | $ | (96 | ) |
| Total earning assets                |   | $                                                | 2,672  |   | $ | (3,489 | ) | $ | (817 | ) | $ | 5,629 |   | $ | (2,772 | ) | $ | 2,857 |   |
|                                |   |                                             |   |   |   |   |   |   |   |   |   |   |   |
| **Interest-Bearing  Liabilities**   |   |                                             |   |   |   |   |   |   |   |   |   |   |   |
|                                |   |                                             |   |   |   |   |   |   |   |   |   |   |   |
| Interest bearing deposits:          |   |                                             |   |   |   |   |   |   |   |   |   |   |   |
|                                |   |                                             |   |   |   |   |   |   |   |   |   |   |   |
| Demand - interest bearing           |   | $                                                | 488    |   | $ | (329 | ) | $ | 159 |   | $ | 106 |   | $ | (58 | ) | $ | 48 |   |
| Savings Accounts                    |   | $                                                | 76     |   | $ | (147 | ) | $ | (71 | ) | $ | 37 |   | $ | (72 | ) | $ | (35 | ) |
| Certificates of Deposit             |   | $                                                | (989   | ) | $ | (1,653 | ) | $ | (2,642 | ) | $ | 2,222 |   | $ | (411 | ) | $ | 1,811 |   |
| Total interest bearing  deposits    |   | $                                                | (425   | ) | $ | (2,129 | ) | $ | (2,554 | ) | $ | 2,365 |   | $ | (541 | ) | $ | 1,824 |   |
| Borrowed funds:                     |   |                                             |   |   |   |   |   |   |   |   |   |   |   |
| Other Borrowings                    |   | $                                                | 11     |   | $ | (26 | ) | $ | (15 | ) | $ | — |   | $ | 55 |   | $ | 55 |   |
| Total Borrowed Funds                |   | $                                                | 11     |   | $ | (26 | ) | $ | (15 | ) | $ | — |   | $ | 55 |   | $ | 55 |   |
| Total Interest Bearing  Liabilities |   | $                                                | (414   | ) | $ | (2,155 | ) | $ | (2,569 | ) | $ | 2,365 |   | $ | (486 | ) | $ | 1,879 |   |
| **Net  Interest Margin/Income**     |   | $                                                | 3,086  |   | $ | (1,334 | ) | $ | 1,752 |   | $ | 3,264 |   | $ | (2,286 | ) | $ | 978 |   |

 

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

 

The Company’s net interest margin is its net interest income expressedas a percentage of average earning assets. The Company’s net interest margin for 2002 was 5.36%, a decline of 13basis points from the 5.49% reported for 2001. For the year 2000, this margin was 6.73%.  The following Distribution, Rate and Yield table shows, for eachof the past three years, the rates earned on each component of the Company’sinvestment and loan portfolio and the rates paid on each segment of theCompany’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.

 

24

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|                                                          |   | **Year  Ended December 31,** |    |
|---------------------------------------------------------------|--------|------------------------------|---------|
|                                                          |   | **2002(a)**                  |    | **2001(a)** |   | **2000(a)** |   |
| **Distribution,  Rate & Yield****(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                                            |   | $                            | 35,641  |   | $ | 573 |   | 1.61 | % | $ | 20,153 |   | $ | 659 |   | 3.27 | % | $ | 9,855 |   | $ | 624 |   | 6.33 | % |
| Taxable                                                       |   | $                            | 1,341   |   | $ | 90 |   | 6.71 | % | $ | 1,475 |   | $ | 92 |   | 6.24 | % | $ | 1,871 |   | $ | 118 |   | 6.31 | % |
| Non-taxable(1)                                                |   | $                            | 1,813   |   | $ | 76 |   | 4.19 | % | $ | 2,463 |   | $ | 120 |   | 4.87 | % | $ | 2,760 |   | $ | 135 |   | 4.89 | % |
| Deposits in Banks                                             |   | $                            | 1,718   |   | $ | 81 |   | 4.71 | % | $ | 947 |   | $ | 61 |   | 6.44 | % | $ | 2,625 |   | $ | 156 |   | 5.94 | % |
| Total Investments                                             |   | $                            | 40,513  |   | $ | 820 |   | 2.02 | % | $ | 25,038 |   | $ | 932 |   | 3.72 | % | $ | 17,111 |   | $ | 1,033 |   | 6.04 | % |
| Loans:(2)                                                     |   |                         |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                          |   |                         |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Agricultural                                                  |   | $                            | 21,345  |   | $ | 1,511 |   | 7.08 | % | $ | 21,835 |   | $ | 1,889 |   | 8.65 | % | $ | 23,481 |   | $ | 2,526 |   | 10.76 | % |
| Commercial                                                    |   | $                            | 50,412  |   | $ | 3,927 |   | 7.79 | % | $ | 43,226 |   | $ | 3,776 |   | 8.74 | % | $ | 37,606 |   | $ | 3,929 |   | 10.45 | % |
| Real Estate                                                   |   | $                            | 126,486 |   | $ | 10,900 |   | 8.62 | % | $ | 112,100 |   | $ | 11,251 |   | 10.04 | % | $ | 70,498 |   | $ | 7,586 |   | 10.76 | % |
| Consumer                                                      |   | $                            | 18,710  |   | $ | 1,414 |   | 7.56 | % | $ | 17,287 |   | $ | 1,541 |   | 8.91 | % | $ | 14,932 |   | $ | 1,457 |   | 9.76 | % |
| Total Loans                                                   |   | $                            | 216,953 |   | $ | 17,752 |   | 8.18 | % | $ | 194,448 |   | $ | 18,457 |   | 9.49 | % | $ | 146,517 |   | $ | 15,498 |   | 10.58 | % |
| Total Earning Assets(3)                                       |   |                         |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                          |   | $                            | 257,466 |   | $ | 18,572 |   | 7.21 | % | $ | 219,486 |   | $ | 19,389 |   | 8.83 | % | $ | 163,628 |   | $ | 16,531 |   | 10.10 | % |
| Non-Earning Assets                                            |   | $                            | 29,401  |   |   |   |   |   | $ | 26,614 |   |   |   |   |   | $ | 23,986 |   |   |   |   |   |
| **Total Assets**                                              |   | $                            | 286,867 |   |   |   |   |   | $ | 246,100 |   |   |   |   |   | $ | 187,614 |   |   |   |   |   |
| **Liabilities and Shareholders’ Equity**                 |   |                         |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-Bearing Deposits:                                    |   |                         |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| NOW                                                           |   | $                            | 86,292  |   | $ | 1,043 |   | 1.21 | % | $ | 56,144 |   | $ | 680 |   | 1.21 | % | $ | 43,312 |   | $ | 607 |   | 1.40 | % |
| Savings                                                       |   | $                            | 18,936  |   | $ | 173 |   | 0.91 | % | $ | 14,449 |   | $ | 244 |   | 1.69 | % | $ | 12,754 |   | $ | 279 |   | 2.19 | % |
| Money Market                                                  |   | $                            | 17,989  |   | $ | 341 |   | 1.90 | % | $ | 14,678 |   | $ | 545 |   | 3.71 | % | $ | 16,873 |   | $ | 570 |   | 3.38 | % |
| TDOA’s, and IRA’s                                   |   | $                            | 6,166   |   | $ | 228 |   | 3.70 | % | $ | 5,314 |   | $ | 292 |   | 5.49 | % | $ | 3,703 |   | $ | 204 |   | 5.51 | % |
| Certificates of Deposit < $100,000                         |   | $                            | 59,010  |   | $ | 2,143 |   | 3.63 | % | $ | 71,623 |   | $ | 3,876 |   | 5.41 | % | $ | 48,341 |   | $ | 2,816 |   | 5.83 | % |
| Certificates of Deposit > $100,000                         |   | $                            | 22,571  |   | $ | 807 |   | 3.58 | % | $ | 28,704 |   | $ | 1,652 |   | 5.76 | % | $ | 16,079 |   | $ | 989 |   | 6.15 | % |
| Total Interest-Bearing Deposits                               |   | $                            | 210,964 |   | $ | 4,735 |   | 2.24 | % | $ | 190,912 |   | $ | 7,289 |   | 3.82 | % | $ | 141,062 |   | $ | 5,465 |   | 3.87 | % |
| Borrowed Funds:                                               |   |                         |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other Borrowings                                              |   | $                            | 767     |   | $ | 40 |   | 5.22 | % | $ | 641 |   | $ | 55 |   | 8.58 | % | $ | 3,480 |   | $ | 53 |   | 1.52 | % |
| Total Borrowed Funds                                          |   | $                            | 767     |   | $ | 40 |   | 5.22 | % | $ | 641 |   | $ | 55 |   | 8.58 | % | $ | 3,480 |   | $ | 53 |   | 1.52 | % |
| Total Interest Bearing Liabilities                            |   | $                            | 211,731 |   | $ | 4,775 |   | 2.26 | % | $ | 191,553 |   | $ | 7,344 |   | 3.83 | % | $ | 144,542 |   | $ | 5,518 |   | 3.82 | % |
| Demand Deposits                                               |   | $                            | 48,774  |   |   |   |   |   | $ | 33,756 |   |   |   |   |   | $ | 26,967 |   |   |   |   |   |
| Other Liabilities                                             |   | $                            | 3,073   |   |   |   |   |   | $ | 1,478 |   |   |   |   |   | $ | 927 |   |   |   |   |   |
| Shareholders’ Equity                                     |   | $                            | 23,289  |   |   |   |   |   | $ | 19,313 |   |   |   |   |   | $ | 15,178 |   |   |   |   |   |
| **Total Liabilities and Shareholders’  Equity**          |   | $                            | 286,867 |   |   |   |   |   | $ | 246,100 |   |   |   |   |   | $ | 187,614 |   |   |   |   |   |
|                                                          |   |                         |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest Income/Earning Assets                                |   |                         |    |   |   | 7.21 | % |   |   |   |   | 8.83 | % |   |   |   |   | 10.10 | % |
| Interest Expense/Earning Assets                               |   |                         |    |   |   | 1.85 | % |   |   |   |   | 3.35 | % |   |   |   |   | 3.37 | % |
| **Net Interest Margin(4)**                                    |   |                         |    | $ | 13,797 |   | 5.36 | % |   |   | $ | 12,045 |   | 5.49 | % |   |   | $ | 11,013 |   | 6.73 | % |

 

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(a) Average balances are obtained from thebest available daily or monthly data.

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

(2) Loan fees have not been included in thecalcualtion of interest income.

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

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

 

During 2002, the Company’s net interest margin was impacted by theoverall decline in interest rates which caused interest income to fall by$817,000.  A large portion of the Bank’sloans carry variable rates and re-price immediately, versus a large base ofcore deposits which are generally slower to re-price. However, due to a favorableshift in the mix of the deposits from higher cost certificates of deposit tolower cost demand accounts, the Company was able to decrease its interestexpense by $2.6 million and show an increase of $1.8 million in net interestincome.  The Company had funded much ofits loan growth in 2001 with brokered out of area certificates of deposit.  During 2002, approximately $14 million ofthese deposits matured and were not renewed. The Company’s net interest marginactually showed improvement toward year-end, as floors on loan rates becameeffective and deposit rates were lowered to match similar decreases incompetitor rates.  As rates continued toadjust downward during 2002, some existing customers were unwilling to acceptthe lower rates being offered for non-liquid deposits and chose to roll theirmaturing time deposit money into money market and NOW accounts.  Average time deposit balances fell by nearly$16 million from 2001 to 2002, while money market and NOW account balancesincreased by $33 million.    Even moresignificantly, though, average 

 

25

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demand deposit balances increased by nearly $15 million, or 44%, from2001 to 2002, which had a substantial positive impact on the Company’s netinterest margin.

 

From 2001 to 2002, the Company’s average loan portfolio grew byapproximately $22 million, or 11.6%, with earnings on that growth, net ofassociated funding costs, contributing to net interest income.  Additionally, loan balances, which are thehighest yielding component of the Company’s earning assets, declined slightlyduring 2002 as a portion of the Company’s average asset base.  During 2002, the loan portfolio averaged75.6% of total assets, while for 2001 and 2000 such balances represented 79.0%and 78.1%, respectively, of average assets.

 

Based on these indications and current economic conditions, the Companyexpects moderate changes in the rates paid on interest-bearing liabilities andrates earned on both the investment and loan portfolio during 2003. TheCompany’s net interest margin is anticipated to stay approximately the same asin 2002, and net interest income should increase if loans grow as planned andthe loan growth is funded by reasonably priced deposits.  However, no assurance can be given that thiswill, in fact, occur.

 

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

 

For the year 2002, non-interest income increased by $2,535,000 or (63%)to $6,561,000 as compared to $4,026,000 for 2001.  The vast majority of this increase ($1,174,000) represents thetax-free net proceeds from key man insurance policies the Bank received inMarch of 2002 as a result of the death of the Company’s Chief OperatingOfficer, John Stanton.  The primarytraditional sources of non-interest income for the Company are service chargeson deposit accounts, gains on the sale of loans, loan servicing income, andmerchant credit card fees.    Servicecharges on deposit accounts and loan sales income in 2002 accounted for 18% and34.8%, respectively, of total non-interest income, as compared to 26.5% and 35.3%,respectively, for 2001.  Loan servicingincome and merchant credit card fees for 2002 were 6.5% and 5.4% respectively,as compared to 9.6% and 6.5%, respectively, during 2001.

 

The primary source of non-interest income continues to be the gainrecognized on the sale of loans.   Loansales income increased proportionate to total non-interest income due to thehigh volume of mortgage loans and government guaranteed loans originated andsold during 2002.  Mortgage loanactivity increased presumably as a result of the relatively low rates availableon such loans.  It is expected that thislevel of loan sales income will be sustained throughout 2003 as the refinancingof existing home loans and the construction of new homes continues.  The loan portfolio also includes loans whichare 75% to 90% guaranteed by the Small Business Administration (SBA), U.S.Department of Agriculture, Rural Business-Cooperative Service (RBS) and FarmServices Agency (FSA).  The guaranteed portionof these loans may be sold to a third party, with the Company retaining theunguaranteed portion.   The Companygenerally receives a premium in excess of the adjusted carrying value of theloan at the time of sale.

 

Loan servicing income increased as well, as the portfolio of realestate loans being serviced by the Company grew by 41% from 2001 to 2002.   The portfolio of SBA, RBS and FSAgovernment guaranteed loans being serviced by the Company grew by 22% from 2001to 2002.

 

Merchant credit card fees increased slightly from 2001 to 2002, butwere approximately the same percentage of average earning assets.  Through more aggressive marketing efforts ofthis product, management expects income from this area to increase somewhat in2003.

 

The Company is increasingly focused on enhancing its fee income tomitigate the effects of a declining net interest margin.  Based on the Company’s efficiency ratio of61% for 2002, 58% for 2001, and 59% for 2000 as compared to the 55% and lowerratios of certain major financial institutions, it is expected that thisactivity will continue for the foreseeable future.

 

The Company’s total non-interest expense increased to $12.5 million in2002, as compared to $9.3 million in 

 

26

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2001 and $8.4 million in 2000.   The largest dollar increase in non-interest expense was insalaries and employee benefits, which increased by $1,261,000, or 23.8% from2001 to 2002.  This increase resulted fromnormal cost of living raises, salaries paid to new employees at the new CentralChico office and expanded Yuba City office, commissions paid to Butte CommunityBank’s Real Estate Loan agents and staffing additions made during the year asthe Company continued to grow and implement the new technology acquiredthroughout the year.  Full timeequivalent employees increased to 153 at December 31, 2002 from 132 at December31, 2001.  Benefit costs and employertaxes increased commensurate with the salaries.  It is management’s opinion that the Company can achievesignificant growth in loans and deposits with only minimal increases instaff.  Thus, it is expected thatsalaries and employee benefits will decline as a percentage of earning assetsduring 2003.

 

Occupancy expenses were higher by $221,000 or 16.5% when compared tothe 2001 total of $1,336,000.  Much ofthe increase in occupancy expense was related to furniture fixtures andequipment for the new Central Chico and Yuba City offices.    The lease agreement implemented during theyear for the Central Chico office, as well as the construction costs associatedwith the new Yuba City office, also added to the year over year increase.   Advertising and marketing expensesincreased by $60,000 from 2001 to 2002 as the Company prepared to open the newfacilities in Chico and Yuba City.  Theincrease in professional services costs of $71,000 from 2001 to 2002 relates tolegal fees paid to resolve problem loans and accounting and legal fees relatedto the formation of the holding company, Community Valley Bancorp.

 

Expenses representing telephone and data communications, postage andmail, stationery and supplies, merchant credit card and ATM operations, andsundry losses totaled $1,021,000 for 2002 as compared to $860,000 in 2001 anincrease of 18.7%.  Management considersthis increase in expenses commensurate with the growth of the Company during2002.

 

Other expenses increased by $1,422,000 from 2001 to 2002.  As discussed in the non-interest incomesection, most of this increase was attributable to the accelerated accrual ofsalary continuation plan benefits totaling $1,081,643 associated with the deathof the Company’s Chief Operating Officer that will be subsequently paid to hisbeneficiary.

 

27

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| **Non  Interest Income/Expense****(dollars  in thousands, unaudited)** |   | **2002** |   | **% of Total** |   | **2001** |   | **% of Total** |   | **2000** |   | **% of Total** |   |
|------------------------------------------------------------------------|--------|----------|--------|----------------|--------|----------|--------|----------------|--------|----------|--------|----------------|--------|
| OTHER  OPERATING INCOME:                                               |   |     |   |           |   |     |   |           |   |     |   |           |   |
| Service charges on deposit  accounts                                   |   | $        | 1,184  |           | 18.05  | %        | $      | 1,068          |   | 26.53    | %      | $              | 1,011  |   | 31.91 | % |
| Merchant credit card fees                                              |   | $        | 354    |           | 5.40   | %        | $      | 260            |   | 6.46     | %      | $              | 210    |   | 6.63 | % |
| Other service charges,  commissions & fees                         |   | $        | 913    |           | 13.92  | %        | $      | 645            |   | 16.02    | %      | $              | 723    |   | 22.82 | % |
| Gains on sales of loans                                                |   | $        | 2,281  |           | 34.77  | %        | $      | 1,422          |   | 35.32    | %      | $              | 706    |   | 22.29 | % |
| Loan servicing income                                                  |   | $        | 423    |           | 6.45   | %        | $      | 388            |   | 9.64     | %      | $              | 314    |   | 9.91 | % |
| Other                                                                  |   | $        | 1,406  |           | 21.43  | %        | $      | 243            |   | 6.04     | %      | $              | 204    |   | 6.44 | % |
| Total non-interest income                                              |   | $        | 6,561  |           | 100.00 | %        | $      | 4,026          |   | 100.00   | %      | $              | 3,168  |   | 100.00 | % |
| As a percentage of average  earning assets                             |   |     |   | 2.55           | %      |     |   | 1.83           | %      |     |   | 1.94           | %      |
|                                                                   |   |     |   |           |   |     |   |           |   |     |   |           |   |
| OTHER OPERATING EXPENSES:                                              |   |     |   |           |   |     |   |           |   |     |   |           |   |
| Salaries and employee  benefits                                        |   | $        | 6,559  |           | 52.34  | %        | $      | 5,298          |   | 56.75    | %      | $              | 4,653  |   | 55.40 | % |
| Occupancy costs                                                        |   |     |   |           |   |     |   |           |   |     |   |           |   |
| Furniture & Equipment                                              |   | $        | 937    |           | 7.48   | %        | $      | 837            |   | 8.97     | %      | $              | 850    |   | 10.12 | % |
| Premises                                                               |   | $        | 620    |           | 4.95   | %        | $      | 499            |   | 5.35     | %      | $              | 432    |   | 5.14 | % |
| Advertising and marketing  costs                                       |   | $        | 191    |           | 1.52   | %        | $      | 131            |   | 1.40     | %      | $              | 112    |   | 1.33 | % |
| Professional services costs                                            |   |     |   |           |   |     |   |           |   |     |   |           |   |
| Legal & Accounting                                                 |   | $        | 225    |           | 1.80   | %        | $      | 177            |   | 1.90     | %      | $              | 136    |   | 1.62 | % |
| Other professional services                                            |   | $        | 397    |           | 3.17   | %        | $      | 374            |   | 4.01     | %      | $              | 310    |   | 3.69 | % |
| Other operating costs                                                  |   |     |   |           |   |     |   |           |   |     |   |           |   |
| Credit Card / ATM                                                      |   | $        | 70     |           | 0.56   | %        | $      | 78             |   | 0.84     | %      | $              | 152    |   | 1.81 | % |
| Telephone & data  communications                                   |   | $        | 226    |           | 1.80   | %        | $      | 209            |   | 2.24     | %      | $              | 249    |   | 2.96 | % |
| Postage & mail                                                     |   | $        | 209    |           | 1.67   | %        | $      | 188            |   | 2.01     | %      | $              | 159    |   | 1.89 | % |
| Other                                                                  |   | $        | 2,581  |           | 20.60  | %        | $      | 1,159          |   | 12.42    | %      | $              | 1,002  |   | 11.93 | % |
| Stationery & supply  costs                                         |   | $        | 458    |           | 3.65   | %        | $      | 323            |   | 3.46     | %      | $              | 312    |   | 3.71 | % |
| Sundry & teller costs                                              |   | $        | 58     |           | 0.46   | %        | $      | 62             |   | 0.66     | %      | $              | 32     |   | 0.38 | % |
| Total non-interest expense                                             |   | $        | 12,531 |           | 100.00 | %        | $      | 9,335          |   | 100.00   | %      | $              | 8,399  |   | 100.00 | % |
| As a% of average earning  assets                                       |   |     |   | 4.87           | %      |     |   | 4.25           | %      |     |   | 5.13           | %      |

 

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

 

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

 

The Company’s provisions in 2002, 2001, and 2000 were $603,000,$500,000, and $805,000 respectively. The loan loss provision is determined by a conducting a monthlyevaluation of the adequacy of the Company’s allowance for loan losses, andcharging the shortfall, if any, to the current month’s expense.  This has the effect of creating variabilityin the amount and frequency of charges to the Company’s earnings.  The procedures for monitoring the adequacyof the allowance, as well as detailed information concerning the allowanceitself, are included below under “Allowance for Loan Losses” and “Allocationfor Loan Loss Allowances.”

 

28

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

 

As indicated in Note 13 in the Notes to the Consolidated FinancialStatements, income tax expense is the sum of two components, current taxexpense and deferred tax expense. Current tax expense results from applying the current tax rate totaxable income, and is in essence the actual current income tax liability.  Some items of income and expense arerecognized in different years for tax purposes than when applying generallyaccepted accounting principles, however, leading to differences between theCompany’s actual tax liability and the amount accrued for this liability basedon book income.  These temporary timingdifferences comprise the deferred portion of the Company’s tax expense.

 

Most of the Company’s temporary differences involve recognizing moreexpenses in its financial statements than it has been allowed to deduct for taxpurposes, and therefore the Company normally carries a net deferred tax asseton its books.  At December 31, 2002, theCompany’s $2.1 net deferred tax asset was primarily due to temporarydifferences in the reported allowance for loan losses, deferred compensation,and future benefit of state tax deduction.

 

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

 

The following discussion of the financial condition of the Company isgrouped into earning assets, comprised of loans and investments; non-earningassets, comprised of cash and due from banks and premises and equipment;liabilities, consisting of deposits and other borrowings; capital resources;and liquidity and market risk.  Eachsection provides details where applicable on volume, rates of change, andsignificance relative to the overall activities of the Company.

 

A comparison between the summary year-end balance sheets for 2002through 1998 was presented previously in the table of Selected Financial Data(see Item 6 above).  As indicated inthat table, the Company’s total assets, loans, deposits, and shareholders’equity have grown each year for the past four years, with asset growth, interms of total dollars, most pronounced in 2002.  Growth in the Company’s total assets over the past yearapproximated $65 million, or 23.8%, as compared to growth in 2001 of $58million, or 26.8%.  Notable growth wasalso achieved during 2000 when total assets grew by $56 million or 34.9%.

 

Also of importance is the fact that earningassets increased from 85.6% of total assets at year-end 2001 to 87.3% atyear-end 2002.  This trend signifiesmore efficient deployment of assets.

 

On the liability side, the deposit mix changed significantly in 2002and the increased weighting of lower-cost funding sources had an obviouspositive impact on the Bank’s cost of interest-bearing liabilities.  The Company had increased its reliance onwholesale funding sources in 2001 to fund the ever increasing loan demand.   This was an intentional asset/liabilitymanagement strategy and was planned to be a temporary condition.   Because deposit balances could not be grownas quickly as loan growth, the Company funded its loan growth with short-termbrokered deposits.  Throughout 2002 wefocused on increasing customer deposits to replace wholesale borrowings.

 

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

 

The Company offers a wide variety of loan types and terms to customersalong with very competitive pricing and quick delivery of the creditdecision.  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, 2002, gross loansrepresented 69.3% of total assets, as compared to 73.8% and 79.7% atDecember 31, 2001 and 2000, respectively. The quality and diversification of the Company’s loan portfolio are importantconsiderations when reviewing the Company’s results of operations.

 

29

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The Selected Financial Data table in Item 6 reflects the net amount ofloans outstanding at December 31st for each year between 1998 and2002.  The Loan Distribution table whichfollows sets forth the amount of the Company’s total loans outstanding in eachcategory at the dates indicated.

 

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

 

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

 
| **Loan Distribution**                |   | **As  of December 31,** |    |
|--------------------------------------|--------|-------------------------|---------|
| **(dollars  in thousands)**          |   | **2002**                |    | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                 |   |                    |    |   |   |   |   |   |   |   |   |
| Agricultural                         |   | $                       | 18,935  |   | $ | 19,407 |   | $ | 18,832 |   | $ | 17,504 |   | $ | 19,078 |   |
| Commercial                           |   | $                       | 48,661  |   | $ | 42,517 |   | $ | 39,673 |   | $ | 33,356 |   | $ | 25,637 |   |
| Real estate - mortgage               |   | $                       | 82,057  |   | $ | 52,315 |   | $ | 50,069 |   | $ | 33,816 |   | $ | 26,248 |   |
| Real estate - construction           |   | $                       | 64,565  |   | $ | 68,943 |   | $ | 45,855 |   | $ | 19,893 |   | $ | 20,297 |   |
| Installment                          |   | $                       | 19,325  |   | $ | 17,764 |   | $ | 16,885 |   | $ | 13,989 |   | $ | 14,880 |   |
|                                 |   | $                       | 233,543 |   | $ | 200,946 |   | $ | 171,314 |   | $ | 118,558 |   | $ | 106,140 |   |
|                                 |   |                    |    |   |   |   |   |   |   |   |   |
| Deferred loan origination  fees, net |   | $                       | (837    | ) | $ | (674 | ) | $ | (562 | ) | $ | (304 | ) | $ | (212 | ) |
| Allowance for loan losses            |   | $                       | (3,007  | ) | $ | (2,397 | ) | $ | (2,000 | ) | $ | (1,390 | ) | $ | (1,328 | ) |
|                                 |   | $                       | 229,699 |   | $ | 197,875 |   | $ | 168,752 |   | $ | 116,864 |   | $ | 104,600 |   |
|                                 |   |                    |    |   |   |   |   |   |   |   |   |
| **Percentage  of Total Loans**       |   |                    |    |   |   |   |   |   |   |   |   |
| Agricultural                         |   | 8.11                    | %       | 9.66 | % | 10.99 | % | 14.76 | % | 17.97 | % |
| Commercial                           |   | 20.84                   | %       | 21.16 | % | 23.16 | % | 28.13 | % | 24.15 | % |
| Real Estate - mortgage               |   | 35.13                   | %       | 26.03 | % | 29.23 | % | 28.52 | % | 24.73 | % |
| Real Estate - construction           |   | 27.65                   | %       | 34.31 | % | 26.77 | % | 16.78 | % | 19.12 | % |
| Installment                          |   | 8.27                    | %       | 8.84 | % | 9.86 | % | 11.80 | % | 14.02 | % |
|                                 |   | 100.00                  | %       | 100.00 | % | 100.00 | % | 100.00 | % | 100.00 | % |

 

As reflected in the Loan Distribution table, aggregate loan balanceshave increased $125 million, or 120%, over the last five years.   The largest percentage growth during 2002came in real estate mortgages, which was also the largest dollar volume increase.

 

Loan growth in the Company’s immediate market has been oriented towardloans secured by real estate, commercial loans, including Small BusinessAdministration loans, as well as consumer loans.  As a result, these areas have comprised the major portion of theCompany’s loan growth over the past few years. Loans secured by real estate grew by $25 million, or 20.9%, andcommercial loans grew by $6 million, or 14.4%, during 2002.  Loans secured by real estate and commercialloans comprised 62.8% and 20.8%, respectively, of the Bank’s total loanportfolio at the end of 2002.

 

The Company’s commercial loans are centered in locally orientedcommercial activities in the markets where the Company has a presence.  Additionally, the Company has a GovernmentLending Division dedicated to its SBA product and its Business and Industry(B&I) Guaranteed Loan Program.  TheCompany was named the number one USDA Business and Industry lender inCalifornia for the fiscal year ending September 30, 2002 by originating over$18 million in loans.  This performance alsoplaced the Company at number seven in the entire United States.  The Company is also designated as an SBAPreferred Lender, which means it has the authority to underwrite and approveSBA 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.

 

30

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The most significant shift in the loan portfolio mix over the past fiveyears has been in loans secured by real estate mortgages, which increased from24.7% of total loans at the end of 1998 to 35.1% of total loans at the end of2002.  Real estate lending is animportant part of the Company’s focus, and is likely to remain so for theimmediate future.  Consumer loans,however, declined to just 8.3% of total loan balances by the end of 2002 from14% at the end of 1998, and agricultural loans dropped during the same periodto 8.1% of the Company’s total loan balances from 18%.  The decline in the percentage ofagricultural loans to total loans over the last few years has been due to thefact that this portion of the portfolio has not grown in relation to the entireportfolio.  We continue to have the sameborrowers year after year and have not expanded this part of our business.

 

Another important aspect of the Company’s loan business has been thatof residential real estate loans which were generated internally by the realestate mortgage loan department and then sold in the secondary market togovernment sponsored enterprises or other long-term lenders. The Company hasconsistently been among the largest real estate mortgage lenders in ButteCounty for the past several years. During 2002, the Company originated and sold aggregate balances ofapproximately $105 million of such loans, an increase from the $76 millionoriginated and sold in 2001.    TheCompany services the mortgage loans sold to the Federal National MortgageAssociation (FNMA).  As of December 31,2002, aggregate balances of $96 million were being serviced as compared to $68million at the end of 2001.

 

In the normal course of business, the Company makes commitments toextend credit as long as there are no violations of any condition establishedin the contractual arrangement.  Totalunused commitments to extend credit were $104 million at December 31, 2002 ascompared to $83 million at December 31, 2001. These commitments represented 45% of outstanding gross loans atDecember 31, 2002 and 41% at December 31, 2001, respectively.  The Company’s stand-by letters of credit atDecember 31, 2002 and 2001 were $2.2 million and $2 million, respectively,which represented approximately 1% of total commitments outstanding at the endof 2002 and 2001.  It is not anticipatedthat all of these stand-by letters of credit will fund.

 

Approximately one half of the loans held by the Company have floatingrates of interest tied to the Company’s base lending rate or to another marketrate indicator so that they may be repriced as interest rates change.   The same interest rate and liquidity risksthat apply to securities are also applicable to lending activity.  Fixed-rate loans are subject to market risk:  they decline in value as interest ratesrise.  The Company’s loans that havefixed rates generally have relatively short maturities or amortize monthly,which effectively lessens the market risk. The table in Note 16 to the consolidated financial statements shows thatat December 31, 2001, the difference in the carrying amount of loans, i.e.,their face value, is about $2.5 million or 1.3% more than their fairvalue.  At the end of 2002, the fairvalue of loans was about $5.0 million or 2.2% less than the carrying amount.

 

Because the Company is not involved with chemicals or toxins that mighthave an adverse effect on the environment, its primary exposure toenvironmental legislation is through its lending activities.  The Company’s lending procedures includesteps to identify and monitor this exposure to avoid any significant loss or liabilityrelated to environmental regulations.

 

**LoanMaturities**

 

The following Loan Maturity table shows the amounts of total loans andleases outstanding as of December 31, 2002, which, based on remaining scheduledrepayments of principal, are due within one year, after one year but less thanfive years, and in more than five years.   (Non-accrual loans are intermixed within each category.)

 

31

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| **Loan Maturity  (dollars in thousands)** |   | **One  year or  less** |    | **One  to five  years** |   | **Over  five  years** |   | **Total** |   | **Floating  rate:  due after  one year** |   | **Fixed  rate:  due after  one year** |   |
|-------------------------------------------|--------|------------------------|---------|-------------------------|--------|-----------------------|--------|-----------|--------|------------------------------------------|--------|---------------------------------------|--------|
| Agricultural                              |   | $                      | 15,607  |                    | $      | 2,799                 |   | $         | 529    |                                     | $      | 18,935                                |   | $ | — |   | $ | 3,328 |   |
| Commercial                                |   | $                      | 22,220  |                    | $      | 14,829                |   | $         | 11,612 |                                     | $      | 48,661                                |   | $ | — |   | $ | 26,441 |   |
| Real Estate Mortgage                      |   | $                      | 48,942  |                    | $      | 17,985                |   | $         | 15,130 |                                     | $      | 82,057                                |   | $ | — |   | $ | 33,115 |   |
| Real Estate Construction                  |   | $                      | 51,342  |                    | $      | 12,938                |   | $         | 285    |                                     | $      | 64,565                                |   | $ | 238 |   | $ | 12,985 |   |
| Installment                               |   | $                      | 9,668   |                    | $      | 8,136                 |   | $         | 1,521  |                                     | $      | 19,325                                |   | $ | — |   | $ | 9,657 |   |
|                                      |   |                   |    |                    |   |                  |   |      |   |                                     |   |                                  |   |
| TOTAL                                     |   | $                      | 147,779 |                    | $      | 56,687                |   | $         | 29,077 |                                     | $      | 233,543                               |   | $ | 238 |   | $ | 85,526 |   |

 

This schedule, which aggregates contractual principal repayments bytime period, can be used in combination with the Investment Maturities table inthe Investment Securities section and the Deposit Maturities table in theDeposits section to identify time periods with potential liquidityexposure.  The referenced maturityschedules do not convey a complete picture of the Company’s re-pricing exposureor interest rate risk, however.  Fordetails on the re-pricing characteristics of the Company’s balance sheet and amore comprehensive discussion of the Company’s sensitivity to changes ininterest rates, see the “Liquidity and Market Risk” section.

 

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

 

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

 

The Company achieves a certain level of loan quality by establishing asound credit plan, which includes defining goals and objectives and devisingand documenting credit policies and procedures.  These policies and procedures identify certain markets, set goalsfor portfolio growth or contraction, and establish limits on industry andgeographic concentrations.  In addition,these policies establish the Company’s underwriting standards and the methodsof monitoring ongoing credit quality. Unfortunately, however, the Company’s asset-quality risk may be affectedby external factors such as the level of interest rates, employment, generaleconomic conditions, real estate values and trends in particular industries orcertain geographic markets.  TheCompany’s internal factors for controlling risk are centered in underwritingpractices, credit granting procedures, training, risk management techniques,and familiarity with our loan customers as well as the relative diversity andgeographic concentration of our loan portfolio.

 

As a multi-community, independent bank headquartered in and servingButte County (with a smaller presence in each of Sutter and Placer counties);the Company has mitigated its risk to any one segment of these NorthernSacramento Valley markets.  TheCompany’s asset quality continues to be excellent with delinquency ratios atvery 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.

 

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From time to time, Management has reason to believe that certainborrowers may not be able to repay their loans within the parameters of thepresent repayment term, even though, in some cases, the loans are current atthe time.  These loans are regarded aspotential problem loans, and a portion of the allowance is assigned and/orallocated, as discussed below, to cover the Company’s exposure to loss wouldthe borrowers indeed fail to perform according to the terms of the notes.  This class of loans does not include loansin a nonaccrual status or 90 days or more delinquent but still accruing, whichare shown in the table below.

 

Non-performing assets are comprised of loans on non-accrual status,loans 90 days or more past due and still accruing interest, loans restructuredwhere the terms of repayment have been renegotiated resulting in a deferral ofinterest or principal and other real estate owned (“OREO”).  Loans are generally placed on non-accrualstatus when they become 90 days past due as to principal or interest.  Loans may be restructured by management whena borrower has experienced some change in financial status causing an inabilityto meet the original repayment terms and where the Company believes theborrower will eventually overcome those circumstances and repay the loan infull.  OREO consists of propertiesacquired by foreclosure or similar means that management intends to offer forsale.

 

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

 

The following table provides information with respect to components ofthe Company’s non-performing assets at the date indicated.  The Company has not had any loans 90 dayspast due and still accruing interest in any periods presented.

 
| **Non-performing Assets**                                                |   | **As of  December 31,** |   |
|--------------------------------------------------------------------------|--------|-------------------------|--------|
| **(dollars in thousands)**                                               |   | **2002**                |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
| **Nonaccrual Loans:**                                                    |   |                    |   |   |   |   |   |   |   |   |   |
| Agricultural                                                             |   | $                       | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Commercial and Industrial                                                |   | $                       | 134    |   | $ | 1,544 |   | $ | 83 |   | $ | 103 |   | $ | 4 |   |
| Real Estate                                                              |   |                    |   |   |   |   |   |   |   |   |   |
| Secured by Commercial/Professional Office                                |   | $                       | — |   | $ | — |   | $ | — |   | $ | 25 |   |   |   |
| Properties Including Construction and Development                        |   | $                       | — |   | $ | 221 |   | $ | 453 |   | $ | 96 |   | $ | — |   |
| Secured by Residential Properties                                        |   | $                       | — |   | $ | — |   | $ | — |   | $ | 124 |   | $ | 41 |   |
| Secured by Farmland                                                      |   | $                       | 460    |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Consumer Loans                                                           |   | $                       | — |   | $ | — |   | $ | — |   | $ | 11 |   | $ | 36 |   |
| **SUBTOTAL**                                                             |   | $                       | 594    |   | $ | 1,765 |   | $ | 536 |   | $ | 359 |   | $ | 81 |   |
|                                                                     |   |                    |   |   |   |   |   |   |   |   |   |
| Other Real Estate (ORE)                                                  |   | $                       | — |   | $ | 13 |   | $ | 51 |   | $ | 431 |   | $ | 341 |   |
| Total non-performing Assets                                              |   | $                       | 594    |   | $ | 1,778 |   | $ | 587 |   | $ | 790 |   | $ | 422 |   |
| Restructured Loans                                                       |   | N/A                     |   | N/A |   | N/A |   | N/A |   | N/A |   |
| Non-performing loans as % of total gross loans                           |   | 0.25                    | %      | 0.88 | % | 0.31 | % | 0.30 | % | 0.08 | % |
| Non-performing assets as a % of total gross loans  and other real estate |   | 0.25                    | %      | 0.88 | % | 0.34 | % | 0.67 | % | 0.40 | % |

 

Total non-performing balances stood at $594,000 at the end of 2002,$460,000 of which is secured by farmland. The Company’s non-performing assets decreased by $1.2 million during2002, due to the repayment of a loan to a single borrower.  Management considers those loans to bewell-reserved (see Allowance for Possible Loan Losses below), and expects toresolve them during 2003.  ORE of$13,000 outstanding at December 31, 2001 was sold during 2002.  There was no ORE outstanding at December 31,2002.

 

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

 

The allowance for loan losses is established through a provision forloan losses based on management’s evaluation of known and inherit risk in ourloan portfolio.  The allowance isincreased by provisions charged against current earnings and reduced by netcharge-offs.  Loans are charged off whenthey are deemed to be uncollectable; recoveries are generally recorded onlywhen cash payments are received subsequent to the charge off.  The following table summarizes the activityin the allowance for loan losses for the past five years.

 

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| **Allowance For Loan Losses**                                       |   | **As of  December 31,** |    |
|---------------------------------------------------------------------|--------|-------------------------|---------|
| **(dollars in thousands)**                                          |   | **2002**                |    | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
| **Balances:**                                                       |   |                    |    |   |   |   |   |   |   |   |   |
| Average gross loans outstanding during period                       |   | $                       | 216,953 |   | $ | 194,448 |   | $ | 146,517 |   | $ | 114,168 |   | $ | 101,006 |   |
| Gross loans outstanding at end of period                            |   | $                       | 233,542 |   | $ | 200,946 |   | $ | 171,315 |   | $ | 118,559 |   | $ | 106,140 |   |
|                                                                |   |                    |    |   |   |   |   |   |   |   |   |
| **Allowance for Loan Losses:**                                      |   |                    |    |   |   |   |   |   |   |   |   |
| Balance at beginning of period                                      |   | $                       | 2,397   |   | $ | 2,000 |   | $ | 1,390 |   | $ | 1,329 |   | $ | 893 |   |
| Adjustments                                                         |   | $                       | —  |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Provision Charged to Expense                                        |   | $                       | 603     |   | $ | 500 |   | $ | 805 |   | $ | 305 |   | $ | 565 |   |
|                                                                |   |                    |    |   |   |   |   |   |   |   |   |
| Loan Charge-offs                                                    |   |                    |    |   |   |   |   |   |   |   |   |
| Agricultural                                                        |   | $                       | —  |   | $ | — |   | $ | — |   | — |   | — |   |
| Commercial & Industrial Loans                                   |   | $                       | —  |   | $ | 29 |   | $ | 112 |   | $ | 146 |   | $ | 18 |   |
| Real Estate Loans                                                   |   | $                       | 4       |   | $ | — |   | $ | 37 |   | $ | 30 |   | $ | — |   |
| Consumer Loans                                                      |   | $                       | 3       |   | $ | 95 |   | $ | 4 |   | $ | 51 |   | $ | 79 |   |
| Credit Card Loans                                                   |   | $                       | —  |   | $ | 9 |   | $ | 63 |   | $ | 31 |   | $ | 43 |   |
| Total                                                               |   | $                       | 7       |   | $ | 133 |   | $ | 216 |   | $ | 258 |   | $ | 140 |   |
|                                                                |   |                    |    |   |   |   |   |   |   |   |   |
| Recoveries                                                          |   |                    |    |   |   |   |   |   |   |   |   |
| Agricultural                                                        |   | $                       | —  |   | $ | — |   | $ | — |   | — |   | — |   |
| Commercial & Industrial Loans                                   |   | $                       | 14      |   | $ | 16 |   | $ | 20 |   | $ | — |   | $ | — |   |
| Real Estate Loans                                                   |   | $                       | —  |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Consumer Loans                                                      |   | $                       | —  |   | $ | 10 |   | $ | 1 |   | $ | 14 |   | $ | 11 |   |
| Credit Card Loans                                                   |   | $                       | —  |   | $ | 4 |   | $ | — |   | $ | — |   | $ | — |   |
| Total                                                               |   | $                       | 14      |   | $ | 30 |   | $ | 21 |   | $ | 14 |   | $ | 11 |   |
| Net Loan Charge-offs                                                |   | $                       | (7      | ) | $ | 103 |   | $ | 195 |   | $ | 244 |   | $ | 129 |   |
| Balance at end of period                                            |   | $                       | 3,007   |   | $ | 2,397 |   | $ | 2,000 |   | $ | 1,390 |   | $ | 1,329 |   |
|                                                                |   |                    |    |   |   |   |   |   |   |   |   |
| **Ratios:**                                                         |   |                    |    |   |   |   |   |   |   |   |   |
| Net Loan Charge-offs to Average Loans                               |   | 0.00                    | %       | 0.05 | % | 0.13 | % | 0.21 | % | 0.13 | % |
| Allowance for Loan Losses to Gross Loans at End of  Period          |   | 1.29                    | %       | 1.19 | % | 1.17 | % | 1.17 | % | 1.25 | % |
| Allowance for Loan Losses to Non-Performing Loans                   |   | 506.23                  | %       | 134.81 | % | 340.72 | % | 175.95 | % | 314.93 | % |
| Net Loan Charge-offs to Allowance for Loan Losses at  End of Period |   | -0.23                   | %       | 4.30 | % | 9.75 | % | 17.55 | % | 9.71 | % |
| Net Loan Charge-offs to Provision Charged to  Operating Expense     |   | -1.16                   | %       | 20.60 | % | 24.22 | % | 80.00 | % | 22.83 | % |

 

We employ a systematic methodology for determining the allowance forloan losses that includes a monthly review process and monthly adjustment ofthe allowance.  Our process includes aperiodic review of individual loans that have been specifically identified asproblem loans or have characteristics which could lead to impairment, as wellas detailed reviews of other loans (either individually or in pools).  While this methodology utilizes historicaland other objective information, the establishment of the allowance for loanlosses and the 

 

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classification of loans is, to some extent, based on management’sjudgment and experience.

 

Our methodology incorporates a variety of risk considerations, bothquantitative and qualitative, in establishing an allowance for loan losses thatmanagement believes is appropriate at each reporting date.  Quantitative factors include our historicalloss experience, delinquency and charge-off trends, collateral values, changesin non-performing loans, and other factors. Quantitative factors also incorporate known information about individualloans, including borrowers’ sensitivity to interest rate movements andborrowers’ sensitivity to quantifiable external factors including commodityprices as well as acts of nature (freezes, earthquakes, fires, etc.) that occurin a particular period.

 

Qualitative factors include the general economic environment in ourmarkets and, in particular, the state of the agriculture industry and other keyindustries in the Northern Sacramento Valley. The way a particular loan might be structured, the extent and nature ofwaivers of existing loan policies, and the rate of portfolio growth are other qualitativefactors that are considered.

 

Our methodology is, and has been, consistently followed.  However, as we add new products, increase incomplexity, and expand our geographic coverage, we expect to enhance ourmethodology to keep pace with the size and complexity of the loanportfolio.  On an ongoing basis weengage outside firms to independently assess our methodology, and to performindependent credit reviews of our loan portfolio.  The Company’s external auditors, the FDIC, and the California Departmentof Financial Institutions also review the allowance for loan losses as anintegral part of the examination processes. Management believes that our current methodology is appropriate givenour size and level of complexity. Further, management believes that the allowance for loan losses isadequate as of December 31, 2002 to cover known and inherent risks in the loanportfolio.  However, fluctuations incredit quality, or changes in economic conditions or other factors could causemanagement to increase or decrease the allowance for loan losses as necessary.

 

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

 
|                                                             |   | **As of December 31,** |   |
|------------------------------------------------------------------|--------|------------------------|--------|
|                                                             |   | **2002**               |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
| **Allocation of Loan Loss Allowance****(dollars in  thousands)** |   | **Amount**             |   | **%****Total(1)Loans** |   | **Amount** |   | **%****Total(1)Loans** |   | **Amount** |   | **%****Total(1)Loans** |   | **Amount** |   | **%****Total(1)Loans** |   | **Amount** |   | **%****Total(1)Loans** |   |
| Agricultural                                                     |   | $                      | 146    |   | 8.11 | % | $ | 142 |   | 9.66 | % | $ | 183 |   | 10.99 | % | $ | 170 |   | 14.76 | % | $ | 185 |   | 17.97 | % |
| Commercial                                                       |   | $                      | 735    |   | 20.84 | % | $ | 494 |   | 21.16 | % | $ | 407 |   | 23.16 | % | $ | 348 |   | 28.13 | % | $ | 251 |   | 24.15 | % |
| Real Estate                                                      |   | $                      | 1,379  |   | 62.78 | % | $ | 1,201 |   | 60.34 | % | $ | 874 |   | 55.99 | % | $ | 424 |   | 45.31 | % | $ | 410 |   | 43.86 | % |
| Installment Loans                                                |   | $                      | 747    |   | 8.27 | % | $ | 560 |   | 8.84 | % | $ | 536 |   | 9.86 | % | $ | 448 |   | 11.80 | % | $ | 483 |   | 14.02 | % |
| **TOTAL**                                                        |   | $                      | 3,007  |   | 100.00 | % | $ | 2,397 |   | 100.00 | % | $ | 2,000 |   | 100.00 | % | $ | 1,390 |   | 100.00 | % | $ | 1,329 |   | 100.00 | % |

 

----

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

 

At December 31, 2002, the Company’s allowance for loan losses was $3million.  The loan loss provisions in2002, 2001, and 2000 totaled $603,000, $500,000, and $805,000,respectively.  Over the past five years,net charge-offs have averaged $133,000. Through the diligent efforts of our loan officers and collectionpersonnel, the Company was able to end 2002 with a net recovery of $7,000.

 

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**OtherLoan Portfolio Information**

 

Loan Concentrations:   The concentration profile of the Company’sloans is discussed in Note 7 to the accompanying Consolidated FinancialStatements.

 

Loan Sales and Mortgage Servicing Rights:  The Company sells or brokers some of the fixed-rate single familymortgage loans it originates as well as other selected portfolio loans.  Some are sold “servicing released” and thepurchaser takes over the collection of the 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 feefor 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.  Generally accepted accounting principles(“GAAP”) require companies engaged in mortgage banking activities to recognizethe rights to service mortgage loans for others as separate assets.  For loans originated for sale, a portion ofthe investment in the loan is attributed to the right to receive this fee forservicing and this value is recorded as a separate asset.  Mortgage servicing assets are carried attheir amortized cost, which approximates fair value.  At December 31, 2002 and 2001, the fair value of these assets was$761,300 and $431,000 respectively.

 

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

 

The investment securities portfolio had a book value of $3.4 million atDecember 31, 2002.  In accordance withSFAS No. 115 “Accounting for Certain Investments in Debt and EquitySecurities”,  the Company classified itsinvestments into two portfolios:  “Held-to-maturity”,and “available-for-sale”.  While SFAS115 also provides for a trading portfolio classification, the Company has noinvestments which are so classified. The held-to-maturity portfolio should consist only of investments thatthe Company has both the intention and ability to hold until maturity, to besold only in the event of concerns with an issuer’s creditworthiness, a changein tax law that eliminates their tax exempt status or other infrequentsituations as permitted by SFAS 115. Given the small and non complex nature of the portfolio, management doesnot rely heavily on these investments as a source of funds for the loanportfolio and therefore has not classified them as available-for-sale.

 

Securities pledged as collateral on repurchase agreements, publicdeposits and for other purposes as required or permitted by law were $480,200and $764,600, for December 31, 2002 and 2001, respectively.

 

The investment portfolio was increased in size in 2002 to $3.4 millionat the end of the year from its starting balance of $3 million.  The Company’s investment portfolio iscomposed primarily of:  (1) U.S.Agency issues for liquidity and pledging; and (2) state, county and municipalobligations which provide tax free income and pledging potential.  The relative distribution of these groupswithin the overall portfolio changed significantly in 2002, with a shift out ofmunicipal obligations and into U.S. Agency issues which are the largest portionof the total portfolio at 64.7%, up from 30.6% at the end of 2001.  Municipal issues comprised 35.3% of totalinvestments at the end of 2002, down from 69.4% at the end of 2001.   The impact of declining interest rates onthe weighted average yield of the portfolio resulted in a decline of 52 basispoints from 5.59% in 2001 to 5.07% in 2002.

 

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

 

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|                                                |   | **As  of December 31,** |   |
|-----------------------------------------------------|--------|-------------------------|--------|
|                                                |   | **2002**                |   | **2001** |   | **2000** |   |
| **Investment  Portfolio****(dollars in thousands)** |   | **Amortized  Cost**     |   | **Fair  Market  Value** |   | **Amortized  Cost** |   | **Fair  Market  Value** |   | **Amortized  Cost** |   | **Fair  Market  Value** |   |
| **Held to  maturity**                               |   |                    |   |   |   |   |   |   |   |   |   |   |   |
| US Government Agencies  & Corporations          |   | 1,882                   |   | 1,910 |   | 619 |   | 625 |   | 1,836 |   | 1,815 |   |
| State & political  subdivisions                 |   | 991                     |   | 1,014 |   | 1,888 |   | 1,912 |   | 2,269 |   | 2,273 |   |
| **Total held  to maturity**                         |   | $                       | 2,873  |   | $ | 2,924 |   | $ | 2,507 |   | $ | 2,537 |   | $ | 4,105 |   | $ | 4,088 |   |
| **Available  for sale**                             |   |                    |   |   |   |   |   |   |   |   |   |   |   |
| US Government Agencies  & Corporations          |   | 300                     |   | 314 |   | 300 |   | 300 |   |   |   |   |   |
| State & political  subdivisions                 |   | 200                     |   | 200 |   | 200 |   | 200 |   | 200 |   | 200 |   |
| **Total  available for sale**                       |   | $                       | 500    |   | $ | 514 |   | $ | 500 |   | $ | 500 |   | $ | 200 |   | $ | 200 |   |
| **Total  Investment Securities**                    |   | $                       | 3,373  |   | $ | 3,438 |   | $ | 3,007 |   | $ | 3,037 |   | $ | 4,305 |   | $ | 4,288 |   |

 

The investment maturities table below summarizes the maturity of theCompany’s investment securities and their weighted average yields at December31, 2002.  Expected remaining maturitiesmay differ from remaining contractual maturities because obligors may have theright to repay certain obligations with or without penalties.

 
|                                       |   | **As of December 31, 2002** |   |
|--------------------------------------------|--------|-----------------------------|--------|
| **Investment  Maturities**                 |   | **Within One  Year**        |   | **After One But  Within Five Years** |   | **After Five Years But  Within Ten Years** |   | **After Ten  Years** |   | **Total** |   |
| **(dollars in thousands)**                 |   | **Amount**                  |   | **Yield** |   | **Amount** |   | **Yield** |   | **Amount** |   | **Yield** |   | **Amount** |   | **Yield** |   | **Amount** |   | **Yield** |   |
| **Held to  maturity**                      |   |                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| US Government agencies &  corporations |   | —                      |   | n/a |   | 1,410 |   | 3.30 | % | 253 |   | 6.25 | % | 219 |   | 6.00 | % | 1,882 |   | 4.01 | % |
| State & political  subdivisions        |   | 215                         |   | 4.85 | % | 550 |   | 6.15 | % | — |   | n/a |   | 226 |   | 5.70 | % | 991 |   | 5.77 | % |
| **Total held  to maturity**                |   | $                           | 215    |   | 4.85 | % | $ | 1,960 |   | 4.10 | % | $ | 253 |   | 6.25 | % | $ | 445 |   | 5.85 | % | $ | 2,873 |   | 4.62 | % |
| **Available  for sale**                    |   |                        |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| US Government agencies &  corporations |   | —                      |   | n/a |   | — |   | n/a |   | 314 |   | 6.25 | % | — |   | n/a |   | 314 |   | 6.25 | % |
| State & political  subdivsions         |   | —                      |   | n/a |   | — |   | n/a |   | 200 |   | 7.00 | % | — |   | n/a |   | 200 |   | 7.00 | % |
| **Total  available for sale**              |   | $                           | — |   | n/a |   | $ | — |   | n/a |   | $ | 514 |   | 6.54 | % | $ | — |   | n/a |   | $ | 514 |   | 6.54 | % |
| **Total  investment securities**           |   | $                           | 215    |   | 4.85 | % | $ | 1,960 |   | 4.10 | % | $ | 767 |   | 6.45 | % | $ | 445 |   | 5.85 | % | $ | 3,387 |   | 4.91 | % |

 

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

 

Cash on hand and balances due from correspondent banks represent themajor portion of the Company’s non-earning assets.  At December 31, 2002 these areas comprised 4.6% of total assets,as compared to 4.5% of total assets at December 31, 2001.  The Company strives to maintain vault cashat a level consistent with the withdrawal needs of the customers.       The Company’s operating branches liewithin the Federal Reserve Bank (FRB) of San Francisco’s responsibility area ofcheck clearing activities, while the Company’s item processing activities areperformed in Chico. As a result, a greater volume of the Company’s balanceswith correspondent banks have been uncollected funds, and therefore due frombank balances could be greater than similar size institutions in metropolitanareas closer to San Francisco where collection activity is morecentralized.  However, if and when theFederal Reserve Banks start accepting electronic items (i.e., imaged checks)for collection, this geographic disadvantage will be removed.

 

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

 

Premises and equipment are stated at cost less accumulated depreciationand amortization.  Depreciation ischarged to income over the estimated useful lives of the assets and leaseholdimprovements are amortized over the terms of the related lease, or theestimated useful lives of the improvements, whichever is shorter.  

 

38

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Depreciation expense was $589,000 for the year ended December 31, 2002as compared to $551,000 during 2001. The following premises and equipment table reflects the balances bymajor category of fixed assets:

 
|                                                     |   | **As of December 31,** |   |
|----------------------------------------------------------|--------|------------------------|--------|
|                                                     |   | **2002**               |   | **2001** |   | **2000** |   |
| **Premises  & Equipment****(dollars  in thousands)** |   | **Cost**               |   | **Accumulated  Depreciation** |   | **Net Book  Value** |   | **Cost** |   | **Accumulated  Depreciation** |   | **Net Book  Value** |   | **Cost** |   | **Accumulated  Depreciation** |   | **Net Book  Value** |   |
| Land                                                     |   | $                      | 1,193  |   | $ | — |   | $ | 1,193 |   | $ | 1,193 |   | $ | — |   | $ | 1,193 |   | $ | 866 |   | $ | — |   | $ | 866 |   |
| Buildings                                                |   | $                      | 4,632  |   | $ | 773 |   | $ | 3,859 |   | $ | 3,564 |   | $ | 674 |   | $ | 2,890 |   | $ | 3,518 |   | $ | 554 |   | $ | 2,964 |   |
| Leasehold Improvements                                   |   | $                      | 330    |   | $ | 144 |   | $ | 186 |   | $ | 127 |   | $ | 122 |   | $ | 5 |   | $ | 127 |   | $ | 100 |   | $ | 27 |   |
| Construction in progress                                 |   | $                      | 103    |   | $ | — |   | $ | 103 |   | $ | 418 |   | $ | — |   | $ | 418 |   | $ | — |   | $ | — |   | $ | — |   |
| Furniture and Equipment                                  |   | $                      | 3,977  |   | $ | 2,665 |   | $ | 1,312 |   | $ | 3,333 |   | $ | 2,197 |   | $ | 1,136 |   | $ | 3,148 |   | $ | 1,788 |   | $ | 1,360 |   |
| **Total**                                                |   | $                      | 10,235 |   | $ | 3,582 |   | $ | 6,653 |   | $ | 8,635 |   | $ | 2,993 |   | $ | 5,642 |   | $ | 7,659 |   | $ | 2,442 |   | $ | 5,217 |   |

 

The net book value of the Company’s premises and equipment increased by$1.0 million in 2002 primarily due to the opening of the new Yuba City andCentral Chico branches.   As apercentage of total assets, however, the Company’s premises and equipment havedeclined to 1.9%, from 2.1% at the end of 2001 and 2.4% at the end of 2000.

 

###### **Deposits**

 

The composition and cost of the Company’s deposit base are importantcomponents in analyzing the Company’s net interest margin and balance sheetliquidity characteristics, both of which are discussed in greater detail inother sections herein.  Net interestmargin is improved to the extent that growth in deposits can be concentrated inhistorically lower-cost core deposits, namely non-interest-bearing demand, NOWaccounts, savings accounts and money market deposit accounts.  Liquidity is impacted by the volatility ofdeposits or other funding instruments, or in other words their propensity toleave the institution for rate-related or other reasons.  Potentially, the most volatile deposits in afinancial institution are large certificates of deposit, which generally meantime deposits with balances exceeding $100,000.  Because these deposits (particularly when considered togetherwith a customer’s other specific deposits) may exceed FDIC insurance limits,depositors may select shorter maturities to offset perceived risk elementsassociated with deposits over $100,000. The Company’s community-orienteddeposit gathering activities in Butte and Sutter counties, however, haveengendered a less volatile than usual base of depositor certificates over$100,000.

 

The Company’s total deposit volume increased to $298 million at the endof 2002, as compared to $246 million at the end of 2001.  Deposit growth of $52 million was achievedduring 2002, both as a result of the two new branches opening and the growth ofthe other five branches within the system. A significant change in the mix of the deposits took place during 2002with lower cost core deposit accounts (demand deposits, NOW accounts, moneymarket, and savings) increasing by 51% or $72 million while the higher costcertificates of deposit balances decreased by 25% or $20 million.

 

As deposit rates continued to decline throughout 2002 depositors chosethe liquid option of putting funds into checking accounts rather thanreinvesting in certificates of deposit that were yielding nearly the sameinterest.  The average rates that arepaid on deposits generally trail behind money market rates because financialinstitutions do not try to change deposit rates with each small increase ordecrease in short-term rates.  Thistrailing characteristic is stronger with time deposits, such as certificates ofdeposit that pay a fixed rate for some specified term, than with deposit typesthat have administered rates.   Withtime deposits accounts, even when new offering rates are established, theaverage rates paid during the year are a blend of the rates paid on individualaccounts.  Only new accounts and thosethat mature and are renewed will bear the new rate.

 

39

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The scheduled maturity distribution of the Company’s time deposits asof December 31, 2002 was as follows:

 
|                                                      |   | **As  of December 31, 2002** |   |
|-----------------------------------------------------------|--------|------------------------------|--------|
| **Deposit Maturity Distribution  (dollars in thousands)** |   | **Three  months  or less**   |   | **Three  to twelve  months** |   | **One  to three  years** |   | **Over  three  Years** |   | **Total** |   |
|                                                      |   |                         |   |   |   |   |   |   |   |   |   |
| Time Certificates of  Deposits < $100,000              |   | $                            | 16,178 |   | $ | 24,330 |   | $ | 17,550 |   | $ | 559 |   | $ | 58,617 |   |
|                                                      |   |                         |   |   |   |   |   |   |   |   |   |
| Other Time Deposits >  $100,000                        |   | $                            | 6,770  |   | $ | 7,904 |   | $ | 10,305 |   | $ | 471 |   | $ | 25,450 |   |
|                                                      |   |                         |   |   |   |   |   |   |   |   |   |
| TOTAL                                                     |   | $                            | 22,948 |   | $ | 32,234 |   | $ | 27,855 |   | $ | 1,030 |   | $ | 84,067 |   |

 

**OtherBorrowings**

 

The ESOP obtained financing through a $1 million unsecured line ofcredit from another financial institution with the Company acting as theguarantor.  The note has a variableinterest rate, based on an independent index, and a maturity date of March 8,2008.  At December 31, 2002, theinterest rate was 4.25%.  Advances onthe line of credit totaled 732,100 and 851,500 at December 31, 2002, and 2001,respectively.  A summary of the activityin this line of credit follows.

 

The Company has $6 million in unsecured borrowing arrangements with twoof its correspondent banks to meet short-term liquidity needs.  There were no borrowings outstanding underthese arrangements at December 31, 2002 and 2001.

 
| **ESOP  Note Payable****(dollars  in thousands)** |   | **2002** |   | **2001** |   | **2000** |   |
|---------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                                              |   |     |   |     |   |     |   |
| Balance at December 31                            |   | $        | 733    |     | $      | 851      |   | $ | 643 |   |
|                                              |   |     |   |     |   |     |   |
| Average amount outstanding                        |   | $        | 788    |     | $      | 770      |   | $ | 621 |   |
|                                              |   |     |   |     |   |     |   |
| Maximum amount outstanding  at any month end      |   | $        | 843    |     | $      | 885      |   | $ | 699 |   |
|                                              |   |     |   |     |   |     |   |
| Average interest rate for  the year               |   | 4.67     | %      | 7.04     | %      | 9.21     | %      |

 

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

 

At December 31, 2002, the Company had total shareholders equity of$25.4 million, comprised of $5.8 million in common stock, and $19.6 million inretained earnings. Total shareholders equity at the end of 2001 was $20.8 million.  Net income has provided $11.7 million incapital over the last three years, of which $1.5 million or approximately 13%was distributed in dividends.  Theretention of earnings has been the Company’s main source 

 

40

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of capital since 1990, however the Company issued $8 million in TrustPreferred Securities in 2002, the proceeds of which are considered Tier 1capital for regulatory purposes but long-term debt in accordance with generallyaccepted accounting principles.

 

The Company paid quarterly cash dividends totaling $882,200 or $.33 pershare in 2002 and $590,600 or $.225 per share in 2001, representing 18% and19%, respectively of the prior year’s earnings.  (As the holding company reorganization became effective on May23, 2002, all of the dividends paid prior to that date were paid by the Bank,rather than the Company.)  Since thesecond quarter of 2001, the Bank (or the Company, as applicable) has adhered toa policy of paying quarterly cash dividends totaling about 18% of the prioryear’s net earnings to the extent consistent with general considerations ofsafety and soundness, provided that such payments do not adversely affect theBank’s or the Company’s financial condition and are not overly restrictive toits growth capacity.    The Companyanticipates paying dividends in the future consistent with the general dividendpolicy as described above.  However, noassurance can be given that the Bank’s and the Company’s future earnings and/orgrowth expectations in any given year will justify the payment of such adividend.

 

The Company uses a variety of measures to evaluate capitaladequacy.  Management reviews variouscapital measurements on a monthly basis and takes appropriate action to ensurethat such measurements are within established internal and externalguidelines.  The external guidelines,which are issued by the FDIC, establish a risk-adjusted ratio relating capitalto different categories of assets and off balance sheet exposures.  There are two categories of capital underthe FDIC guidelines: Tier 1 and Tier 2 Capital.  Tier 1 Capital includes common shareholders’ equity and theproceeds from the issuance of trust-preferred securities (subject to thelimitations previously discussed), less goodwill and certain other deductions,notably the unrealized net gains or losses (after tax adjustments) onsecurities available for sale, which are carried at fair market value.  Tier 2 Capital includes preferred stock andcertain types of debt equity, which the Company does not hold, as well as theallowance for loan losses, subject to certain limitations. (For a more detaileddefinition, see “Item 1, Business-Supervision and Regulation — Capital AdequacyRequirements” herein.)

 

At December 31, 2002, the Company had a Tier 1 risk based capital ratioof 12.8%, a total capital to risk-weighted assets ratio of 14.0%, and aleverage ratio of 10.4%.  The Bank had aTier 1 risk-based capital ratio of 9.7%, a total risk-based capital ratio of10.9%, and a leverage ratio of 7.9% at December 31, 2001.  Note 11 of the Notes to ConsolidatedFinancial Statements provides more detailed information concerning theCompany’s capital amounts and ratios as of December 31, 2002 and 2001.

 

At the current time, the Bank is “well capitalized” by regulatorystandards. With the accumulation of retained earnings and the addition ofregulatory capital via the issuance of Trust Preferred Securities in 2002, theCompany’s regulatory capital ratios improved substantially.  It is anticipated that the current level ofcapital will allow the Company to grow substantially and remain wellcapitalized, although no assurance can be given that this will be the case.

 

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

 

The Company must address on a daily basis the various and sundryfactors which impact its continuing operations.  Three of these factors, the economic climate which encompassesour business environment, the regulatory framework which governs our practicesand procedures, and credit risk have been previously discussed.  There are other risks specific to theoperation of a financial institution which also need to be managed, and thissection will address liquidity risk and market risk.

 

Liquidity refers to the Company’s ability to maintain a cash flowadequate to fund operations, and to meet obligations and other commitments in atimely and cost-effective fashion.  Atvarious times the Company requires funds to meet short-term cash requirementsbrought about by loan growth or deposit outflows, the purchase of assets, orliability repayments.  To manageliquidity needs properly, cash inflows must be timed to 

 

41

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coincide with anticipated outflows, or sufficient liquidity resourcesmust be available to meet varying demands. The Company manages its own liquidity in such a fashion as to be able tomeet unexpected sudden changes in levels of its assets or deposit liabilities,without maintaining excessive amounts of on-balance sheet liquidity.  Excess balance sheet liquidity cannegatively impact the interest margin.

 

An integral part of the Company’s ability to manage its liquidityposition appropriately is provided by the Company’s large base of coredeposits, which were generated by offering traditional banking services in thecommunities in its service area and which have, historically, been a verystable source of funds.

 

Additionally, the Company maintains $6 million in unsecured borrowingarrangements with two of its correspondent banks.  The Company also has the ability to raise deposits throughvarious deposit brokers, sell investment securities, or sell loans if requiredfor liquidity purposes.  Because of therapid pace of loan growth in the second half of 2001, the Company lackedsufficient time to generate customer deposits to fund that growth.  Through the use of short term brokereddeposits, the Company was able to meet the loan demand.

 

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

 

The principal objective of interest rate risk management (oftenreferred to as “asset/liability management”) is to manage the financialcomponents of the Company in a manner that will optimize the risk/rewardequation for earnings and capital in relation to changing interest rates.  In order to identify areas of potentialexposure to rate changes, the Company calculates its re-pricing gap on amonthly basis.  It also performs anearnings simulation analysis and a market value of portfolio equity calculationon a monthly basis to identify more dynamic interest rate risk exposures thanthose apparent in the standard re-pricing gap analysis.

 

Modeling software is used by the Company for asset/liability managementin order to simulate the effects of potential interest rate changes on theCompany’s net interest margin.  Thesesimulations can also provide both static and dynamic information on theprojected fair market values of the Company’s financial instruments underdiffering interest rate assumptions. The simulation program utilizes specific individual loan and depositmaturities, embedded options, rates and re-pricing characteristics to determinethe effects of a given interest rate change on the Company’s interest incomeand interest expense.  Rate scenariosconsisting of key rate and yield curve projections are run against theCompany’s investment, loan, deposit and borrowed funds portfolios.  These rate projections can be shocked (animmediate and sustained change in rates, up or down), ramped (an incrementalincrease or decrease in rates over a specified time period), economic (based oncurrent trends and econometric models) or stable (unchanged from current actuallevels).  The Company typically uses sevenstandard interest rate scenarios in conducting the simulation, namely stable,an upward shock of 100, 200, and 300 basis points, and a downward shock of 100,200, and 300 basis points.

 

The Company’s policy is to limit the change in the Company’s netinterest margin and economic value to plus or minus 5%, 15%, and 25% uponapplication of interest rate shocks of 100 bp, 200 bp, and 300 bp as comparedto a base rate scenario.  As of December31, 2002, the Company had the following estimated net interest marginsensitivity profile:

 
|                   |   | **Immediate Change  in Rate** |    | **Immediate  Change in Rate** |   | **Immediate  Change in Rate** |   |
|------------------------|--------|-------------------------------|---------|-------------------------------|--------|-------------------------------|--------|
|                   |   | **+100 bp**                   |    | **-100 bp**                   |   | **+200 bp**                   |   | **-200 bp** |   | **+300 bp** |   | **-300 bp** |   |
| Net Int. Income Change |   | $                             | 167,000 |                          | $      | (271,000                      | )      | $ | 111,000 |   | $ | (1,262,000 | ) | $ | 56,000 |   | $ | (2,524,000 | ) |
|                        |        |                               |         |                               |        |                               |        |  |  |  |  |  |  |  |  |  |  |  |  |

 

42

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The above profile illustrates that if there were an immediate increaseof 200 basis points in interest rates, the Company’s annual net interest incomewould likely increase by around $111,000, or approximately .77%.  By the same token, if there were animmediate downward adjustment of 200 basis points in interest rates, theCompany’s net interest income would likely fall by approximately $1.3 million,or 8.77%, over the next year.  The relationshipbetween the change in net interest income under rising and declining ratescenarios is typically inversely proportionate, and the Company is exposed todeclining rates while benefiting in a rising rate environment.

 

Further, the economic value of the Company’s loan and depositportfolios would also change under the interest rate variances previouslydiscussed.  The amount of change isbased on the profiles of each loan and deposit class, which include the rate,the likelihood of prepayment or repayment, whether its rate is fixed or floating,the maturity of the instrument and the particular circumstances of thecustomer.  The quantification of thechange in economic value is somewhat apparent in Note 16, Fair Value ofFinancial Instruments, in the Consolidated Financial Report; however suchvalues change over time based on certain assumptions about interest rates andlikely changes in the yield curve.

 

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

 

The financial statements begin on page 51 of this report.

 

43

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**SelectedQuarterly Financial Data**

 
| **Quarterly Financial Data**                        |   | **(Dollars  in thousands, except per share data)** |   |
|-----------------------------------------------------|--------|----------------------------------------------------|--------|
| **2002 Quarter**                                    |   | **1st**                                            |   | **2nd** |   | **3rd** |   | **4th** |   |
|                                                |   |                                               |   |   |   |   |   |   |   |
| Interest income                                     |   | $                                                  | 4,347  |   | $ | 4,379 |   | $ | 4,891 |   | $ | 4,956 |   |
| Net Interest income                                 |   | $                                                  | 3,007  |   | $ | 3,212 |   | $ | 3,773 |   | $ | 3,807 |   |
| Net interest income after provision for loan losses |   | $                                                  | 2,904  |   | $ | 3,062 |   | $ | 3,623 |   | $ | 3,607 |   |
|                                                |   |                                               |   |   |   |   |   |   |   |
| Net Income                                          |   | $                                                  | 1,253  |   | $ | 972 |   | $ | 1,292 |   | $ | 1,332 |   |
|                                                |   |                                               |   |   |   |   |   |   |   |
| Net income per share, basic                         |   | $                                                  | 0.51   |   | $ | 0.50 |   | $ | 0.38 |   | $ | 0.49 |   |
|                                                |   |                                               |   |   |   |   |   |   |   |
| Net income per share, diluted                       |   | $                                                  | 0.49   |   | $ | 0.47 |   | $ | 0.36 |   | $ | 0.46 |   |
|                                                |   |                                               |   |   |   |   |   |   |   |
| Dividends Declared                                  |   | $                                                  | 0.075  |   | $ | 0.075 |   | $ | 0.08 |   | $ | 0.10 |   |

 
| **Quarterly Financial Data**                        |   | **(Dollars  in thousands, except per share data )** |   |
|-----------------------------------------------------|--------|-----------------------------------------------------|--------|
| **2001 Quarter**                                    |   | **1st**                                             |   | **2nd** |   | **3rd** |   | **4th** |   |
|                                                |   |                                                |   |   |   |   |   |   |   |
| Interest income                                     |   | $                                                   | 4,875  |   | $ | 4,983 |   | $ | 5,005 |   | $ | 4,653 |   |
| Net Interest income                                 |   | $                                                   | 3,028  |   | $ | 3,036 |   | $ | 3,114 |   | $ | 2,994 |   |
| Net interest income after provision for loan losses |   | $                                                   | 2,903  |   | $ | 2,786 |   | $ | 3,014 |   | $ | 2,969 |   |
|                                                |   |                                                |   |   |   |   |   |   |   |
| Net Income                                          |   | $                                                   | 942    |   | $ | 1,015 |   | $ | 994 |   | $ | 860 |   |
|                                                |   |                                                |   |   |   |   |   |   |   |
| Net income per share, basic                         |   | $                                                   | 0.34   |   | $ | 0.40 |   | $ | 0.41 |   | $ | 0.40 |   |
|                                                |   |                                                |   |   |   |   |   |   |   |
| Net income per share, diluted                       |   | $                                                   | 0.33   |   | $ | 0.38 |   | $ | 0.39 |   | $ | 0.37 |   |
|                                                |   |                                                |   |   |   |   |   |   |   |
| Dividends Declared                                  |   | $                                                   | — |   | $ | 0.075 |   | $ | 0.075 |   | $ | 0.075 |   |

 

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

 

There were no changes ordisagreements with Accountants for the year 2002.

 

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**PARTIII**

 

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

The information required by Item 10 isincorporated herein by reference to the sections titled “The Board ofDirectors” and “Executive Officers” in the Company’s definitive Proxy Statementfor the annual meeting to be held May 29, 2003 (“Proxy Statement”).

 

**Item 11****. ****   ****Executive Compensation**

The information required by Item 11 isincorporated herein by reference to the section titled “Executive Compensation”in the Company’s Proxy Statement.

 

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

The information required by Item 12 isincorporated herein by reference to the section titled “Beneficial OwnershipChart” in the Company’s Proxy Statement.

 

**Item 13****. ****   ****Certain Relationships and Related Transactions**

The information required by Item 13 isincorporated herein by reference to the section titled “Other Information” inthe Company’s Proxy Statement.

 

**Item 14****. ****   ****Controls and Procedures**

 

During the 90-day period prior to the filing of this annual report, anevaluation was performed under the supervision and with the participation ofthe Company’s management, including the Company’s Chief Executive Officer (CEO)and Chief Financial Officer (CFO), of the effectiveness of the design andoperation of the Company’s disclosure controls and procedures (as defined inRules 13a - 14(c) and 15d - 14(c) under the Securities Exchange Act of1934, as amended). Following that evaluation, the Company’s management,including the CEO and CFO, concluded that the Company’s disclosure controls andprocedures were effective at that time. There have been no significant changesin the Company’s internal controls, other factors that could significantlyaffect internal controls, or significant or material weaknesses with regard tothe Company’s internal controls identified by the Company subsequent to thatevaluation.

 

45

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**PARTIV**

 

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

 

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

 

(1)                   **FinancialStatements**

 

The followingfinancial statements and independent auditor’s reports are included in thisAnnual Report on Form 10-K immediately following.

 
| I.   | Independent Auditor’s  Report                                                                                   |
|------|----------------------------------------------------------------------------------------------------------------------|
| II.  | Consolidated Balance Sheet  - December 31, 2002 and 2001                                                             |
| III. | Consolidated  Statement of Income - Years Ended  December 31, 2002, 2001 and 2000                               |
| IV.  | Consolidated  Statement of Changes in Shareholders’ Equity - Years Ended  December 31, 2002, 2001 and 2000 |
| V.   | Consolidated  Statement of Cash Flows - Years Ended  December 31, 2002, 2001 and 2000                                |
| VI.  | Notes to  the Consolidated Financial Statements                                                                      |

 

(2)                   **FinancialStatement Schedules**

 

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

 

(3)                   **Exhibits**

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

 

46

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| (10.4)  |   | 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.                                                                                                |
|---------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (10.5)  |   | 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.                                                                                                   |
| (10.6)  |   | 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)  |   | 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. |
| (10.8)  |   | 2000 Stock Option Agreement for John F.  Coger dated March 14, 2000 Incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the period ended June 30, 2002, filed with  the Commission on August 14, 2002..                                                                                                   |
| (10.9)  |   | 1997 Stock Option Agreement for M. Robert  Ching dated May 1, 1997 Incorporated by reference to the Company’s Quarterly  Report on Form 10-Q for the period ended June 30, 2002, filed with the  Commission on August 14, 2002..                                                                                                    |
| (10.10) |   | 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.                                                                                              |
| (10.11) |   | 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..                                                                                                     |
| (10.12) |   | 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.                                                                                               |
| (10.13) |   | 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.                                                                                                |
| (10.14) |   | 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.                                                                                                      |
| (10.15) |   | 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.                                                                                                  |
| (10.16) |   | 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..                                                                                                  |
| (10.17) |   | 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..                                                                                                  |
| (10.18) |   | 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..                                                                                                  |
| (10.19) |   | 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..                                                                                                   |
| (10.20) |   | 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..                                                                                                   |

 

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| (10.21) |   | 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.      |
|---------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (10.22) |   | 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..             |
| (10.23) |   | 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..               |
| (10.24) |   | 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.               |
| (10.25) |   | 1997 Stock Option Agreement for Hubert I.  Townshend dated May 1, 1997 Incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the period ended June 30, 2002, filed with  the Commission on August 14, 2002..           |
| (10.26) |   | 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..           |
| (10.27) |   | 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..         |
| (10.28) |   | 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..          |
| (10.29) |   | 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..           |
| (10.30) |   | 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.     |
| (10.31) |   | 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..      |
| (10.32) |   | 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..        |
| (10.33) |   | 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. |
| (10.34) |   | 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..         |
| (10.35) |   | 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..            |
| (10.36) |   | 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.   |
| (10.37) |   | 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.      |
| (10.38) |   | 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                                                            |

 

48

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|    |   | 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 M&H Realty Partners IV L.P., a California limited partnership,  dated January 28, 2002, related to Unit #101-37 North Valley Plaza, East and  Cohasset Avenues, 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. |
| (11)    |   | See Item 6. Selected Financial Data Note 1  for Statement re computation of earnings per share                                                                                                                                                                                                                                                                                                             |
| (12)    |   | See Item 6. Selected Financial Data Notes 2  through 6 for Statements re computation of ratios                                                                                                                                                                                                                                                                                                             |
| (21)    |   | Listing of Subsidiaries of Registrant  attached.                                                                                                                                                                                                                                                                                                                                                           |
| (23)    |   | Consent of Perry-Smith LLP                                                                                                                                                                                                                                                                                                                                                                                 |
| (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  is incorporated by reference from Company's Registration Statement Form S-8,  filed August 14, 2002.                                                                                                                                                                                                                                                          |
| (99.5)  |   | Certification pursuant to Section 906  Sarbanes Oxley                                                                                                                                                                                                                                                                                                                                                      |
| (99.6)  |   | Certification pursuant to Section 906  Sarbanes Oxley                                                                                                                                                                                                                                                                                                                                                      |

 

(b) Reports on Form 8-K

 

On December 27, 2002, the Company filed a Report on form 8-k announcinga ten cent per share Cash Dividend.

 

49

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**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934,the Registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
| Dated:  March 18, 2003 | **COMMUNITY VALLEY BANCORP** |
|-----------------------------|------------------------------|
|                        | a California  corporation    |
|                        |                         |
|                        | By:                          | /s*/ Keith C. Robbins* |   |
|                        |                         | Keith C. Robbins |
|                        |                         | President and Chief Executive Officer |
|                        |                         |   |
|                        | By:                          | */s/ John F. Coger* |   |
|                        |                         | John F. Coger |
|                        |                         | Executive Vice  President  and Chief Financial Officer |

 

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

 
| **Signature**           |   | **Title** |                         | **Date** |
|-------------------------|--------|-----------|------------------------------|----------|
|                    |   |      |                         |     |
| */s/ M. Robert Ching*   |   |      | Director                     |     | March 18, 2003 |
| M. Robert Ching         |   |      |                         |     |   |
|                    |   |      |                         |     |   |
| */s/ Eugene B. Even*    |   |      | Director                     |     | March 18, 2003 |
| Eugene B. Even          |   |      |                         |     |   |
|                    |   |      |                         |     |   |
| */s/ John D. Lanam*     |   |      | Director                     |     | March 18, 2003 |
| John D. Lanam           |   |      |                         |     |   |
|                    |   |      |                         |     |   |
| */s/ Donald W. Leforce* |   |      | Chairman of the Board        |     | March 18, 2003 |
| Donald W. Leforce       |   |      |                         |     |   |
|                    |   |      |                         |     |   |
| */s/ Ellis L. Matthews* |   |      | Director                     |     | March 18, 2003 |
| Ellis L. Matthews       |   |      |                         |     |   |
|                    |   |      |                         |     |   |
| */s Robert L. Morgan*   |   |      | Director                     |     | March 18, 2003 |
| Robert L. Morgan        |   |      |                         |     |   |
|                    |   |      |                         |     |   |
| /s*/ Keith C. Robbins*  |   |      | President, Chief  Executive  |     | March 18, 2003 |
| Keith C. Robbins        |   |      | Officer and Director         |     |   |
|                    |   |      |                         |     |   |
| */s/ James S. Rickards* |   |      | Director and                 |     | March 18, 2003 |
| James S. Rickards       |   |      | Corporate Secretary          |     |   |
|                    |   |      |                         |     |   |
| */s/ Gary B. Strauss*   |   |      | Director                     |     | March 18, 2003 |
| Gary B. Strauss         |   |      | Vice Chairman                |     |   |
|                    |   |      |                         |     |   |
| */s/ Hubert Townshend*  |   |      | Director                     |     | March 18, 2003 |
| Hubert Townshend        |   |      |                         |     |   |
|                    |   |      |                         |     |   |
| */s/ John F. Coger*     |   |      | Executive Vice  President    |     | March 18, 2003 |
| John F. Coger           |   |      | and Chief  Financial Officer |     |   |

 

50

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#### **Certifications:  Pursuant to Section 302 of theSarbanes-Oxley Act of 2002**

 

I, Keith C. Robbins, certify that:

 

1. I have reviewed this annual report on Form10-K of Community Valley Bancorp;

 

2. Based on my knowledge, this annual reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this annual report;

 

3. Based on my knowledge, the financialstatements, and other financial information included in this annual report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this annual report;

 

4. The registrant’s other certifying officerand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and have:

 

a) designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this annual report isbeing prepared;

 

b) evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this annual report (the “Evaluation Date”); and

 

c) presented in this annual report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5. The registrant’s other certifying officerand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent functions):

 

a) all significant deficiencies in the designor operation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

b) any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

 

6. The registrant’s other certifying officerand I have indicated in this annual report whether there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 
| Date: March 18, 2003 | By:                                                  | /s/ Keith C. Robbins |   |
|----------------------|------------------------------------------------------|----------------------|--------|
|                 |                                                 |                 |   |
|                 | Keith C. Robbins, President, Chief Executive Officer |

 

51

----

 

I, John F. Coger, certify that:

 

1. I have reviewed this annual report on Form10-K of Community Valley Bancorp;

 

2. Based on my knowledge, this annual reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this annual report;

 

3. Based on my knowledge, the financialstatements, and other financial information included in this annual report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this annual report;

 

4. The registrant’s other certifying officerand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and have:

 

a) designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this annual report isbeing prepared;

 

b) evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this annual report (the “Evaluation Date”); and

 

c) presented in this annual report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5. The registrant’s other certifying officerand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent functions):

 

a) all significant deficiencies in the designor operation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

b) any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

 

6. The registrant’s other certifying officerand I have indicated in this annual report whether there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 
| Date: March 18, 2003 | By:                                               | /s/ John F. Coger |   |
|----------------------|---------------------------------------------------|-------------------|--------|
|                 |                                              |              |   |
|                 | John F. Coger                                     |
|                 | Executive Vice President, Chief Financial Officer |

 

52

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**COMMUNITY VALLEY BANCORP AND SUBSIDIARIES**

 

 

**CONSOLIDATED FINANCIAL STATEMENTS**

 

 

**FOR THE YEARS ENDED**

 

**DECEMBER 31, 2002, 2001 AND 2000**

 

**AND**

 

 

53

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**INDEPENDENTAUDITOR’S REPORT**

 

The Board ofDirectors

and Shareholders

Community ValleyBancorp

and subsidiaries

 

We have audited the accompanying consolidated balancesheet of Community Valley Bancorp and subsidiaries as of December 31, 2002 and2001, and the related consolidated statements of income, changes inshareholders' equity and cash flows for each of the years in the three-yearperiod ended December 31, 2002.  Thesefinancial statements are the responsibility of the company's management.  Out responsibility is to express an opinionon these financial statements based on our audits.

 

We conducted our audits in accordance with auditingstandards generally accepted in the United States of America.  Those standards require that we plan andperform the audits to obtain reasonable assurance about whether theconsolidated financial statements are free of amounts and disclosures in thefinancial statements.  An audit alsoincludes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation.  We believe that ouraudits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the consolidatedfinancial position of Community Valley Bancorp and subsidiaries as of December31,2002 and 2001 and the consolidated results of their operations and theircash flows for each of the years in the three-year period ended December 31,2002, in conformity with accounting principles generally accepted in the UnitedStates of America.  

 

 

                                                                                                       /s/Perry-SmithLLP

 

Sacramento, California

February 13, 2003

 

54

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**COMMUNITY VALLEY BANCORP AND SUBSIDIARIES**

 

**CONSOLIDATEDBALANCE SHEET**

 

**December 31, 2002 and 2001**

 
|                                                                                                                                    |   | **2002**    |        | **2001**    |   |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------|-------------|-------------|-------------|--------|
|                                                                                                                                    |   |        |        |        |   |
| **ASSETS**                                                                                                                              |   |        |        |        |   |
|                                                                                                                                    |   |        |        |        |   |
| Cash and due  from banks                                                                                                                |   | $           | 15,621,400  |        | $      | 12,401,600 |   |
| Federal funds  sold                                                                                                                     |   | 57,410,000  |        | 37,270,000  |   |
| Interest-bearing  deposits in banks                                                                                                     |   | 4,061,000   |        | 694,000     |   |
| Loans held for  sale                                                                                                                    |   | 7,911,700   |        | 5,978,500   |   |
| Investment  securities (Note 2):                                                                                                        |   |        |        |        |   |
| Available-for-sale,  at market value                                                                                                    |   | 514,000     |        | 499,800     |   |
| Held-to-maturity,  at cost, with market values of $2,924,000 in 2002 and $2,537,300 in 2001                                             |   | 2,872,900   |        | 2,507,000   |   |
| Loans, less  allowance for loan losses of $3,006,800 in 2002 and $2,396,700 in 2001 (Notes  3, 7 and 14)                                |   | 229,699,200 |        | 197,875,100 |   |
| Bank premises  and equipment, net (Note 5)                                                                                              |   | 6,653,100   |        | 5,642,100   |   |
| Accrued interest  receivable and other assets (Notes 4, 13 and 15)                                                                      |   | 12,492,000  |        | 9,595,400   |   |
|                                                                                                                                    |   |        |        |        |   |
|                                                                                                                                    |   | $           | 337,235,300 |        | $      | 272,463,500 |   |
|                                                                                                                                    |   |        |        |        |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                          |   |        |        |        |   |
|                                                                                                                                    |   |        |        |        |   |
| Deposits:                                                                                                                               |   |        |        |        |   |
| Non-interest  bearing                                                                                                                   |   | $           | 62,888,900  |        | $      | 45,838,200 |   |
| Interest bearing  (Note 6)                                                                                                              |   | 235,091,900 |        | 200,581,700 |   |
|                                                                                                                                    |   |        |        |        |   |
| Total deposits                                                                                                                          |   | 297,980,800 |        | 246,419,900 |   |
|                                                                                                                                    |   |        |        |        |   |
| Employee stock  ownership plan (ESOP) note payable (Notes 10 and 15)                                                                    |   | 732,100     |        | 851,500     |   |
| Mandatorily  redeemable cumulative trust preferred securities of subsidiary grantor trust  (Note 8)                                     |   | 8,000,000   |        |        |   |
| Accrued interest  payable and other liabilities                                                                                         |   | 5,141,800   |        | 4,371,900   |   |
|                                                                                                                                    |   |        |        |        |   |
| Total  liabilities                                                                                                                      |   | 311,854,700 |        | 251,643,300 |   |
|                                                                                                                                    |   |        |        |        |   |
| Commitments and  contingencies (Note 7)                                                                                                 |   |        |        |        |   |
|                                                                                                                                    |   |        |        |        |   |
| Shareholders’  equity (Note 11):                                                                                                   |   |        |        |        |   |
| Common stock -  no par value; authorized – 20,000,000 shares, issued – 2,685,351 shares in  2002 and 2,648,389 shares in 2001 |   | 6,660,000   |        | 6,131,300   |   |
| Unearned ESOP  shares (65,437 shares in 2002 and 73,669 shares in 2001, at cost) (Note 15)                                              |   | (851,900    | )           | (902,100    | )      |
| Retained  earnings                                                                                                                      |   | 19,558,400  |        | 15,591,000  |   |
| Accumulated  other comprehensive income (Note 2)                                                                                        |   | 14,100      |        |        |   |
|                                                                                                                                    |   |        |        |        |   |
| Total  shareholders’ equity                                                                                                        |   | 25,380,600  |        | 20,820,200  |   |
|                                                                                                                                    |   |        |        |        |   |
|                                                                                                                                    |   | $           | 337,235,300 |        | $      | 272,463,500 |   |

 

The accompanying notesare an integralpart of these consolidated financial statements.

 

 

55

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**COMMUNITY VALLEY BANCORP AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENT OF INCOME**

 

### **For the Years Ended December 31, 2002, 2001 and 2000**

 
|                                                     |   | **2002**   |       | **2001**   |   | **2000**   |   |
|----------------------------------------------------------|--------|------------|------------|------------|--------|------------|--------|
|                                                     |   |       |       |       |   |       |   |
| Interest income:                                         |   |       |       |       |   |       |   |
| Interest and  fees on loans                              |   | $          | 17,752,500 |       | $      | 18,456,700 |   | $ | 15,498,400 |   |
| Interest on  Federal funds sold                          |   | 572,700    |       | 659,400    |   | 624,200    |   |
| Interest on  deposits in banks                           |   | 81,200     |       | 60,800     |   | 155,700    |   |
| Interest on  investment securities:                      |   |       |       |       |   |       |   |
| Taxable                                                  |   | 89,400     |       | 91,700     |   | 118,500    |   |
| Exempt from  Federal income taxes                        |   | 76,200     |       | 120,100    |   | 135,100    |   |
|                                                     |   |       |       |       |   |       |   |
| Total interest  income                                   |   | 18,572,000 |       | 19,388,700 |   | 16,531,900 |   |
|                                                     |   |       |       |       |   |       |   |
| Interest  expense:                                       |   |       |       |       |   |       |   |
| Interest expense  on deposits (Note 6)                   |   | 4,735,000  |       | 7,289,300  |   | 5,465,300  |   |
| Interest expense  on ESOP note payable (Notes 10 and 15) |   | 39,500     |       | 55,000     |   | 52,600     |   |
|                                                     |   |       |       |       |   |       |   |
| Total interest  expense                                  |   | 4,774,500  |       | 7,344,300  |   | 5,517,900  |   |
|                                                     |   |       |       |       |   |       |   |
| Net interest  income                                     |   | 13,797,500 |       | 12,044,400 |   | 11,014,000 |   |
|                                                     |   |       |       |       |   |       |   |
| Provision for  loan losses (Note 3)                      |   | 603,000    |       | 500,000    |   | 805,000    |   |
|                                                     |   |       |       |       |   |       |   |
| Net interest  income after provision for loan losses     |   | 13,194,500 |       | 11,544,400 |   | 10,209,000 |   |
|                                                     |   |       |       |       |   |       |   |
| Non-interest  income:                                    |   |       |       |       |   |       |   |
| Service charges  and fees                                |   | 1,183,700  |       | 1,067,600  |   | 1,011,300  |   |
| Loan servicing  income                                   |   | 423,200    |       | 388,300    |   | 314,000    |   |
| Gain on sale of  loans                                   |   | 2,281,000  |       | 1,421,700  |   | 706,200    |   |
| Other (Note 12)                                          |   | 2,673,300  |       | 1,148,800  |   | 1,136,500  |   |
|                                                     |   |       |       |       |   |       |   |
| Total  non-interest income                               |   | 6,561,200  |       | 4,026,400  |   | 3,168,000  |   |
|                                                     |   |       |       |       |   |       |   |
| Non-interest  expense:                                   |   |       |       |       |   |       |   |
| Salaries and  employee benefits                          |   |       |       |       |   |       |   |
| (Notes 3 and 15)                                         |   | 6,558,700  |       | 5,297,800  |   | 4,652,800  |   |
| Occupancy and  equipment (Notes 5 and 7)                 |   | 1,557,400  |       | 1,336,300  |   | 1,281,500  |   |
| Other (Note 12)                                          |   | 4,415,100  |       | 2,701,300  |   | 2,464,200  |   |
|                                                     |   |       |       |       |   |       |   |
| Total  non-interest expense                              |   | 12,531,100 |       | 9,335,400  |   | 8,398,500  |   |
|                                                     |   |       |       |       |   |       |   |
| Income before  income taxes                              |   | 7,224,600  |       | 6,235,400  |   | 4,978,500  |   |
|                                                     |   |       |       |       |   |       |   |
| Income taxes  (Note 13)                                  |   | 2,375,000  |       | 2,424,000  |   | 1,932,000  |   |
|                                                     |   |       |       |       |   |       |   |
| Net income                                               |   | $          | 4,849,600  |       | $      | 3,811,400  |   | $ | 3,046,500 |   |
|                                                     |   |       |       |       |   |       |   |
| Basic earnings  per share (Note 11)                      |   | $          | 1.87       |       | $      | 1.53       |   | $ | 1.29 |   |
|                                                     |   |       |       |       |   |       |   |
| Diluted earnings  per share (Note 11)                    |   | $          | 1.78       |       | $      | 1.43       |   | $ | 1.16 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

56

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

 

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

 

**For the Years Ended December 31, 2002, 2001 and 2000**

 
|                                                                            |   | **Common  Stock** |       | **Unearned  ESOP  Shares** |       | **Retained  Earnings** |       | **Compre-  hensive  Income** |       | **Share-  holders’  Equity** |       | **Accum-  ulated  Other  Compre-  hensive  Income** |       |
|---------------------------------------------------------------------------------|--------|-------------------|------------|----------------------------|------------|------------------------|------------|------------------------------|------------|-----------------------------------|------------|-----------------------------------------------------|------------|
| **Shares**                                                                      |   | **Amount**        |
|                                                                            |   |              | ** ** |                       | ** ** |                   | ** ** |                         | ** ** |                              | ** ** |                                                | ** ** |   |   |
| Balance, January 1, 2000                                                        |   | 2,393,036         |       | $                          | 4,758,200  |                   | $          | (244,300                     | )          | $                                 | 9,323,700  |                                                |       |   | $ | 13,837,600 |   |   |   |
|                                                                            |   |              |       |                       |       |                   |       |                         |       |                              |       |                                                |       |   |   |
| Comprehensive income:                                                           |   |              |       |                       |       |                   |       |                         |       |                              |       |                                                |       |   |   |
| Net income                                                                      |   |              |       |                       |       |                   |       | 3,046,500                    |       |                              |       | 3,046,500                                           |       | $ | 3,046,500 |   |
|                                                                            |   |              |       |                       |       |                   |       |                         |       |                              |       |                                                |       |   |   |
| Exercise of stock options and related tax benefit (Note 11)                     |   | 45,425            |       | 301,700                    |       |                   |       |                         |       |                              |       | 301,700                                             |       |   |   |
| Earned ESOP shares (Note 15)                                                    |   |              |       | 85,200                     |       | 92,500                 |       |                         |       |                              |       | 177,700                                             |       |   |   |
| Shares acquired by ESOP (Note 15)                                               |   |              |       |                       |       | (519,700               | )          |                         |       |                              |       | (519,700                                            | )          |   |   |
|                                                                            |   |              |       |                       |       |                   |       |                         |       |                              |       |                                                |       |   |   |
| Balance, December 31, 2000                                                      |   | 2,438,461         |       | 5,145,100                  |       | (671,500               | )          | 12,370,200                   |       |                              |       | 16,843,800                                          |       |   |   |
|                                                                            |   |              |       |                       |       |                   |       |                         |       |                              |       |                                                |       |   |   |
| Comprehensive income:                                                           |   |              |       |                       |       |                   |       |                         |       |                              |       |                                                |       |   |   |
| Net income                                                                      |   |              |       |                       |       |                   |       | 3,811,400                    |       |                              |       | 3,811,400                                           |       | $ | 3,811,400 |   |
|                                                                            |   |              |       |                       |       |                   |       |                         |       |                              |       |                                                |       |   |   |
| Exercise of stock options and related tax benefit (Note 11)                     |   | 209,928           |       | 908,600                    |       |                   |       |                         |       |                              |       | 908,600                                             |       |   |   |
| Earned ESOP shares (Note 15)                                                    |   |              |       | 77,600                     |       | 61,300                 |       |                         |       |                              |       | 138,900                                             |       |   |   |
| Shares acquired by ESOP (Note 15)                                               |   |              |       |                       |       | (291,900               | )          |                         |       |                              |       | (291,900                                            | )          |   |   |
| Cash dividends - $.225 per share (Note 11)                                      |   |              |       |                       |       |                   |       | (590,600                     | )          |                              |       | (590,600                                            | )          |   |   |
|                                                                            |   |              |       |                       |       |                   |       |                         |       |                              |       |                                                |       |   |   |
| Balance, December 31, 2001                                                      |   | 2,648,389         |       | 6,131,300                  |       | (902,100               | )          | 15,591,000                   |       |                              |       | 20,820,200                                          |       |   |   |
|                                                                            |   |              |       |                       |       |                   |       |                         |       |                              |       |                                                |       |   |   |
| Comprehensive income:                                                           |   |              |       |                       |       |                   |       |                         |       |                              |       |                                                |       |   |   |
| Net income                                                                      |   |              |       |                       |       |                   |       | 4,849,600                    |       |                              |       | 4,849,600                                           |       | $ | 4,849,600 |   |
| Other comprehensive income:                                                     |   |              |       |                       |       |                   |       |                         |       |                              |       |                                                |       |   |   |
| Unrealized gains on available-for-sale investment securities (Note 2)           |   |              |       |                       |       |                   |       |                         |       | $                                 | 14,100     |                                                | 14,100     |   | 14,100 |   |
|                                                                            |   |              |       |                       |       |                   |       |                         |       |                              |       |                                                |       |   |   |
| Total comprehensive income                                                      |   |              |       |                       |       |                   |       |                         |       |                              |       |                                                |       | $ | 4,863,700 |   |
|                                                                            |   |              |       |                       |       |                   |       |                         |       |                              |       |                                                |       |   |   |
| Exercise of stock options and related tax benefit (Note 11)                     |   | 36,962            |       | 426,200                    |       |                   |       |                         |       |                              |       | 426,200                                             |       |   |   |
| Earned ESOP shares (Note 15)                                                    |   |              |       | 107,800                    |       | 50,200                 |       |                         |       |                              |       | 158,000                                             |       |   |   |
| Cash dividends - $.33 per share (Note 11)                                       |   |              |       |                       |       |                   |       | (882,200                     | )          |                              |       | (882,200                                            | )          |   |   |
| Cash in lieu of fractional shares in four-for-three stock split  (Note 11) |   |              |       | (5,300                     | )          |                   |       |                         |       |                              |       | (5,300                                              | )          |   |   |
|                                                                            |   |              |       |                       |       |                   |       |                         |       |                              |       |                                                |       |   |   |
| Balance, December 31, 2002                                                      |   | 2,685,351         |       | $                          | 6,660,000  |                   | $          | (851,900                     | )          | $                                 | 19,558,400 |                                                | $          | 14,100 |   | $ | 25,380,600 |   |   |   |

 

The accompanying notesare an integralpart of these consolidated financial statements.

 

57

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

 

**CONSOLIDATED STATEMENT OF CASH FLOWS**

 

**For the Years Ended December 31, 2002, 2001 and 2000**

 
|                                                                                                                 |   | **2002**    |       | **2001**    |   | **2000**    |    |
|----------------------------------------------------------------------------------------------------------------------|--------|-------------|------------|-------------|--------|-------------|---------|
|                                                                                                                 |   |        |       |        |   |        |    |
| Cash flows from  operating activities:                                                                               |   |        |       |        |   |        |    |
| Net income                                                                                                           |   | $           | 4,849,600  |        | $      | 3,811,400   |    | $ | 3,046,500 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:                                   |   |        |       |        |   |        |    |
| Provision for  loan losses                                                                                           |   | 603,000     |       | 500,000     |   | 805,000     |    |
| Increase in loan  origination fees, net                                                                              |   | 162,800     |       | 111,200     |   | 258,400     |    |
| Depreciation,  amortization and accretion, net                                                                       |   | 764,400     |       | 693,500     |   | 665,400     |    |
| Increase in cash  surrender value of life insurance policies, net                                                    |   | (176,600    | )          | (206,000    | )      | (203,500    | )       |
| Non-cash  compensation cost associated with the ESOP                                                                 |   | 158,000     |       | 138,900     |   | 177,700     |    |
| (Gain) loss on  disposition of premises and equipment                                                                |   | (153,000    | )          | (29,200     | )      | 25,200      |    |
| Gain on sale of  other real estate                                                                                   |   |        |       |        |   | (65,800     | )       |
| Gain on life  insurance death benefit                                                                                |   | (1,172,600  | )          |        |   |        |    |
| Writedown of  other real estate to market value                                                                      |   |        |       | 39,200      |   |        |    |
| Increase in  loans held for sale                                                                                     |   | (1,933,200  | )          | (4,318,900  | )      | (1,502,800  | )       |
| (Increase)  decrease in accrued interest receivable and other assets                                                 |   | (2,140,700  | )          | 1,114,300   |   | (845,500    | )       |
| Increase in  accrued interest payable and other liabilities                                                          |   | 699,900     |       | 879,400     |   | 922,500     |    |
| Deferred taxes                                                                                                       |   | (634,000    | )          | (286,000    | )      | (466,000    | )       |
|                                                                                                                 |   |        |       |        |   |        |    |
| Net cash  provided by operating activities                                                                           |   | 1,027,600   |       | 2,447,800   |   | 2,817,100   |    |
|                                                                                                                 |   |        |       |        |   |        |    |
| Cash flows from  investing activities:                                                                               |   |        |       |        |   |        |    |
| Purchase of  available-for-sale investment securities                                                                |   |        |       | (299,800    | )      | (200,000    | )       |
| Purchase of  held-to-maturity investment securities                                                                  |   | (1,617,000  | )          | (462,200    | )      |        |    |
| Proceeds from  matured or called held-to-maturity investment securities                                              |   | 1,135,000   |       | 2,057,000   |   | 946,000     |    |
| Proceeds from  principal repayments of held-to-maturity investment securities                                        |   | 94,600      |       |        |   |        |    |
| Net (increase)  decrease in interest-bearing deposits in banks                                                       |   | (3,367,000  | )          | 890,000     |   | 2,080,000   |    |
| Net increase in  loans                                                                                               |   | (32,589,900 | )          | (29,734,500 | )      | (52,886,500 | )       |
| Premiums paid  for life insurance policies                                                                           |   | (396,300    | )          | (143,700    | )      | (831,800    | )       |
| Death benefit  from life insurance policies                                                                          |   | 1,750,000   |       |        |   |        |    |
| Purchases of  premises and equipment                                                                                 |   | (2,017,000  | )          | (1,142,700  | )      | (302,400    | )       |
| Capitalized  additions to other real estate                                                                          |   |        |       |        |   | (18,800     | )       |
| Proceeds from  sale of equipment                                                                                     |   | 416,000     |       | 56,800      |   |        |    |
| Proceeds from  sale of other real estate                                                                             |   | 12,600      |       |        |   | 400,000     |    |
|                                                                                                                 |   |        |       |        |   |        |    |
| Net cash used in  investing activities                                                                               |   | (36,579,000 | )          | (28,779,100 | )      | (50,813,500 | )       |
|                                                                                                                 |   |        |       |        |   |        |    |
| Cash flows from  financing activities:                                                                               |   |        |       |        |   |        |    |
| Net increase in  demand, interest-bearing and savings deposits                                                       |   | $           | 72,408,500 |        | $      | 32,081,700  |    | $ | 25,713,900 |   |
| Net (decrease)  increase in time deposits                                                                            |   | (20,847,600 | )          | 20,213,300  |   | 25,537,400  |    |
| Repayments of  ESOP note payable                                                                                     |   | (119,400    | )          | (83,800     | )      | (122,800    | )       |
| Proceeds from  ESOP note payable                                                                                     |   |        |       | 291,900     |   | 516,400     |    |
| Purchase of  unearned ESOP shares                                                                                    |   |        |       | (291,900    | )      | (519,700    | )       |
| Proceeds from  exercise of stock options                                                                             |   | 287,200     |       | 454,000     |   | 103,800     |    |
| Cash paid for  fractional shares                                                                                     |   | (5,300      | )          |        |   |        |    |
| Payment of cash  dividend                                                                                            |   | (812,200    | )          | (391,900    | )      |        |    |
| Proceeds from  issuance of mandatorily redeemable cumulative trust preferred securities of  subsidiary grantor trust |   | 8,000,000   |       |        |   |        |    |
|                                                                                                                 |   |        |       |        |   |        |    |
| Net cash  provided by financing activities                                                                           |   | 58,911,200  |       | 52,273,300  |   | 51,229,000  |    |
|                                                                                                                 |   |        |       |        |   |        |    |
| Increase in cash  and cash equivalents                                                                               |   | 23,359,800  |       | 25,942,000  |   | 3,232,600   |    |
|                                                                                                                 |   |        |       |        |   |        |    |
| Cash and cash  equivalents at beginning of year                                                                      |   | 49,671,600  |       | 23,729,600  |   | 20,497,000  |    |
|                                                                                                                 |   |        |       |        |   |        |    |
| Cash and cash  equivalents at end of year                                                                            |   | $           | 73,031,400 |        | $      | 49,671,600  |    | $ | 23,729,600 |   |
|                                                                                                                 |   |        |       |        |   |        |    |
| Supplemental  disclosure of cash flow information:                                                                   |   |        |       |        |   |        |    |
|                                                                                                                 |   |        |       |        |   |        |    |
| Cash paid during  the year for:                                                                                      |   |        |       |        |   |        |    |
| Interest                                                                                                             |   | $           | 5,523,700  |        | $      | 7,240,600   |    | $ | 5,372,900 |   |
| Income taxes                                                                                                         |   | $           | 2,751,000  |        | $      | 2,279,000   |    | $ | 1,986,000 |   |
|                                                                                                                 |   |        |       |        |   |        |    |
| Non-cash  investing activities:                                                                                      |   |        |       |        |   |        |    |
| Net change in  unrealized gain on available-for-sale investment securities                                           |   | $           | 14,100     |        |   |        |    |   |
| Real estate acquired  through foreclosure                                                                            |   |        |       |        |   | $           | 876,500 |   |
|                                                                                                                 |   |        |       |        |   |        |    |
| Non-cash  financing activities:                                                                                      |   |        |       |        |   |        |    |
| Release of  unearned ESOP shares                                                                                     |   | $           | 50,200     |        | $      | 61,300      |    | $ | 92,500 |   |
| Accrual of cash  dividend declared                                                                                   |   | $           | 268,500    |        | $      | 198,700     |    |   |   |

 

The accompanying notesare an integralpart of these consolidated financial statements.

 

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

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

 

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

 

General

 

In May 2002, CommunityValley Bancorp (“Community Valley”) was incorporated as a bank holding companyfor the purpose of acquiring Butte Community Bank (the “Bank”) in a one bankholding company reorganization.  The newcorporate structure gives Community Valley and the Bank greater flexibility interms of operation, expansion and diversification.  The reorganization was approved by the Bank’s shareholders onMay 23, 2002, and all required regulatory approvals with respect to thereorganization were obtained.  Thereorganization was consummated in June 2002, subsequent to which the Bankcontinued its operations as previously conducted but as a wholly ownedsubsidiary of Community Valley.

 

On December 19, 2002,Community Valley formed a wholly-owned subsidiary, Community Valley BancorpTrust I, a Delaware statutory business trust, for the purpose of issuing andselling trust preferred securities (see Note 8).

 

The accounting andreporting policies of Community Valley Bancorp and its subsidiaries (collectively,the “Company”) conform with accounting principles generally accepted in theUnited States of America and prevailing practice within the bankingindustry.  The more significant of thesepolicies applied in the preparation of the accompanying consolidated financialstatements are discussed below.

 

Principles ofConsolidation

 

The accompanyingconsolidated financial statements include the accounts of Community Valley andits wholly-owned subsidiaries, Butte Community Bank and Community ValleyBancorp Trust I.  Significantintercompany transactions and balances have been eliminated in consolidation.

 

Reclassifications

 

Certain reclassificationshave been made to prior years’ balances to conform to classifications used in2002.

 

Use of Estimates

 

The preparation ofconsolidated financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions.  Theseestimates and assumptions affect the reported amounts of assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Actual results could 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 for one-day periods.

 

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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 comprehensiveincome 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 and mayonly change the classification in certain limited circumstances.  All transfers between categories areaccounted for at fair value.

 

Gains or losses on thesale of investment securities are computed using the specific identificationmethod.  Interest earned on investmentsecurities is reported in interest income, net of applicable adjustments foraccretion of discounts and amortization of premiums.  In addition, unrealized losses that are other than temporary are recognizedin earnings for all investments.

 

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 accrued daily based uponoutstanding loan balances.  However,when, in the opinion of management, loans are considered to be impaired and thefuture collectibility of interest and principal is in serious doubt, loans areplaced on nonaccrual status and the accrual of interest income issuspended.  Any interest accrued butunpaid is charged against income. Payments received are applied to reduce principal to the extentnecessary to ensure collection. Subsequent payments on these loans, or payments received on nonaccrualloans for which the ultimate collectibility of principal is not in doubt, areapplied first to earned but unpaid 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.  An impaired loan is measured based on thepresent value of expected future cash flows discounted at the loan’s effectiveinterest rate or, as a practical matter, at the loan’s observable market priceor the fair value of collateral if the loan is collateral dependent.

 

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 deferredfees and costs is reported as a component of net loans.

 

60

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Loan Sales and Servicing

 

Servicing rights acquiredthrough 1) a purchase or 2) the origination of loans which are sold orsecuritized with servicing rights retained are recognized as separate assets orliabilities.  Servicing assets orliabilities are recorded at the difference between the contractual servicingfees and adequate compensation for performing the servicing, and aresubsequently amortized in proportion to and over the period of the related netservicing income or expense.  Servicingassets are periodically evaluated for impairment.  Fair values are estimated using discounted cash flows based oncurrent market interest rates.  Forpurposes of measuring impairment, servicing assets are stratified based on noterate and term.  The amount of impairmentrecognized is the amount by which the servicing assets for a stratum exceedtheir fair value.

 

In addition, assets(accounted for as interest-only (IO) strips) are recorded at the fair value ofthe difference between note rates and rates paid to purchasers (the interestspread) and contractual servicing fees, if applicable.  IO strips are carried at fair value withgains or losses recorded as a component of shareholders’ equity, similar toavailable-for-sale investment securities.

 

###### **Government Guaranteed Loans**

 

Included in the portfolioare 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 loans may be sold to a third party, withthe Company retaining the unguaranteed portion.  The Company generally receives a premium in excess of theadjusted carrying value of the loan at the time of sale.  The Company may be required to refund aportion of the sales premium if the borrower defaults or the loan prepayswithin 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 portion of the loan is recognized as incomeat the time of sale.  The carrying valueof the retained portion of the loan is discounted based on the estimated valueof a comparable non-guaranteed loan. The servicing asset is amortized over the estimated life of the relatedloan.  Significant future prepayments ofthese loans will result in the recognition of additional amortization ofrelated servicing assets and an adjustment to the carrying value of related IOstrips.

 

The Company serviced SBA,RBS and FSA government guaranteed loans for others totaling $58,867,200 and$48,138,000 as of December 31, 2002 and 2001, respectively.

 

61

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###### **Mortgage Loans**

 

The Company originatesmortgage loans that are either held in the Company’s loan portfolio or sold inthe secondary market.  Loansheld-for-sale are carried at the lower of cost or market value.  Market value is determined by the specificidentification method as of the balance sheet date or the date which thepurchasers have committed to purchase the loans.  At the time the loan is sold, the related right to service theloan is either retained, with the Company earning future servicing income, orreleased in exchange for a one-time servicing-released premium.  Loans subsequently transferred to the loanportfolio are transferred at the lower of cost or market value at the date oftransfer.  Any difference between 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 $95,746,600and $68,313,000 as of December 31, 2002 and 2001, respectively.

 

ParticipationLoans

 

The Company also servicedloans which it has participated with other financial institutions totaling$7,069,400 and $11,034,000 as of December 31, 2002 and 2001, 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 theallowance for loan losses is based on estimates made by management, to includeconsideration of the character of the loan portfolio, specifically identifiedproblem loans, potential losses inherent in the portfolio taken as a whole andeconomic conditions in the Company’s service area.

 

Loans determined to beimpaired or classified are individually evaluated by management for specificrisk of loss.  In addition, a reserve factoris assigned to currently performing loans based on management’s assessment ofthe following for each identified loan type: (1) inherent credit risk, (2) historical losses and, (3) where theCompany has not experienced losses, the loss experience of peer banks.  These estimates are particularly susceptibleto changes in the economic environment and market conditions.

 

The Company’s LoanCommittee reviews the adequacy of the allowance for loan losses at leastquarterly, to include consideration of the relative risks in the portfolio andcurrent economic conditions.  Theallowance for loan losses is adjusted based on that review if, in the judgmentof the Loan Committee and management, changes are warranted.

 

62

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The allowance for loanlosses is established through a provision for loan losses which is charged toexpense.  Additions to the allowance forloan losses are expected to maintain the adequacy of the total allowance afterloan losses and loan growth.  Theallowance for loan losses at December 31, 2002 and 2001 reflectsmanagement’s estimate of possible losses in the portfolio.

 

Bank Premises andEquipment

 

Premises and equipmentare carried at cost.  Depreciation isdetermined using the straight-line method over the estimated useful lives ofthe related assets.  The useful lives ofBank premises are estimated to be thirty to thirty-nine years.  Leasehold improvements are amortized overthe life of the improvement or the life of the related lease, whichever isshorter.  The useful lives of furniture,fixtures and equipment are estimated to be three to ten years.  When assets are sold or otherwise disposedof, the cost and related accumulated depreciation are removed from theaccounts, and any resulting gain or loss is recognized in income for theperiod.  The cost of maintenance andrepairs is charged to expense as incurred.

 

Other Real Estate

 

Other real estateincludes real estate acquired in full or partial settlement of loanobligations.  When property is acquired,any excess of the Company’s recorded investment in the loan balance and accruedinterest income over the estimated fair market value of the property is chargedagainst the allowance for loan losses. A valuation allowance for losses on other real estate is maintained toprovide for temporary declines in value. The allowance is established through a provision for losses on otherreal estate which is included in other expenses.  Subsequent gains or losses on sales or writedowns resulting frompermanent impairments are recorded in other income or expense as incurred.  On the consolidated balance sheet, otherreal estate is included in accrued interest receivable and other assets and wasnot significant at December 31, 2002 and 2001.

 

Income Taxes

 

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

 

The Company accounts forincome taxes using the liability or balance sheet method.  Under this method, deferred tax assets andliabilities are recognized for the tax consequences of temporary differencesbetween the reported amounts of assets and liabilities and their taxbases.  Deferred tax assets andliabilities are adjusted for the effects of changes in tax laws and rates onthe date of enactment.  On theconsolidated balance sheet, net deferred tax assets are included in accruedinterest receivable and other assets.

 

63

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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 unearned shares of the Employee StockOwnership Plan.  Diluted EPS reflectsthe potential dilution that could occur if securities or other contracts toissue common stock, such as stock options, result in the issuance of common stockwhich shares in the earnings of the Company. The treasury stock method has been applied to determine the dilutiveeffect of stock options in computing diluted EPS.

 

Comprehensive Income

 

Comprehensive income isreported in addition to net income for all periods presented.  Comprehensive income represents net incomeplus or minus other comprehensive income or loss.  Unrealized gains or losses on the Company’s available-for-saleinvestment securities are the principle source of other comprehensive income orloss.  Because the Company holds itsinvestment securities principally as held-to-maturity securities, the Company’snet income approximates its comprehensive income.  Comprehensive income is reported in the accompanying Statement ofChanges in Shareholders’ Equity.

 

Stock-Based Compensation

 

At December 31, 2002, theCompany has three stock-based employee compensation plans, which are describedmore fully in Note 11.  The Companyaccounts for these plans under the recognition and measurement principles ofAPB Opinion No. 25, *Accounting for StockIssued to Employees*, and related Interpretations.  No stock-based employee compensation cost isreflected in net income, as all options granted under these plans had anexercise price equal to the market value of the underlying common stock on thedate of grant.

 

64

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The following tableillustrates the effect on net income and earnings per share if the Company hadapplied the fair value recognition provisions of FASB Statement No. 123, *Accounting for Stock-Based Compensation*,to stock-based employee compensation. Pro forma adjustments to the Company’s consolidated net earnings andearnings per share are disclosed during the years in which the options becomevested.

 
|                                                                                                                                                    |   | **2002** |      | **2001** |   | **2000**  |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|-----------|----------|--------|-----------|--------|
|                                                                                                                                                    |   |     |      |     |   |      |   |
| Net earnings, as reported                                                                                                                               |   | $        | 4,849,600 |     | $      | 3,811,400 |   | $ | 3,046,500 |   |
| Deduct:  Total stock-based employee compensation  expense determined under the fair value based method for all awards, net of  related tax effects |   | 273,900  |      | 150,800  |   | 159,200   |   |
|                                                                                                                                                    |   |     |      |     |   |      |   |
| Pro forma net  earnings                                                                                                                                 |   | $        | 4,575,700 |     | $      | 3,660,600 |   | $ | 2,887,300 |   |
|                                                                                                                                                    |   |     |      |     |   |      |   |
| Basic earnings  per share -as reported                                                                                                                  |   | $        | 1.87      |     | $      | 1.53      |   | $ | 1.29 |   |
| Basic earnings  per share - pro forma                                                                                                                   |   | $        | 1.76      |     | $      | 1.47      |   | $ | 1.23 |   |
|                                                                                                                                                    |   |     |      |     |   |      |   |
| Diluted earnings  per share - as reported                                                                                                               |   | $        | 1.78      |     | $      | 1.43      |   | $ | 1.16 |   |
| Diluted earnings  per share - pro forma                                                                                                                 |   | $        | 1.72      |     | $      | 1.40      |   | $ | 1.11 |   |

 

The fair value of eachoption is estimated on the date of grant using an option pricing model with thefollowing assumptions:

 
|                                                            |   | **2002** |   | **2000**  |   |
|-----------------------------------------------------------------|--------|----------|--------|-----------|--------|
| Expected  volatility                                            |   | 64.58    | %      | 52.09     | %      |
| Risk-free  interest rate                                        |   | 4.58     | %      | 6.31-6.68 | %      |
| Expected option  life                                           |   | 10 years |   | 10 years  |   |
| Weighted average  fair value of options granted during the year |   | $        | 5.72   |      | $      | 8.30 |   |
|                                                                 |        |          |        |           |        |  |  |

 

65

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Impact of New FinancialAccounting Standards

 

InDecember 2002, the Financial Accounting Standards Board (FASB) issued SFASNo. 148, *Accounting for Stock-BasedCompensation—Transition and Disclosure—an amendment of FASB Statement No. 123*.  This Statement amends SFAS No. 123, *Accounting for Stock-Based Compensation*,to provide alternativemethods of transition for a voluntary change to the fair value based method ofaccounting for stock-based employee compensation.  In addition, this statement amends the disclosure requirements ofSFAS No. 123 to require prominent disclosures in both annual and interimfinancial statements about the method of accounting for stock-based employeecompensation and the effect of the method used on reported results.  The transition guidance and annualdisclosure provisions of SFAS No.  148 are effective for fiscal yearsending after December 15, 2002. The interim disclosure provisions are effective for financial reportingcontaining financial statements for interim periods beginning afterDecember 15, 2002.  Because theCompany accounts for the compensation cost associated with its stock optionplan under the intrinsic value method, the alternative methods of transitionwill not apply to the Company.  Theadditional disclosure requirements of the statement are included in thesefinancial statements.  In management’sopinion, the adoption of this Statement did not have a material impact on theCompany’s consolidated financial position or results of operations.

 

**2.****                   INVESTMENTSECURITIES**

 

The amortized cost and estimated market value of investment securities at December 31, 2002and 2001 consisted of the following:

 

Available-for-Sale:

 
|                                                |   | **2002**            |    |
|-----------------------------------------------------|--------|---------------------|---------|
|                                                |   | **Amortized  Cost** |    | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Estimated  Market  Value** |   |
|                                                |   |                |    |   |   |   |   |   |   |
| U.S. Government  agencies                           |   | $                   | 299,900 |   | $ | 14,100 |   |   |   | $ | 314,000 |   |
| Obligations of  states and political sub- divisions |   | 200,000             |    |   |   |   |   | 200,000 |   |
|                                                |   |                |    |   |   |   |   |   |   |
|                                                |   | $                   | 499,900 |   | $ | 14,100 |   | $ | — |   | $ | 514,000 |   |
|                                                     |        |                     |         |  |  |  |  |  |  |  |  |  |  |

 

66

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|                                                |   | **2001**            |    |
|-----------------------------------------------------|--------|---------------------|---------|
|                                                |   | **Amortized  Cost** |    | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Estimated  Market  Value** |   |
|                                                |   |                |    |   |   |   |   |   |   |
| U.S. Government  agencies                           |   | $                   | 299,800 |   |   |   |   |   | $ | 299,800 |   |
| Obligations of  states and political sub- divisions |   | 200,000             |    |   |   |   |   | 200,000 |   |
|                                                |   |                |    |   |   |   |   |   |   |
|                                                |   | $                   | 499,800 |   | $ | — |   | $ | — |   | $ | 499,800 |   |
|                                                     |        |                     |         |  |  |  |  |  |  |  |  |  |  |

 

Unrealized gains onavailable-for-sale investment securities totaling $14,100 were recorded asaccumulated other comprehensive income within shareholders’ equity at December31, 2002.  Tax expense associated with such gains werenot significant.  There were no sales ortransfers of available-for-sale investment securities for the years endedDecember 31, 2002, 2001 and 2000.

 

Held-to Maturity:

 

 
|                                                |   | **2002**            |      |
|-----------------------------------------------------|--------|---------------------|-----------|
|                                                |   | **Amortized  Cost** |      | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Estimated  Market  Value** |   |
|                                                |   |                |      |   |   |   |   |   |   |
| U.S. Government  agencies                           |   | $                   | 1,882,000 |   | 28,400 |   | (100 | ) | $ | 1,910,300 |   |
| Obligations of  states and political sub- divisions |   | 990,900             |      | 23,900 |   | (1,100 | ) | 1,013,700 |   |
|                                                |   |                |      |   |   |   |   |   |   |
|                                                |   | $                   | 2,872,900 |   | $ | 52,300 |   | $ | (1,200 | ) | $ | 2,924,000 |   |
|                                                     |        |                     |           |  |  |  |  |  |  |  |  |  |  |

 

 

 
|                                                |   | **2001**            |      |
|-----------------------------------------------------|--------|---------------------|-----------|
|                                                |   | **Amortized  Cost** |      | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Estimated  Market  Value** |   |
|                                                |   |                |      |   |   |   |   |   |   |
| U.S. Government  agencies                           |   | $                   | 619,500   |   | $ | 5,500 |   |   |   | $ | 625,000 |   |
| Obligations of  states and political sub- divisions |   | 1,887,500           |      | 28,400 |   | (3,600 | ) | 1,912,300 |   |
|                                                |   |                |      |   |   |   |   |   |   |
|                                                |   | $                   | 2,507,000 |   | $ | 33,900 |   | $ | (3,600 | ) | $ | 2,537,300 |   |
|                                                     |        |                     |           |  |  |  |  |  |  |  |  |  |  |

 

67

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There were no sales or transfers of held-to-maturityinvestment securities for the years ended December 31, 2002, 2001 and 2000.

 

The amortized cost and estimated market value ofinvestment securities at December 31, 2002, by contractual maturity, areshown below.  Expected maturities willdiffer from contractual maturities because the issuers of securities may havethe right to call or prepay obligations with or without prepayment penalties.

 
|                                |   | **Available-for-Sale** |    | **Held-to-Maturity**         |   |
|-------------------------------------|--------|------------------------|---------|------------------------------|--------|
|                                |   | **Amortized  Cost**    |    | **Estimated  Market  Value** |   | **Amortized  Cost** |   | **Estimated  Market  Value** |   |
|                                |   |                   |    |                         |   |   |   |   |   |
| Within one year                     |   |                   |    |                         |   | $ | 215,100 |   | $ | 218,600 |   |
| After one year  through five years  |   |                   |    |                         |   | 1,960,100 |   | 2,000,000 |   |
| After five years  through ten years |   | $                      | 499,900 |                         | $      | 514,000 |   | 252,900 |   | 261,600 |   |
| After ten years                     |   |                   |    |                         |   | 444,800 |   | 443,800 |   |
|                                |   | $                      | 499,900 |                         | $      | 514,000 |   | $ | 2,872,900 |   | $ | 2,924,000 |   |

 

Investment securities with amortized costs totaling$465,000 and $751,200 and  market valuestotaling $480,200 and $764,600 were pledged to secure public deposits andtreasury, tax and loan accounts at December 31, 2002 and 2001, respectively.

 

**3.****                   LOANS**

 

Outstanding loans are summarized as follows:

 
|                                 |   | **December  31,** |        |
|--------------------------------------|--------|-------------------|-------------|
|                                 |   | **2002**          |        | **2001** |   |
|                                 |   |              |        |   |   |
| Real estate -  mortgage              |   | $                 | 82,056,900  |   | $ | 52,315,200 |   |
| Real estate -  construction          |   | 64,565,200        |        | 68,939,900 |   |
| Commercial                           |   | 48,660,700        |        | 42,517,100 |   |
| Agricultural                         |   | 18,934,700        |        | 19,406,500 |   |
| Installment                          |   | 19,325,000        |        | 17,766,800 |   |
|                                 |   |              |        |   |   |
|                                 |   | 233,542,500       |        | 200,945,500 |   |
|                                 |   |              |        |   |   |
| Deferred loan  origination fees, net |   | (836,500          | )           | (673,700 | ) |
| Allowance for  loan losses           |   | (3,006,800        | )           | (2,396,700 | ) |
|                                 |   |              |        |   |   |
|                                 |   | $                 | 229,699,200 |   | $ | 197,875,100 |   |

 

68

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Changes in the allowancefor loan losses were as follows:

 
|                             |   | **Year Ended  December 31,** |      |
|----------------------------------|--------|------------------------------|-----------|
|                             |   | **2002**                     |      | **2001** |   | **2000** |   |
|                             |   |                         |      |   |   |   |   |
| Balance,  beginning of year      |   | $                            | 2,396,700 |   | $ | 2,000,200 |   | $ | 1,390,000 |   |
| Provision  charged to operations |   | 603,000                      |      | 500,000 |   | 805,000 |   |
| Losses charged  to allowance     |   | (7,400                       | )         | (133,300 | ) | (215,600 | ) |
| Recoveries                       |   | 14,500                       |      | 29,800 |   | 20,800 |   |
|                             |   |                         |      |   |   |   |   |
| Balance, end of  year            |   | $                            | 3,006,800 |   | $ | 2,396,700 |   | $ | 2,000,200 |   |

 

The Company had nosignificant loans which management considered to be impaired during the yearsended December 31, 2002, 2001 and 2000.

 

At December 31, 2002 and2001, nonaccrual loans totaled $594,300 and $1,765,000, respectively.  Interest foregone on nonaccrual loanstotaled $35,400, $21,600 and $28,200 for the years ended December 31, 2002,2001 and 2000, respectively.

 

Salaries and employeebenefits totaling$980,100, $820,600 and $790,600 have been deferred as loan origination costsfor the years ended December 31, 2002, 2001 and 2000, respectively.

 

**4.****                   MORTGAGESERVICING ASSETS**

 

Mortgage servicing assetsare carried at their amortized cost, which approximates fair value, of $761,300and $431,000 at December 31, 2002 and 2001, respectively.  Originated mortgage servicing assetstotaling $546,000, $87,700 and $19,300 were recognized during the years endedDecember 31, 2002, 2001 and 2000, respectively.  In addition, during the year ended December 31, 2000 the Companypaid $166,000 to another financialinstitution to acquire the rights to service mortgage loans totaling$15,838,000.  Amortization of mortgageservicing assets totaled $209,900, $176,300 and $132,300 for the years endedDecember 31, 2002, 2001 and 2000, respectively.  On the consolidated balance sheet, mortgage servicing assets areincluded in accrued interest receivable and other assets.

 

69

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

 

Premises and equipmentconsisted of the following:

 
|                               |   | **December  31,** |      |
|------------------------------------|--------|-------------------|-----------|
|                               |   | **2002**          |      | **2001** |   |
|                               |   |              |      |   |   |
| Land                               |   | $                 | 1,192,800 |   | $ | 1,192,800 |   |
| Building and  improvements         |   | 4,632,600         |      | 3,564,600 |   |
| Furniture,  fixtures and equipment |   | 3,977,100         |      | 3,333,400 |   |
| Leasehold  improvements            |   | 329,800           |      | 127,000 |   |
| Construction in  progress          |   | 102,700           |      | 417,700 |   |
|                               |   |              |      |   |   |
|                               |   | 10,235,000        |      | 8,635,500 |   |
| Less accumulated  depreciation     |   |              |      |   |   |
| and amortization                   |   | (3,581,900        | )         | (2,993,400 | ) |
|                               |   |              |      |   |   |
|                               |   | $                 | 6,653,100 |   | $ | 5,642,100 |   |

 

Depreciation andamortization included in occupancy and equipment expense totaled $742,800, $690,200 and $654,900 for theyears ended December 31, 2002, 2001 and 2000, respectively.

 

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

 

Interest-bearing depositsconsisted of the following:

 

 
|                            |   | **December 31,** |        |
|---------------------------------|--------|------------------|-------------|
|                            |   | **2002**         |        | **2001** |   |
|                            |   |             |        |   |   |
| Savings                         |   | $                | 19,558,100  |   | $ | 16,192,200 |   |
| Money market                    |   | 22,851,800       |        | 11,538,100 |   |
| NOW accounts                    |   | 108,615,100      |        | 67,936,900 |   |
| Individual  retirement accounts |   | 6,874,400        |        | 5,801,700 |   |
| Time, $100,000  or more         |   | 23,830,800       |        | 28,439,500 |   |
| Other time                      |   | 53,361,700       |        | 70,673,300 |   |
|                            |   |             |        |   |   |
|                            |   | $                | 235,091,900 |   | $ | 200,581,700 |   |

 

Aggregate annualmaturities of time deposits at December 31, 2002 are as follows:

 

| **Year Ending December 31,** |   |       |       |
|------------------------------|--------|------------|------------|
|                         |   |       |       |
| 2003                         |   | $          | 50,662,400 |   |
| 2004                         |   | 2,735,100  |       |
| 2005                         |   | 22,858,900 |       |
| 2006                         |   | 936,100    |       |
|                         |   |       |       |
|                         |   | $          | 77,192,500 |   |

 

70

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

 
|                            |   | **Year Ended  December 31,** |      |
|---------------------------------|--------|------------------------------|-----------|
|                            |   | **2002**                     |      | **2001** |   | **2000** |   |
|                            |   |                         |      |   |   |   |   |
| Savings                         |   | $                            | 173,400   |   | $ | 244,100 |   | $ | 279,200 |   |
| Money market                    |   | 341,400                      |      | 545,100 |   | 569,900 |   |
| NOW accounts                    |   | 1,042,800                    |      | 680,400 |   | 607,400 |   |
| Individual  retirement accounts |   | 218,400                      |      | 276,900 |   | 191,200 |   |
| Time, $100,000  or more         |   | 807,300                      |      | 1,652,000 |   | 988,700 |   |
| Other time                      |   | 2,151,700                    |      | 3,890,800 |   | 2,828,900 |   |
|                            |   |                         |      |   |   |   |   |
|                            |   | $                            | 4,735,000 |   | $ | 7,289,300 |   | $ | 5,465,300 |   |

 

**7.****                   COMMITMENTSAND CONTINGENCIES**

 

Leases

 

The Company leases threebranch offices and certain equipment under noncancellable operatingleases.  Future minimum lease payments,net of sublease income, are as follows:

 

 

| **Year Ending December 31,** |   |    |    |
|------------------------------|--------|---------|---------|
|                         |   |    |    |
| 2003                         |   | $       | 75,700  |   |
| 2004                         |   | 67,600  |    |
| 2005                         |   | 78,800  |    |
| 2006                         |   | 87,700  |    |
| 2007                         |   | 96,400  |    |
| Thereafter                   |   | 502,600 |    |
|                         |   |    |    |
|                         |   | $       | 908,800 |   |

 

Rental expense, net ofrental income, included in occupancy and equipment expense totaled $144,800,$137,700 and $105,400 for the years ended December 31, 2002, 2001 and 2000,respectively.

 

The North Chico branchlease can be renewed for two successive three-year terms after the leaseexpires March 31, 2003 and the Central Chico branch can be renewed for foursuccessive five-year terms after the lease expires September 30, 2011.

 

71

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Financial InstrumentsWith Off-Balance-Sheet Risk

 

The Company is a party tofinancial instruments with off-balance-sheet risk in the normal course ofbusiness in order to meet the financing needs of its customers.  These financial instruments includecommitments to extend credit and letters of credit.  These instruments involve, to varying degrees, elements of creditand interest rate risk in excess of the amount recognized on the balance sheet.

 

The Company’s exposure tocredit loss in the event of nonperformance by the other party for commitmentsto extend credit and letters of credit is represented by the contractual amountof those instruments.  The Company usesthe same credit policies in making commitments and letters of credit as it doesfor loans included on the balance sheet.

 

The following financialinstruments represent off-balance-sheet credit risk:

 
|                          |   | **December 31,** |        |
|-------------------------------|--------|------------------|-------------|
|                          |   | **2002**         |        | **2001** |   |
|                          |   |             |        |   |   |
| Commitments to  extend credit |   | $                | 103,605,300 |   | $ | 82,621,000 |   |
| Letters of  credit            |   | $                | 2,229,500   |   | $ | 2,048,900 |   |

 

Commitments to extendcredit are agreements to lend to a customer as long as there is no violation ofany condition established in the contract. Commitments generally have fixed expiration dates or other terminationclauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawnupon, the total commitment amounts do not necessarily represent future cashrequirements.  Each customer’screditworthiness is evaluated on a case-by-case basis.  The amount of collateral obtained, if deemednecessary upon extension of credit, is based on management’s credit evaluationof the borrower.  Collateral heldvaries, but may include deposit accounts, accounts receivable, inventory,equipment and deeds of trust on residential real estate and income-producingcommercial properties.

 

Letters of credit areconditional commitments issued to guarantee the performance of a customer to athird party.  The credit risk involvedin issuing letters of credit is essentially the same as that involved inextending loans to customers.

 

Commercial loancommitments represent approximately 14% of total commitments and are generallyunsecured or secured by collateral other than real estate and have variableinterest rates.  Agricultural loancommitments represent approximately 8% of total commitments and are generallysecured by crop assignments, accounts receivable and farm equipment and havevariable interest rates.  Real estateloan commitments represent approximately 70% of total commitments and aregenerally secured by property with a loan-to-value ratio not to exceed80%.  The majority of real estate commitmentsalso have variable interest rates. Personal lines of credit and home equity lines of credit represent theremaining 8% of total commitments and are generally unsecured or secured byresidential real estate and have both variable and fixed interest rates.

 

72

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SignificantConcentrations of Credit Risk

 

The Company grants realestate mortgage, real estate construction, commercial, agricultural andconsumer loans to customers throughout Butte, Sutter, Yuba and Placer Counties.

 

Although the Company hasa diversified loan portfolio, a substantial portion of its portfolio is securedby commercial and residential real estate. However, personal and business income represent the primary source ofrepayment for a majority of these loans.

 

In addition, theCompany’s real estate construction loans represent approximately 28% ofoutstanding loans at December 31, 2002, compared to approximately 34% atDecember 31, 2001.  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 more than the normal risk of collection, asubstantial decline in the performance of the economy in general or a declinein real estate values in the Company’s primary market areas, in particular,could have an adverse impact on the collectibility of these loans.

 

Correspondent BankingAgreements

 

The Company maintainsfunds on deposit with other federally insured financial institutions undercorrespondent banking agreements. Uninsured deposits totaled $1,421,100 at December 31, 2002.

 

Federal ReserveRequirements

###### ** **

Banks are required tomaintain reserves with the Federal Reserve Bank equal to a percentage of theirreservable deposits less vault cash. The Bank’s vault cash fulfilled its reserve requirement at December 31,2002.

 

Contingencies

 

The Company is subject tolegal proceedings and claims which arise in the ordinary course ofbusiness.  In the opinion of management,the amount of ultimate liability with respect to such actions will notmaterially affect the financial position or results of operations of theCompany.

 

**8.****                   MANDATORILY REDEEMABLE CUMULATIVE TRUSTPREFERRED SECURITIES OF SUBSIDIARY GRANTOR TRUST**

 

Community Valley BancorpTrust I (CVB Trust I) is a Delaware statutory business trust formed by theCompany for the sole purpose of issuing trust preferred securities fully andunconditionally guaranteed by the Company.

 

73

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In December 2002, theCompany issued to CVB Trust I subordinated deferrable interest debentures dueDecember 31, 2032.  Simultaneously, CVBTrust I issued 8,000 floating rate capital securities, with liquidation valuesof $1,000 per security, for gross proceeds of $8,000,000.  The subordinated debentures represent thesole assets of CVB Trust I.  The subordinateddebentures are redeemable by the Company, subject to the receipt by the Companyof prior approval from the Federal Reserve Bank (FRB), if then required underapplicable capital guidelines or policies of the FRB.  The Company may redeem the subordinated debentures on anyDecember 31st on or after December 31, 2007. The redemption price shall be par plus accrued and unpaid interest,except in the case of redemption under a special event which is defined in thedebenture.  The floating rate capitalsecurities are subject to mandatory redemption to the extent of any earlyredemption of the subordinated debentures and upon maturity of the subordinateddebentures on December 31, 2032.

 

Holders of the securitiesare entitled to cumulative cash distributions on the liquidation amount of$1,000 per security.  Interest rates onthe capital securities and debentures are computed on a 360-day basis.  The stated interest rate is the three-monthLondon Interbank Offered Rate (LIBOR) plus 3.3%, with a maximum rate of 12.5%annually, adjustable quarterly.

 

The subordinateddebentures and related CVB Trust I investment in the subordinated debentureshave been eliminated in consolidation and the capital securities are reflectedas outstanding in the accompanying consolidated balance sheet.  Under applicable regulatory guidelines, allof the capital securities qualify as Tier 1 capital for the Company at December31, 2002.

 

**9.****                   SHORT-TERMBORROWING ARRANGEMENTS**

 

The Company has $6,000,000 in unsecured borrowingarrangements with two of its correspondent banks to meet short-term liquidityneeds.  There were no borrowingsoutstanding under these arrangements at December 31, 2002 and 2001.

 

**10.****            EMPLOYEESTOCK OWNERSHIP PLAN (ESOP) NOTE PAYABLE**

 

The ESOP obtained financing through a $1,000,000unsecured line of credit from another financial institution with the Companyacting as the guarantor (see Note 15). The note has a variable interest rate, based on an independent index,and a maturity date of March 8, 2008. At December 31, 2002, the interest rate was 4.25%.  Advances on the line of credit totaled $732,100and $851,500 at December 31, 2002 and 2001, respectively.

 

74

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

 

Dividends

 

The California FinancialCode restricts the total dividend payment of any bank in any calendar year tothe lesser of (1) the bank’s retained earnings or (2) the bank’s net income forits last three fiscal years, less distributions made to shareholders during thesame three-year period.  At December 31,2002, retained earnings of $10,394,700 were free of such restrictions.

 

On December 17, 2002, theBoard of Directors declared a cash dividend of $.10 per common stock sharepayable January 28, 2003 to shareholders of record on January 2,2003.  On the consolidated balancesheet, the dividends payable are included in accrued interest payable and otherliabilities and a corresponding reduction is shown in retained earnings.  In January, April, July and October 2002,the Company paid cash dividends of $.075, $.075, $.075 and $.08 per share ofcommon stock to shareholders of record on January 2, April 19, July 5 andOctober 8, respectively.  In 2001, theCompany paid cash dividends of $.075 per share of common stock to shareholdersof record on June 1 and October 1, 2001.

 

Stock Split

 

On August 20, 2002, theBoard of Directors declared a four-for-three stock split effective September30, 2002 for shareholders of record on September 16, 2002.  All share and per share data has beenretroactively adjusted to reflect the stock split.

 

75

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Stock Options

 

The Company has established stock option plans forwhich shares of common stock have been reserved for issuance to employees anddirectors under incentive and nonstatutory agreements.  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 in full at the time the option isexercised.  The options expire on a datedetermined by the Board of Directors, but not later than ten years from thedate of grant.  The vesting period isdetermined by the Board of Directors and is generally over five years; however,nonstatutory options granted during 1997 vested immediately.  Under the 1997 and 1991 plans, 171,002shares of common stock are reserved for issuance to employees and directors,and the related options are exercisable until their expiration.  However, no new options will be grantedunder these plans.  Under the Company’s2000 stock option plan, 279,865 shares of common stock are reserved forissuance to employees and directors, of which 86,371 shares are available forfuture grants.

 
|                                    |   | **2002**   |         | **2001**                                |         | **2000**   |         |
|-----------------------------------------|--------|------------|--------------|-----------------------------------------|--------------|------------|--------------|
|                                    |   | **Shares** |         | **Weighted   Average  Exercise  Price** |         | **Shares** |         | **Weighted  Average  Exercise  Price** |   | **Shares** |   | **Weighted  Average  Exercise  Price** |   |
|                                    |   |       |         |                                    |         |       |         |   |   |   |   |   |   |
| ***Incentive  Options***                |   |       | *** *** |                                    | *** *** |       | *** *** |   | *** *** |
|                                    |   |       | *** *** |                                    | *** *** |       | *** *** |   | *** *** |   | *** *** |   | *** *** |
| Options  outstanding, beginning of year |   | 162,649    |         | $                                       | 8.46         |       | 294,573      |   | $ | 5.71 |   | 260,575 |   | $ | 4.00 |   |
|                                    |   |       |         |                                    |         |       |         |   |   |   |   |   |   |
| Options granted                         |   | 63,666     |         | $                                       | 18.88        |       |         |   |   |   | 53,333 |   | $ | 12.71 |   |
| Options  exercised                      |   | (26,730    | )            | $                                       | 8.41         |       | (131,924     | ) | $ | 2.33 |   | (19,335 | ) | $ | 2.97 |   |
|                                    |   |       |         |                                    |         |       |         |   |   |   |   |   |   |
| Options  outstanding, end of year       |   | 199,585    |         | $                                       | 11.79        |       | 162,649      |   | $ | 8.46 |   | 294,573 |   | $ | 5.71 |   |
|                                    |   |       |         |                                    |         |       |         |   |   |   |   |   |   |
| Options  exercisable, end of year       |   | 108,155    |         | $                                       | 7.48         |       | 98,064       |   | $ | 7.00 |   | 192,343 |   | $ | 3.41 |   |
|                                    |   |       | *** *** |                                    | *** *** |       | *** *** |   | *** *** |   | *** *** |   | *** *** |
| ***Nonstatutory  Options***             |   |       | *** *** |                                    | *** *** |       | *** *** |   | *** *** |
|                                    |   |       | *** *** |                                    | *** *** |       | *** *** |   | *** *** |   | *** *** |   | *** *** |
| Options  outstanding, beginning of year |   | 184,886    |         | $                                       | 9.60         |       | 262,890      |   | $ | 7.30 |   | 188,980 |   | $ | 3.92 |   |
|                                    |   |       |         |                                    |         |       |         |   |   |   |   |   |   |
| Options granted                         |   |       |         |                                    |         |       |         |   |   | 100,000 |   | $ | 12.56 |   |
| Options  exercised                      |   | (10,232    | )            | $                                       | 6.12         |       | (78,004      | ) | $ | 1.97 |   | (26,090 | ) | $ | 1.78 |   |
|                                    |   |       |         |                                    |         |       |         |   |   |   |   |   |   |
| Options  outstanding, end of year       |   | 174,654    |         | $                                       | 9.80         |       | 184,886      |   | $ | 9.60 |   | 262,890 |   | $ | 7.30 |   |
|                                    |   |       |         |                                    |         |       |         |   |   |   |   |   |   |
| Options  exercisable, end of year       |   | 114,654    |         | $                                       | 8.37         |       | 104,886      |   | $ | 7.35 |   | 162,890 |   | $ | 4.25 |   |

 

76

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###### **A summary of options outstanding at December31, 2002 follows:**

 
| **Range of Exercise Prices**                                     |   | **Number of  Options  Outstanding  December 31,  2002** |       | **Weighted  Average  Remaining  Contractual  Life** |       | **Number of  Options  Exercisable  December 31,  2002** |       |
|------------------------------------------------------------------|--------|---------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------------|------------|
|                                                             |   |                                                    | ** ** |                                                | ** ** |                                                    | ** ** |
| **Incentive Options**                                            |   |                                                    | ** ** |                                                | ** ** |                                                    | ** ** |
|                                                             |   |                                                    | ** ** |                                                | ** ** |                                                    | ** ** |
| $    2.73   -  $    7.03 |   | 85,239                                                  |       | 4.3 years                                           |       | 83,461                                                  |       |
| $  10.13   -  $  14.06                       |   | 50,680                                                  |       | 7.1 years                                           |       | 24,694                                                  |       |
| $  18.30   -  $  20.01                       |   | 63,666                                                  |       | 9.7 years                                           |       |                                                    |       |
|                                                             |   |                                                    |       |                                                |       |                                                    |       |
|                                                             |   | 199,585                                                 |       |                                                |       | 108,155                                                 |       |
|                                                             |   |                                                    | ** ** |                                                | ** ** |                                                    | ** ** |
| **Non-qualified  Options**                                       |   |                                                    | ** ** |                                                | ** ** |                                                    | ** ** |
|                                                             |   |                                                    | ** ** |                                                | ** ** |                                                    | ** ** |
| $    6.12                                         |   | 74,654                                                  |       | 4.3 years                                           |       | 74,654                                                  |       |
| $  12.56                                                    |   | 100,000                                                 |       | 7.3 years                                           |       | 40,000                                                  |       |
|                                                             |   |                                                    |       |                                                |       |                                                    |       |
|                                                             |   | 174,654                                                 |       |                                                |       | 114,654                                                 |       |

 

###### **EarningsPer Share**

 

###### **A reconciliation of the**numerators and denominators of the basic and diluted earnings per sharecomputations is as follows:

 
| **For the Year Ended**            |   | **Net  Income** |       | **Weighted  Average  Number of  Shares  Outstanding** |       | **Per Share  Amount** |       |
|-----------------------------------|--------|-----------------|------------|-------------------------------------------------------|------------|-----------------------|------------|
|                              |   |            | ** ** |                                                  | ** ** |                  | ** ** |
| **December 31,  2002**            |   |            | ** ** |                                                  | ** ** |                  | ** ** |
|                              |   |            | ** ** |                                                  | ** ** |                  | ** ** |
| Basic earnings  per share         |   | $               | 4,849,600  |                                                  | 2,595,836  |                  | $          | 1.87 |   |
|                              |   |            |       |                                                  |       |                  |       |
| Effect of  dilutive stock options |   |            |       | 134,111                                               |       |                  |       |
|                              |   |            |       |                                                  |       |                  |       |
| Diluted earnings  per share       |   | $               | 4,849,600  |                                                  | 2,729,947  |                  | $          | 1.78 |   |

 

77

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| **  For the  Year Ended**          |   | **Net  Income** |       | **Weighted  Average  Number of  Shares  Outstanding** |       | **Per Share  Amount** |       |
|-----------------------------------------|--------|-----------------|------------|-------------------------------------------------------|------------|-----------------------|------------|
|                                    |   |            | ** ** |                                                  | ** ** |                  | ** ** |
| **  December 31, 2001**            |   |            | ** ** |                                                  | ** ** |                  | ** ** |
|                                    |   |            | ** ** |                                                  | ** ** |                  | ** ** |
|   Basic earnings per share         |   | $               | 3,811,400  |                                                  | 2,492,572  |                  | $          | 1.53 |   |
|                                    |   |            |       |                                                  |       |                  |       |
|   Effect of dilutive stock options |   |            |       | 187,733                                               |       |                  |       |
|                                    |   |            |       |                                                  |       |                  |       |
|   Diluted earnings per share       |   | $               | 3,811,400  |                                                  | 2,680,305  |                  | $          | 1.43 |   |
|                                    |   |            | ** ** |                                                  | ** ** |                  | ** ** |
| **  December 31, 2000**            |   |            | ** ** |                                                  | ** ** |                  | ** ** |
|                                    |   |            | ** ** |                                                  | ** ** |                  | ** ** |
|   Basic earnings per share         |   | $               | 3,046,500  |                                                  | 2,361,935  |                  | $          | 1.29 |   |
|                                    |   |            |       |                                                  |       |                  |       |
|   Effect of dilutive stock options |   |            |       | 267,520                                               |       |                  |       |
|                                    |   |            |       |                                                  |       |                  |       |
|   Diluted earnings per share       |   | $               | 3,046,500  |                                                  | 2,629,455  |                  | $          | 1.16 |   |

 

Shares of common stockissuable under stock options for which the exercise prices were greater thanthe average market prices were not included in the computation of dilutedearnings per share due to their antidilutive effect.  Options to issue 155,111 and 153,333 shares of common stock atprices ranging from $12.10 to $14.06 were not included in the computation ofdiluted earnings per share for the first two quarters of the year endingDecember 31, 2001 and the entire year ending December 31, 2000 becausetheir effect would be antidilutive.

 

Regulatory Capital

 

The Company and the Bankare subject to certain regulatory capital requirements administered by theBoard of Governors of the Federal Reserve System and the Federal DepositoryInsurance Corporation (FDIC).  Failureto meet these minimum capital requirements can initiate certain mandatory, andpossibly additional discretionary, actions by regulators that, if undertaken,could have a direct material effect on the Company’s consolidated financialstatements.  Under capital adequacy guidelinesand the regulatory framework for prompt corrective action, the Bank must meetspecific capital guidelines that involve quantitative measures of their assets,liabilities and certain off-balance-sheet items as calculated under regulatoryaccounting practices.  The Company’s andthe Bank’s capital amounts and classifications are also subject to qualitativejudgments by the regulators about components, risk weightings and otherfactors.

 

78

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Quantitative measuresestablished by regulation to ensure capital adequacy require the Company andthe Bank to maintain minimum amounts and ratios of total and Tier 1 capital torisk-weighted assets and of Tier 1 capital to average assets as set forth onthe following table.  Each of thesecomponents is defined in the regulations. Management believes that the Company and the Bank meet all their capitaladequacy requirements as of December 31, 2002 and 2001.

 

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

 
|                                     |   | **Actual** |       | **For  Capital  Adequacy Purposes** |       | **To Be Well  Capitalized  Under Prompt Corrective  Action Provisions** |       |
|------------------------------------------|--------|------------|------------|-------------------------------------|------------|-------------------------------------------------------------------------|------------|
|                                     |   | **Amount** |       | **Ratio**                           |       | **Minimum  Amount**                                                     |       | **Minimum  Ratio** |   | **Minimum  Amount** |   | **Minimum  Ratio** |   |
|                                     |   |       | ** ** |                                | ** ** |                                                                    | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **December 31,  2002**                   |   |       | ** ** |                                | ** ** |                                                                    | ** ** |   | ** ** |   | ** ** |   | ** ** |
|                                     |   |       | ** ** |                                | ** ** |                                                                    | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Company:                                 |   |       |       |                                |       |                                                                    |       |   |   |   |   |   |   |
| Total capital  (to risk-weighted assets) |   | $          | 36,249,300 |                                | 14.0       | %                                                                       | $          | 20,786,800 |   | 8.0 | % | N/A |   | N/A |   |
| Tier 1 capital (to risk-weighted assets) |   | $          | 33,242,500 |                                | 12.8       | %                                                                       | $          | 10,393,400 |   | 4.0 | % | N/A |   | N/A |   |
| Tier 1 capital (to average assets)       |   | $          | 33,242,500 |                                | 10.4       | %                                                                       | $          | 12,808,500 |   | 4.0 | % | N/A |   | N/A |   |
|                                     |   |       |       |                                |       |                                                                    |       |   |   |   |   |   |   |
| Bank:                                    |   |       |       |                                |       |                                                                    |       |   |   |   |   |   |   |
| Total capital (to risk-weighted assets)  |   | $          | 28,249,300 |                                | 10.9       | %                                                                       | $          | 20,786,800 |   | 8.0 | % | $ | 25,983,500 |   | 10.0 | % |
| Tier 1 capital (to risk-weighted assets) |   | $          | 25,452,500 |                                | 9.7        | %                                                                       | $          | 10,393,400 |   | 4.0 | % | $ | 15,590,100 |   | 6.0 | % |
| Tier 1 capital (to average assets)       |   | $          | 25,452,500 |                                | 7.9        | %                                                                       | $          | 12,808,500 |   | 4.0 | % | $ | 16,010,700 |   | 5.0 | % |
|                                     |   |       | ** ** |                                | ** ** |                                                                    | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **December 31,  2001**                   |   |       | ** ** |                                | ** ** |                                                                    | ** ** |   | ** ** |   | ** ** |   | ** ** |
|                                     |   |       | ** ** |                                | ** ** |                                                                    | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Bank:                                    |   |       |       |                                |       |                                                                    |       |   |   |   |   |   |   |
| Total capital (to risk-weighted assets)  |   | $          | 23,220,100 |                                | 11.6       | %                                                                       | $          | 16,066,000 |   | 8.0 | % | $ | 20,082,600 |   | 10.0 | % |
| Tier 1 capital (to risk-weighted assets) |   | $          | 20,820,200 |                                | 10.4       | %                                                                       | $          | 8,033,000 |   | 4.0 | % | $ | 12,049,500 |   | 6.0 | % |
| Tier 1 capital (to average assets)       |   | $          | 20,820,200 |                                | 7.7        | %                                                                       | $          | 10,812,500 |   | 4.0 | % | $ | 13,575,700 |   | 5.0 | % |

 

79

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

 

Other non-interest incomeconsisted of the following:

 
|                                                                                          |   | **Year Ended  December 31,** |      |
|-----------------------------------------------------------------------------------------------|--------|------------------------------|-----------|
|                                                                                          |   | **2002**                     |      | **2001** |   | **2000** |   |
|                                                                                          |   |                         |      |   |   |   |   |
| Earnings and  death benefit from cash surrender value life insurance policies, net (Note  15) |   | $                            | 1,406,400 |   | $ | 243,700 |   | $ | 203,500 |   |
| Merchant card  processing fees                                                                |   | 353,700                      |      | 259,700 |   | 210,100 |   |
| Other                                                                                         |   | 913,200                      |      | 645,400 |   | 722,900 |   |
|                                                                                          |   |                         |      |   |   |   |   |
|                                                                                          |   | $                            | 2,673,300 |   | $ | 1,148,800 |   | $ | 1,136,500 |   |

 

Other expense consistedof the following:

 
|                                                                  |   | **Year Ended December 31,** |      |
|-----------------------------------------------------------------------|--------|-----------------------------|-----------|
|                                                                  |   | **2002**                    |      | **2001** |   | **2000** |   |
|                                                                  |   |                        |      |   |   |   |   |
| Professional  fees                                                    |   | $                           | 622,300   |   | $ | 550,900 |   | $ | 446,000 |   |
| Telephone and  postage                                                |   | 436,200                     |      | 397,000 |   | 408,200 |   |
| Stationery and  supplies                                              |   | 457,800                     |      | 323,400 |   | 311,800 |   |
| Director fees  and retirement accrual                                 |   | 298,000                     |      | 207,000 |   | 194,900 |   |
| Advertising and  promotion                                            |   | 190,300                     |      | 131,100 |   | 112,000 |   |
| Beneficiary  benefit accrual under salary continuation plan (Note 15) |   | 1,136,400                   |      |   |   |   |   |
| Other                                                                 |   | 1,274,100                   |      | 1,091,900 |   | 991,300 |   |
|                                                                  |   |                        |      |   |   |   |   |
|                                                                  |   | $                           | 4,415,100 |   | $ | 2,701,300 |   | $ | 2,464,200 |   |

 

Professional fees includeamounts paid to outside vendors to perform accounting services for companiesthat maintain large non-interest bearing deposits with the Bank.  Total costs incurred were dependent upon thevolume of deposits and totaled $126,000, $231,900 and $221,200 for the yearsended December 31, 2002, 2001 and 2000, respectively.  During these same periods, the companies maintained averageavailable balances of approximately $16.1 million, $12.8 million and $8.4million, respectively.

 

80

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**13.****            INCOMETAXES**

 

The provision for incometaxes for the years ended December 31, 2002, 2001 and 2000 consisted of thefollowing:

 
|                |   | **Federal** |      | **State** |   | **Total** |   |
|---------------------|--------|-------------|-----------|-----------|--------|-----------|--------|
| 2002                |   |        |      |      |   |      |   |
|                |   |        |      |      |   |      |   |
| Current             |   | $           | 2,240,000 |      | $      | 769,000   |   | $ | 3,009,000 |   |
| Deferred            |   | (497,000    | )         | (137,000  | )      | (634,000  | )      |
|                |   |        |      |      |   |      |   |
| Income tax  expense |   | $           | 1,743,000 |      | $      | 632,000   |   | $ | 2,375,000 |   |
|                |   |        |      |      |   |      |   |
| 2001                |   |        |      |      |   |      |   |
|                |   |        |      |      |   |      |   |
| Current             |   | $           | 2,020,000 |      | $      | 690,000   |   | $ | 2,710,000 |   |
| Deferred            |   | (216,000    | )         | (70,000   | )      | (286,000  | )      |
|                |   |        |      |      |   |      |   |
| Income tax  expense |   | $           | 1,804,000 |      | $      | 620,000   |   | $ | 2,424,000 |   |
|                |   |        |      |      |   |      |   |
| 2000                |   |        |      |      |   |      |   |
|                |   |        |      |      |   |      |   |
| Current             |   | $           | 1,752,000 |      | $      | 646,000   |   | $ | 2,398,000 |   |
| Deferred            |   | (363,000    | )         | (103,000  | )      | (466,000  | )      |
|                |   |        |      |      |   |      |   |
| Income tax  expense |   | $           | 1,389,000 |      | $      | 543,000   |   | $ | 1,932,000 |   |

 

Deferred tax assets(liabilities) are comprised of the following at December 31, 2002 and 2001:

 
|                                           |   | **2002**  |      | **2001**  |   |
|------------------------------------------------|--------|-----------|-----------|-----------|--------|
| Deferred tax assets:                           |   |      |      |      |   |
| Allowance for  loan losses                     |   | $         | 1,171,000 |      | $      | 949,000 |   |
| Deferred  compensation                         |   | 1,056,000 |      | 438,000   |   |
| Future benefit  of state tax deduction         |   | 254,000   |      | 194,000   |   |
| Bank premises  and equipment                   |   |      |      | 49,000    |   |
|                                           |   |      |      |      |   |
| Total deferred  tax assets                     |   | 2,481,000 |      | 1,630,000 |   |
|                                           |   |      |      |      |   |
| Deferred tax liabilities:                      |   |      |      |      |   |
| Future liability  of state deferred tax assets |   | (163,000  | )         | (116,000  | )      |
| Bank premises  and equipment                   |   | (170,000  | )         |      |   |
|                                           |   |      |      |      |   |
| Total deferred  tax liabilities                |   | (333,000  | )         | (116,000  | )      |
|                                           |   |      |      |      |   |
| Net deferred tax  assets                       |   | $         | 2,148,000 |      | $      | 1,514,000 |   |

 

81

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The provision for incometaxes differs from amounts computed by applying the statutory Federal incometax rate to operating income before income taxes.  The items comprising these differences are as follows:

 
|                                            |   | **Year Ended  December 31,** |      |
|-------------------------------------------------|--------|------------------------------|-----------|
|                                            |   | **2002**                     |      | **2001** |   | **2000** |   |
|                                            |   | **Amount**                   |      | **Rate %** |   | **Amount** |   | **Rate %** |   | **Amount** |   | **Rate %** |   |
|                                            |   |                         |      |   |   |   |   |   |   |   |   |   |   |
| Federal income  tax expense, at statutory rate  |   | $                            | 2,456,000 |   | 34.0 |   | $ | 2,120,000 |   | 34.0 |   | $ | 1,692,700 |   | 34.0 |   |
| State franchise  tax, net of Federal tax effect |   | 422,000                      |      | 5.9 |   | 410,000 |   | 6.6 |   | 296,300 |   | 6.0 |   |
| Tax-exempt  income from life insurance policies |   | (478,000                     | )         | (6.6 | ) | (83,000 | ) | (1.3 | ) | (69,200 | ) | (1.4 | ) |
| Other                                           |   | (25,000                      | )         | (.4 | ) | (23,000 | ) | (.4 | ) | 12,200 |   | .2 |   |
|                                            |   |                         |      |   |   |   |   |   |   |   |   |   |   |
|                                            |   | $                            | 2,375,000 |   | 32.9 |   | $ | 2,424,000 |   | 38.9 |   | $ | 1,932,000 |   | 38.8 |   |

 

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

 

During the normal courseof business, the Company enters into transactions with related parties,including Directors and executive officers. These transactions include borrowings with substantially the same terms,including rates and collateral, as loans to unrelated parties.  The following is a summary of the aggregateactivity involving related party borrowers during 2002:

 
| Balance, January 1, 2002                                       |   | $          | 5,207,000 |   |
|----------------------------------------------------------------|--------|------------|-----------|--------|
|                                                           |   |       |      |
| Disbursements                                                  |   | 4,414,600  |      |
| Amounts repaid                                                 |   | (5,134,600 | )         |
|                                                           |   |       |      |
| Balance,  December 31, 2002                                    |   | $          | 4,487,000 |   |
|                                                           |   |       |      |
| Undisbursed  commitments to related parties, December 31, 2002 |   | $          | 3,064,400 |   |

 

82

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

 

Salary Continuation andRetirement Plans

 

Salary continuation plansare in place for seven key executives. In addition, a retirement plan is in place for members of the Board ofDirectors.  Under these plans, the directorsand executives, or designated beneficiaries, will receive monthly payments forfive to fifteen years after retirement or death.  These benefits are substantially equivalent to those availableunder insurance policies purchased by the Company on the lives of the directorsand executives.  In addition, theestimated present value of these future benefits is accrued over the periodfrom the effective dates of the plans until their expected retirementdates.  The expense recognized underthese plans for the years ended December 31, 2002, 2001 and 2000 totaled$225,300, $224,500 and $217,700, respectively.

 

In connection with theseplans, the Company purchased single premium life insurance policies with cashsurrender values totaling $4,290,900 and $4,295,400 at December 31, 2002 and2001, respectively.  On the consolidatedbalance sheet, the cash surrender values are included in accrued interestreceivable and other assets.  Incomeearned on these policies, net of expenses, totaled $233,800, $243,700 and$203,500 for the years ended December 31, 2002, 2001 and 2000, respectively.

 

In addition, upon thedeath of one of the executives during 2002, salary continuation plan benefitexpense totaling $1,081,600 was accelerated to accrue for benefits to be paidto the beneficiary under the plan.  Thisexpense was offset by tax-free death benefits totaling $1,172,600 frominsurance policies on the life of the executive.

 

###### **Savings Plan**

 

The Butte Community Bank401(k) Savings Plan commenced January 1, 1993 and is available to employeesmeeting certain service requirements. Under the plan, employees may defer a selected percentage of theirannual compensation.  The Bank may makea discretionary contribution to the plan which would be allocated as follows:

 

•     A matchingcontribution to be determined by the Board of Directors each plan year under whichthe Bank will match a percentage of each participant’s contribution.

 

•     A basiccontribution that would be allocated in the same ratio as each participant’scontribution bears to total compensation.

 

There were no employercontributions for the years ended December 31, 2002, 2001 or 2000.

 

83

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Employee Stock OwnershipPlan

 

Under the Butte CommunityBank Employee Stock Ownership Plan (“ESOP”), employees who have been creditedwith at least 1,000 hours of service during a twelve month period and who haveattained age eighteen are eligible to participate.  The ESOP has funded purchases of the Bank’s common stock througha loan from another financial institution (see Note 9).  The loan is repaid from discretionarycontributions to the ESOP determined by the Bank’s Board of Directors.  Annual contributions are limited on aparticipant-by-participant basis to the lesser of $30,000 or twenty-fivepercent of the participant’s compensation for the year.  Employee contributions are not permitted.

 

As a leveraged ESOP,interest expense is recognized on the loan in the Company’s consolidatedfinancial statements.  Shares areallocated on the basis of eligible compensation, as defined in the ESOP plandocument, in the year of allocation. Benefits generally become 100% vested after seven years of creditedservice.  Employees with at least three,but fewer than seven, years of credited service receive a partial vestingaccording to a sliding schedule. However, in the event of normal retirement, disability, or death, anyunvested portion of benefits vest immediately.

 

As shares are purchasedby the ESOP with proceeds from the loan, the Company records the cost of theseunearned ESOP shares as a contra-equity account.  These amounts are shown as a reduction of shareholders’ equity inthe Company’s consolidated balance sheet. As the debt is repaid, the shares are released from unearned ESOP sharesin proportion to the debt service paid during the year and allocated to eligibleemployees.  As shares are released fromunearned ESOP shares, the Company reports compensation expense equal to thecurrent market price of the shares, and the shares are recognized asoutstanding for earnings per share computations.  Benefits are distributed in the form of qualifying Companysecurities.  However, the Company willissue a put option to each participant upon distribution of the securitieswhich, if exercised, requires the Company to purchase the qualifying securitiesat fair market value.

 

No stock was purchasedwith proceeds from the line of credit during the year ended December 31,2002.  During 2001 and 2000, the ESOPpurchased 21,839 and 36,751 shares of the Company’s common stock at costs of$291,900 and $519,700, respectively, that were funded by the proceeds fromthe  line of credit to the ESOP.  Interest expense of $39,500, $55,000 and$52,600 was recognized in connection with the line of credit during the yearsended December 31, 2002, 2001 and 2000, respectively.

 

Compensation expense of$158,100 and  $138,900 was recognizedfor the years ended December 31, 2002 and 2001.  Compensation expense of $203,800, of which $26,100 representedthe cost to purchase distributed shares from participants, was recognized forthe year ended December 31, 2000.

 

84

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Allocated and unearnedESOP shares at December 31, 2002, 2001 and 2000, adjusted for the 2002 stocksplit, were as follows:

 
|                           |   | **2002** |      | **2001** |   | **2000**  |   |
|--------------------------------|--------|----------|-----------|----------|--------|-----------|--------|
|                           |   |     |      |     |   |      |   |
| Allocated shares               |   | 73,175   |      | 64,943   |   | 54,917    |   |
| Unearned shares                |   | 65,437   |      | 73,669   |   | 61,856    |   |
|                           |   |     |      |     |   |      |   |
| Total ESOP  shares             |   | 138,612  |      | 138,612  |   | 116,773   |   |
|                           |   |     |      |     |   |      |   |
| Fair value of  unearned shares |   | $        | 1,328,371 |     | $      | 1,337,100 |   | $ | 740,900 |   |
|                                |        |          |           |          |        |           |        |  |  |  |

 

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

 

Estimated fair values aredisclosed for financial instruments for which it is practicable to estimatefair value.  These estimates are made ata specific point in time based on relevant market data and information aboutthe 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 ramifications related to the realization ofunrealized gains and losses can have a significant effect on fair valueestimates and have not been considered in any of these estimates.

 

Because no market existsfor a significant portion of the Company’s financial instruments, fair valueestimates are based on judgments regarding current economic conditions, riskcharacteristics of various financial instruments and other factors.  These estimates are subjective in nature andinvolve uncertainties and matters of significant judgment and therefore cannotbe determined with precision.  Changesin assumptions could significantly affect the fair values presented.

 

The following methods andassumptions were used by the Company to estimate the fair value of itsfinancial instruments at December 31, 2002 and 2001:

 

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

 

Interest-bearing depositsin banks:  The fairvalues of interest-bearing deposits in banks are estimated by discounting theirfuture cash flows using rates at each reporting date for instruments withsimilar remaining maturities offered by comparable financial institutions.

 

Investment securities:  For investment securities, fair values arebased on quoted market prices, where available.  If quoted market prices are not available, fair values areestimated using quoted market prices for similar securities and indications ofvalue provided by brokers.

 

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Loans:  For variable-rate loans that repricefrequently with no significant change in credit risk, fair values are based oncarrying values.  Fair values of loansheld for sale are estimated using quoted market prices for similar loans or theamount that purchasers have committed to purchase the loans.  The fair values for other loans areestimated using discounted cash flow analyses, using interest rates offered ateach reporting date for loans with similar terms to borrowers of comparablecreditworthiness.  The carrying amountof accrued interest receivable approximates its fair value.

 

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

 

Life insurance policies:  The fair values of life insurance policiesare based on cash surrender values at each reporting date provided by theinsurers.

 

Deposits:  The fair values for demand deposits are, bydefinition, equal to the amount payable on demand at each reporting daterepresented 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.  The carrying amount of accrued interestpayable approximates its fair value.

 

Note payable:The note payable reprices based upon an independent index.  The carrying amount of the note payableapproximates its fair value.

 

Mandatorily redeemablecumulative trust preferred securities of subsidiary grantor trusts:  The fair value of mandatorily redeemablecumulative trust preferred securities of subsidiary grantor trusts wasdetermined based on the current market value for like kind instruments of asimilar maturity and structure.

 

Commitments to extendcredit:  Commitmentsto extend credit are primarily for variable rate loans and letters ofcredit.  For these commitments, there isno difference between the committed amounts and their fair values.  Commitments to fund fixed rate loans are atrates which approximate fair value at each reporting date.

 

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The estimated fair valuesof the Bank’s financial instruments are as follows:

 
|                                                          |   | **December  31, 2002** |        | **December  31, 2001** |   |
|---------------------------------------------------------------|--------|------------------------|-------------|------------------------|--------|
|                                                          |   | **Carrying  Amount**   |        | **Fair  Value**        |   | **Carrying  Amount** |   | **Fair  Value** |   |
|                                                          |   |                   |        |                   |   |   |   |   |   |
| Financial  assets:                                            |   |                   |        |                   |   |   |   |   |   |
| Cash and due  from banks                                      |   | $                      | 15,621,400  |                   | $      | 15,621,400 |   | $ | 12,401,600 |   | $ | 12,401,600 |   |
| Federal funds  sold                                           |   | 57,410,000             |        | 57,410,000             |   | 37,270,000 |   | 37,270,000 |   |
| Interest-bearing  deposits in banks                           |   | 4,061,000              |        | 4,125,300              |   | 694,000 |   | 709,000 |   |
| Loans held for  sale                                          |   | 7,911,700              |        | 8,000,260              |   | 5,978,500 |   | 5,978,500 |   |
| Investment  securities                                        |   | 3,386,900              |        | 3,438,000              |   | 3,006,800 |   | 3,037,100 |   |
| Loans                                                         |   | 229,699,200            |        | 232,882,317            |   | 197,875,100 |   | 195,375,600 |   |
| Other  investments                                            |   | 263,200                |        | 263,200                |   | 263,200 |   | 263,200 |   |
| Accrued interest  receivable                                  |   | 2,330,300              |        | 2,330,300              |   | 2,052,400 |   | 2,052,400 |   |
| Cash surrender  value of life insurance policies              |   | 4,290,900              |        | 4,290,900              |   | 4,295,400 |   | 4,295,400 |   |
|                                                          |   |                   |        |                   |   |   |   |   |   |
| Financial  liabilities:                                       |   |                   |        |                   |   |   |   |   |   |
| Deposits                                                      |   | $                      | 297,980,800 |                   | $      | 299,513,600 |   | $ | 246,419,900 |   | $ | 247,892,100 |   |
| Note payable                                                  |   | 732,100                |        | 732,100                |   | 851,500 |   | 851,500 |   |
| Mandatorily  redeemable cumulative trust preferred securities |   | 8,000,000              |        | 8,000,000              |   |   |   |   |   |
| Accrued interest  payable                                     |   | 450,900                |        | 450,900                |   | 1,200,100 |   | 1,200,100 |   |
|                                                          |   |                   |        |                   |   |   |   |   |   |
| Off-balance-sheet  financial instruments:                     |   |                   |        |                   |   |   |   |   |   |
| Commitments to  extend credit                                 |   | $                      | 103,605,300 |                   | $      | 103,605,300 |   | $ | 82,621,000 |   | $ | 82,621,000 |   |
| Standby letters  of credit                                    |   | 2,229,500              |        | 2,229,500              |   | 2,048,900 |   | 2,048,900 |   |

 

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**17.****           ****PARENT********ONLY****CONDENSED FINANCIALSTATEMENTS**

 

Community Valley Bancorpcommenced operations in June 2002.  As aresult, comparative financial information is not available.  The information below is presented as ofDecember 31, 2002 and for the year then ended as if the reorganization hadtaken place on January 1, 2002.

 

**BALANCE SHEET**

 

**December 31, 2002**

 
| *ASSETS*                                                |   |       |       |
|---------------------------------------------------------|--------|------------|------------|
|                                                    |   |       |       |
| Cash and due from banks                                 |   | $          | 7,758,600  |   |
| Investment in bank subsidiary                           |   | 25,542,900 |       |
| Investment in trust subsidiary                          |   | 248,000    |       |
| Other assets                                            |   | 301,700    |       |
|                                                    |   |       |       |
| Total assets                                            |   | $          | 33,851,200 |   |
|                                                    |   |       |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**          |   |       |       |
|                                                    |   |       |       |
| Liabilities:                                            |   |       |       |
| Subordinated debentures due to subsidiary grantor trust |   | $          | 8,248,000  |   |
| Other liabilities                                       |   | 222,600    |       |
|                                                    |   |       |       |
| Total liabilities                                       |   | 8,470,600  |       |
|                                                    |   |       |       |
| Shareholders’ equity:                              |   |       |       |
| Common stock                                            |   | 6,660,000  |       |
| Unearned ESOP shares                                    |   | (851,900   | )          |
| Retained earnings                                       |   | 19,558,400 |       |
| Accumulated other comprehensive income                  |   | 14,100     |       |
|                                                    |   |       |       |
| Total shareholders’ equity                         |   | 25,380,600 |       |
|                                                    |   |       |       |
| Total liabilities and shareholders’ equity         |   | $          | 33,851,200 |   |

 

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**STATEMENT OF INCOME**

 

**For the Year Ended December 31, 2002**

 
| Income:                                                    |   |      |      |
|------------------------------------------------------------|--------|-----------|-----------|
| Dividends declared by bank subsidiary                      |   | $         | 794,700   |   |
|                                                       |   |      |      |
| Expenses:                                                  |   |      |      |
| Professional fees                                          |   | 97,200    |      |
| Other expenses                                             |   | 23,300    |      |
|                                                       |   |      |      |
| Total expenses                                             |   | 120,500   |      |
|                                                       |   |      |      |
| Income before equity in undistributed income of subsidiary |   | 674,200   |      |
|                                                       |   |      |      |
| Equity in undistributed income of subsidiary               |   | 4,127,400 |      |
|                                                       |   |      |      |
| Income before income tax benefit                           |   | 4,801,600 |      |
|                                                       |   |      |      |
| Income tax benefit                                         |   | 48,000    |      |
|                                                       |   |      |      |
| Net income                                                 |   | $         | 4,849,600 |   |

 

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**STATEMENT OF CASH FLOWS**

 

**For the Year Ended December 31, 2002**

 
| Cash flows from operating activities:                                                         |   |       |      |
|-----------------------------------------------------------------------------------------------|--------|------------|-----------|
| Net income                                                                                    |   | $          | 4,849,600 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities:            |   |       |      |
| Undistributed net income of subsidiary                                                        |   | (4,127,400 | )         |
| Increase in other assets                                                                      |   | (301,700   | )         |
| Decrease in other liabilities                                                                 |   | (45,900    | )         |
|                                                                                          |   |       |      |
| Net cash provided by operating activities                                                     |   | 374,600    |      |
|                                                                                          |   |       |      |
| Cash flows from investing activities:                                                         |   |       |      |
| Investment in Butte Community Bank                                                            |   | (85,700    | )         |
| Investment in Community Valley Bancorp Trust I                                                |   | (248,000   | )         |
|                                                                                          |   |       |      |
| Net cash used in investing activities                                                         |   | (333,700   | )         |
|                                                                                          |   |       |      |
| Cash flows from financing activities:                                                         |   |       |      |
| Proceeds from the issuance of junior subordinated debentures due to  subsidiary grantor trust |   | 8,248,000  |      |
| Dividends paid                                                                                |   | (812,200   | )         |
| Proceeds from exercise of stock options                                                       |   | 287,200    |      |
| Cash paid for fractional shares                                                               |   | (5,300     | )         |
|                                                                                          |   |       |      |
| Net cash provided by financing activities                                                     |   | 7,717,700  |      |
|                                                                                          |   |       |      |
| Cash and cash equivalents at end of year                                                      |   | $          | 7,758,600 |   |
|                                                                                          |   |       |      |
| Non-cash investing activities:                                                                |   |       |      |
|                                                                                          |   |       |      |
| Net change in unrealized gain on investment securities  available-for-sale                    |   | $          | 14,100    |   |
|                                                                                          |   |       |      |
| Accrual of cash  dividend declared                                                            |   | $          | 268,500   |   |
|                                                                                          |   |       |      |
| Release of  unearned ESOP shares                                                              |   | $          | 158,000   |   |

 

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